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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K/A No. 2
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(Mark one)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2008
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____________ to ____________
Commission File Number: 1-9293
PRE-PAID LEGAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1016728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Pre-Paid Way
Ada, Oklahoma 74820
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (580) 436-1234
Securities registered pursuant to Section 12(b) of the Exchange Act:
Name of each exchange on
Title of each class which registered
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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 if registrant is a well-known seasoned issuer, as defined
in Rule 405 of the Securities Act. Yes | | No |X|
Indicate by check mark if registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes | | No |X|
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No | |
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K |X|.
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Check one:
Large accelerated filer | | Accelerated filer |X| Non-accelerated file | |
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act) Yes | | No |X|
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was last sold, or the average bid and asked prices of such common equity, as of
the last business day of the registrant's most recently completed second fiscal
quarter. As of June 30, 2008: $576,352,000
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date: As of February 19, 2009 there
were 11,194,317 shares of Common Stock, par value $.01 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE.
None.
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EXPLANATORY NOTE
We are filing this Amendment No. 2 to Form 10-K in response to comments received
from the Securities and Exchange Commission (the "Commission") regarding the
Form 10-K filed with the Commission on February 27, 2009 and 10-K/A filed on
June 29, 2009.
While we are filing the entire Form 10-K to ensure proper page numbering, we are
making revisions only to the following sections:
o "Front Cover Page" and "Table of Contents" to reflect changes to the
items contained in the amended filing and to reflect revised page
numbering;
o "BUSINESS - Industry Overview," "BUSINESS - Description of
Memberships," "BUSINESS - Provider Law Firms" and "BUSINESS -
Marketing" to add new descriptions or information or to clarify
previous information;
o "Risk Factors" to add a new risk factor regarding our share
repurchases and to add underlining to existing risk factor headings;
o "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION - Overview of Our Financial Model," "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION - Measures of Member Retention" and "MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION -
Liquidity and Capital Resources" to add new descriptions or
information or to clarify previous information;
o We have included all Part III information previously contained in our
proxy statement in the amended Form 10-K;
o "Index to Exhibits," "Exhibit 10.23," "Exhibit 10.24," "Exhibit 23.1,"
"Exhibit 31.1," "Exhibit 31.2," "Exhibit 32.1" and "Exhibit 32.2" to
include new exhibits 10.23 and 10.24 which are letter agreements
regarding share repurchase transactions and to update exhibits 23.1,
31.1, 31.2, 32.1 and 32.2 to reflect updated signatures.
This Form 10-K/A continues to speak as of the date of the Form 10-K and no
attempt has been made to modify or update disclosures in the original Form 10-K
except as noted above. This Form 10-K/A does not reflect events occurring after
the filing of the Form 10-K or modify or update any related disclosures, and
information not affected by this amendment is unchanged and reflects the
disclosure made at the time of the filing of the Form 10-K with the Commission.
In particular, any forward-looking statements included in this form 10-K/A
represent management's view as of the filing date of the Form 10-K.
Accordingly, this amendment should be read in conjunction with the Company's
other filings made with the Commission subsequent to the filing date of the
original Form 10-K.
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
For the Year Ended December 31, 2008
TABLE OF CONTENTS
PART I Page
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ITEM 1. BUSINESS
General....................................................................................... 1
Industry Overview............................................................................. 1
Description of Memberships.................................................................... 2
Specialty Legal Service Plans................................................................. 5
Provider Law Firms............................................................................ 7
Identity Theft Shield Provider................................................................ 10
Marketing..................................................................................... 11
Operations.................................................................................... 14
Quality Control............................................................................... 15
Competition................................................................................... 15
Regulation.................................................................................... 15
Employees..................................................................................... 17
Foreign Operations............................................................................ 17
Availability of Information................................................................... 17
ITEM 1A. RISK FACTORS...................................................................................... 18
ITEM 1B. UNRESOLVED STAFF COMMENTS......................................................................... 20
ITEM 2. PROPERTIES........................................................................................ 20
ITEM 3. LEGAL PROCEEDINGS................................................................................. 21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................... 21
PART II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Market Price of and Dividends on the Common Stock............................................. 22
Recent Sales of Unregistered Securities....................................................... 22
Issuer Purchases of Equity Securities......................................................... 23
Shareholder Return Performance Graph.......................................................... 24
ITEM 6. SELECTED FINANCIAL DATA........................................................................... 25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Overview of our Financial Model............................................................... 26
Critical Accounting Policies.................................................................. 27
Other General Matters......................................................................... 32
Measures of Member Retention.................................................................. 33
Results of Operations
Comparison of 2008 to 2007................................................................ 36
Comparison of 2007 to 2006................................................................ 37
Liquidity and Capital Resources............................................................... 39
Forward Looking Statements.................................................................... 42
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........................................ 42
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................................................... 44
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.............. 71
ITEM 9A. CONTROLS AND PROCEDURES........................................................................... 71
ITEM 9B. OTHER INFORMATION................................................................................. 71
PART III
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ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE............................................ 72
ITEM 11 EXECUTIVE COMPENSATION............................................................................ 74
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.... 84
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTORR INDEPENDENCE........................ 86
ITEM 14 PRINCIPAL ACCOUNTING FEES AND SERVICES............................................................ 88
PART IV
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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES........................................................... 88
SIGNATURES...................................................................................................... 89
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2008
PART I
ITEM 1. BUSINESS.
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General
We were one of the first companies in the United States organized solely to
design, underwrite and market legal expense plans. Our predecessor commenced
business in 1972 and began offering legal expense reimbursement services as a
"motor service club" under Oklahoma law. In 1976, we were formed and acquired
our predecessor in a stock exchange. We began offering Memberships independent
of the motor service club product by adding a legal consultation and advice
service, and in 1979 we implemented a legal expense benefit that provided for
partial payment of legal fees in connection with the defense of certain civil
and criminal actions. Our life events legal plans (referred to as "Memberships")
currently provide for a variety of legal services. 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 44
states, the Legal Shield rider can be added to the standard plan for only $1 per
month and provides members with 24-hour access to a toll-free number for
attorney assistance if the member is arrested or detained. We also offer our
Identity Theft Shield ("IDT") to new and existing members at $9.95 per month if
added to a legal service Membership ("add-on IDT") or IDT may be purchased
separately for $12.95 per month ("stand-alone IDT"). The identity theft related
benefits include a credit report and related instructional guide, a credit score
and related instructional guide, credit report monitoring with daily online and
monthly offline notification of any changes in credit information and
comprehensive identity theft restoration services.
Life events legal plan benefits are generally provided through a network of
independent provider law firms, typically one firm per state or province and IDT
plan benefits are provided by Kroll Background America, Inc., a subsidiary of
Kroll Inc. ("Kroll"). Members have direct, toll-free access to Kroll or their
provider law firm rather than having to call for a referral. At December 31,
2008, we had 1,559,154 Memberships in force with members in all 50 states, the
District of Columbia and the Canadian provinces of Ontario, British Columbia,
Alberta and Manitoba. Approximately 90% of such Memberships were in 29 states
and provinces.
Industry Overview
Legal service plans, while used in Europe for more than one hundred years
and representing more than a $4 billion European industry, were first developed
in the United States in the late 1960s. Since that time, there has been
substantial growth in the number of Americans entitled to receive various forms
of legal services through legal service plans. The National Resource Center for
Consumers of Legal Services ("NRC") previously provided market information for
different types of legal service plans and estimates of number of users.
However, the NRC is no longer in existence and we are unaware of any current
comparable information sources. In the last NRC report in 2002, the NRC
estimated there were 164 million Americans without any type of legal service
plan. We believe the legal service plan industry continues to evolve and market
acceptance of legal service plans, as indicated by the continuing growth in the
number of individuals covered by plans, is increasing.
"Public Perceptions of Lawyers: Consumer Research Findings, April 2002"
prepared on behalf of the American Bar Association concluded that nearly seven
in ten households had some occasion during the past year that might have led
them to hire a lawyer. This report further suggested that "for the consumer,
legal services are among the most difficult services to buy. The prospect of
doing so is rife with uncertainty and potential risk." And further concluded
that "the challenge (and opportunity) for the legal profession is to make
lawyers more accessible and less threatening to consumers who might need them."
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The American Bar Association's web site also reflects the legal
profession's support of the legal service plan concept by saying "The ABA has
long supported prepaid legal services plans as a way to increase access to the
justice system for low- and middle-income Americans. These plans allow
individuals and families to address legal issues before they become significant
problems, reducing demands on already overburdened court systems and instilling
confidence in our justice system. The ABA web site points out that:
o Group legal plans are important to maintaining confidence in our
justice system and the rule of law.
o Group legal plans efficiently and inexpensively provide preventative
legal services to low and middle income Americans.
o Group legal services help ease the burden on overtaxed government
programs.
o Group legal plans enhance productivity by allowing employees to focus
on their jobs, not their legal troubles.
Legal service plans are offered through various organizations and marketing
methods and contain a wide variety of benefits. Free plans include those
sponsored by labor unions, elder hotlines, the American Association of Retired
Persons and the National Education Association and employee assistance plans
that are also automatic enrollment plans without direct cost to participants
designed to provide limited telephonic access to attorneys for members of
employee groups. There are also employer paid plans pursuant to which more
comprehensive benefits are offered by the employer as a fringe benefit. Finally,
there are individual enrollment plans, other employment based plans, including
voluntary payroll deduction plans, and miscellaneous plans. These plans
typically have more comprehensive benefits, higher utilization, involve higher
costs to participants, and are offered on an individual enrollment or voluntary
basis. This is the market segment in which we compete.
According to the latest estimates of the census bureaus of the United
States and Canada, the two geographic areas in which we operate, the number of
households in the combined area exceeds 138 million. Since we have always
disclosed our members in terms of Memberships and individuals covered by the
Membership include the individual who purchases the Membership together with his
or her spouse and never married children living at home up to age 21 or up to
age 23 if the children are full time college students, we believe that our
market share should be viewed as a percentage of households. Historically, we
have described and suggested to our independent sales associates that their
primary market focus should be the "middle" eighty percent of such households
rather than the upper and lower ten percent segments based on our belief that
the upper ten percent may already have access to legal services 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 110 million
households, we currently have an approximate 1.5% share of the estimated market
based on our existing 1.6 million active Memberships and, over the last 30
years, an additional 6% of households have previously purchased, but no longer
own, Memberships. We routinely remarket to previous members and reinstated
approximately 82,000, 83,000 and 76,000 Memberships during 2008, 2007 and 2006,
respectively.
Description of Memberships
The Memberships we sell generally allow members to access legal services
through a network of independent law firms ("provider law firms") under contract
with us. Provider law firms are paid a monthly fixed fee on a capitated basis to
render services to plan members residing within the state or province in which
the provider law firm attorneys are licensed to practice. Because the fixed fee
payments by us to benefit providers do not vary based on the type and amount of
benefits utilized by the member, this capitated arrangement provides significant
advantages to us in managing claims risk since we know the percentage of
Membership fees that will be paid to the benefit providers to deliver the
Membership benefits and the timing of such payments. At December 31, 2008,
Memberships subject to the capitated provider law firm arrangement comprised
more than 99% of our active Memberships. The remaining Memberships, less than
1%, were primarily sold prior to 1987 and allow members to locate their own
lawyer ("open panel") to provide legal services available under the Membership
with the member's lawyer being reimbursed for services rendered based on usual,
reasonable and customary fees, or are in states where there is no provider law
firm in place and our referral attorney network described below is utilized.
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Membership benefits utilization
During 2008, our provider law firms processed more than 2.3 million
intakes, an average of 1.6 per Member. An intake represents a member's request
for assistance on a specific legal matter. These intakes usually include
multiple telephone consultation(s) and often include document review(s),
letter(s) written or telephone call(s) made to third parties on the members'
behalf, preparation of last will(s) and testament(s) and other legal assistance
as described below. Although not all of our provider law firms maintain specific
records of how often the legal engagement leads to additional fees being paid by
members, provider law firms representing approximately 40% of our Membership
base reported that on average, less than 1% of these intakes resulted in
additional fees being paid by the member.
Family Legal Plan
The Family Legal Plan we currently market in most jurisdictions consists of
five basic benefit groups that provide coverage for a broad range of preventive
and litigation-related legal expenses. The Family Legal Plan accounted for
approximately 91% of our Membership fees (including the add-on identity theft
shield benefit, 75% and 76%, respectively, excluding such add-ons) in 2008 and
2007. In addition to the Family Legal Plan, we market other specialized legal
services products specifically related to employment in certain professions
described below.
In 12 states, certain of our plans are available in the Spanish language.
For the Spanish language plans, the provider law firms have both bilingual staff
and lawyers and we have bilingual staff for customer service, attorney resources
and marketing service functions. We will continue to evaluate making our plans
available in additional languages in markets where there is both sufficient
demand and qualified staff and attorneys available.
In exchange for a fixed monthly, semi-annual or annual payment, members are
entitled to specified legal services. Those individuals covered by the
Membership include the individual who purchases the Membership along with his or
her spouse and never married children living at home up to age 21 or up to age
23 if the children are full time college students. Also included are children up
to age 18 for whom the member is legal guardian and any dependent child,
regardless of age, who is mentally or physically disabled. Each Membership,
other than the Business Owners' Legal Solutions Plan, is guaranteed renewable,
except in the case of fraud or nonpayment of Membership fees. Historically, we
have not raised rates to existing members. If new benefits become available,
existing members may choose the newer, more comprehensive plan at a higher rate
or keep their existing Memberships. Memberships are automatically renewed at the
end of each Membership period unless the member cancels prior to the renewal
date or fails to make payment on a timely basis.
The basic legal service plan Membership is sold as a package consisting of
five separate benefit groups. Memberships range in cost from $14.95 to $25.00
per month depending in part on the schedule of benefits, which may vary from
state or province in compliance with regulatory requirements. Benefits for
domestic matters, bankruptcy and drug and alcohol related matters are limited in
most Memberships.
Preventive Legal Services. These benefits generally offer unlimited
toll-free access to a member's provider law firm for advice and consultation on
any legal matter. These benefits also include letters and phone calls on the
member's behalf, review of personal contracts and documents, each up to 10 pages
in length, last will and testament preparation for the member and annual will
reviews at no additional cost. Additional wills for spouse and other covered
members may be prepared at a cost of $20.
Motor Vehicle Legal Protection. These benefits offer legal assistance for
matters resulting from the operation of a licensed motor vehicle. Members have
assistance available to them at no additional cost for: (a) defense in the court
of original jurisdiction of moving traffic violations deemed meritorious, (b)
defense in the court of original jurisdiction of any charge of manslaughter,
involuntary manslaughter, vehicular homicide or negligent homicide as the result
of a licensed motor vehicle accident, (c) up to 2.5 hours of assistance per
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incident for collection of minor property damages (up to $2,000) sustained by
the member's licensed motor vehicle in an accident, (d) up to 2.5 hours of
assistance per incident for collection of personal injury damages (up to $2,000)
sustained by the member or covered family member while driving, riding or being
struck as a pedestrian by a motor vehicle, and (e) up to 2.5 hours of assistance
per incident in connection with an action, including an appeal, for the
maintenance or reinstatement of a member's driver's license which has been
canceled, suspended, or revoked. No coverage under this benefit of the basic
legal service plan is offered to members for pre-existing conditions, drug or
alcohol related matters, or for commercial vehicles over two axles or operation
without a valid license.
Trial Defense. These benefits offer assistance to the member and the
member's spouse through an increasing schedule of benefits based on Membership
year. Up to 60 hours are available for the defense of civil or job-related
criminal charges by the provider law firm in the first Membership year. The
criminal action must be within the scope and responsibility of employment
activities of the member or spouse. Up to 2.5 hours of assistance are available
prior to trial, and the balance is available for actual trial services. The
schedule of benefits under this benefit area increases by 60 hours each
Membership year to: 120 hours in the second Membership year, 3 hours of which
are available for pre-trial services; 180 hours in the third Membership year,
3.5 hours of which are available for pre-trial services; 240 hours in the fourth
Membership year, 4 hours of which are available for pre-trial services, to the
maximum limit of 300 hours in the fifth Membership year, 4.5 hours of which are
available for pre-trial services. This benefit excludes domestic matters,
bankruptcy, deliberate criminal acts, alcohol or drug-related matters, business
matters, and pre-existing conditions.
In addition to the pre-trial benefits of the basic legal plan described
above, there are additional pre-trial hours available as an option, or add-on,
to the basic plan. These optional benefits cost $9.00 per month and add 15 hours
of pre-trial services during the first year of the Membership increasing 5
additional hours each Membership year to the maximum limit of 35 hours in the
fifth Membership year and increases total pre-trial and trial defense hours
available pursuant to the expanded Membership to 75 hours during the first
Membership year to 335 hours in the fifth Membership year. These pre-trial hours
are in addition to those hours already provided by the basic plan so that the
member, in the first year of the Membership, has a combined total of 17.5
pre-trial hours available escalating to a combined total of 39.5 pre-trial hours
in the fifth Membership year. There were approximately 487,000 subscribers of
this benefit at December 31, 2008 compared to 530,000 at December 31, 2007.
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.
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Preferred Member Discount for All Other Services. Provider law firms have
agreed to provide to members any legal services beyond those stipulated in the
Membership at a fee discounted 25% from the provider law firm's customary and
usual hourly rate. This "customary and usual hourly rate" is a fixed single
hourly rate for each provider firm that is generally an average of the firm's
various hourly rates for its attorneys which typically vary based on experience
and expertise.
Legal Shield Benefit
In 45 states and four Canadian provinces, the Legal Shield plan can be
added to the standard or expanded Family Legal Plan for $1 per month and
provides members with 24-hour access to a toll-free number for provider law firm
assistance if the member is arrested or detained. The Legal Shield member, if
detained, can present their Legal Shield card to the officer that has detained
them to make it clear that they have access to legal representation and that
they are requesting to contact a lawyer immediately. The benefits of the Legal
Shield plan are subject to conditions imposed by the detaining authority, which
may not allow for the provider law firm to communicate with the member on an
immediate basis. The Legal Shield benefit was introduced in 1999. There were
approximately 1,091,000 Legal Shield subscribers at December 31, 2008 compared
to approximately 1,080,000 at December 31, 2007.
Identity Theft Shield Benefit
Through a joint marketing agreement with Kroll Background America Inc., a
subsidiary of Kroll Inc., our independent sales associates market Kroll's
identity theft benefits in 50 states and four Canadian provinces. By adding the
Identity Theft Shield to their existing family Membership, members have toll
free access to the identity theft specialists at Kroll. This benefit can be
added to a legal service Membership for $9.95 per month or purchased separately
for $12.95 per month. The identity theft related benefits include a credit
report provided through Experian and related instructional guide, a credit score
calculated by an independent scoring service and related instructional guide,
credit report monitoring through Experian with daily online and monthly offline
notification of any changes in credit information and comprehensive identity
theft restoration services.. Beginning in the first quarter of 2009, our
Identity Theft membership will be offered as an on-line service where new
members can authenticate their membership by logging on to the Internet and get
an immediate credit report delivered via the web making the method of requesting
and receiving the credit report more streamlined and efficient. There were
approximately 771,000 and 715,000 subscribers at December 31, 2008 and 2007,
respectively, comprised of 681,000 and 632,000 subscribers at $9.95 per month
and 90,000 and 83,000 subscribers at $12.95 per month.
Canadian Family Plan
The Family Legal Plan is currently marketed in the Canadian provinces of
Ontario, British Columbia, Alberta and Manitoba. We began operations in Ontario
and British Columbia during 1999 and Alberta and Manitoba in 2001. Benefits of
the Canadian plan include expanded preventive benefits including assistance with
Canadian Government agencies, warranty assistance and small claims court
assistance as well as the preferred member discount. Canadian Membership fees
collected during 2008 were approximately $8.2 million (including foreign
currency translation adjustments) in U.S. dollars compared to $7.6 million
collected in 2007 and $6.8 million collected in 2006.
Specialty Legal Service Plans
In addition to the Family Legal Plan described above, we also offer other
specialty or niche legal service plans. These specialty plans usually contain
many of the Family Legal Plan benefits adjusted as necessary to meet specific
industry or prospective member requirements. In addition to those specialty
plans described below, we will continue to evaluate and develop other such plans
as the need and market allow.
Business Owners' Legal Solutions Plan
The Business Owners' Legal Solutions plan was developed during 1995 and
provides business oriented legal service benefits for small businesses with 99
or fewer employees. This plan was developed and test marketed in selected
geographical areas and more widely marketed beginning in 1996 at a monthly rate
of $69.00. This plan provides for-profit 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,
5
the coverage offered pursuant to this plan was expanded to include trial defense
benefits and Membership in GoSmallBiz.com, an unrelated Internet based service
provider. Through GoSmallBiz.com, members may receive unlimited business
consultations from business consultants and have access to timely small business
articles, educational software, Internet tools and more. This expanded plan is
currently marketed at a monthly rate ranging from $69 to $150 ($175 in Canada)
depending on the number of employees and provides business oriented legal
service benefits for any for-profit business with 99 or fewer employees. This
plan is available in 44 states and three Canadian provinces and represented
approximately 5.4%, 5.3% and 5.1% of our Membership fees during 2008, 2007 and
2006, respectively.
Commercial Driver Legal Plan
The Commercial Driver Legal Plan is designed specifically for the
professional truck driver and offers a variety of driving-related benefits,
including coverage for moving and non-moving violations. This plan provides
coverage by a provider law firm for persons who drive a commercial vehicle. This
legal service plan is currently offered in 45 states. In certain states, the
Commercial Driver Legal Plan is underwritten by the Road America Motor Club, an
unrelated motor service club. During 2008 this plan accounted for approximately
..8% of Membership fees compared to approximately .9% of Membership fees during
2007 and 2006. The Plan underwritten by the Road America Motor Club is available
at the monthly rate of $35.95 or at a group rate of $32.95. Plans underwritten
by us are available at the monthly rate of $32.95 or at a group rate of $29.95.
Benefits include the motor vehicle related benefits described above, defense of
Department of Transportation violations and the 25% discounted rate for services
beyond plan scope, such as defense of non-moving violations. The Road America
Motor Club underwritten plan includes bail and arrest bonds and services for
family vehicles.
Home-Based Business Rider
The Home-Based Business plan was designed to provide small business owners
access to commonly needed legal services. It can be added to the Expanded Family
Legal Plan in approved states. To qualify, the business and residence address
must be the same with three or fewer employees and be a for-profit business that
is not publicly traded. Benefits under this plan include unlimited business
telephone consultation, review of three business contracts per month, three
business and debt collection letters per month and discounted trial defense
rates. This plan also includes Membership in GoSmallBiz.com. This plan is
available in 39 states and two Canadian provinces and represented approximately
1.9% of our Membership fees during 2008 compared to approximately 1.8% during
2007 and 2006.
Comprehensive Group Legal Services Plan
In late 1999 we introduced the Comprehensive Group plan, designed for the
large group employee benefit market. This plan, available in 36 states, provides
all the benefits of the Family Legal Plan as well as mortgage document
preparation, assistance with uncontested legal situations such as adoptions,
name changes, separations and divorces. Additional benefits include the
preparation of health care power of attorney and living wills or directives to
physicians. Although sales of this plan during the last three years (2,599
Memberships, 2,735 Memberships and 5,892 Memberships during 2008, 2007 and 2006,
respectively) are not significant compared to our total Membership sales, we
still believe this plan improves our competitive position in the large group
market. We continue to emphasize group marketing to employee groups of less than
50 rather than larger groups where there is more competition, price negotiation
and typically a longer sales cycle.
Other than additional benefits such as the Legal Shield and Identity Theft
Shield benefits described above, the basic structure and design of the
Membership benefits has not significantly changed over the last several years.
The consistency in plan design and delivery provides us consistent, accurate
data about plan utilization which enables us to manage our benefit costs through
the capitated payment structure to provider firms. We frequently evaluate and
consider other plan benefits that may include other services complimentary to
the basic legal service plan.
6
Provider Law Firms
Our Memberships generally allow members to access legal services through a
network of independent provider law firms under contract with us generally
referred to as "provider law firms." Provider law firms are paid a fixed fee on
a per capita basis to render services to plan members residing within the state
or province as provided by the contract. Because the fixed fee payments by us to
provider law firms in connection with the Memberships do not vary based on the
type and amount of benefits utilized by the member, this arrangement provides
significant advantages to us in managing our cost of benefits. Pursuant to these
provider law firm arrangements and due to the volume of revenue directed to
these firms, we have the ability to more effectively monitor the customer
service aspects of the legal services provided, the financial leverage to help
ensure a customer friendly emphasis by the provider law firms and access to
larger, more diversified law firms. Through our members, we are typically the
largest client base of our provider law firms.
Provider law firms are selected to serve members based on a number of
factors, including recommendations from provider law firms and other lawyers in
the area in which the candidate provider law firm is located and in neighboring
states, our investigation of bar association standing and client references,
evaluation of the education, experience and areas of practice of lawyers within
the firm, on-site evaluations by our management, and interviews with lawyers in
the firm who would be responsible for providing services. Most importantly,
these candidate law firms are evaluated on the firm's customer service
philosophy.
Approximately 96% of provider law firms, representing more than 99% of our
legal service members, are connected to us via high-speed digital links to our
management information systems, thereby providing real-time monitoring
capability. This online connection offers the provider law firm access to
specially designed software developed by us for administration of legal services
by the firm. These systems provide statistical reports of each law firm's
activity and performance and allow virtually all of the members served by
provider law firms to be monitored on a near real-time basis. The few provider
law firms that are not online with us typically have a small Membership base and
must provide various weekly reports to us to assist in monitoring the firm's
service level. The combination of the online statistical reporting and weekly
service reports for smaller provider law firms allows quality control monitoring
of over 15 separate service delivery benchmarks. In addition, we regularly
conduct extensive random surveys of members who have used the legal services of
a provider law firm. We survey members in each state every 60 days, compile the
results of such surveys and provide the provider law firms with copies of each
survey and the overall summary of the results. If a member indicates on a survey
the service did not meet their expectation, the member is contacted as soon as
possible to resolve the issue.
Each month, provider law firms are presented with a comprehensive report of
ratings related to our online monitoring, member assistance requests, member
survey evaluations, telephone reports and other information developed in
connection with member service monitoring. If a problem is detected, we
recommend immediate remedial actions to the provider law firms to eliminate
service deficiencies. In the event the deficiencies of a provider law firm are
not eliminated through discussions and additional training with us, such
deficiencies may result in the termination of the provider law firm. We are in
constant communication with our provider law firms and meet with them frequently
for additional training, to encourage increased communications with us and to
share suggestions relating to the timely and effective delivery of services to
our members.
Each attorney member of the provider law firm rendering services must have
at least two years of experience as a lawyer, unless we waive this requirement
due to special circumstances such as instances when the lawyer demonstrates
significant legal experience acquired in an academic, judicial or similar
capacity other than as a lawyer. We provide customer service training to the
provider law firms and their support staff through on-site training that allows
us to observe the individual lawyers of provider law firms as they directly
assist the members. Additionally, we provide initial orientation and training
for new staff and new attorneys joining the firm via weekly conference calls.
Agreements with provider law firms: (a) generally permit termination of the
agreement by either party upon 60 days prior written notice, (b) permit us to
terminate the Agreement for cause immediately upon written notice, (c) require
7
the firm to maintain a minimum amount of malpractice insurance on each of its
attorneys, in an amount not less than $100,000, (d) preclude us from
interference with the lawyer-client relationship, (e) provide for periodic
review of services provided, (f) provide for protection of our proprietary
information and (g) require the firm to indemnify us against liabilities
resulting from legal services rendered by the firm. We are precluded from
contracting with other law firms to provide the same service in the same
geographic area, except in situations where the designated law firm has a
conflict of interest, we enroll a group of 500 or more members, or when the
agreement is terminated by either party. Provider law firms are precluded from
contracting with other prepaid legal service companies without our approval.
Provider law firms receive a fixed monthly payment for each member who are
residents in the service area and are responsible for providing the Membership
benefits without additional remuneration. If a provider law firm delivers legal
services to an open panel member, the law firm is reimbursed for services
rendered according to the open panel Membership. As of December 31, 2008,
provider law firms averaged approximately 48 employees each and on average are
relatively evenly split between support staff and lawyers.
The following table reflects the composition of our provider law firm
network by state/province, together with each firm's Memberships and attorneys
as of December 31, 2008 and year 2008 intakes by state/province. As reflected in
the table below, the average number of intakes per member during 2008 was 1.6.
8
Member-
Member- Attor- hips per
State/Province Provider Firm ships neys attorney Intakes
---------------- -------------------------------------------- ---------- ------- ------- -----------
Colorado Riggs, Abney, Neal, Turpen, Orbison & Lewis 35,807 32 1,119 54,008
Oklahoma Riggs, Abney, Neal, Turpen, Orbison & Lewis 41,907 97 432 39,887
Nebraska Morrow, Poppe, Watermeier & Lonowski, P.C. 2,321 8 290 2,763
Texas Ross & Matthews, P.C. 134,809 97 1,390 186,271
Louisiana Provasty, Sadler, DeLaunay, Florenza & Sobel 22,280 21 1,061 24,565
Missouri Dubail Judge 25,354 21 1,207 36,140
Illinois Evans, Loewenstein, Shimanovsky & Moscardini 43,246 22 1,966 87,434
W. Virginia Caldwell & Riffee 3,789 5 758 2,305
California Parker Stanbury 217,334 65 3,344 419,185
Arkansas Lisle Law Firm, P.C. 13,813 8 1,727 20,738
Florida DeBeaubien, Knight, Simmons 55,300 46 1,202 102,157
Florida Glantz & Glantz 47,914 33 1,452 94,133
Georgia Deming, Parker, Hoffman, Green, Campbell & 61,173 42 1,457 122,409
Daly
Alabama The Anderson Law Firm LLC 18,830 8 2,354 22,275
Tennessee Merritt, Flebotte, Wilson, Webb & Caruso 24,198 9 2,689 33,689
Kentucky O'Koon Hintermeister, PLLC 8,907 5 1,781 12,959
S. Carolina Merritt, Flebotte, Wilson, Webb & Caruso 22,153 14 1,582 33,603
Ohio Maguire & Schneider 41,619 25 1,665 68,424
Kansas Riling, Burkhead & Nitcher 13,888 13 1,068 16,193
Hawaii Bervar & Jones 13,049 10 1,305 22,609
Michigan Powers, Chapman, DeAgostino, Meyers & Milia 45,897 23 1,996 83,581
New York Feldman, Kramer & Monaco, P.C. 48,833 54 904 79,350
Massachusetts Framme Law Firm 3,565 2 1,783 6,326
Pennsylvania Welch, Gold & Siegel 34,363 22 1,562 50,567
Wisconsin Wagner, Falconer & Judd, LTD 12,317 9 1,369 25,190
Utah Smart, Schofield, Shorter & Lunceford 14,535 17 855 22,142
Indiana O'Koon Hintermeister, PLLC 23,246 14 1,660 37,251
Oregon Kivel & Howard, LLP 23,215 12 1,935 33,989
Idaho The Huntley Law Firm, PLLC 8,604 12 717 11,916
Arizona Davis Miles PLLC - Arizona 45,608 51 894 79,226
Washington Lombino Martino, PS 41,729 26 1,605 73,382
Nevada Dempsey, Roberts & Smith 18,581 33 563 40,896
Virginia Framme Law Firm 39,701 18 2,206 50,139
Minnesota Wagner, Falconer & Judd, LTD 18,545 22 843 32,802
Wyoming Referral attorneys * 1,829 - - 1,080
Iowa McEnroe, Gotsdiner, Brewer, et al. 5,327 6 888 3,678
N. Carolina Merritt, Flebotte, Wilson, Webb & Caruso 59,874 27 2,218 88,215
Mississippi Framme Law Firm of Mississippi 10,039 3 3,346 14,219
Maryland/D.C. Weinstock, Friedman & Friedman, P.C. 40,703 37 1,100 54,490
New Jersey Mattleman, Weinroth & Miller 31,221 26 1,201 43,981
Montana Rimel & Mrkich, PLLP 4,642 2 2,321 4,437
New Mexico Davis Miles PLLC 18,610 8 2,326 22,449
N. Dakota Referral attorneys * 293 - - 240
S. Dakota Demersseman Jensen et al 2,243 7 320 1,310
Delaware Mattleman, Weinroth & Miller 4,769 7 681 7,149
New Hampshire Framme Law Firm 3,261 1 3,261 6,651
Connecticut Willinger, Willinger & Bucci, P.C. 8,761 13 674 14,921
Vermont Framme Law Firm 521 1 521 5,159
Maine Robinson, Kriger & McCallum 4,027 14 288 9,185
Alaska Referral attorneys * 9 - - -
Rhode Island Framme Law Firm 869 2 435 1,294
Alberta Nickerson, Roberts, Holinski & Mercer 3,646 10 365 3,291
British Columbia Watson, Goepel & Maledy 4,463 36 124 8,886
Manitoba Tapper Cuddy 1,543 22 70 3,398
Ontario Mills & Mills 16,257 25 650 28,222
---------- ------- ------- -----------
Total Closed Panel Memberships 1,449,337 1,143 1,268 2,350,759
---------- ------- ------- -----------
"Stand-alone" IDT Memberships 89,839
Open Panel Memberships 10,845
Commercial Driver Legal Plan Memberships 9,133
----------
Total Memberships 1,559,154
----------
*States/provinces without a designated provider law firm. Services are provided
by referral attorneys.
9
We have had occasional disputes with provider law firms, some of which have
resulted in litigation. The toll-free telephone lines utilized and paid for by
the provider law firms are owned by us so that in the event of a termination,
the members' calls can be rerouted very quickly. Nonetheless, we believe that
our relations with provider law firms are generally very good. At the end of
2008, we had provider law firms representing 47 states and four provinces, the
same as we had at the end of 2007. During the last three calendar years, our
relationships with a total of six provider law firms were terminated by us or
the provider law firm. As of December 31, 2008, 36 provider law firms have been
under contract with us for more than eight years with the average tenure of all
provider law firms being in excess of 10 years.
There are occasions when members need to be referred by the provider law
firm or PPL to an attorney outside the provider law firm. These instances are
for geographic reasons, expertise reasons or if the matter is a conflict of
interest for the provider law firm. We have an extensive database of referral
lawyers developed for PPL and the provider law firms to access when members need
services to be coordinated outside the provider law firm. Lawyers with whom
members have experienced verified service problems, or are otherwise
inappropriate for the referral system, are removed from our database of referral
lawyers.
We design our plans for the convenience of our member. The provider law
firms primarily deliver consultation benefits via the telephone while document
reviews and letters are primarily delivered by fax, email and mail, and thus,
the member does not normally need to travel to any law firm to receive the
majority of their benefits. They can utilize their benefits from the comfort of
their home or office and not take time off from work.
The provider law firms provide and/or coordinate all benefits for our
members. After the provider law firm has provided telephone consultation
benefits and possible document review and letters, if appropriate, the provider
law firm will provide further benefits or coordinate a referral to a local
attorney if that is necessary. We have a database of referral attorneys covering
North America should a member need a local attorney. The provider law firm
coordinates these referrals based on the member's legal needs and the location
of the courts.
Members' benefits carry over to the local attorneys when referred, based on
the specific legal matter being referred and the specific benefit applicable to
the member. Some referrals are free to the member by way of the specific plan
benefit and the referral attorney is paid by the provider law firm. Other
referrals are provided under the 25% discount benefit of the plan, where the
member pays the discounted fee to the local attorney.
Referrals are made on a case by case basis, depending on the specific legal
matter and the applicable benefits. The majority of referrals are based on
geography of where the member lives, in conjunction with the legal venue and/or
the location of the court. Occasionally a member is referred because of
expertise that is required on a particular issue.
Identity Theft Shield Benefits Provider
Kroll is one of the world's leading risk consulting companies. For more
than 30 years, Kroll has helped companies, government agencies and individuals
reduce their exposure to risk and capitalize on business opportunities. Kroll is
an operating unit of Marsh & McLennan Companies, Inc., the global professional
services firm. With offices in more than 65 cities in the U.S. and abroad, Kroll
can scrutinize accounting practices and financial documents; gather and filter
electronic evidence for attorneys; recover lost or damaged data from computers
and servers; conduct in-depth investigations; screen domestic and foreign-born
job candidates; protect individuals, and enhance security systems and
procedures. Kroll's clients include many of the world's largest and most
prestigious corporations, law firms, academic institutions, non-profit
organizations, sovereign governments, government agencies, and high net-worth
individuals, entertainers and celebrities. Kroll's seasoned professionals were
handpicked and recruited from leading management consulting companies, top law
firms, international auditing companies, multinational corporations, special
operations forces, law enforcement and intelligence agencies. Kroll also
maintains a network of highly trained specialists in cities throughout the world
who can respond to global needs 24 hours a day, seven days a week. Over the last
four years, Kroll has developed a unique solution for victims of identity theft
and this service is now available to our members through the Identity Theft
Shield benefit. Similar to the provider law firms, Kroll is paid a fixed fee on
a monthly per capita basis to render services to IDT members.
10
Marketing
Multi-Level Marketing
We market Memberships through a multi-level marketing program that
encourages individuals to sell Memberships and allows individuals to recruit and
develop their own sales organizations. Commissions are paid only when a
Membership is sold. No commissions are paid based solely on recruitment. When a
Membership is sold, commissions are paid to the associate making the sale, and
to other associates (on average, eight others at December 31, 2008 and December
31, 2007 and nine others at December 31, 2006) who are in the line of associates
who directly or indirectly recruited the selling associate. We provide training
materials, organize area-training meetings and designate personnel at the home
office specially trained to answer questions and inquiries from associates. We
offer various communication avenues to our sales associates to keep such
associates informed of any changes in the marketing of our Memberships. The
primary communication vehicles we utilize to keep our sales associates informed
include extensive use of conference calls and e-mail, an interactive voice-mail
service, The Connection monthly magazine, an interactive voice response system
and our website, prepaidlegal.com.
Multi-level marketing is primarily used for marketing based on personal
sales since it encourages individual or group face-to-face meetings with
prospective members and has the potential of attracting a large number of sales
personnel within a short period of time. Our marketing efforts towards
individuals typically target the middle income family or individual and seek to
educate potential members concerning the benefits of having ready access to
legal counsel for a variety of everyday legal problems. Memberships with
individuals or families sold by the multi-level sales force constituted 74% of
our Memberships in force at December 31, 2008, compared to 75% at December 31,
2007 and 76% at December 31, 2006. 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.
Group marketing
Our marketing efforts towards employee groups, principally on a payroll
deduction payment basis, are designed to permit our sales associates to reach
more potential members with each sales presentation and strive to capitalize on,
among other things, what we perceive to be a growing interest among employers in
the value of providing legal and identity theft service plans to their
employees. Memberships sold through employee groups constituted approximately
26% of total Memberships in force at December 31, 2008, compared to 25% and 24%
at December 31, 2007 and 2006, respectively. Most employee group Memberships are
sold to school systems, governmental entities and businesses. We emphasize group
marketing to employee groups of less than 50 rather than larger groups where
there is more competition, price negotiation and typically a longer sales cycle.
No group accounted for more than 1% of our consolidated revenues from
Memberships during 2008, 2007 or 2006. Substantially all group Memberships are
paid on a monthly basis. We are active in legislative lobbying efforts to
enhance our ability to market to public employee groups and to encourage
Congress to reenact legislation to permit legal service plans to qualify for
pre-tax payments under tax qualified employee cafeteria plans.
Affirmative Defense Response System
We developed the Affirmative Defense Response System ("ADRS") to provide
businesses and their employees a way to minimize their risk in regard to
identity theft by encouraging businesses to take proactive measures to protect
non-public information. Once our sales associates have been through the required
training, they can begin to offer businesses the forms they will need and the
education their employees will require to take reasonable and affirmative steps
to reduce the harm and risk of having a breach of non-public information. We
encourage businesses to host mandatory employee meetings and training sessions
on identity theft and privacy compliance. At such meetings, our associates will
provide the employees of the business an opportunity to purchase our legal
service and identity theft plans. Since our Identity Theft Shield provides
identity restoration benefits and our legal plans provide help on related
issues, we believe the majority of the time in restoring an employee's identity
is covered by our plan and therefore is not done on company time or at company
expense. We believe our suite of services including our legal plan, the Legal
Shield and the Identity Theft Shield provide employees assistance in every phase
of identity theft - before, during and after the crime occurs. The ADRS was
developed to enhance our group marketing efforts and we intend to continue to
utilize this program in 2009.
11
General
Sales associates are generally engaged as independent contractors, are
provided with training materials and are given the opportunity to participate in
our training programs. Sales associates are required to complete a specified
training program prior to marketing our Memberships to employee groups. All
advertising and solicitation materials used by sales associates must be approved
by us prior to use. At December 31, 2008, we had 425,018 "vested" sales
associates compared to 442,361 and 444,499 "vested" sales associates at December
31, 2007 and 2006, respectively. A sales associate is considered to be "vested"
if he or she has met our vesting requirements. 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. In order to meet the
vesting requirements and be eligible to receive commissions, sales associates
must have an active Associate Agreement. In order to keep an active Agreement;
sales associates must (1) maintain an active personal legal services membership
or (2) make three personal membership sales per calendar quarter. If a sales
associate fails to do either, his or her Associate Agreement will be placed in a
precancel status for one quarter ("quarterly vesting probationary period").
During this period, the Associate must either (1) reinstate their personal legal
services membership or (2) make six personal membership sales. If these
requirements are not met, the Associate will go into a dropped status at the end
of the probationary period. Upon the date the Associate Agreement is dropped,
the Associate loses all downline, level, counters and qualifications and
forfeits any pending advanced commission, earnings and bonuses.
During 2008, we had 81,731 sales associates who personally sold at least
one Membership, of which 43,674 (53%) made first time sales. During 2007 and
2006 we had 90,123 and 90,206 sales associates producing at least one Membership
sale, respectively, of which 49,117 (55%) and 49,955 (55%), respectively, made
first time sales. During 2008, we had 6,996 sales associates who personally sold
more than ten Memberships compared to 9,047 and 8,858 in 2007 and 2006,
respectively. A substantial number of our sales associates market our
Memberships on a part-time basis only. For the year 2008, new sales associates
enrolled decreased 18% to 122,255 with an average enrollment fee of $72 from the
148,802 enrolled in 2007 with an average enrollment fee of $57.
The following table recaps, on a quarterly basis for the last two fiscal
years, total vested sales associates that made new Membership sales and those
that did not as well as those that own a Membership and those that do not own a
Membership, by their respective levels of sales:
Assocs Without A Membership (3)
---------------------------
(1) (2) Assocs Selling (4)
Assocs Selling Assocs Selling With a Assocs Not (5)
Qtr/Year 3 or more Less than 3 Membership Selling Total Assocs
------------ -------------- -------------- -------------- ---------- ------------
Q1/07 212 297 34,443 398,956 433,908
Q2/07 152 583 33,092 400,387 434,214
Q3/07 140 540 34,196 408,424 443,300
Q4/07 146 497 34,444 407,274 442,361
Q1/08 93 366 30,174 397,575 428,208
Q2/08 90 358 30,614 401,289 432,351
Q3/08 95 402 31,702 392,118 424,317
Q4/08 98 367 29,177 395,376 425,018
(1) Represents sales associates that do not own a Membership that have sold 3
or more new Memberships during the quarter indicated.
(2) Represents sales associates that do not own a Membership that have sold
less than 3 new Memberships during the quarter indicated.
12
(3) Represents sales associates who owned a Membership and sold at least 1 new
Membership during the quarter indicated.
(4) Represents sales associates who owned a Membership or were in their
quarterly vesting probationary period but did not sell at least 1 new
Membership during the quarter indicated.
(5) Represents the total vested associates (including those associates in their
quarterly vesting probationary period) during the quarter indicated.
We derive revenues from our multi-level marketing sales force, including
one-time enrollment fee from each new sales associate for which we provide
initial marketing supplies and enrollment services to the associate. Amounts
collected from sales associates are intended primarily to offset our costs
incurred in recruiting and training and providing materials to sales associates
and are not intended to generate profits from such activities. Other revenues
from sales associates represent the sale of marketing supplies and promotional
materials and include fees related to our eService program for associates. The
eService program provides subscribers Internet based back office support such as
reports, on-line documents, tools, a personal e-mail account and multiple
personalized web sites with "flash" movie presentations.
We continually review our compensation plan for the multi-level marketing
force to assure that the various financial incentives in the plan encourage our
desired goals. We offer various incentive programs from time to time and
frequently adjust the program to maintain appropriate incentives and to improve
Membership production and retention.
We hold our International Convention once a year, typically in the spring,
and a Leadership Summit, typically in the fall, and routinely host more than
10,000 of our sales associates at these events. These events are intended to
provide additional training, corporate updates, new announcements, motivation
and associate recognition. Additionally, we offer the Player's Club incentive
program providing additional incentives to our associates as a reward for
consistent, quality business. Associates can earn the right to attend an annual
incentive trip by meeting certain qualification requirements and maintaining
certain personal retention rates. Associates can also earn the right to receive
additional monthly bonuses by meeting the monthly qualification requirements for
twelve consecutive months and maintaining certain personal retention rates for
the Memberships sold during that twelve month period.
Regional Vice Presidents
Prior to January 1, 2007, we had a group of approximately 115 employees
that served as Regional Vice Presidents ("RVPs") and were responsible for
associate activity in given geographic regions and had the ability to appoint
independent contractors as Area Coordinators within the RVP's region. Effective
January 1, 2007, we dramatically revamped this program by reducing the number of
RVPs from approximately 115 to 15; eliminated the employee relationship of the
RVPs so that all are independent contractors; significantly increased both the
size of their regions and the commission override percentages that can be earned
by the RVPs; put in place additional bonus compensation available based on
growth in their assigned regions; replaced the previous large number of Area
Coordinators with substantially fewer Regional Managers appointed by the RVPs;
created commission overrides than can be earned by the Regional Managers in
their regions and created a new class of appointees, Certified Meeting
Coordinators that are appointed by the Regional Managers. Additionally, we have
significantly increased the frequency of communications between us and the RVPs
and the frequency and the amount of reporting both from and to, the RVPs. At
December 31, 2008, we had 28 RVPs assigned.
The RVP/Regional Manager/Certified Meeting Coordinator program provides a
basis to effectively monitor current sales activity, further educate and
motivate the sales force and otherwise enhance the relationships between the
associates and us. New products, incentives and initiatives will be channeled
through the RVPs.
13
Pre-Paid Legal Benefits Association
The PPL Benefits Association ("PPLBA") was founded in 1999 with the intent
of providing sales associates the opportunity to have access, at their own
expense, to health insurance and life insurance benefits. Membership in the
Association allows a sales associate to become eligible to enroll in numerous
benefit programs, as well as take advantage of attractive affinity agreements.
Membership in this Association is open to sales associates that reach a certain
level within our marketing programs who also maintain an active personal legal
services Membership. The PPLBA is a separate association not owned or controlled
by us and is governed by an 8 member Board of Directors, including four officer
positions. None of the officers or directors of the PPLBA serve in any such
capacity with us. The PPLBA employs a Director of Associate Benefits paid by the
Association. Affinity programs available to members of the PPLBA include credit
cards, long-distance, wireless services, vehicle purchasing services, safety
trip plan, mortgage and real estate assistance and a travel club. As determined
by its Board of Directors, some of the revenue generated by the PPLBA through
commissions from vendors of the benefits and affinity programs or contributed to
the Association by us may be used to make open-market purchases of our stock for
use in stock bonus awards to Association members based on criteria established
from time to time by the Board of Directors of the PPLBA. Since inception and
through December 31, 2008, approximately 45,900 shares were purchased by the
PPLBA for awards to its members. The PPLBA awarded approximately 1,900, 2,075
and 3,000 shares of stock to Association members representing the 2008, 2007 and
2006 stock bonus awards, respectively.
Cooperative Marketing
We have in the past, and may in the future, develop marketing strategies
pursuant to which we seek arrangements with insurance and service companies that
have established sales forces. Under such arrangements, the agents or sales
force of the cooperative marketing partner market our Memberships along with the
products already marketed by the partner's agents or sales force. Such
arrangements allow the cooperative marketing partner to enhance its existing
customer relationships and distribution channels by adding our product to the
marketing partner's existing range of products and services, while we are able
to gain broader Membership distribution and access to established customer
bases.
We have a cooperative marketing agreement with Atlanta-based Primerica
Financial Services ("PFS"), a subsidiary of Citigroup, Inc. PFS is one of the
largest financial services marketing organizations in North America with more
than 100,000 personal financial analysts across the U.S. and Canada. Although
these Memberships were sold by PFS representatives, we have a direct billing and
service relationship with the members. The PFS cooperative marketing agreement
resulted in approximately 24,000 new Membership sales during 2008 compared to
25,000 and 26,000, respectively for 2007 and 2006.
We have had limited success with cooperative marketing arrangements in the
past and are unable to predict with certainty what success we will achieve, if
any, under our existing or future cooperative marketing arrangements.
Operations
Our corporate operations involve Membership application processing,
member-related customer service, and various associate-related services
including commission payments, receipt of Membership fees, related general
ledger accounting, human resources, internal audit and managing and monitoring
the provider law firm relationships.
We utilize a management information system to control operations costs and
monitor benefit utilization. Among other functions, the system evaluates benefit
claims, monitors member use of benefits and monitors marketing/sales data and
financial reporting records. Our dominant concerns in the architecture of
private networks and web systems include security, scalability, and capacity to
accommodate peak traffic and business continuity in the event of a disaster. We
believe our management information system has substantial capacity to
accommodate increases in business data before substantial upgrades will be
14
required. We believe this excess capacity will enable us to experience a
significant increase in the number of members serviced with less than a
commensurate increase of administrative costs.
We have built a strong Internet presence to strengthen the services
provided to both members and associates. Our Internet site, at
www.prepaidlegal.com, welcomes the multifaceted needs of our members, sales
force, investors and prospects. It has also reduced costs associated with
communicating critical information to the associate sales force.
Our operations also include departments specifically responsible for
marketing support and regulatory and licensing compliance. We have an internal
production staff that is responsible for the development of new audio and video
sales materials.
Quality Control
In addition to our quality control efforts for provider law firms described
above, we also closely monitor the performance of our home office personnel,
especially those who have telephone contact with members or sales associates. We
record home office employee telephone calls with our members and sales
associates to assure that our policies are being followed and to gather data
about recurring problems that may be avoided through modifications in policies.
We also use such recorded calls for training and recognition purposes.
Competition
We compete in a variety of market segments in the legal service plan
industry, including, among others, individual enrollment plans, employee benefit
plans and certain specialty segments. Our competitors with a national presence
would include Hyatt Legal Plans (a MetLife company), ARAG(R) North America and
Legal Services Plan of America (a GE Money company, formerly the Signature
Group). Most of these concentrate their marketing to larger employer groups and
offer open panel plans.
There are many entities offering some level of benefits related to identity
theft, credit monitoring, etc. Most of the credit repositories offer some type
of fee based services to the public as well as many financial institutions and
independent companies such as LifeLock. Most of these entities are focused on
credit monitoring rather than identity theft restoration. We believe our
identity theft restoration product is unique due to the combination of our
identity theft restoration partner (Kroll) and our provider law firms.
If a greater number of companies seek to enter the legal service plan
market or offer more comprehensive identity theft solutions, we will experience
increased competition in the marketing of our Memberships. However, we believe
our competitive position is enhanced by our actuarial database, the combination
of our existing network of provider attorney law firms and Kroll and our ability
to tailor products to suit various types of distribution channels or target
markets. We believe that no other competitor has the ability to monitor the
customer service aspect of the delivery of legal services to the same extent we
do. Finally, we have intentionally concentrated our group marketing to small
employer groups. Serious competition is most likely from companies with
significant financial resources and advanced marketing techniques.
Regulation
We are regulated by or required to file with or obtain approval of State
Insurance Departments, Secretaries of State, State Bar Associations and State
Attorney General Offices depending on individual state opinions of regulatory
responsibility for legal expense plans. We are also required to file with
similar government agencies in Canada. While some states or provinces regulate
legal expense plans as insurance or specialized legal expense products, others
regulate them as services.
15
As of December 31, 2008, we or one of our subsidiaries were marketing new
Memberships in 37 jurisdictions that require no special licensing. Our
subsidiaries serve as operating companies in 17 jurisdictions that regulate
Memberships as insurance or specialized legal expense products. The most
significant of these wholly owned subsidiaries are Pre-Paid Legal Casualty, Inc.
("PPLCI"), Pre-Paid Legal Services, Inc. of Florida ("PPLSIF") and Legal Service
Plans of Virginia, Inc. ("LSPV"). Of our total Memberships in force as of
December 31, 2008, 38% were written in jurisdictions that subject us or one of
our subsidiaries to insurance or specialized legal expense plan regulation (27%
written through our subsidiaries). We are actively working with regulators in
the various states in which our subsidiaries are regulated as insurance to
explore other regulatory alternatives to eliminate some of the agent licensing
or financial and marketing regulation that is prevalent in the insurance
industry.
We sell Memberships in the Canadian provinces of Ontario, British Columbia,
Alberta and Manitoba. The Memberships we currently market in such provinces do
not constitute an insurance product and therefore are exempt from insurance
regulation.
In states with no special licensing or regulatory requirements, we commence
operations only when advised by the appropriate regulatory authority that
proposed operations do not constitute conduct of the business of insurance.
There is no assurance that Memberships will be exempt from insurance regulation
even in states or provinces with no specific regulations. In these situations,
we or one of our subsidiaries would be required to qualify as an insurance
company in order to conduct business.
PPLCI serves as the operating company in most states where Memberships are
determined to be an insurance product. PPLCI is organized as a casualty
insurance company under Oklahoma law and as such is subject to regulation and
oversight by various state insurance agencies where it conducts business. These
agencies regulate PPLCI's forms, rates, trade practices, allowable investments
and licensing of agents and sales associates. These agencies also prescribe
various reports, require regular evaluations by regulatory authorities, and set
forth-minimum capital and reserve requirements. Our insurance subsidiaries are
routinely evaluated and examined by representatives from the various regulatory
authorities in the normal course of business. Such examinations have not and are
not expected to adversely impact our operations or financial condition in any
material way. We believe that all of our subsidiaries meet any required capital
and reserve requirements. Dividends paid by PPLCI are restricted under Oklahoma
law to available surplus funds derived from realized net profits.
We are required to register and file reports with the Oklahoma Insurance
Commissioner as a member of a holding company system under the Oklahoma
Insurance Holding Company System Regulatory Act. Transactions between PPLCI and
us or any other subsidiary must be at arm's-length with consideration for the
adequacy of PPLCI's surplus, and may require prior approval of the Oklahoma
Insurance Commissioner. Payment of any extraordinary dividend by PPLCI to us
requires approval of the Oklahoma Insurance Commissioner. The payment of
dividends by PPLCI is restricted under the Oklahoma Insurance Code to available
surplus funds derived from realized net profits and requires the approval of the
Oklahoma Insurance Commissioner for any dividend representing more than the
greater of 10% of such accumulated available surplus or the previous years' net
profits. During 2008, PPLCI declared and after obtaining all necessary
regulatory approvals, paid extraordinary dividends to us of $14.9 million
compared to the $7.4 million and $13.4 million paid to us during 2007 and 2006,
respectively. Any change in our control, defined as acquisition by any method of
more than 10% of our outstanding voting stock, including rights to acquire such
stock by conversion of preferred stock, exercise of warrants or otherwise,
requires approval of the Oklahoma Insurance Commissioner. Holding company laws
in some states in which PPLCI operates provide for comparable registration and
regulation of us.
Certain states have enacted special licensing or regulatory requirements
designed to apply only to companies offering legal service products. These
states most often follow regulations similar to those regulating casualty
insurance providers. Thus, the operating company may be expected to comply with
specific minimum capitalization and unimpaired surplus requirements; seek
approval of forms, Memberships and marketing materials; adhere to required
levels of claims reserves, and seek approval of premium rates and agent
licensing. These laws may also restrict the amount of dividends paid to us by
such subsidiaries. PPLSIF is subject to restrictions of this type under the laws
of the State of Florida, including restrictions with respect to payment of
dividends to us. At January 1, 2009, none of PPLCI, PPLSIF or LSPV had funds
16
available for payment of substantial dividends without the prior approval of the
insurance commissioner. LSPV declared and paid us a $4.1 million dividend during
2008 compared to $1.6 million during 2007 and $3.7 million during 2006.
As the legal plan industry continues to mature, additional legislation may
be enacted that would affect us and our subsidiaries. We cannot predict with any
accuracy if such legislation would be adopted or its ultimate effect on
operations, but expect to continue to work closely with regulatory authorities
to minimize any undesirable impact and, as noted above, to reduce regulatory
cost and burden where possible.
Our operations are further impacted by the American Bar Association Model
Rules of Professional Conduct ("Model Rules") and the American Bar Association
Code of Professional Responsibility ("ABA Code") as adopted by various states.
Arrangements for payments to a lawyer by an entity providing legal services to
its members are permissible under both the Model Rules and the ABA Code, so long
as the arrangement prohibits the entity from regulating or influencing the
lawyer's professional judgment. The ABA Code prohibits lawyer participation in
closed panel legal service programs in certain circumstances. Our agreements
with provider law firms comply with both the Model Rules and the ABA Code. We
rely on the lawyers serving as the designated provider law firms for the closed
panel benefits to determine whether their participation would violate any
ethical guidelines applicable to them. We and our subsidiaries comply with
filing requirements of state bar associations or other applicable regulatory
authorities.
We are also required to comply with state, provincial and federal laws
governing our multi-level marketing approach. These laws generally relate to
unfair or deceptive trade practices, lotteries, business opportunities and
securities. The U.S. Federal Trade Commission has proposed business opportunity
regulations which may have an effect upon our method of operating in the United
States, but such regulations are in the early stages of development and it is
not possible to gauge the potential impact or the effective date at this time.
We have experienced no material problems with marketing compliance. In
jurisdictions that require associates to be licensed, we receive all
applications for licenses from the associates and forward them to the
appropriate regulatory authority. We maintain records of all associates
licensed, including effective and expiration dates of licenses and all states in
which an associate is licensed. We do not accept new Membership sale
applications from any unlicensed associate in such jurisdictions.
Employees
At December 31, 2008, we employed 801 individuals on a full-time basis,
exclusive of independent agents and sales associates who are not employees. None
of our employees are represented by a union. We consider our employee relations
generally to be very good.
Foreign Operations
We have operations in the Canadian provinces of Ontario, British Columbia,
Alberta and Manitoba and derived aggregate revenues, including Membership fees
and revenues from associate services, from Canada of $8.7 million in U.S.
dollars during 2008 compared to $7.9 million and $7.1 million in 2007 and 2006,
respectively. In addition, we incur expenses in Canada in relation to these
revenues. As reflected in the attached Consolidated Statements of Comprehensive
Income, we have recorded negative foreign currency translation adjustments of
$2.0 million during 2008 and have a cumulative negative foreign currency
translation adjustment balance of $425,000 at December 31, 2008. These amounts
are subject to dramatic change in conjunction with the relative values of the
Canadian and U.S. dollars.
Availability of Information
We file periodic reports and proxy statements with the Securities and
Exchange Commission ("SEC"). The public may read and copy any materials we file
with the SEC at the SEC's Public Reference Room at 100 F Street, N. E.,
17
Washington, D.C. 20549. The public may obtain information about the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. We file our
reports with the SEC electronically. The SEC maintains an Internet site that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC. The address of this
site is http://www.sec.gov.
Our Internet address is www.prepaidlegal.com. We make available on our
website free of charge copies of our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments to those
reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon
as reasonably possible after we electronically file such material with, or
furnish it to, the SEC.
ITEM 1A. RISK FACTORS
----------------------
Our financial position, results of operations and cash flows are subject to
various risks, many of which are not exclusively within our control that may
cause actual performance to differ materially from historical or projected
future performance. Information contained within this Form 10-K should be
carefully considered by investors in light of the risk factors described below.
In addition to factors discussed elsewhere in this report, the following are
some of the important factors that could affect our financial condition or
results of operations:
Our future results may be adversely affected if Membership persistency or
---------------------------------------------------------------------------
renewal rates are lower than our historical experience.
-------------------------------------------------------
We have over 25 years of actual historical experience to measure the
expected retention of new members. These retention rates could be adversely
affected by the quality of services delivered by provider law firms, the
existence of competitive products or services, our ability to provide
administrative services to members or other factors. If our Membership
persistency or renewal rates are less than we have historically experienced, our
cash flow, earnings and growth rates could be adversely affected.
We may not be able to grow Memberships and revenues at the same rate as we
--------------------------------------------------------------------------------
have historically experienced and have recently experienced declines in new
--------------------------------------------------------------------------------
Membership sales and associate recruitment.
-------------------------------------------
Our year end active Memberships decreased 1.1% from December 31, 2007 to
December 31, 2008, increased 2.4% during 2007 and remained virtually unchanged
during 2006. Changes in net income for the same three years were 18%, (1%) and
45%, respectively. In years prior to 2004, we were able to grow Memberships more
significantly. Our ability to grow Memberships and revenues is substantially
dependent upon our ability to expand or enhance the productivity of our sales
force, develop additional legal expense products, develop alternative marketing
methods or expand geographically. There is no assurance that we will be able to
achieve increases in Membership and revenue growth comparable to our historical
growth rates.
We are dependent upon the continued active participation of our principal
--------------------------------------------------------------------------------
executive officer.
------------------
Our success depends substantially on the continued active participation of
our principal executive officer, Harland C. Stonecipher. Although our management
includes other individuals with significant experience in our business, the loss
of the services of Mr. Stonecipher could have a material adverse effect on our
financial condition and results of operations.
There is litigation pending that may have a material adverse effect on us
--------------------------------------------------------------------------------
if adversely determined.
------------------------
See "Item 3. Legal Proceedings." Any of the legal proceedings described in
Item 3 could have a material adverse effect on our financial condition and
results of operations.
We may have compromises of our information security.
----------------------------------------------------
We collect and store certain personal information that our members and
sales associates provide to purchase products or services, enroll in certain
programs, register on our web site, or otherwise communicate and interact with
us. We also gather and retain information about our employees, members and sales
associates in the normal course of business. We may share information about such
persons with vendors that assist with certain aspects of our business. We rely
on encryption and authentication technology licensed from third parties to
18
provide the security and authentication necessary to effect secure transmission
of confidential information such as member and sales associate credit card
numbers. We cannot provide assurance that advances in computer capabilities, new
discoveries in the field of cryptography or other events or developments will
not result in a compromise or breach of the algorithms or systems that we use to
protect customer transaction data. Despite these instituted safeguards for the
protection of such information, we cannot be certain that all of our systems are
entirely free from vulnerability to attack. A breach of our security system
resulting in member, sales associate or employee personal information being
obtained by unauthorized persons could adversely affect our reputation, disrupt
our operations and expose us to claims from employees, members, sales
associates, financial institutions, payment card associations and other persons,
which could have a material adverse effect on our business, financial condition
and results of operations. We may not comply with requirements placed on us by
payment card associations or other financial processors. In addition, our online
operations at www.prepaidlegal.com depend upon the secure transmission of
confidential information over public networks, including information permitting
cashless payments.
During a downturn in the economy, consumer purchases of discretionary items
--------------------------------------------------------------------------------
may be affected, which could materially harm our sales, retention rates,
--------------------------------------------------------------------------------
profitability and financial condition.
--------------------------------------
Although we believe our products and services can greatly assist our
members during these challenging economic times, consumer spending is generally
affected by a number of factors, including general economic conditions,
inflation, interest rates, energy costs, gasoline prices and consumer confidence
generally, all of which are beyond our control. Consumer purchases of
discretionary items tend to decline during recessionary periods, when disposable
income is lower, and such decline may impact sales and retention of our products
should potential members have less money for discretionary purchases as a result
of job losses, foreclosures, bankruptcies, reduced access to credit and sharply
falling home prices, among other things.
We are in a regulated industry and regulations could have an adverse effect
---------------------------------------------------------------------------
on our ability to conduct our business.
---------------------------------------
We are regulated by or required to file with or obtain approval of State
Insurance Departments, State Bar Associations and State Attorney General's
Offices, depending on individual state positions regarding regulatory
responsibility for legal service plans. Regulation of our activities is
inconsistent among the various states in which we do business with some states
regulating legal service plans as insurance or specialized legal service
products and others regulating such plans as services. Such disparate regulation
requires us to structure our Memberships and operations differently in certain
states in accordance with the applicable laws and regulations. Our multi-level
marketing strategy is also subject to U.S. federal, Canadian provincial and U.S.
state regulation under laws relating to consumer protection, pyramid sales,
business opportunity, lotteries and multi-level marketing. The U.S. Federal
Trade Commission has proposed business opportunity regulations which may have an
effect upon our method of operating in the United States, but such regulations
are in the early stages of development and it is not possible to gauge the
potential impact or the effective date at this time. Changes in the regulatory
environment for our business could increase the compliance costs we incur in
order to conduct our business or limit the jurisdictions in which we are able to
conduct business.
The business in which we operate is competitive.
------------------------------------------------
There are a number of existing and potential competitors that have the
ability to offer competing products that could adversely affect our ability to
grow. In addition, we may face competition from a growing number of Internet
based legal sites with the potential to offer legal and related services at
competitive prices. Increased competition could have a material adverse effect
on our financial condition and results of operations. See "Description of
Business - Competition."
We are dependent upon the success of our marketing force.
---------------------------------------------------------
Our principal method of product distribution is through multi-level
marketing. The success of a multi-level marketing force is highly dependent upon
our ability to offer a commission and organizational structure and sales
training and incentive program that enable sales associates to recruit and
develop other sales associates to create an organization. There are a number of
other products and services that use multi-level marketing as a distribution
19
method and we must compete with these organizations to recruit, maintain and
grow our multi-level marketing force. In order to do so, we may be required to
increase our marketing costs through increases in commissions, sales incentives
or other features, all of which could adversely affect our future earnings. In
addition, the level of confidence of the sales associates in our ability to
perform is an important factor in maintaining and growing a multi-level
marketing force. Adverse financial developments concerning us, including
negative publicity or common stock price declines, could adversely affect our
ability to maintain the confidence of our sales force.
Our stock price may be affected by short sellers of our stock.
--------------------------------------------------------------
As of January 31, 2009, the New York Stock Exchange reported that
approximately 1.5 million shares of our stock were sold short, which constitutes
approximately 14% of our outstanding shares and 20% of our public float. During
2008, the number of shares sold short was as high as 1.9 million and represented
one of the largest short interest positions of any New York Stock Exchange
listed company in terms of the number of average trading days it would take to
cover the short positions. Short sellers expect to make a profit if our shares
decline in value. We have been the subject of a negative publicity campaign from
several known sources of information who support short sellers. The existence of
this short interest position may contribute to volatility in our stock price and
may adversely affect the ability of our stock price to rise if market conditions
or our performance would otherwise justify a price increase.
We have not been able to significantly increase our employee group
---------------------------------------------------------------------------
Membership sales.
-----------------
Our success in growing Membership sales is dependent in part on our ability
to market to employee groups. At December 31, 2008, group memberships
represented 26% of total Memberships compared to 25% at December 31, 2007 and
24% at December 31, 2006. Adverse publicity about us may affect our ability to
market successfully to employee groups, particularly larger groups. There is no
assurance that we will be able to increase our group business.
We have repurchased more than half our outstanding shares over the past ten
---------------------------------------------------------------------------
years.
------
We announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of our common stock. The
Board of Directors has increased such authorization from 500,000 shares to 15
million shares through subsequent board actions. At June 30, 2009, we had
purchased 14.2 million treasury shares under these authorizations in both open
market and non-open market transactions for a total consideration of $421.2
million, an average price of $29.70 per share. The repurchase program of $421.2
million combined with $17.1 million in dividends has resulted in our returning
$438.3 million to shareholders since April 1999 and represents more than 100% of
our net earnings during the same timeframe. Our stock price, earnings per share
and cash flow would have been different had we invested these funds differently.
Additionally, due to these repurchases, the lower number of shares outstanding
could favorably impact our stock price assuming our net income remained
unchanged resulting in higher earnings per share. Conversely, these repurchases
may have contributed to lower average trading volume potentially leading to
reduced interest in our stock by large institution investors that typically make
larger investments. Any future treasury stock purchases could have a similar
impact on our stock price, earnings per share and cash flow.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
------------------------------------
None.
ITEM 2. PROPERTIES.
--------------------
Our executive and administrative offices and our subsidiaries are located
at One Pre-Paid Way, Ada, Oklahoma. The office complex, owned by us, contains
approximately 170,000 square feet of office space and was constructed on
approximately 87 acres contributed to us by the City of Ada in 2001 as part of
an economic development incentive package. Construction was completed in 2004 at
a cost of approximately $34.1 million, including $706,000 in capitalized
20
interest costs, and was funded from existing resources and proceeds from a $20
million line of credit.
Our headquarters contains two long bars of open office area designed to
serve as podiums, which stretch east from the northern and southern edges of the
tower. Two and three stories high respectively, the podiums house the call
centers and Information Technology departments. Only 60 feet across, they are
designed to ensure that employees are never more than thirty feet from a source
of daylight. Shared corporate services -- including a 650-seat auditorium,
dining hall, exercise facility, and a connecting corridor containing a company
history gallery -- are located at the east end of the bars, creating a central
courtyard. The courtyard features a reflecting pool and a 12-foot bronze
sculpture of our logo, the Lady of Justice, a universal symbol of justice. The
building's main entrance welcomes our frequent visitors, celebrates our history,
and is designed to convey the tradition of civic judicial buildings. Although we
substantially occupy our current facility, the building is designed to expand
over time without negatively impacting the site layout or the building concept
and we emphasized the use of modular furnishings to provide enhanced
flexibility. We placed importance on the goal of providing each employee with an
excellent work environment.
Additionally, we fully utilize another distribution facility located about
two miles from our new offices and containing approximately 17,000 square feet
of office and warehouse and shipping space. Our previous headquarters of
approximately 40,000 square feet and two other buildings containing
approximately 18,600 combined square feet located adjacent to the distribution
facility are now primarily used as disaster recovery, or business continuity,
sites as well as storage locations.
During January 2006, we acquired an additional 40,000 square foot building
in Duncan, Oklahoma for $1 million. We completely refurbished the space at an
additional cost of $3.4 million, resulting in total capitalized cost of $4.4
million, which was funded from existing resources. We moved from space
previously leased to the completely refurbished and redesigned space with
redundant infrastructure components in July 2006 and currently have
approximately 130 customer service representatives in the facility but have the
capacity to accommodate 350 employees.
In addition to the property described above that we own, we opened an
additional Customer Care facility in Antlers, Oklahoma during March 2000, in
building space provided by the City of Antlers. In conjunction with a rural
economic development program coordinated by the City of Antlers, a new facility
was built at no cost to us that can accommodate approximately 100 customer
service representatives. We leased the facilities from the City of Antlers upon
completion of the construction in November 2002 and currently have approximately
60 customer service representatives in the facility.
ITEM 3. LEGAL PROCEEDINGS.
---------------------------
Discussion of legal matters is incorporated by reference from Part II, Item
8, Note 13, "Commitments and Contingencies," of this document, and should be
considered an integral part of Part I, Item 3, "Legal Proceedings."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
-------------------------------------------------------------
We did not submit any matters to a vote of our stockholders during the
fourth quarter of 2008.
21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
--------------------------------------------------------------------------------
ISSUER PURCHASES OF EQUITY SECURITIES.
-------------------------------------
Market Price of and Dividends on the Common Stock
At February 19, 2009, there were 1,461 holders of record (including
brokerage firms and other nominees) of our common stock, which is listed on the
New York Stock Exchange under the symbol "PPD." The following table sets forth,
for the periods indicated, the range of high and low sales prices for the common
stock, as reported by the New York Stock Exchange.
High Low
---- ---
2009:
1st Quarter (through February 19)............... $ 38.06 $ 30.65
2008:
4th Quarter..................................... $ 41.58 $ 30.01
3rd Quarter..................................... 45.59 39.25
2nd Quarter..................................... 48.65 39.45
1st Quarter..................................... 57.50 42.34
2007:
4th Quarter..................................... $ 62.39 $ 48.88
3rd Quarter..................................... 71.49 39.50
2nd Quarter..................................... 66.34 48.89
1st Quarter..................................... 60.66 37.68
No dividends were declared in 2008, 2007 or 2006. It is anticipated that
earnings generated from our operations will be used to finance our growth, to
continue to purchase shares of our stock, to retire existing debt and possibly
pay cash dividends. Our ability to pay dividends is dependent in part on our
ability to derive dividends from our subsidiaries. The payment of dividends by
PPLCI is restricted under the Oklahoma Insurance Code to available surplus funds
derived from realized net profits and requires the approval of the Oklahoma
Insurance Commissioner for any dividend representing more than the greater of
10% of such accumulated available surplus or the previous years' net profits.
PPLSIF and LSPV are similarly restricted pursuant to their respective insurance
laws. The following table reflects subsidiary dividends during the last three
years:
Dividends Paid
----------------------------------------------------- Expected Dividends
Regulated Subsidiary 2008 2007 2006 1/1/2009
-------------------------------- -------------------- --------------- -------------- -------------------
Pre-Paid Legal Casualty, Inc. $ 14.9 millio $ 7.4 million $ 13.4 million $ -
Legal Service Plans of Virginia 4.1 million 1.6 million - -
At December 31, 2008 the amount of restricted net assets of consolidated
subsidiaries was $24.2 million, representing amounts that may not be paid to us
as dividends either under the applicable regulations or without regulatory
approval.
Recent Sales of Unregistered Securities
None.
22
Issuer Purchases of Equity Securities
The following table provides information about our purchases of stock in
the open market during the fourth quarter of 2008.
Total Number of Maximum Number of
Shares Purchased as Shares that May Yet
Part of Publicly Be Purchased Under
Total Number of Average Price Paid Announced Plans or the Plans or
Period Shares Purchased per Share Programs Programs (1)
----------------------- ---------------- ------------------ ------------------- --------------------
October 2008........... 12,287 $ 36.20 12,287 462,739
November 2008.......... 55,201 35.13 55,201 407,538
December 2008.......... 153,278 35.16 153,278 254,260
---------------- ------------------ -------------------
Total.................. 220,766 $ 35.21 220,766
---------------- ------------------ -------------------
-----------
(1) We announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of our common
stock in the open market. The Board of Directors has subsequently from
time to time increased such authorization from 500,000 shares to 15
million shares. The most recent authorization was for 1 million
additional shares on February 18, 2009 which is not reflected in the
year-end table above. There has been no time limit set for completion
of the repurchase program.
23
Shareholder Return Performance Graph
The following graph compares the cumulative total shareholder returns of
our Common Stock during the five years ended December 31, 2008 with the
cumulative total shareholder returns of the Russell 2000 Index and the Hemscott,
Inc. Personal Services industry index. The comparison assumes an investment of
$100 on January 1, 2004 in each of our Common Stock, the Russell 2000 Index and
Hemscott's Personal Services industry index and that any dividends were
reinvested.
[GRAPHIC OMITTED]
12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007 12/31/2008
---------- ---------- ---------- ---------- ---------- ----------
Pre-Paid Legal Services, Inc. 100.00 145.71 150.74 154.37 218.35 147.11
Personal Services 100.00 105.62 109.98 121.22 123.97 80.32
Russell 2000 Index 100.00 117.49 121.40 142.12 135.10 88.09
24
ITEM 6. SELECTED FINANCIAL DATA.
---------------------------------
The following table sets forth selected financial and statistical data for
us as of the dates and for the periods indicated. This information is not
necessarily indicative of our future performance. The following information
should be read in conjunction with our Consolidated Financial Statements and
Notes thereto and Management's Discussion and Analysis of Financial Condition
and Results of Operation included elsewhere herein.
Year Ended December 31,
----------------------------------------------------------------
2008 2007 2006 2005 2004
----------- ------------ ------------- ------------ ------------
Income Statement Data: (In thousands, except ratio, per share and Membership
amounts)
Revenues:
Membership fees...................................... $ 436,778 $ 427,428 $ 412,200 $ 389,255 $ 355,461
Associate services................................... 23,534 25,112 26,857 28,963 24,901
Other................................................ 4,177 4,549 4,967 5,162 5,575
----------- ------------ ------------- ------------ ------------
Total revenues..................................... 464,489 457,089 444,024 423,380 385,937
----------- ------------ ------------- ------------ ------------
Costs and expenses:
Membership benefits.................................. 150,318 148,792 145,771 137,150 122,280
Commissions.......................................... 126,758 130,593 126,762 141,631 118,757
Associate services and direct marketing.............. 23,582 28,875 29,493 30,453 29,325
General and administrative expenses.................. 53,021 50,474 50,078 49,015 43,742
Other, net........................................... 13,413 13,841 12,232 10,456 9,578
----------- ------------ ------------- ------------ ------------
Total costs and expenses........................... 367,092 372,575 364,336 368,705 323,682
----------- ------------ ------------- ------------ ------------
Income before income taxes............................... 97,397 84,514 79,688 54,675 62,255
Provision for income taxes............................... 37,225 33,312 27,890 18,863 21,478
----------- ------------ ------------- ------------ ------------
Net income............................................... $ 60,172 $ 51,202 $ 51,798 $ 35,812 $ 40,777
----------- ------------ ------------- ------------ ------------
Basic earnings per common share.......................... $ 5.05 $ 3.89 $ 3.54 $ 2.31 $ 2.50
----------- ------------ ------------- ------------ ------------
Diluted earnings per common share........................ $ 5.04 $ 3.88 $ 3.51 $ 2.29 $ 2.48
Dividends declared per common share...................... $ - $ - $ - $ .60 $ .50
Weighted avg. number of common shares outstanding - basic 11,916 13,151 14,642 15,470 16,313
Weighted avg. number of common shares outstanding - diluted 11,934 13,197 14,739 15,652 16,458
Membership Benefits Cost and Statistical Data:
Membership benefits ratio (1)........................... 34.4% 34.8% 35.4% 35.2% 34.4%
Commissions ratio (1)................................... 29.0% 30.6% 30.8% 36.4% 33.4%
General and administrative expense ratio (1)............ 12.1% 11.8% 12.1% 12.6% 12.3%
Commission cost per new Membership sold................. $ 229 $ 213 $ 207 $ 0 202 $ 190
New Memberships and stand-alone IDT plans sold.......... 552,327 612,096 612,726 700,727 624,525
Period end Memberships and stand-alone IDT plans in 1,559,154 1,575,802 1,538,740 1,542,789 1,451,700
force
New add-on IDT memberships sold......................... 344,869 381,419 389,157 441,108 335,792
Period end add-on IDT memberships in 680,862 631,910 540,253 461,094 283,889
force..............
Average annual Membership fee........................... $ 301 $ 298 $ 293 $ 287 $ 274
Cash Flow Data:
Net cash provided by operating activities................. 64,317 67,178 54,385 50,131 47,263
Net cash (used in) provided investing activities.......... (4,411) 30,064 (52,613) (15,545) (11,322)
Net cash used in financing activities.................... (58,319) (84,332) (23,698) (26,601) (31,428)
Balance Sheet Data:
Total assets............................................ $ 162,843 $ 167,632 $ 188,547 $ 164,865 $ 146,064
Total liabilities....................................... 131,036 149,793 157,687 113,471 114,617
Stockholders' 31,807 17,839 30,860 51,394 31,447
equity....................................
Income Statement Data:
Depreciation and amortization expense................... $ 8,756 $ 8,532 $ 8,260 $ 7,489 $ 7,709
Interest expense........................................ 4,221 6,678 5,726 2,682 1,990
-----------
25
(1) The Membership benefits ratio, the commissions ratio and the general and
administrative expense ratio represent those costs as a percentage of
Membership fees. These ratios do not measure total profitability because
they do not take into account all revenues and expenses.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
------------------------------------------------------------------------
RESULTS OF OPERATIONS.
----------------------
Overview of the Our Financial Model
We are in one line of business - the marketing of legal expense and other
complimentary plans through a multi-level marketing force to individuals and a
direct sales force to employee groups. Our principal revenues are derived from
Membership fees, and to a much lesser extent, revenues from marketing
associates. Our principal expenses are commissions, Membership benefits,
associate services and direct marketing costs and general and administrative
expense. The following table reflects the changes in these categories of
revenues and expenses in the last three years (dollar amounts in 000's):
% % %
Change Change Change
% of from % of from % of from
Total Prior Total Prior Total Prior
Revenues: 2008 Revenue Year 2007 Revenue Year 2006 Revenue Year
--------- --------- ------ --------- ---------- ------ --------- --------- ---------
Membership fees............ $ 436,778 94.0 2.2 $ 427,428 93.5 3.7 $412,200 92.8 5.9
Associate services......... 23,534 5.1 (6.3) 25,112 5.5 (6.5) 26,857 6.1 (7.3)
Other...................... 4,177 0.9 (8.2) 4,549 1.0 (8.4) 4,967 1.1 (3.8)
--------- --------- ------ --------- ---------- ------ --------- --------- ---------
464,489 100.0 1.6 457,089 100.0 2.9 444,024 100.0 4.9
--------- --------- ------ --------- ---------- ------ --------- --------- ---------
Costs and expenses:
Membership benefits........ 150,318 32.4 1.0 148,792 32.6 2.1 145,771 32.8 6.3
Commissions................ 126,758 27.3 (2.9) 130,593 28.6 3.0 126,762 28.6 (10.5)
Associate services and
direct marketing......... 23,582 5.1 (18.3) 28,875 6.3 (2.1) 29,493 6.6 (3.2)
General and administrative. 53,021 11.4 5.0 50,474 11.0 0.8 50,078 11.3 2.2
Other, net................. 13,413 2.9 (3.1) 13,841 3.0 13.2 12,232 2.8 17.0
--------- --------- ------ --------- ---------- ------ --------- --------- ---------
367,092 79.1 (1.5) 372,575 81.5 2.3 364,336 82.1 (1.2)
--------- --------- ------ --------- ---------- ------ --------- --------- ---------
Provision for income taxes... 37,225 8.0 11.7 33,312 7.3 19.4 27,890 6.3 47.9
--------- --------- ------ --------- ---------- ------ --------- --------- ---------
Net Income................... $ 60,172 12.9 17.5 $ 51,202 11.2 (1.2) $ 51,798 11.6 44.6
--------- --------- ------ --------- ---------- ------ --------- --------- ---------
The following table reflects certain data concerning our Membership sales and
associate recruiting:
% Change % Change
from from
New Memberships: 2008 Prior Year 2007 Prior Year 2006
---------------- ---------- ---------- ---------- ---------- ----------
New legal service Membership sales.................... 521,522 (8.6) 570,637 (2.4) 584,408
New "stand-alone" IDT Membership sales................ 30,805 (25.7) 41,459 46.4 28,318
---------- ---------- ---------- ---------- ----------
Total new Membership sales................... 552,327 (9.8) 612,096 (0.1) 612,726
---------- ---------- ---------- ---------- ----------
New "add-on" IDT Membership sales..................... 344,869 (9.6) 381,419 (2.0) 389,157
Average annual Membership fee......................... $324.52 1.0 $321.18 (2.2) $328.36
Active Memberships:
Active legal service memberships at end of period..... 1,469,315 (1.5) 1,492,341 1.3 1,473,710
Active "stand-alone" IDT memberships at end of period. 89,839 7.6 83,461 28.3 65,030
---------- ---------- ---------- ---------- ----------
Total active memberships at end of period.... 1,559,154 (1.1) 1,575,802 2.4 1,538,740
---------- ---------- ---------- ---------- ----------
Active "add-on" IDT memberships at end of period...... 680,862 7.7 631,910 17.0 540,253
New Sales Associates:
New sales associates recruited........................ 122,255 (17.8) 148,802 (14.0) 172,999
Average enrollment fee paid by new sales associates... $71.53 26.0 $56.75 14.2 $49.69
Average Membership fee in force:
Average Annual Membership fee......................... $300.80 1.1 $297.62 1.6 $293.00
26
The number of active Memberships in force and the average monthly fee will
directly determine Membership fees and their impact on total revenues during any
period. The two most important variables impacting the number of active
Memberships during a period are the number of new Memberships written during the
period combined with the retention characteristics of both new and existing
Memberships. See "Measures of Member Retention" below for a discussion of our
Membership retention. Associate services revenues are a function of the number
of new sales associates enrolled and the price of entry during the period, the
number of associates subscribing to our eService offering and the amount of
sales tools purchased by the sales force.
Membership benefits expense is primarily determined by the number of active
Memberships and the per capita contractual rate that exists between us and our
benefits providers. During the last five years has been and is expected to
continue to be a relatively consistent percentage of Membership revenues of
approximately 34%-35%. Commissions paid to associates are primarily dependent on
the number and price of new Memberships sold during a period and any special
incentives that may be in place during the period. We expense advance
commissions ratably over the first month of the related Membership. The level of
commission expense in relation to Membership revenues varies depending on the
level of new Memberships written and is expected to be higher when we experience
increases in new Membership sales. During the last five years this percentage
has ranged from approximately 29% to 36% of Membership revenues. Associate
services and direct marketing expenses are directly impacted by the number of
new associates enrolled during a period due to the cost of materials provided to
such new associates, the number of associates subscribing to our eService
offering, the amount of sales tools purchased by the sales force as well as the
number of those associates who successfully meet the incentive award program
qualifications. General and administrative expenses are expected to trend up in
terms of dollars, but remain relatively constant as a percent of Membership
fees. During the past five years, general and administrative expenses have
ranged from 12% to 13% of Membership fees.
The primary benchmarks monitored by us throughout the various periods
include the number of active Memberships and their related retention
characteristics, the number of new Memberships written and the number of new
associates enrolled.
Although we have grown our Membership fees in each of the past 16 years,
the rate of growth has not been one we find acceptable. We believe however, that
our current product design, pricing parameters and business model are generally
appropriate and we have no immediate plans to change these fundamental sectors.
Instead of making changes to our basic product and business model, we believe
changes must be made to our marketing methods to increase the exposure of our
products and business opportunity. We will consider an increased focus on
benefit brokers, independent insurance agents and small businesses as well as
considering additional methods of distribution such as an increased focus on
Internet based marketing efforts. We will also consider increased incentives
such as enhancements to our basic commission structure as well as increased use
of performance bonuses. Should we implement additional commissions or bonuses,
our marketing related expenses will be increased which may be partially or fully
offset by increased Membership fees. Our focus during 2009 will continue to be
on improved training of our associates, enhancing the quality of sales tools
provided to new and existing associates, providing incentives for associates to
write consistent, quality business and continued emphasis on improving the basic
retention characteristics of our Memberships.
Critical Accounting Policies
Our financial statements and accompanying notes are prepared in accordance
with accounting principles generally accepted in the United States of America.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses. These estimates and assumptions are affected by management's
application of accounting policies. If these estimates or assumptions are
incorrect, there could be a material change in our financial condition or
operating results. Many of these "critical accounting policies" are common in
the insurance and financial services industries; others are specific to our
business and operations. Our critical accounting policies include estimates
relating to revenue recognition related to Membership and associate fees,
deferral of Membership and associate related costs, expense recognition related
27
to commissions to associates, accrual of incentive awards payable and accounting
for legal contingencies.
Revenue recognition - Membership and Associate Fees
Our principal revenues are derived from Membership fees, most of which are
collected on a monthly basis. Memberships are generally guaranteed renewable and
non-cancelable except for fraud, non-payment of Membership fees or upon written
request. Membership fees are recognized in income ratably over the related
service period in accordance with Membership terms, which generally require the
holder of the Membership to remit fees on an annual, semi-annual or monthly
basis. Approximately 95% of members remit their Membership fees on a monthly
basis. The majority of our Memberships that pay us via credit card or automatic
bank draft pay us in advance. At December 31, 2008, approximately 69% of our
legal service Memberships and our IDT Memberships were paid in advance and,
therefore, those payments are deferred and recognized over their respective
periods. At December 31, 2008 the deferred revenue associated with the
Membership fees was $21.1 million which is classified as a current liability.
We also charge new members, who are not part of an employee group, a $10
enrollment fee. This enrollment fee and related incremental direct and
origination costs are deferred and recognized in income over the estimated life
of a Membership in accordance with SEC Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements," ("SAB 101") as revised by SEC
Staff Accounting Bulletin No. 104. At December 31, 2008 the deferred revenue
associated with the Membership enrollment fees was $4.8 million, of which $2.0
million was classified as a current liability. We compute the expected
Membership life using more than 25 years of actuarial data as explained in more
detail in "Measures of Membership Retention" below. At December 31, 2008,
management computed the expected Membership life to be approximately three
years, which is unchanged from year end 2007. If the expected Membership life
were to change significantly, which management does not expect in the short
term, the deferred Membership enrollment fee and related costs would be
recognized over a longer or shorter period.
We derive revenues from services provided to our marketing sales force
including a one-time non-refundable enrollment fee from each new sales associate
for which we provide initial sales and marketing supplies and enrollment
services to the associate. Average enrollment fees paid by new sales associates
were $72, $57 and $50 for 2008, 2007 and 2006, respectively. Revenue from, and
costs of, the initial sales and marketing supplies (approximately $13) are
recognized when the materials are delivered to the associates. The remaining
revenues and related incremental direct and origination costs are deferred and
recognized over the estimated average active service period of associates which
at December 31, 2008 is estimated to be approximately five months, which is
unchanged from year end 2007. At December 31, 2008, the deferred revenue
associated with sales associate enrollment fees was $764,000, which is
classified as a current liability. Management estimates the active service
period of an associate periodically based on the average number of months an
associate produces new Memberships including those associates that fail to write
any Memberships. If the active service period of associates changes
significantly, which management does not expect in the short term, the deferred
revenue and related costs would be recognized over the new estimated active
service period.
Member and Associate Costs
Deferred costs represent the incremental direct and origination costs we
incur in enrolling new Members and new associates related to the deferred
revenue discussed above, and that portion of payments made to provider law firms
($7.0 million deferred at December 31, 2008 which is classified as a current
asset) and associates related to deferred Membership revenue. Deferred costs for
enrolling new members include the cost of the Membership kit and salary and
benefit costs for employees who process Membership enrollments, and were $4.8
million at December 31, 2008, of which $2.0 million is classified in current
assets. Deferred costs for enrolling new associates include training and success
bonuses paid to individuals involved in recruiting the associate and salary and
benefit costs of employees who process associate enrollments, and were $699,000
at December 31, 2008, and are classified as a current asset. Such costs are
deferred to the extent of the lesser of actual costs incurred or the amount of
the related fee charged for such services. Deferred costs are amortized to
expense over the same period as the related deferred revenue as discussed above.
28
Deferred costs that will be recognized within one year of the balance sheet date
are classified as current and all remaining deferred costs are considered
noncurrent. Associate related costs are reflected as associate services and
direct marketing, and are expensed as incurred if not related to the deferred
revenue discussed above. These costs include providing materials and services to
associates, associate introduction kits, associate incentive programs, group
marketing and marketing services departments (including costs of related travel,
marketing events, leadership summits and international sales convention).
Commissions to Associates
Prior to March 1, 1995, our commission program provided for advance
commission payments to associates of approximately 70% of first year Membership
fees on new Membership sales and commissions were earned by the associate at a
rate of approximately 16% in all subsequent years. Beginning with new
Memberships written after March 1, 1995, we implemented a level commission
schedule of approximately 27% per annum with up to a three-year advance
commission payment. Effective March 1, 2002, and in order to offer additional
incentives for increased Membership retention rates, we returned to a
differential commission structure with rates of approximately 80% of first year
Membership fees on new Memberships written and variable renewal commission rates
ranging from five to 25% per annum based on the first 12 month Membership
retention rate of the associate's personal sales and those of his organization.
Beginning in August 2003, we allowed the associate to choose between the level
commission structure and up to a three year commission advance or the
differential commission structure with a one year commission advance.
Prior to January 1997 we advanced commissions at the time of sale of all
new Memberships. In January 1997, we implemented a policy whereby the associate
received only earned commissions on the first three sales unless the associate
met specified criteria. For all sales beginning with the fourth Membership or
all sales made by an associate who met the specified criteria, advance
commission payments were made at the time of sale of a new Membership. Beginning
April 1, 2007, we began advancing commissions at the time of sale of all new
Memberships. 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 nine, the overall initial advance may be paid to
approximately 30 different individuals, each at a different level within the
overall commission structure. The commission advance immediately increases an
associate's unearned advance commission balance to us.
Although prior to March 1, 2002, we advanced our sales associates up to
three years commission when a Membership was sold and subsequent to March 1,
2002, up to one year commission, the average commission advance paid to our
sales associates as a group is actually less than the maximum amount possible
because some associates choose to receive less than a full advance and we pay
less than a full advance on some of our specialty products. In addition, we may
from time to time place associates on a less than full advance basis if there
are problems with the quality of the business being submitted or other
performance problems with an associate. Additionally, we do not advance
commissions on certain categories of group business which have historically
demonstrated below average retention characteristics. Also, any residual
commissions due an associate (defined as commission on an individual Membership
after the advance has been earned) are retained to reduce any remaining unearned
commission advance balances prior to being paid to that sales associate. For
those associates that have made at least 10 personal sales, opened at least one
group and personally write 15% or more of their organizational business, 15% of
their commissions are set aside in individual reserve balance accounts, further
reducing the amount of advance commissions. The average commission advance paid
as a percentage of the maximum advance possible pursuant to our commission
structures was approximately 88%, 82% and 78% during 2008, 2007 and 2006,
respectively. The commission cost per new Membership sold has increased over the
prior year by 8%, 3% and 2% for 2008, 2007 and 2006, respectively, and varies
depending on the compensation structure that is in place at the time a new
Membership is sold, the monthly Membership fee of the Membership sold and the
amount of any charge-backs (recoupment of previous commission advances) that are
deducted from amounts that would otherwise be paid to the various sales
associates that are compensated for the Membership sale. Should we add
additional products, such as the Identity Theft Shield described above or add
additional commissions to our compensation plan or reduce the amount of
chargebacks collected from our associates, the commission cost per new
Membership will increase accordingly.
29
We expense advance commissions ratably over the first month of the related
Membership. At December 31, 2008, advance commissions deferred were $5.3 million
and included as a current asset. As a result of this accounting policy, our
commission expenses are all recognized over the first month of a Membership and
there is no commission expense recognized for the same Membership during the
remainder of the advance period. We track our unearned advance commission
balances outstanding in order to ensure the advance commissions are recovered
before any renewal commissions are paid and for internal purposes of analyzing
our commission advance program. While not recorded as an asset, unearned advance
commission balances from associates for the following years ended December 31
were:
2008 2007 2006
------------ ------------ -------------
(Amounts in 000's)
Beginning unearned advance commission balances (1)..................$ 184,531 $ 188,647 $ 195,792
Advance commissions, net of chargebacks and other.................... 120,908 126,880 121,737
Earned commissions applied........................................... (127,496) (126,836) (124,983)
Advance commission write-offs........................................ (3,572) (4,160) (3,899)
------------ ------------ -------------
Ending unearned advance commission balances before estimated
unrecoverable balances (1)......................................... 174,371 184,531 188,647
Estimated unrecoverable advance commission balances (1).............. (44,526) (42,850) (40,091)
------------ ------------ -------------
Ending unearned advance commission balances, net (1)............... $ 129,845 $ 141,681 $ 148,556
------------ ------------ -------------
(1) These amounts do not represent fair value, as they do not take into
consideration timing of estimated recoveries.
The ending unearned advance commission balances, net, above includes net
unearned advance commission balances of non-vested associates of $62 million,
$56 million and $49 million at December 31, 2008, 2007 and 2006, respectively.
As such, at December 31, 2008 future commissions and related expense will be
reduced as unearned advance commission balances of $68 million are recovered.
Commissions are earned by the associate as Membership fees are earned by us,
usually on a monthly basis. We reduce unearned advance commission balances or
remit payments to associates, as appropriate, when commissions are earned.
Should a Membership lapse before the advances have been recovered for each
commission level, we, except as described below, generate an immediate
"charge-back" to the applicable sales associate to recapture up to 50% of any
unearned advance on Memberships written prior to March 1, 2002, and 100% on any
Memberships written thereafter. Beginning in August 2003, we allowed the
associate to choose between the level commission structure and up to three year
commission advance and up to 50% chargebacks or the differential commission
structure with a one year commission advance and up to 100% chargebacks. This
charge-back is deducted from any future advances that would otherwise be payable
to the associate for additional new Memberships. In order to encourage
additional Membership sales, we waived chargebacks for associates that met
certain criteria in December 2002 and March 2003, which effectively increased
our commission expense. Any remaining unearned advance commission balance may be
recovered by withholding future residual earned commissions due to an active
associate on active Memberships. Additionally, even though a commission advance
may have been fully recovered on a particular Membership, no additional
commission earnings from any Membership are paid to an associate until all
previous advances on all Memberships, both active and lapsed, have been
recovered. We also have reduced chargebacks from 100% to 50% for certain senior
marketing associates who have demonstrated the ability to maintain certain
levels of sales over specified periods and maintain certain Membership retention
levels. We may adjust chargebacks from time to time in the future in order to
encourage certain production incentives.
We have the contractual right to require associates to repay unearned
advance commission balances from sources other than earned commissions including
cash (a) from all associates either (i) upon termination of the associate
relationship, which includes but is not limited to when an associate becomes
non-vested or (ii) when it is ascertained that earned commissions are
insufficient to repay the unearned advance commission payments and (b) upon
demand, from agencies or associates who are parties to the associate agreements
signed between October 1989 and July 1992 or July 1992 to August 1998,
respectively. The sources, other than earned commissions, that may be available
to recover associate unearned advance commission balances are potentially
30
subject to limitation based on applicable state laws relating to creditors'
rights generally. Historically, we have not demanded repayments of the unearned
advance commission balances from associates, including terminated associates,
because collection efforts would likely increase costs and have the potential to
disrupt our relationships with our sales associates. This business decision by
us has a significant effect on our cash flow by electing to defer collection of
advance payments of which approximately $44.5 million were not expected to be
collected from future commissions at December 31, 2008. However, we regularly
review the unearned advance commission balance status of associates and will
exercise our right to require associates to repay advances when management
believes that such action is appropriate.
Non-vested associates are those that are no longer "vested" because they
fail to meet our established vesting requirements by selling at least three new
Memberships per quarter or retaining a personal Membership. Non-vested
associates lose their right to any further commissions earned on Memberships
previously sold at the time they become non-vested. As a result we have no
continuing obligation to individually account to these associates as we do to
active associates and are entitled to retain all commission earnings that would
be otherwise payable to these terminated associates. We do continue to reduce
the unearned advance commission balances for commissions earned on active
Memberships previously sold by those associates. Substantially all individual
non-vested associate unearned advance commission balances were less than $1,000
and the average balance was $392 at December 31, 2008.
Although the advance commissions are expensed ratably over the first month
of the related Membership, we assess, at the end of each quarter, on an
associate-by-associate basis, the recoverability of each associate's unearned
advanced commission balance by estimating the associate's future commissions to
be earned on active Memberships. Each active Membership is assumed to lapse in
accordance with our estimated future lapse rate, which is based on our actual
historical Membership retention experience as applied to each active
Membership's year of origin. The lapse rate is based on our more than 25-year
history of Membership retention rates, which is updated quarterly to reflect
actual experience. We also closely review current data for any trends that would
affect the historical lapse rate. The sum of all expected future commissions to
be earned for each associate is then compared to that associate's unearned
advance commission balance. We estimate unrecoverable advance commission
balances when expected future commissions to be earned on active Memberships
(aggregated on an associate-by-associate basis) are less than the unearned
advance commission balance. If an associate with an outstanding unearned advance
commission balance has no active Memberships, the unearned advance commission
balance is written off but has no financial statement impact as advance
commissions are expensed ratably over the first month of the related
Memberships. Refer to "Measures of Member Retention - Expected Membership Life,
Expected Remaining Membership Life" for a description of the method used by us
to estimate future commission earnings.
Further, our analysis of the recoverability of unearned advance commission
balances is also based on the assumption that the associate does not write any
new Memberships. We believe that this assessment methodology is highly
conservative since our actual experience is that many associates do continue to
sell new Memberships and we, through our chargeback rights, gain an additional
source to recover unearned advance commission balances.
Changes in our estimates with respect to recoverability of unearned
commissions could occur if the underlying Membership persistency changes from
historical levels. Should Membership persistency decrease, the unearned
commissions would be recovered over a longer period and the amount not recovered
would most likely increase, although any increase in uncollectible unearned
commissions would not have any immediate expense impact since the commission
advances are expensed in the month they are incurred. Holding all other factors
constant, the decline in persistency would also lead to lower Membership fees,
less net income and less cash flow from operations. Conversely, should
persistency increase, the unearned commissions would be recovered more quickly,
the amount unrecovered would decrease and, holding all other factors constant,
we would enjoy higher Membership fees, more net income and more cash flow from
operations.
31
Incentive awards payable
Associates can earn the right to attend an annual incentive trip by meeting
monthly qualification requirements for the entire calendar year and maintaining
certain personal retention rates for the Memberships sold during the calendar
year. Associates can also earn the right to receive additional monthly bonuses
by meeting the monthly qualification requirements for twelve consecutive months
and maintaining certain personal retention rates for the Memberships sold during
that twelve month period. The incentive awards payable at any date is estimated
based on an evaluation of the existing associates that have met the monthly
qualifications, any changes to the monthly qualification requirements, the
estimated cost for each incentive earned and the number of associates that have
historically met the personal retention rates. At December 31, 2008, the accrued
amount payable was $3.1 million. Changes to any of these assumptions would
directly affect the amount accrued but we do not expect any of the significant
trends impacting this account to change significantly in the near term.
Legal Contingencies
We are subject to various legal proceedings and claims, the outcomes of
which are subject to significant uncertainty. Given the inherent
unpredictability of litigation, it is difficult to estimate the impact of
litigation on our financial condition or results of operation. SFAS 5,
Accounting for Contingencies, requires that an estimated loss from a loss
contingency be accrued by a charge to income if it is probable that an asset has
been impaired or a liability has been incurred and the amount of the loss can be
reasonably estimated. Disclosure of a contingency is required if there is at
least a reasonable possibility that a loss has been incurred. We evaluate, among
other factors, the degree of probability of an unfavorable outcome and the
ability to make a reasonable estimate of the amount of loss. We have established
an accrued liability we believe will be sufficient to cover estimated damages in
connection with various cases, which at December 31, 2008 was $500,000. This
process requires subjective judgment about the likely outcomes of litigation.
Liabilities related to most of our lawsuits are especially difficult to estimate
due to the nature of the claims, limitation of available data and uncertainty
concerning the numerous variables used to determine likely outcomes or the
amounts recorded. Litigation expenses are recorded as incurred and we do not
accrue for future legal fees. It is possible that an adverse outcome in certain
cases or increased litigation costs could have an adverse effect upon our
financial condition, operating results or cash flows in particular quarterly or
annual periods. See "Legal Proceedings."
Other General Matters
Operating Ratios
Three principal operating measures monitored by us in addition to measures
of Membership retention are the Membership benefits ratio, commission ratio and
the general and administrative expense ratio. The Membership benefits ratio, the
commissions ratio and the general and administrative expense ratio represent
those costs as a percentage of Membership fees. We strive to maintain these
ratios as low as possible while at the same time providing adequate incentive
compensation to our sales associates and provider law firms. These ratios do not
measure total profitability because they do not take into account all revenues
and expenses.
Cash Flow Considerations Relating to Sales of Memberships
We generally advance significant commissions at the time a Membership is
sold. Since approximately 95% of Membership fees are collected on a monthly
basis, a significant cash flow deficit is created at the time a Membership is
sold. This deficit is reduced as monthly Membership fees are remitted and no
additional commissions are paid on the Membership until all previous unearned
advance commission balances have been fully recovered. Since the cash advanced
at the time of sale of a new Membership may be recovered over a multi-year
period, cash flow from operations may be adversely affected depending on the
number of new Memberships written in relation to the existing active base of
Memberships and the composition of new or existing sales associates producing
such Memberships.
Investment Policy
Our investment policy is to some degree controlled by certain insurance
regulations, which, coupled with management's own investment philosophy, results
in a conservative investment portfolio that is not risk oriented. Our investment
purchases consist of investment grade bonds primarily issued by corporations,
the United States Treasury, and state and municipal tax-exempt bonds,
32
certificates of deposit, auction rate securities and EURO deposits. We are
required to pledge investments to various state insurance departments as a
condition to obtaining authority to do business in certain states.
Recently Issued Accounting Pronouncements
Information regarding recently issued accounting pronouncements is included
in Note 1 to the Consolidated Financial Statements.
Measures of Member Retention
One of the major factors affecting our profitability and cash flow is our
ability to retain a Membership, and therefore continue to receive fees, once it
has been sold. We monitor our overall Membership persistency rate, as well as
the retention rates with respect to Memberships sold by individual associates
and agents and retention rates with respect to Memberships by year of issue,
geographic region, utilization characteristics and payment method, and other sub
groupings.
Terminology
The following terms are used in describing the various measures of
retention:
o Membership life is a period that commences on the day of initial enrollment
of a member and continues until the individual's Membership eventually
terminates or lapses (the terms terminate or lapse may be used
interchangeably here).
o Membership age means the time since the Membership has been in effect.
o Lapse rate means the percentage of Memberships of a specified group of
Memberships that lapse in a specified time period.
o Retention rate is the complement of a lapse rate, and means the percentage
of Memberships of a specified group that remain in force at the end of a
specified time period.
o Persistency and retention are used in a general context to mean the
tendency for Memberships to continue to remain in force, while the term
persistency rate is a specific measure that is defined below.
o Lapse rates, retention rates, persistency rates, and expected Membership
life may be referred to as measures of Membership retention.
o Expected Membership life means the average number of years a new Membership
is expected to remain in force.
o Blended rate when used in reference to any measure of member retention
means a rate computed across a mix of Memberships of various Membership
ages.
o Expected remaining Membership life means the number of additional years
that an existing member is expected to continue to renew from a specific
point in time based on the Membership life.
Variations in Membership Retention by Sub-Groups, Impact on Aggregate
Numbers Companywide 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.
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Measures of Membership retention of different sub-groups may vary. For
example, our experience indicates that first year retention rate of Memberships
owned by members who have accessed the services of the provider law firms
historically have higher retention rates than those who have not. They also
likely have a better understanding and appreciation of the benefits of the
Membership, which may have contributed in fact to their decision to keep their
Membership active.
All aggregate measures of Membership retention or expected life may be
impacted by shifts in the underlying enrollment mix of sub-groups that have
different retention rates. A shift in mix alone could, over time, cause an
increase in reported aggregate retention measures and expected member life, even
if the retention rates within each sub-group do not change. It is important to
note that all blended rates discussed here may reflect the impact of such shifts
in enrollment mixes. The following table presents new Memberships produced,
Memberships canceled and ending active Memberships for members who are sales
associates, and the respective percentage, and members who are not sales
associates.
Memberships Produced Memberships Canceled Active Memberships
c Assoc s Assoc s Assoc
Year Non-Asso Assocs Total % Non-Assoc Assocs Total % Non-Assoc Assocs Total %
2004 535,295 89,230 624,525 14.3 (510,007) (81,815) (591,822) 16.0 1,148,569 303,131 1,451,700 20.9
2005 480,437 220,290 700,727 31.4 (496,710) (112,928) (609,638) 18.5 1,132,296 410,493 1,542,789 26.6
2006 477,937 134,789 612,726 22.0 (466,561) (150,214) (616,775) 24.4 1,143,672 395,068 1,538,740 25.7
2007 498,072 114,024 612,096 18.6 (456,704) (118,330) (575,034) 20.6 1,185,040 390,762 1,575,802 24.8
2008 457,000 95,327 552,327 17.3 (499,894) (69,081) (568,975) 12.1 1,142,146 417,008 1,559,154 26.7
Variations in Retention over Life of a Membership, Impact on Aggregate
Measures
Measures of member retention also vary significantly by the Membership age.
Historically, we have observed that Memberships in their first year have a
significantly higher lapse rate than Memberships in their second year, and so
on. The following chart shows the historical observed lapse rates and
corresponding yearly retention rates as a function of Membership age. For
example, 49.3% of all new Memberships lapse during the first year, leaving 50.7%
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, 2008 and 2007 our blended retention rate and lapse rates based on
our historical experience for the last 25 years.
Membership Retention versus Membership Age
----------------------------------------------------------------------------------------
As of December 31, 2008 As of December 31, 2007
------------------------------------ ---------------------------------
Yearly Yearly
Lapse Yearly End of Year Membership Lapse Yearly End of Year
Rate Retention Memberships Year Rate Retention Memberships
-------- --------- ----------- --------------- ------ ----------- -----------
100.0 0 100.0
49.3% 50.7% 50.7 1 49.4% 50.6% 50.6
32.2% 67.8% 34.4 2 32.0% 68.0% 34.4
23.7% 76.3% 26.2 3 23.0% 77.0% 26.5
18.1% 81.9% 21.5 4 18.5% 81.5% 21.6
15.0% 85.0% 18.3 5 14.8% 85.2% 18.4
12.5% 87.5% 16.0 6 10.3% 89.7% 16.5
8.5% 91.5% 14.6 7 7.9% 92.1% 15.2
Membership Persistency
Our Membership persistency rate is a specific computation that measures the
number of Memberships in force at the end of a year as a percentage of the total
of (i) Memberships in force at the beginning of such year, plus (ii) new
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Memberships sold during such year. From 1981 through the year ended December 31,
2008, our annual Membership persistency rates, using the foregoing method, have
averaged approximately 72.0%.
Beginning New Ending
Year Memberships Memberships Total Memberships Persistency
---- ----------- --------------- --------- ----------- -----------
2004 1,418,997 624,525 2,043,522 1,451,700 71.0%
2005 1,451,700 700,727 2,152,427 1,542,789 71.7%
2006 1,542,789 612,726 2,155,515 1,538,740 71.4%
2007 1,538,740 612,096 2,150,836 1,575,802 73.3%
2008 1,575,802 552,327 2,128,129 1,559,154 73.3%
Our overall Membership persistency rate varies based on, among other
factors, the relative age of total Memberships in force, and shifts in the mix
of members enrolled. Our overall Membership persistency rate could become lower
when the Memberships in force include a higher proportion of newer Memberships,
as will happen following periods of rapid growth. Our overall Membership
persistency rate could also become lower when the new enrollments include a
higher proportion of non-associate members.
Unless offset by other factors, these factors could result in a decline in
our overall Membership persistency rate as determined by the formula described
above, but does not necessarily indicate that the new Memberships written are
less persistent.
Expected Membership Life
Using historical data through 2008 for all past Members enrolled, the
expected Membership life can be computed to be approximately three years. This
number represents the average number of years a new Membership can be expected
to remain in force. Although about half of all new Memberships may lapse in the
first year, the expected Membership life is much longer due to the contribution
of higher annual retention rates in subsequent years.
Since our experience is that the retention rate of a given generation of
new Memberships improves with Membership age, the expected remaining Membership
life of a Membership also increases with Membership age. For example, while a
new Membership may have an expected Membership life of three years, the expected
remaining Membership life of a Membership that reaches its first year
anniversary is approximately 4.8 years.
Since the actual population of Memberships in force at any time is a
distribution of ages from zero to more than 25 years, the expected remaining
Membership life of the entire population at large greatly exceeds four years per
Membership. As of December 31, 2008, based on the historical data described
above, the current expected remaining Membership life of the actual population
is approximately 8.9 years per Membership. This measure is used by us to
estimate the future revenues expected from Memberships currently in place.
Expected Membership life measures are based on more than 25 years of
historical Membership retention data, unlike the Membership persistency rate
described above which is computed from, and determined by, the most recent
one-year period only. Both or these measures however include data from
Memberships of all Membership ages and hence are referred to as "blended"
measures.
Actions that May Impact Retention in the Future
The potential impact on our future profitability and cash flow due to
future changes in Membership retention can be significant. While blended
retention rates have not changed dramatically over the past five years, we have
implemented several initiatives aimed at improving the retention rate of both
new and existing Memberships. Such initiatives include an optional revised
compensation structure featuring variable renewal commission rates ranging from
five to 25% per annum based on the 12 month Membership retention rate of the
associate's personal sales and those of his organization and implementation of a
"non-taken" administrative fee to sales associates of $35 for any Membership
35
application that is processed but for which a payment is never received. We have
designed and implemented an enhanced member "life cycle" communication process
aimed at both increasing the overall amount of communication from us to the
members as well as more specific target messaging to members based on the length
of their Membership as well as utilization characteristics.
During 2006, we began providing an additional service focused on Membership
retention, Member Advantage Services, to our associates for a one-time fee of
$5.95 per Membership. This service consists of several out-bound calls, emails
and letters by our employees during the first year of the Membership as well as
out-bound calls to the member any time the Membership moves into pre-cancel
status throughout the life of the Membership. We verify the Membership data in
our files on the very first call and make any necessary changes immediately as
well as fully explain the Membership benefits and answer any questions the
member may have, essentially reselling the Membership. We provide Provider law
firm contact information and make sure the member understands how to contact
their Provider. We encourage our members to immediately begin the process of
having their will prepared and also help the member begin the credit monitoring
process for Identity Theft Shield members. We believe that such efforts may
ultimately increase the utilization by members and therefore lead to higher
retention rates. We intend to continue to develop programs and initiatives
designed to improve retention. At December 31, 2008 approximately 612,000
Memberships were part of our Member Advantage Services.
Results of Operations
Comparison of 2008 to 2007
Net income for 2008 increased 18% to $60.2 million from $51.2 million for
2007. Diluted earnings per share for 2008 increased 30% to $5.04 per share from
$3.88 per share for the prior year due to increased net income of 18% and an
approximate 10% decrease in the weighted average number of outstanding shares.
Membership fees and their impact on total revenues in any period are
determined directly by the number of active Memberships in force during any such
period and the average annual fee. The active Memberships in force are
determined by both the number of new Memberships sold in any period together
with the renewal rate of existing Memberships. New Membership sales decreased
10% during 2008 to 552,327 from 612,096 during 2007. At December 31, 2008, there
were 1,559,154 active Memberships in force compared to 1,575,802 at December 31,
2007, a decrease of 1%. However, the average annual fee per Membership has
increased from $298 for all Memberships in force at December 31, 2007 to $301
for all Memberships in force at December 31, 2008, a 1% increase, primarily as a
result of an increase in the percentage of members with our Identity Theft
Shield Membership. These changes resulted in a 2% increase in Membership fees
for 2008 to $436.8 million from $427.4 million for 2007 marking the sixteenth
consecutive year of increased Membership revenue.
Associate services revenue decreased 6% from $25.1 million for 2007 to
$23.5 million during 2008 primarily as a result of fewer associates recruited.
The eService fees totaled $12.1 million during 2008 compared to $12.4 million
for 2007, a decrease of 2%. We recognized revenue from associate fees of
approximately $9.2 million during 2008 compared to $9.8 million during 2007, a
decrease of 6%. New associates typically pay a fee ranging from $49 to $249,
depending on special promotions we implement from time to time. Although the new
enrollments of sales associates decreased 18% during 2008 to 122,255 from
148,802 for 2007, the average associate fee paid during 2008 was $72 compared to
$57 for 2007, an increase of 26% due to higher average enrollment fees charged
to new associates. Future revenues from associate services will depend primarily
on the number of new associates enrolled, the price charged for new associates
and the number who choose to participate in our eService program, but we expect
that such revenues will continue to be largely offset by the direct and indirect
cost to us of training, providing associate services and other direct marketing
expenses.
Other revenue decreased 8%, from $4.5 million to $4.2 million primarily due
to the decrease in revenue recognized from Membership enrollment fees.
Primarily as a result of the increase in Membership fees, total revenues
increased to $464.5 million for 2008 from $457.1 million during 2007, an
increase of 2%.
36
Membership benefits, which primarily represent payments to provider law
firms and Kroll, totaled $150.3 million for 2008 compared to $148.8 million for
2007 and represented 34% and 35% of Membership fees, respectively. This
Membership benefit ratio (Membership benefits as a percentage of Membership
fees) should be slightly reduced going forward as substantially all active
Memberships provide for a capitated cost and we have reduced the capitated cost
of the Identity Theft plan benefits effective April 1, 2007 with additional
reductions effective beginning January 1, 2008, 2009 and 2010.
Commissions to associates decreased 3% from $130.6 million for 2007 to
$126.8 million for 2008, and represented 31% and 29% of Membership fees,
respectively. Commissions to associates are primarily dependent on the number of
new Memberships sold during a period and the average fee of those Memberships.
New Memberships sold during 2008 totaled 552,327, a 10% decrease from the
612,096 sold during 2007, and the "add-on" IDT Membership sales which are not
included in these totals decreased 10% to 344,869 for 2008 from 381,419 for
2007. Although our new Membership fees written during 2008 decreased 10%,
commissions to associates declined only 3% due to a change effective April 1,
2007 when we began advancing commissions on the first Membership sale and in
June 2008 when we added additional levels (Expansion Bonuses) to our
compensation plan.
Associate services and direct marketing expenses decreased $5.3 million to
$23.6 million for 2008 from $28.9 million for 2007. We had a $3.0 million
decrease in direct marketing and marketing services costs and a $789,000
decrease in training fees and bonuses and a $949,000 decrease in Player's Club
costs. Training fees and bonuses are affected by the number of new sales
associates that successfully meet the qualification criteria established by us,
i.e. more training bonuses will be paid when a higher number of new sales
associates meet such criteria. These expenses include the costs of providing
associate services and marketing expenses as discussed under Member and
Associate Costs.
General and administrative expenses during 2008 and 2007 were $53.0 million
and $50.5 million, respectively, and represented 12% of Membership fees for such
years. The $2.5 million increase in general and administrative expenses was due
to increases in advertising, consultant fees, employee expenses, and legal fees.
We had decreases in our bank service charges and telecommunication costs during
2008.
Other expenses, net, which includes depreciation and amortization,
litigation accruals, premium taxes and interest expense reduced by interest
income, decreased 3% to $13.4 million for 2008 from $13.8 million for 2007.
Depreciation and amortization increased to $8.8 million for 2008 from $8.5
million for 2007. Litigation expense was $906,000 for 2008 compared to $15,000
during 2007. Premium taxes decreased from $1.9 million for 2007 to $1.8 million
for 2008. Interest expense decreased to $4.2 million for 2008 compared to $6.7
million for the prior year. Interest income decreased to $2.2 million for 2008
from $3.3 million for 2007.
The provision for income taxes increased during 2008 to $37.2 million
compared to $33.3 million for 2007, representing 38.2% and 39.4%, respectively,
of income before income taxes. The 2007 provision included a $2.0 million
charge, representing 2.4% of income before income taxes, relating to income
taxes for years 2007 and prior. This charge resulted from a clerical error,
which we discovered and corrected, in the amount of net operating loss reported
in a 2003 state income tax return which resulted in nonpayment of income taxes
in that state for several years. The 2008 and 2007 provisions include state
income taxes of $3.8 million and $3.2 million, respectively, net of federal
benefits, representing 4.0% and 3.8%, respectively, of income before income
taxes.
Comparison of 2007 to 2006
Net income for 2007 decreased 1% to $51.2 million from $51.8 million for
2006. Diluted earnings per share for 2007 increased 11% to $3.88 per share from
$3.51 per share for the prior year due to decreased net income of 1% and an
approximate 10% decrease in the weighted average number of outstanding shares.
Membership revenues for 2007 were up 4% to $427.4 million from $412.2 million
for the prior year marking the fifteenth consecutive year of increased
Membership revenue.
37
Membership fees and their impact on total revenues in any period are
determined directly by the number of active Memberships in force during any such
period and the average annual fee. The active Memberships in force are
determined by both the number of new Memberships sold in any period together
with the renewal rate of existing Memberships. New Membership sales decreased
less than 1% during 2007 to 612,096 from 612,726 during 2006. At December 31,
2007, there were 1,575,802 active Memberships in force compared to 1,538,740 at
December 31, 2006, an increase of 2%. Additionally, the average annual fee per
Membership has increased from $293 for all Memberships in force at December 31,
2006 to $298 for all Memberships in force at December 31, 2007, a 2% increase,
primarily as a result of an increase in the percentage of members with our
Identity Theft Shield Membership. These changes resulted in a 4% increase in
Membership fees for 2007 to $427.4 million from $412.2 million for 2006.
Associate services revenue decreased 7% from $26.9 million for 2006 to
$25.1 million during 2007 primarily as a result of fewer associates recruited.
The eService fees totaled $12.4 million during 2007 compared to $12.8 million
for 2006, a decrease of 3%. We recognized revenue from associate fees of
approximately $9.8 million during 2007 compared to $10.6 million during 2006, a
decrease of 8%. New associates typically pay a fee ranging from $49 to $249,
depending on special promotions we implement from time to time. Although the new
enrollments of sales associates decreased 14% during 2007 to 148,802 from
172,999 for 2006, the average associate fee paid during 2007 was $56.75 compared
to $49.69 for 2006, an increase of 14% due to higher average enrollment fees
charged to new associates.
Other revenue decreased 10%, from $5.0 million to $4.5 million primarily
due to the decrease in revenue recognized from Membership enrollment fees.
Primarily as a result of the increase in Membership fees, total revenues
increased to $457.1 million for 2007 from $444.0 million during 2006, an
increase of 3%.
Membership benefits, which primarily represent payments to provider law
firms and Kroll, totaled $148.8 million for 2007 compared to $145.8 million for
2006 and represented 35% of Membership fees for both years.
Commissions to associates increased 3% from $126.8 million for 2006 to
$130.6 million for 2007, and represented 31% of Membership fees for both years.
Commissions to associates are primarily dependent on the number of new
Memberships sold during a period and the average fee of those Memberships. New
Memberships sold during 2007 totaled 612,096, virtually unchanged from the
612,726 sold during 2006, and the "add-on" IDT Membership sales which are not
included in these totals decreased 2% to 381,419 for 2007 from 389,157 for 2006.
Although our new Membership fees written during 2007 decreased 2%, the 3%
increase in commissions to associates resulted due to a change effective April
1, 2007 when we began advancing commissions on the first Membership sale.
Associate services and direct marketing expenses decreased $600,000 to
$28.9 million for 2007 from $29.5 million for 2006. We had a $500,000 decrease
in direct marketing and marketing services costs and a $1.1 million decrease in
training fees and bonuses partially offset by a $900,000 increase in Player's
Club costs. Training fees and bonuses are affected by the number of new sales
associates that successfully meet the qualification criteria established by us,
i.e. more training bonuses will be paid when a higher number of new sales
associates meet such criteria. These expenses include the costs of providing
associate services and marketing expenses as discussed under Member and
Associate Costs.
General and administrative expenses during 2007 and 2006 were $50.5 million
and $50.1 million, respectively, and represented 12% of Membership fees for such
years. Decreases in the 2007 period were attributable primarily to
reclassification of $3.8 million of state income taxes to the provision for
income taxes. For 2006 we recorded state income taxes of $2.7 million. This $2.7
million reduction in state income taxes recorded in general and administrative
expenses was offset by increases in advertising, consultant fees, employee
expenses, telecommunications and legal fees resulting in a $400,000 increase in
general and administrative expenses.
38
Other expenses, net, which includes depreciation and amortization,
litigation accruals, premium taxes and interest expense reduced by interest
income, increased 13% to $13.8 million for 2007 from $12.2 million for 2006.
Depreciation and amortization increased to $8.5 million for 2007 from $8.3
million for 2006. Litigation expense was $15,000 for 2007 compared to a negative
$710,000 during 2006. Premium taxes increased from $1.8 million for 2006 to $1.9
million for 2007. Interest expense increased to $6.7 million for 2007 compared
to $5.7 million for the prior year. Interest income increased to $3.3 million
for 2007 from $2.9 million for 2006.
The provision for income taxes increased during 2007 to $33.3 million
compared to $27.9 million for 2006, representing 39.4% and 35.0%, respectively,
of income before income taxes. The 2007 provision included a $2.0 million
charge, representing 2.4% of income before income taxes, relating to income
taxes for years 2006 and prior. This charge resulted from a clerical error,
which we discovered and corrected, in the amount of net operating loss reported
in a 2003 state income tax return which resulted in nonpayment of income taxes
in that state for several years. The 2007 provision also includes year 2007
state income taxes of $3.2 million, net of federal benefits as discussed above,
representing 3.8% of income before income taxes.
Liquidity and Capital Resources
The number of active Memberships in force and the average monthly fee will
directly determine Membership fees collected and their contribution to cash flow
from operations during any period. Cash receipts from associate services are
directly impacted by the number of new sales associates enrolled and the price
of entry during the period, the number of associates subscribing to our eService
offering and the amount of sales tools purchased by the sales force.
The cash outlay related to Membership benefits is directly impacted by the
number of active Memberships and the contractual rate that exists between us and
our benefits providers. Commissions paid to associates are primarily dependent
on the number and price of new Memberships sold during a period and any special
incentives that may be in place during the period. Cash requirements related to
associate services and direct marketing activities are directly impacted by the
number of new associates enrolled during a period due to the cost of materials
provided to such new associates, the number of associates subscribing to our
eService offering, the amount of sales tools purchased by the sales force as
well as the number of those associates who successfully meet the incentive award
program qualifications.
Membership revenues are more than sufficient to fund the cash requirements
for membership benefits (at approximately 34%-35% of Membership revenues),
commissions (ranging from 29% to 36% of Membership revenues) and general and
administrative expense (at approximately 12% to 13% of Membership revenues). We
have generated significant cash flow from operations of approximately $64
million, $67 million and $54 million in 2008, 2007 and 2006, respectively, which
has been used to provide for future growth in Memberships, to repay our debt and
make necessary capital expenditures and as discussed below, we have used a
significant portion of our cash flow to repurchase shares of our stock in the
open market. Cash flow from operations could be reduced if we experienced
significant growth in new members because of the negative cash flow
characteristics of our commission advance policies discussed above.
As a result of our ability to generate cash flow from operations, including
in periods of Membership growth, we have not historically been dependent on, and
do not expect to need in the future, external sources of financing from the sale
of securities or from bank borrowings to fund our basic business operations.
However, as described below, during the last three years, we incurred debt for
limited and specific purposes to permit us to construct a new corporate
headquarters, purchase equipment and to accelerate our treasury stock purchase
program.
General
Consolidated net cash provided by operating activities was $64.3 million,
$67.2 million and $54.4 million for 2008, 2007 and 2006, respectively. Net cash
provided by operating activities decreased approximately $2.9 million primarily
due to a $7.0 million increase in cash received from our members and a $4.3
39
million decrease in commission payments to our associates which was reduced by a
$1.6 million increase in payments to our membership benefit providers and an
$11.2 million increase in income tax payments.
Net cash (used in) provided by investing activities was $(4.4) million,
$30.1 million and $(52.6) million for 2008, 2007 and 2006, respectively. Capital
expenditures were $5.3 million, $5.9 million and $9.0 million during 2008, 2007
and 2006, respectively. Sales and maturities of available-for-sale investments
exceeded the purchases of such investments by $843,000 and $35.9 million during
2008 and 2007, respectively, while purchases exceeded the sales and maturities
of such investments by $43.7 million in 2006.
Net cash used in financing activities was $58.3 million, $84.3 million and
$23.7 million for 2008, 2007 and 2006, respectively. This $26.0 million change
during 2008 was primarily comprised of a $21.7 million decrease in purchases of
treasury stock and a $3.7 million decrease in repayment of debt.
We had a consolidated working capital deficit of $2.3 million at December
31, 2008, a decrease of $700,000 compared to a consolidated working capital
deficit of $3.0 million at December 31, 2007. The decrease was primarily due to
the $5.6 million decrease in income taxes payable and the $1.6 million increase
in cash and cash equivalents partially offset by the $4.2 million increase in
the current portion of notes payable, a $1.6 million decrease in refundable
income taxes and an $800,000 decrease in deferred member and associate service
costs. The $2.3 million working capital deficit at December 31, 2008 would have
been $8.5 million in excess working capital excluding the $10.8 million of
current portion of deferred revenue and fees in excess of the current portion of
deferred member and associate service costs. These amounts will be eliminated by
the passage of time without the utilization of other current assets or us
incurring other current liabilities. Additionally, at the current rate of cash
flow provided by operations ($64.3 million during 2008), we do not expect any
difficulty in meeting our financial obligations in the short term or the long
term.
We generally advance significant commissions to associates at the time a
Membership is sold. We expense these advances ratably over the first month of
the related Membership. During 2008, we paid advance commissions to associates
of $120.9 million on new Membership sales compared to $126.9 million for 2007.
Since approximately 95% of Membership fees are collected on a monthly basis, a
significant cash flow deficit is created on a per Membership basis at the time a
Membership is sold. Since there are no further commissions paid on a Membership
during the advance period, we typically derive significant positive cash flow
from the Membership over its remaining life. See Commissions to Associates above
for additional information on advance commissions.
We announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of our common stock. The
Board of Directors has increased such authorization from 500,000 shares to 15
million shares during subsequent board meetings. The most recent authorization
was for 1 million additional shares on February 18, 2009. At December 31, 2008,
we had purchased 13.7 million treasury shares under these authorizations for
$407.1 million, an average price of $29.62 per share, including $44.7 million of
purchases in 2008. Treasury stock purchases will be made at prices that are
considered attractive by management and at such times that management believes
will not unduly impact our liquidity, however, due to restrictions contained in
our debt agreements with lenders, we are limited in our treasury stock
purchases. At December 31, 2008, we had approximately $17 million of
availability under existing bank covenant restrictions to purchase additional
treasury shares. No time limit has been set for completion of the treasury stock
purchase program. Given the current interest rate environment, the nature of
other investments available and our expected cash flows, management believes
that purchasing treasury shares enhances shareholder value. We expect to
continue our treasury stock program. From time to time, we evaluate alternative
sources of financing to continue or accelerate this program.
We believe that we have the ability to finance the next twelve months of
operations, anticipated capital expenditures and required debt repayment
obligations based on our existing amount of cash and cash equivalents and
unpledged investments at December 31, 2008 of $60.0 million. We believe our
long-term liquidity needs will be met by our ability to generate cash flow from
operations and our existing cash and cash equivalent balances. We expect to
maintain cash and cash equivalents and investment balances on an on-going basis
of approximately $20 million to $30 million in order to meet expected working
40
capital needs and regulatory capital requirements. Balances in excess of this
amount would be used for discretionary purposes such as treasury stock
purchases, dividends, and advance repayment of debt subject to the restrictions
contained in our debt agreements.
Notes Payable
In addition to customary covenants for loans of a similar type, the
principal covenants for the Senior Loan are:
* a limitation on incurring any indebtedness in excess of the remaining
existing bank indebtedness outstanding and $2.3 million in permitted
capitalized leases or purchase money debt;
* a limitation on our ability to pay dividends or make stock purchases,
other than with the net proceeds of the Term Loan, unless we meet
certain cash flow tests;
* a prohibition on prepayment of other debt;
* a requirement to maintain consolidated EBITDA (Earnings before
Interest, Taxes, Depreciation and Amortization) for the twelve month
period ending December 31, 2006 and each quarter thereafter of at
least $80 million ($75 million for us and our top tier direct
subsidiaries);
* a requirement to maintain a quarterly fixed charge coverage ratio
(EBITDA (with certain adjustments) divided by the sum of interest
expense, income taxes and scheduled principal payments) of at least
1.1 to 1;
* a requirement to maintain at least 1.3 million members;
* a requirement to maintain a Leverage Ratio (funded indebtedness as of
the end of each quarter divided by EBITDA for the trailing twelve
months) of no more than 1.5 to 1;
* we must have availability (unused portion of the Revolving Facility)
plus Qualified Cash (the amount of unrestricted cash and cash
equivalents) greater than or equal to $12,500,000; and
* an event of default occurs if Harland Stonecipher ceases to be our
Chairman and Chief Executive Officer for a period of 120 days unless
replaced with a person approved by Wells Fargo.
We were in compliance with these covenants at December 31, 2008. Additional
information regarding Notes Payable is included in Note 6 to the Consolidated
Financial Statements.
Parent Company Funding and Dividends
Although we are the operating entity in many jurisdictions, our
subsidiaries serve as operating companies in various states that regulate
Memberships as insurance or specialized legal expense products. The most
significant of these wholly owned subsidiaries are PPLCI, PPLSIF and LSPV. The
ability of these subsidiaries to provide funds to us is subject to a number of
restrictions under various insurance laws in the jurisdictions in which they
conduct business, including limitations on the amount of dividends and
management fees that may be paid and requirements to maintain specified levels
of capital and reserves. In addition PPLCI will be required to maintain its
stockholders' equity at levels sufficient to satisfy various state or provincial
regulatory requirements, the most restrictive of which is currently $3 million.
Additional capital requirements of PPLCI, PPLSIF or LSPV, or any of our
regulated subsidiaries, will be funded by us in the form of capital
contributions or surplus debentures. At January 1, 2009, none of PPLCI, PPLSIF
or LSV had funds available for payment of substantial dividends without the
prior approval of the insurance commissioner. At December 31, 2008 the amount of
restricted net assets of consolidated subsidiaries was $24.2 million,
representing amounts that may not be paid to us as dividends either under the
applicable regulations or without regulatory approval.
41
Contractual Obligations
The following table reflects our contractual obligations as of December 31,
2008.
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.................................... $ 59,659 $ 22,408 $ 31,756 $ 1,912 $ 3,583
Purchase obligations (1).......................... 9,417 4,049 4,155 1,213 -
Capital leases.................................... 934 24 80 96 734
Deferred compensation plan........................ 7,898 - - - 7,898
Operating leases.................................. 664 119 218 103 224
----------- ---------- ---------- ---------- ---------
Total (2)......................................... $ 78,572 $ 26,600 $ 36,209 $ 3,324 $ 12,439
----------- ---------- ---------- ---------- ---------
(1) Includes contractual commitments pursuant to executory contracts for
products and services such as voice and data services and contractual
obligations related to future Company events such as hotel room blocks,
meeting space and food and beverage guarantees. We expect to receive
proceeds from such future events and reimbursement from provider law firms
for certain voice and data services that will partially offset these
obligations.
(2) Does not include commitments for attorney provider payments, commissions,
etc. which are expected to remain in existence for several years but as to
which our obligations vary directly either based on Membership revenues or
new Memberships sold and are not readily estimable.
Forward-Looking Statements
All statements in this report other than purely historical information,
including but not limited to, statements relating to our future plans and
objectives, expected operating results and the assumptions on which such
forward-looking statements are based, constitute "Forward-Looking Statements"
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934 and are based on our historical operating
trends and financial condition as of December 31, 2008 and other information
currently available to management. We caution that the Forward-Looking
Statements are subject to all the risks and uncertainties incident to our
business, including but not limited to risks described herein. Moreover, we may
make acquisitions or dispositions of assets or businesses, enter into new
marketing arrangements or enter into financing transactions. None of these can
be predicted with certainty and, accordingly, are not taken into consideration
in any of the Forward-Looking Statements made herein. For all of the foregoing
reasons, actual results may vary materially from the Forward-Looking Statements.
We assume no obligation to update the Forward-Looking Statements to reflect
events or circumstances occurring after the date of the statement.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
---------------------------------------------------------------------
Disclosures About Market Risk
Our consolidated balance sheets include a certain amount of assets and
liabilities whose fair values are subject to market risk. Due to our significant
investment in fixed-maturity investments, interest rate risk represents the
largest market risk factor affecting our consolidated financial position.
Increases and decreases in prevailing interest rates generally translate into
decreases and increases in fair values of those instruments. Additionally, fair
values of interest rate sensitive instruments may be affected by the
creditworthiness of the issuer, prepayment options, relative values of
alternative investments, liquidity of the instrument and other general market
conditions.
42
As of December 31, 2008, our investments consisted of the following:
Description Fair Value
--------------------------------------------------------------------- -------------
Obligations of state and political subdivisions...................... $ 30,777
Certificates of deposit.............................................. 5,753
Auction Rate Securities.............................................. 375
U. S. Government obligations......................................... 233
Corporate obligations................................................ 350
-------------
Total investments.................................................... $ 37,488
-------------
We do not hold any investments classified as trading account assets or
derivative financial instruments.
The table below summarizes the estimated effects of hypothetical increases
and decreases in interest rates on our fixed-maturity investment portfolio. It
is assumed that the changes occur immediately and uniformly, with no effect
given to any steps that management might take to counteract that change.
The hypothetical changes in market interest rates reflect what could be
deemed best and worst case scenarios. The fair values shown in the following
table are based on contractual maturities. Significant variations in market
interest rates could produce changes in the timing of repayments due to
prepayment options available. The fair value of such instruments could be
affected and, therefore, actual results might differ from those reflected in the
following table:
Hypothetical change Estimated fair value
in interest rate after hypothetical
Fair Value (bp = basis points) change in interest rate
---------- ---------------------- -----------------------
(Dollars in thousands)
Fixed-maturity investments at December 31, 2008 (1).... $ 31,360 100 bp increase $ 29,831
200 bp increase 28,457
50 bp decrease 32,134
100 bp decrease 32,907
Fixed-maturity investments at December 31, 2007 (1).... $ 33,692 100 bp increase $ 32,307
200 bp increase 31,019
50 bp decrease 34,310
100 bp decrease 34,928
--------------------
(1) Excluding short-term investments in certificates of deposit and auction
rate certificates with a fair value of $6.1 million at December 31, 2008
and short-term investments in certificates of deposit with a fair value of
$4.6 million at December 31, 2007.
The table above illustrates, for example, that an instantaneous 200 basis
point increase in market interest rates at December 31, 2008 would reduce
the estimated fair value of our fixed-maturity investments by approximately
$2.9 million at that date. At December 31, 2007, and based on the fair
value of fixed-maturity investments of $33.7 million, an instantaneous 200
basis point increase in market interest rates would have reduced the
estimated fair value of our fixed-maturity investments by approximately
$2.7 million at that date. The definitive extent of the interest rate risk
is not quantifiable or predictable due to the variability of future
interest rates, but we do not believe such risk is material.
We primarily manage our exposure to interest rate risk by purchasing
investments that can be readily liquidated should the interest rate environment
begin to significantly change.
Interest Rate Risk
We are exposed to market risk related to changes in interest rates. As of
December 31, 2008, we had $59.7 million in notes payable outstanding at interest
rates indexed to the 30 day LIBOR rate that exposes us to the risk of increased
interest costs if interest rates rise. Assuming a 100 basis point increase in
interest rates on the floating rate debt, annual interest expense would increase
by approximately $597,000. As of December 31, 2008, we had not entered into any
43
interest rate swap agreements with respect to the term loans or the variable
rate municipal bonds.
Foreign Currency Exchange Rate Risk
Although we are exposed to foreign currency exchange rate risk inherent in
revenues, net income and assets and liabilities denominated in Canadian dollars,
the potential change in foreign currency exchange rates is not a substantial
risk, as less than 2% of our revenues are derived outside of the United States.
As reflected in the attached Consolidated Statements of Comprehensive Income, we
have recorded negative foreign currency translation adjustments of $2.0 million
during 2008 and have a cumulative negative foreign currency translation
adjustment balance of $425,000 at December 31, 2008. These amounts are subject
to change dynamically in conjunction with the relative values of the Canadian
and U.S. dollars.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
-----------------------------------------------------
PRE-PAID LEGAL SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Reports of Independent Registered Public Accounting Firm..................................................... 45
Management's Annual Report on Internal Control over Financial Reporting...................................... 47
Consolidated Financial Statements
---------------------------------
Consolidated Balance Sheets - December 31, 2008 and 2007..................................................... 48
Consolidated Statements of Income - For the years ended December 31, 2008, 2007 and 2006..................... 49
Consolidated Statements of Cash Flows - For the years ended December 31, 2008, 2007 and 2006................. 50
Consolidated Statements of Changes In Stockholders' Equity - For the years ended
December 31, 2008, 2007 and 2006........................................................................... 51
Notes to Consolidated Financial Statements................................................................... 52
Financial Statement Schedules
-----------------------------
Schedule I - Condensed Financial Information of the Registrant............................................... 90
(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.)
44
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Pre-Paid Legal Services, Inc.
We have audited Pre-Paid Legal Services, Inc.'s (an Oklahoma corporation)
internal control over financial reporting as of December 31, 2008, based on
criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Pre-Paid Legal Services, Inc.'s management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting, included in the
accompanying "Management's Annual Report on Internal Control Over Financial
Reporting". Our responsibility is to express an opinion on Pre-Paid Legal
Services, Inc.'s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, Pre-Paid Legal Services, Inc. maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2008, based on criteria established in Internal Control--Integrated Framework
issued by COSO.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets as
of December 31, 2008 and 2007, 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, 2008 and our report dated February 27,
2009 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 27, 2009
45
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Pre-Paid Legal Services, Inc.
We have audited the accompanying consolidated balance sheets of Pre-Paid Legal
Services, Inc. (an Oklahoma corporation) and subsidiaries as of December 31,
2008 and 2007, 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, 2008. Our audits of the basic financial statements included
Schedule I as of December 31, 2008 and 2007 and for each of the three years in
the period ended December 31, 2008. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pre-Paid Legal
Services, Inc. and subsidiaries as of December 31, 2008 and 2007, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2008 in conformity with accounting principles
generally accepted in the United States of America. Also in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material
respects, the information therein.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), Pre-Paid Legal Services, Inc.'s
internal control over financial reporting as of December 31, 2008, based on the
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated February 27, 2009 expressed an unqualified opinion on the effectiveness of
the Company's internal control over financial reporting.
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 27, 2009
46
MANAGEMENT'S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting. In order to evaluate the
effectiveness of internal control over financial reporting, as required by
Section 404 of the Sarbanes-Oxley Act, our management has conducted an
assessment, including testing, using the criteria in Internal Control-Integrated
Framework, issued by the Committee of Sponsoring Organizations of the Treadway
Commission ("COSO"). Our system of internal control over financial reporting is
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. Our internal control
over financial reporting includes those policies and procedures that (i) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of our assets; (ii) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting
principles, and that our receipts and expenditures are being made only in
accordance with authorizations of our management and directors; and (iii)
provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of our assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Based on the assessment, our management has concluded that we maintained
effective internal control over financial reporting as of December 31, 2008,
based on criteria in Internal Control-Integrated Framework issued by COSO. The
effectiveness of our internal control over financial reporting as of December
31, 2008, has been audited by Grant Thornton LLP, an independent registered
public accounting firm, as stated in their report which is included herein.
Our management, including our Chief Executive Officer and Chief Financial
Officer, does not expect that our disclosure controls and procedures or our
internal controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the Company have been detected.
47
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts and shares in 000's, except par values)
ASSETS
December 31,
-------------------------
2008 2007
------------ -----------
Current assets:
Cash and cash equivalents............................................................ $ 26,528 $ 24,941
Available-for-sale investments, at fair value........................................ 12,812 13,177
Membership fees receivable........................................................... 6,639 5,831
Inventories.......................................................................... 1,285 1,511
Refundable income taxes.............................................................. 687 2,253
Deferred member and associate service costs.......................................... 15,737 16,510
Deferred income taxes................................................................ 5,151 5,163
Other assets......................................................................... 6,200 6,793
------------ -----------
Total current assets............................................................. 75,039 76,179
Available-for-sale investments, at fair value.......................................... 20,637 20,766
Investments pledged.................................................................... 4,039 4,341
Property and equipment, net............................................................ 53,445 56,963
Deferred member and associate service costs............................................ 2,003 2,380
Other assets........................................................................... 7,680 7,003
------------ -----------
Total assets................................................................... $ 162,843 $ 167,632
------------ -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits payable.......................................................... $ 12,013 $ 12,155
Deferred revenue and fees............................................................ 26,556 27,271
Current portion of capital leases payable............................................ 24 22
Current portion of notes payable..................................................... 22,408 18,241
Income taxes payable................................................................. - 5,590
Accounts payable and accrued expenses................................................ 16,327 15,891
------------ -----------
Total current liabilities.......................................................... 77,328 79,170
Capital leases payable............................................................... 910 934
Notes payable........................................................................ 37,251 55,492
Deferred revenue and fees............................................................ 2,003 2,380
Deferred income taxes................................................................ 5,646 5,273
Other non-current liabilities........................................................ 7,898 6,544
------------ -----------
Total liabilities................................................................ 131,036 149,793
------------ -----------
Stockholders' equity:
Common stock, $.01 par value; 100,000 shares authorized; 16,254 and
17,291 issued at December 31, 2008 and 2007, respectively.......................... 163 173
Retained earnings.................................................................... 130,832 114,873
Accumulated other comprehensive income............................................... (160) 1,821
Treasury stock, at cost; 4,852 shares held at December 31, 2008
and 2007, respectively............................................................. (99,028) (99,028)
------------ -----------
Total stockholders' equity....................................................... 31,807 17,839
------------ -----------
Total liabilities and stockholders' equity..................................... $ 162,843 $ 167,632
------------ -----------
The accompanying notes are an integral part of these financial statements.
48
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in 000's, except per share amounts)
Year Ended December 31,
------------------------------------------
2008 2007 2006
------------- ------------- -------------
Revenues:
Membership fees...................................................... $ 436,778 $ 427,428 $ 412,200
Associate services................................................... 23,534 25,112 26,857
Other................................................................ 4,177 4,549 4,967
------------- ------------- -------------
464,489 457,089 444,024
------------- ------------- -------------
Costs and expenses:
Membership benefits.................................................. 150,318 148,792 145,771
Commissions.......................................................... 126,758 130,593 126,762
Associate services and direct marketing.............................. 23,582 28,875 29,493
General and administrative........................................... 53,021 50,474 50,078
Other, net........................................................... 13,413 13,841 12,232
------------- ------------- -------------
367,092 372,575 364,336
------------- ------------- -------------
Income before income taxes............................................. 97,397 84,514 79,688
Provision for income taxes............................................. 37,225 33,312 27,890
------------- ------------- -------------
Net income............................................................. $ 60,172 $ 51,202 $ 51,798
------------- ------------- -------------
Basic earnings per common share........................................ $ 5.05 $ 3.89 $ 3.54
------------- ------------- -------------
Diluted earnings per common share...................................... $ 5.04 $ 3.88 $ 3.51
------------- ------------- -------------
The accompanying notes are an integral part of these financial statements.
49
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in 000's)
Year Ended December 31,
-----------------------------------
2008 2007 2006
---------- ---------- ----------
Cash flows from operating activities:
Net income....................................................................... $ 60,172 $ 51,202 $ 51,798
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for deferred income taxes............................................ 385 (552) 774
Depreciation and amortization.................................................. 8,756 8,532 8,260
Increase in accrued Membership fees receivable................................. (808) (313) (123)
Decrease (increase) in inventories............................................. 226 (174) 380
Decrease (increase) in refundable income taxes................................. 1,566 (1,600) (653)
Decrease (increase) in deferred member and associate service costs............. 1,150 (375) 698
Increase in other assets....................................................... (84) (1,062) (2,254)
(Decrease) increase in Membership benefits payable............................. (142) 160 357
(Decrease) increase in deferred revenue and fees............................... (1,092) 975 (618)
Increase in other non-current liabilities...................................... 1,354 1,337 1,275
(Decrease) increase in income taxes payable.................................... (5,590) 5,590 (1,738)
(Decrease) increase in accounts payable and accrued expenses................... (1,576) 3,458 (3,771)
---------- ---------- ----------
Net cash provided by operating activities.................................... 64,317 67,178,, 54,385
---------- ---------- ----------
Cash flows from investing activities:
Additions to property and equipment............................................ (5,254) (5,858) (8,956)
Purchases of investments - available-for-sale.................................. (64,983) (270,435) (179,799)
Maturities and sales of investments - available-for-sale....................... 65,826 306,357 136,142
---------- ---------- ----------
Net cash (used in) provided by investing activities.......................... (4,411) 30,064 (52,613)
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of debt................................................. 10,000 9,556 85,000
Repayments of debt............................................................. (24,074) (27,793) (31,500)
Proceeds from exercise of stock options........................................ 338 (84) 485
Tax benefit on exercise of stock options....................................... 156 790 703
Purchases of treasury stock.................................................... (44,717) (66,460) (73,423)
Repayment of capital lease obligations......................................... (22) (341) (320)
Dividends paid................................................................. - - (4,643)
---------- ---------- ----------
Net cash used in financing activities........................................ (58,319) (84,332) (23,698)
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents............................. 1,587 12,910 (21,926)
Cash and cash equivalents at beginning of year................................... 24,941 12,031 33,957
---------- ---------- ----------
Cash and cash equivalents at end of year......................................... $ 26,528 $ 24,941 $ 12,031
---------- ---------- ----------
Supplemental disclosure of cash flow information:
Cash paid for interest......................................................... $ 4,443 $ 6,541 $ 5,540
---------- ---------- ----------
Cash paid for income taxes..................................................... $ 42,142 $ 30,937 $ 28,780
---------- ---------- ----------
Purchases of treasury stock pursuant to tender offer........................... $ - $ - $ 6,584
---------- ---------- ----------
The accompanying notes are an integral part of these financial statements.
50
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Amounts and shares in 000's, except dividend rates and par values)
Retained Accum.
Common Stock Earnings OCI((1)) Treasury Stock Total
Shares Amount Shares Amount
January 1, 2006............................ --------- --------- ----------- -------- --------- ----------- ---------
20,326 $ 203 $ 149,832 $ 387 4,852 $(99,028) $51,394
Exercise of stock options and other...... 121 1 484 - - - 485
Income tax benefit related to exercise
of stock options....................... - - 703 - - - 703
Net income............................... - - 51,798 - - - 51,798
Other comprehensive income(1)............ - - - (97) - - (97)
Treasury shares purchased................ - - - - 1,959 (73,423) (73,423)
Treasury shares retired.................. (1,959) (19) (73,404) - (1,959) 73,423 -
--------- --------- ----------- -------- --------- ----------- ---------
December 31, 2006.......................... 18,488 185 129,413 290 4,852 (99,028) 30,860
Exercise of stock options and other...... 122 1 (85) - - - (84)
Income tax benefit related to exercise
of stock options....................... - - 790 - - - 790
Net income............................... - - 51,202 - - - 51,202
Other comprehensive income(1)............ - - - 1,531 - - 1,531
Treasury shares purchased................ - - - - 1,319 (66,460) (66,460)
Treasury shares retired.................. (1,319) (13) (66,447) - (1,319) 66,460 -
--------- --------- ----------- -------- --------- ----------- ---------
December 31, 2007.......................... 17,291 173 114,873 1,821 4,852 (99,028) 17,839
Exercise of stock options and other...... 16 - 338 - - - 338
Income tax benefit related to exercise
of stock options....................... - - 156 - - - 156
Net income............................... - - 60,172 - - - 60,172
Other comprehensive income(1)............ - - - (1,981) - - (1,981)
Treasury shares purchased................ - - - - 1,053 (44,717) (44,717)
Treasury shares retired.................. (1,053) (10) (44,707) - (1,053) 44,717 -
December 31, 2008.......................... --------- --------- ----------- -------- --------- ----------- ---------
16,254 $ 163 $ 130,832 $ (160) 4,852 $(99,028) $31,807
--------- --------- ----------- -------- --------- ----------- ---------
(1) Other Comprehensive Income Year Ended December 31,
-------------------------------
2008 2007 2006
-------- --------- ----------
Net income.................................................................... $60,172 $51,202 $51,798
Other comprehensive income, net of tax:
Foreign currency translation adjustment..................................... (2,028) 1,206 (59)
-------- --------- ----------
Unrealized gains (losses) on investments:
Unrealized holding gains (losses) arising during period................... 21 182 (14)
Less: reclassification adjustment for losses (gains) included in net 26 143 (24)
-------- --------- ----------
income......................................................................
47 325 (38)
-------- --------- ----------
Other comprehensive income, net of income taxes of $25, $207 and $(24) in 2008,
2007 and 2006, respectively................................................. (1,981) 1,531 (97)
-------- --------- ----------
Comprehensive income.......................................................... $58,191 $52,733 $51,701
-------- --------- ----------
The accompanying notes are an integral part of these financial statements.
51
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") develop and market legal service plans (referred
to as "Memberships"). The Memberships sold by us allow members to access legal
services through a network of independent law firms ("provider law firms") under
contract with us. We offer our Identity Theft Shield to new and existing members
at $9.95 per month if added to a legal service Membership or it may be purchased
separately for $12.95 per month. The nationwide provider of the Identity Theft
Shield benefits and the Provider law firms are paid a fixed fee on a capitated
basis to render services to plan members residing within the state or province
in which the provider law firm is licensed to practice. Because the fixed fee
payments by us to benefit providers do not vary based on the type and amount of
benefits utilized by the member, this capitated arrangement provides significant
advantages to us in managing claims risk. At December 31, 2008, Memberships
subject to the capitated benefit provider arrangement comprised approximately
99% of our active Memberships. The remaining Memberships, less than 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, 2008, we had 1,559,154 Memberships in force with members in all 50
states, the District of Columbia and the Canadian provinces of Ontario, British
Columbia, Alberta and Manitoba. Approximately 90% of the Memberships were in 29
states and provinces. The Memberships are marketed by an independent sales force
referred to as "associates."
Basis of Presentation
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
("generally accepted accounting principles") which vary in some respects from
statutory accounting principles used when reporting to state insurance
regulatory authorities.
Principles of Consolidation
The consolidated financial statements include our accounts and our wholly
owned subsidiaries. Our primary subsidiaries include Pre-Paid Legal Casualty,
Inc. ("PPLCI"), Legal Service Plans of Virginia ("LSPV") and Pre-Paid Legal
Services, Inc. of Florida ("PPLSIF"). All significant intercompany accounts and
transactions have been eliminated.
Foreign Currency Translation
The financial results of our Canadian operations are measured in local
currency and then translated into U.S. dollars. All balance sheet accounts have
been translated using the current rate of exchange at the balance sheet date.
Results of operations have been translated using the average rates prevailing
throughout the year.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Fair Value of Financial Instruments
Our financial instruments consist primarily of cash, certificates of
deposit, short-term investments, debt and equity securities, Membership fees
receivable, Membership benefits payable, notes payable and accounts payable and
accrued expenses. Fair value estimates have been determined by us, using
52
available market information and appropriate valuation methodologies. Fair
values of actively traded debt securities are based on quoted market prices.
Fair values of inactively traded debt securities are based on quoted market
prices of identical or similar securities or based on observable inputs like
interest rates. The carrying value of cash, certificates of deposit, Membership
fees receivable, Membership benefits payable and accounts payable and accrued
expenses are considered to be representative of their respective fair value, due
to the short term nature of these instruments. The carrying value of notes
payable is considered to be representative of their respective fair values, due
to the variable interest rate feature of such notes. The fair value disclosures
relating to debt and equity securities are presented in Note 2.
Cash and Cash Equivalents
We consider all highly liquid unpledged investments with maturities of
three months or less at time of acquisition to be cash equivalents. We place our
temporary cash investments with high credit quality financial institutions. At
times such investments may be in excess of the Federal Deposit Insurance
Corporation (FDIC) insurance limit. We have not experienced any losses in such
accounts and believe we are not exposed to any significant credit risk on cash
and cash equivalents.
Investments
We classify our investments held as available-for-sale and account for them
at fair value with unrealized gains and losses, net of taxes, excluded from
earnings and reported as other comprehensive income. We classify
available-for-sale securities as current if we expect to sell the securities
within one year, or if we intend to utilize the securities for current
operations. All other available-for-sale securities are classified as
non-current.
All investment securities are adjusted for amortization of premiums and
accretion of discounts. Amortization of premiums and accretion of discounts are
recorded to income over the contractual maturity or estimated life of the
individual investment on the level yield method. Gain or loss on sale of
investments is based upon the specific identification method. Income earned on
our investments in certain state and political subdivision debt instruments is
not generally taxable for federal income tax purposes.
Membership fees receivable
Our Membership fees receivable consists of amounts due from members for
services provided pursuant to their Membership contract. Membership fees are
principally collected on a monthly basis. Membership fees receivable is a result
of a portion of members, mostly group members, who pay their Membership fees in
arrears and are recorded at amounts due under the terms of the Membership
agreement. An allowance for doubtful accounts is not necessary as the recorded
amount is adjusted to net realizable value at period-end based on our historical
experience and the short period of time after period-end in which the accounts
will be collected.
Inventories
Inventories include the cost of materials and packaging and are stated at
the lower of cost or market.
Property and Equipment
Property and equipment is stated at cost less accumulated depreciation and
amortization. Depreciation of property and equipment is computed using the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized over the estimated useful lives of the related assets
or the period of the lease, whichever is shorter. Maintenance and repairs are
expensed as incurred and renewals and betterments are capitalized. Interest cost
incurred during the construction period of major facilities is capitalized. The
capitalized interest is recognized as part of the asset to which it relates and
is amortized over the asset's estimated useful life.
Revenue recognition - Membership and Associate Fees
Our principal revenues are derived from Membership fees, most of which are
collected on a monthly basis. Memberships are generally guaranteed renewable and
non-cancelable except for fraud, non-payment of Membership fees or upon written
request. Membership fees are recognized in income ratably over the related
service period in accordance with Membership terms, which generally require the
holder of the Membership to remit fees on an annual, semi-annual or monthly
53
basis. Approximately 95% of members remit their Membership fees on a monthly
basis. Approximately 69% of our Membership fees are paid in advance and,
therefore, are deferred and recognized over their respective periods.
We also charge new members, who are not part of an employee group, a $10
enrollment fee. This enrollment fee and related incremental direct and
origination costs of $10 for 2008 are deferred and recognized in income over the
estimated life of a Membership in accordance with SEC Staff Accounting Bulletin
No. 101, "Revenue Recognition in Financial Statements," ("SAB 101"). We compute
the expected Membership life using more than 25 years of actuarial data. At
December 31, 2008, we computed the expected Membership life to be approximately
three years. If the expected Membership life were to change significantly, which
management does not expect in the short term, the deferred Membership enrollment
fee and related costs would be recognized over a longer or shorter period.
We derive revenues from services provided to our marketing sales force
primarily from a one-time non-refundable enrollment fee from each new sales
associate for which we provide initial sales and marketing supplies and
enrollment services to the associate. Average enrollment fees paid by new sales
associates were $72, $57 and $50 for 2008, 2007 and 2006, respectively. Revenue
from, and costs of, the initial sales and marketing supplies (approximately $13)
are recognized when the materials are delivered to the associates. The remaining
revenues and related incremental direct and origination costs are deferred and
recognized over the estimated average active service period of associates which
at December 31, 2008 is estimated to be approximately five months, unchanged
from year end 2007. Management estimates the active service period of an
associate periodically based on the average number of months an associate
produces new Memberships including those associates that fail to write any
Memberships. If the active service period of associates changes significantly,
which management does not expect in the short term, the deferred revenue and
related costs would be recognized over the new estimated active service period.
Associate services revenue also includes revenue recognized on the sale of
marketing supplies and promotional material to associates and includes fees
related to our eService program for associates. The eService program provides
subscribers Internet based back office support such as reports, on-line
documents, tools, a personal e-mail account and multiple personalized web sites
with "flash" movie presentations.
Member and Associate Costs
Deferred costs represent the incremental direct and origination costs we
incur in enrolling new members and new associates and that portion of payments
made to provider law firms and associate commissions related to the deferred
revenue discussed above. 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, associate introduction kits, the associate incentive
program, group marketing and marketing services departments (including costs of
related travel, marketing events, leadership summits and international sales
convention). Shipping and handling costs of $1.7 million, $1.9 million and $2.2
million in 2008, 2007 and 2006, respectively, are primarily included in
Associate services and direct marketing costs.
Membership Benefits Liability
The Membership benefits liability represents per capita amounts due the
provider of Identity Theft Shield benefits and provider law firms on
approximately 99% of the Memberships and claims reported but not paid and
actuarially estimated claims incurred but not reported on the remaining
non-provider Memberships which represent less than 1%. We calculate the benefit
54
liability on the non-provider Memberships based on completion factors that
consider historical claims experience based on the dates that claims are
incurred, reported to us and subsequently paid. Processing costs related to
these claims are accrued based on an estimate of expenses to process such
claims.
Income Taxes
We account for income taxes using the asset and liability approach that
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that are recognized in different periods in
our financial statements and tax returns. In estimating future tax consequences,
we generally consider all future events other than future changes in the tax law
or rates that have not been enacted.
Deferred income taxes are determined based on the difference between the
financial statement and tax bases of assets and liabilities using enacted tax
rates in effect in the years in which the differences are expected to reverse.
We record deferred tax assets related to the recognition of future tax benefits
of temporary differences and net operating loss and tax credit carryforwards. To
the extent that realization of such benefits is not considered more likely than
not, we establish a valuation allowance to reduce such assets to the estimated
realizable amount.
We and our subsidiaries are subject to U.S. Federal income tax, Canadian
income tax, as well as income tax of multiple state and local jurisdictions. Our
2004 - 2008 U.S. federal income tax returns remain open to examination by the
Internal Revenue Service (IRS). Our state and local income tax returns for years
2000 through 2008 remain open to examination by the state and local taxing
authorities. Canadian income tax returns for 1999 through 2002 are currently
under examination and years 1999 - 2008 are open to examination. The IRS
examined our U.S. federal income tax return for 2004 resulting in no recommended
adjustments to the tax return.
We recognize interest and/or penalties related to income tax matters in
general and administrative expenses.
Commissions to Associates
Prior to March 1, 2002, we had a level Membership commission schedule of
approximately 27% of Membership fees and advanced the equivalent of up to three
years of commissions on new Membership sales. Effective March 1, 2002, and in
order to offer additional incentives for increased Membership retention rates,
we returned to a differential commission structure with rates of approximately
80% of first year Membership fees on new Memberships written and variable
renewal commission rates ranging from five to 25% per annum based on the 12
month Membership retention rate of the associate's sales organization. Beginning
in August 2003, we allowed the associate to choose between the level commission
structure and up to three year commission advance or the differential commission
structure with a one year commission advance.
We expense advance commissions ratably over the first month of the related
Membership. As a result of this accounting policy, our advance commission
expenses are recorded in the first month of a Membership and there is no
commission expense recognized for the same Membership during the remainder of
the advance period. Associates must qualify for advance commissions by writing
at least three Memberships.
Long-Lived Assets
We review long-lived assets to be held and used in operations when events
or changes in circumstances indicate that the assets might be impaired. The
carrying value of long-lived assets is considered impaired when the identifiable
undiscounted cash flows estimated to be generated by those assets are less than
their carrying amounts. In that event, a loss is recognized based on the amount
by which the carrying value exceeds the fair value of the long-lived asset. Fair
value is determined primarily using the anticipated cash flows discounted at a
rate commensurate with the risk involved. Losses on long-lived assets to be
disposed of are determined in a similar manner, except that fair values are
reduced by disposal costs.
55
Stock-Based Compensation
In December 2004, the Financial Accounting Standards Board issued SFAS No.
123R, Share-Based Payment ("SFAS No. 123R" or the "Statement"). This Statement
is a revision of SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS
123"), and supersedes Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees ("APB No. 25") and its related implementation
guidance. On January 1, 2006, we adopted the provisions of SFAS No. 123R using
the modified prospective method. SFAS No. 123R focuses primarily on accounting
for transactions in which an entity obtains employee services in share-based
payment transactions. The Statement requires entities to recognize compensation
expense for awards of equity instruments to employees based on the grant-date
fair value of those awards (with limited exceptions). SFAS No. 123R also
requires the benefits of tax deductions in excess of recognized compensation
expense to be reported as financing cash flows, rather than as an operating cash
flow as prescribed under the prior accounting rules. This requirement reduces
net operating cash flows and increases net financing cash flows in periods after
adoption. Total cash flow remains unchanged from what would have been reported
under prior accounting rules.
Prior to the adoption of SFAS No. 123R, we followed the intrinsic value
method in accordance with APB No. 25 to account for our equity instruments to
employees. Accordingly, no compensation expense was recognized in connection
with the issuance of equity instruments to employees under any of our stock
option plans for periods ended prior to January 1, 2006. The adoption of SFAS
No. 123R primarily resulted in a change in our method of recognizing the fair
value of share-based compensation. Our adoption of SFAS No. 123R did not result
in our recording compensation expense for equity instruments issued to
employees, since all options had vested, no modifications were made to existing
options and no new options were granted.
We did not grant any additional equity instruments to employees or modify
any existing options and therefore did not recognize any share-based payments'
expense from the issuance of equity instruments to employees in 2008, 2007 or
2006. The options outstanding at December 31, 2005 did not affect 2006
consolidated results of operations and financial position since all
option-holders were fully vested in such options at December 31, 2005.
Incentive awards payable
Associates can earn the right to attend an annual incentive trip by meeting
monthly qualification requirements for the entire calendar year and maintaining
certain personal retention rates for the Memberships sold during the calendar
year. Associates can also earn the right to receive additional monthly bonuses
by meeting the monthly qualification requirements for twelve consecutive months
and maintaining certain personal retention rates for the Memberships sold during
that twelve month period. The incentive awards payable at any date is estimated
based on an evaluation of the existing associates that have met the monthly
qualifications, any changes to the monthly qualification requirements, the
estimated cost for each incentive earned and the number of associates that have
historically met the personal retention rates. Changes to any of these
assumptions would directly affect the amount accrued but we do not expect any of
the significant trends impacting this account to change significantly in the
near term.
Legal Contingencies
We account for legal contingencies in accordance with SFAS 5, Accounting
for Contingencies, which requires that a loss contingency should be accrued by a
charge to income if it is probable that an asset has been impaired or a
liability has been incurred and the amount of the loss can be reasonably
estimated. Disclosure of a contingency is required if there is at least a
reasonable possibility that a loss has been incurred. We evaluate, among other
factors, the degree of probability of an unfavorable outcome and the ability to
make a reasonable estimate of the amount of loss. This process requires
subjective judgment about the likely outcomes of litigation. Liabilities related
to most of our lawsuits are especially difficult to estimate due to the nature
of the claims, limitation of available data and uncertainty concerning the
numerous variables used to determine likely outcomes or the amounts recorded.
Litigation expenses are recorded as incurred and we do not accrue for future
legal fees. It is possible that an adverse outcome in certain cases or increased
litigation costs could have an adverse effect upon our financial condition,
operating results or cash flows in particular quarterly or annual periods.
56
Treasury Stock
We immediately retire all our treasury stock purchases at cost. We retired,
at cost, 1,053,614, 1,318,721, and 1,959,487 shares of common stock during 2008,
2007 and 2006, respectively.
Segment Information
Operating segments are defined as components of an enterprise for which
separate financial information is available that is evaluated regularly by the
chief operating decision maker(s) in deciding how to allocate resources and in
assessing performance. Disclosures about products and services and geographic
areas are presented in Note 17.
Recently Issued Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value
Measurements" ("SFAS 157"). SFAS 157 defines fair value, establishes a framework
for measuring fair value, and expands disclosures about fair value measurements.
We adopted SFAS 157 on January 1, 2008, as required for our financial assets and
financial liabilities. However, the FASB deferred the effective date of SFAS 157
for one year as it relates to fair value measurement requirements for
nonfinancial assets and nonfinancial liabilities that are not recognized or
disclosed at fair value on a recurring basis. The adoption of SFAS 157 for our
financial assets and financial liabilities did not have a material impact on our
consolidated financial statements. The adoption of SFAS 157 for our nonfinancial
assets and nonfinancial liabilities will have no impact on our consolidated
financial statements. See Note 18 below.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities". SFAS No. 159 permits an entity to
choose, at specified election dates, to measure eligible financial instruments
and certain other items at fair value that are not currently required to be
measured at fair value. An entity reports unrealized gains and losses on items
for which the fair value option has been elected in earnings at each subsequent
reporting date. Upfront costs and fees related to items for which the fair value
option is elected are recognized in earnings as incurred and not deferred. SFAS
159 also established presentation and disclosure requirements designed to
facilitate comparisons between entities that choose different measurement
attributes for similar types of assets and liabilities. SFAS 159 was effective
for financial statements issued for fiscal years beginning after November 15,
2007 and interim periods within those fiscal years. At the effective date, an
entity could elect the fair value option for eligible items that existed at that
date. As such, the adoption of SFAS 159 did not have any impact on our
consolidated financial position, results of operations or cash flows. We did not
elect the fair value option for eligible items that existed as of January 1,
2008.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations ("SFAS 141R"). SFAS 141R establishes principles and requirements
for how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, any noncontrolling
interest in the acquiree and the goodwill acquired. SFAS 141R also establishes
disclosure requirements to enable the evaluation of the nature and financial
effects of the business combination. This statement is effective for us
beginning January 1, 2009.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements--an amendment of Accounting Research Bulletin
No. 51 ("SFAS 160"). SFAS 160 establishes accounting and reporting standards for
ownership interests in subsidiaries held by parties other than the parent, the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest, changes in a parent's ownership interest, and the
valuation of retained noncontrolling equity investments when a subsidiary is
deconsolidated. SFAS 160 also establishes disclosure requirements that clearly
identify and distinguish between the interests of the parent and the interests
of the noncontrolling owners. This statement is effective for us beginning
January 1, 2009. The adoption of SFAS 160 will have no impact on our
consolidated financial position, results of operations or cash flows.
In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally
Accepted Accounting Principles" (SFAS 162). This statement identifies the
sources of accounting principles and the framework for selecting the principles
used in the preparation of financial statements of nongovernmental entities that
are presented in accordance with GAAP. With the issuance of this statement, the
57
FASB concluded that the GAAP hierarchy should be directed toward the entity and
not its auditor, and reside in the accounting literature established by the FASB
as opposed to the American Institute of Certified Public Accountants (AICPA)
Statement on Auditing Standards No. 69, "The Meaning of Present Fairly in
Conformity With Generally Accepted Accounting Principles." This statement is
effective 60 days following the SEC's approval of the Public Company Accounting
Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly in
Conformity With Generally Accepted Accounting Principles." We have evaluated the
new statement and have determined that it will not have a significant impact on
the determination or reporting of our financial results.
In October 2008, the FASB issued FASB Staff Position FAS 157-3,
"Determining the Fair Value of a Financial Asset When the Market for That Asset
Is Not Active" ("FSP 157-3"). FSP 157-3 clarified the application of FAS 157.
FSP 157-3 demonstrated how the fair value of a financial asset is determined
when the market for that financial asset is inactive. FSP 157-3 was effective
upon issuance, including prior periods for which financial statements had not
been issued. The implementation of this standard did not have an impact on our
consolidated financial position, results of operations or cash flows.
In January 2009, the FASB issued FASB Staff Position No. Emerging Issues
Task Force 99-20-1, "Amendments to the Impairment Guidance of EITF Issue No.
99-20" (FSP No. EITF 99-20-1). This FSP provided additional guidance with
respect to how entities determine whether an "other-than-temporary impairment"
(OTTI) exists for certain beneficial interests in a securitized transaction,
such as asset-backed securities and mortgage-backed securities, that (1) do not
have a high quality rating or (2) can be contractually prepaid or otherwise
settled such that the holder would not recover substantially all of its
investment. FSP No. EITF 99-20-1 amended EITF Issue No. 99-20 to more closely
align its OTTI guidance with that of SFAS No. 115, "Accounting for Certain
Investment in Debt and Equity Securities." This FSP was effective for us
prospectively beginning October 1, 2008. We considered this FSP's additional
interpretation of EITF Issue No. 99-20 when classifying respective additional
impairments as "temporary" or "other-than-temporary" beginning with the fourth
quarter of 2008. This FSP had no impact on such classifications on our
consolidated financial position, results of operations or cash flows.
Note 2 - Investments
A summary of the amortized cost, unrealized gains and losses and fair
values of our investments at December 31, 2008 and 2007 follows:
December 31, 2008
----------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale Cost Gains Losses Value
------------------ ------------ ----------- ---------- -------------
U.S. Government obligations........................ $ 217 $ 16 $ - $ 233
Corporate obligations.............................. 350 - - 350
Obligations of state and political subdivisions.... 30,385 938 (546) 30,777
Auction Rate Certificates.......................... 375 - - 375
Certificates of deposit............................ 5,753 - - 5,753
------------ ----------- ---------- -------------
Total.............................................. $ 37,080 $ 954 $ (546) $ 37,488
------------ ----------- ---------- -------------
December 31, 2007
----------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale Cost Gains Losses Value
------------------ ------------ ----------- ---------- -------------
U.S. Government obligations........................ $ 1,513 $ 22 $ (8) $ 1,527
Corporate obligations.............................. 837 - (53) 784
Obligations of state and political subdivisions.... 31,007 389 (14) 31,382
Certificates of deposit............................ 4,591 - - 4,591
------------ ----------- ---------- -------------
Total.............................................. $ 37,948 $ 411 $ (75) $ 38,284
------------ ----------- ---------- -------------
58
In determining whether declines in the fair value of available-for-sale
securities below their cost are other than temporary, management considers the
financial condition of the issuer, causes for the decline in fair value (i.e.,
interest rate fluctuations or declines in creditworthiness) and severity and
duration of the decline, among other things. At December 31, 2008 we had eight
out of 331 securities (primarily municipal securities) with unrealized losses in
four consecutive quarters with combined market losses of $409,000. These losses
were determined to be temporary since these securities were rated A2 or better
and we have the ability to hold these to maturity.
The contractual maturities of our available-for-sale investments in debt
securities and certificates of deposit at December 31, 2008 by maturity date
follows:
Amortized
Cost Fair Value
------------ -------------
One year or less................................... $ 6,167 $ 6,169
Two years through five years....................... 5,722 5,898
Six years through ten years........................ 14,068 14,550
More than ten years................................ 11,123 10,871
------------ -------------
Total.............................................. $ 37,080 $ 37,488
------------ -------------
Our investment securities are included in the accompanying consolidated
balance sheets at December 31, 2008 and 2007 as follows:
December 31,
2008 2007
------------ -------------
Available-for-sale investments (current)........... $ 12,812 $ 13,177
Available-for-sale investments (non-current)....... 20,637 20,766
Investments pledged................................ 4,039 4,341
------------ -------------
Total.............................................. $ 37,488 $ 38,284
------------ -------------
We are required to pledge investments to various state insurance
departments as a condition to obtaining authority to do business in certain
states. The fair value of investments pledged to state regulatory agencies is as
follows:
December 31,
2008 2007
------------ -------------
Certificates of deposit............................ $ 1,917 $ 2,292
Obligations of state and political subdivisions.... 1,889 1,203
U. S. Government obligations....................... 233 846
------------ -------------
Total.............................................. $ 4,039 $ 4,341
------------ -------------
Proceeds from sales of investments during 2008, 2007 and 2006 were $14.4
million, $14.2 million and $135.8 million, respectively, and resulted in gross
realized gains of $109,000, $248,000 and $43,000 and gross realized losses of
$72,000, $13,000 and $82,000, respectively.
59
Note 3 - Property and Equipment
Property and equipment is comprised of the following:
Deccember 31,
Estimated -----------------------
Useful Life 2008 2007
------------- ---------- -----------
Equipment, furniture and fixtures.......... 3-10 years $ 44,967 $ 41,289
Computer software.......................... 3 years 16,660 15,226
Buildings.................................. 20-40 years 39,420 39,367
Automotive and aviation equipment.......... 3-10 years 14,152 14,152
Land....................................... N/A 445 445
---------- -----------
115,644 110,479
Accumulated depreciation................................. (62,199) (53,516)
---------- -----------
Property and equipment, net.............................. $ 53,445 $ 56,963
---------- -----------
As of December 31, 2008 and 2007, capitalized interest of $706,000 was
included in the cost of the building. No interest was capitalized during 2008,
2007 or 2006.
Note 4 - Other Assets, Current
Other Assets, current, are comprised of the following:
December 31,
------------------------
2008 2007
---------- ----------
Prepaid Canadian income taxes...................... $ 3,161 $ 4,293
Other prepaid expenses, current portion............ 1,969 1,542
Accrued interest receivable........................ 489 487
Other.............................................. 581 471
---------- ----------
Total.............................................. $ 6,200 $ 6,793
---------- ----------
Note 5 - Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses are comprised of the following:
December 31,
2008 2007
---------- ----------
Accounts payable................................... $ 4,003 $ 5,679
Marketing bonuses payable.......................... 3,399 2,392
Incentive awards payable........................... 3,080 3,337
Litigation accrual................................. 500 75
Other.............................................. 5,345 4,408
---------- ----------
Total.............................................. $ 16,327 $ 15,891
---------- ----------
Note 6 - Notes Payable
During 2006, we received $80 million of senior, secured financing (the
"Senior Loan") from Wells Fargo Foothill, Inc. ("Wells Fargo") consisting of a
$75 million five year term loan facility (the "Term Facility") and a $5 million
five year revolving credit facility (the "Revolving Facility"). At December 31,
2008, we had the full Revolving Facility available to us. After payment of an
origination fee of 1%, lender costs and retirement of $15.3 million of existing
bank indebtedness, the net proceeds of the Term Facility we received were $58.8
million and were used to purchase treasury stock.
60
The Term Facility provides for a five-year maturity and amortizes in
monthly installments of $1.25 million commencing August 1, 2006, with interest
on the outstanding balances under the Term Facility and the Revolving Facility
payable, at our option, at a rate equal to Wells Fargo base rate or at the 30
day LIBOR rate plus 150 basis points. The interest rate at December 31, 2008 was
2.93%, but decreased to 1.95% effective January 1, 2009. We are also obligated
to make additional quarterly payments equal to 50% of our "excess cash flow" (as
defined in the Senior Loan agreement) if our Leverage Ratio is greater than or
equal to 1 to 1 at the end of a quarter. Our Leverage Ratio was 0.55 to 1 at
December 31, 2008. We expect to be able to repay the facilities with cash flow
from operations. We have the right to prepay the Term Facility in whole or in
part without penalty.
The Senior Loan is guaranteed by our non-regulated wholly owned
subsidiaries and is secured by all of our tangible and intangible personal
property (other than aircraft), including stock in all of our direct
subsidiaries, and a mortgage on a building we recently acquired in Duncan,
Oklahoma and remodeled to relocate and expand our existing customer service
facility in Duncan.
In addition to customary covenants for loans of a similar type, the
principal covenants for the Senior Loan are:
* a limitation on incurring any indebtedness in excess of the remaining
existing bank indebtedness outstanding and $2.3 million in permitted
capitalized leases or purchase money debt;
* a limitation on our ability to pay dividends or make stock purchases,
other than with the net proceeds of the Term Loan, unless we meet
certain cash flow tests;
* a prohibition on prepayment of other debt;
* a requirement to maintain consolidated EBITDA (Earnings before
Interest, Taxes, Depreciation and Amortization) for the twelve month
period ending December 31, 2006 and each quarter thereafter of at
least $80 million ($75 million for us and our top tier direct
subsidiaries);
* a requirement to maintain a quarterly fixed charge coverage ratio
(EBITDA (with certain adjustments) divided by the sum of interest
expense, income taxes and scheduled principal payments) of at least
1.1 to 1;
* a requirement to maintain at least 1.3 million members;
* a requirement to maintain a Leverage Ratio (funded indebtedness as of
the end of each quarter divided by EBITDA for the trailing twelve
months) of no more than 1.5 to 1;
* we must have availability (unused portion of the Revolving Facility)
plus Qualified Cash (the amount of unrestricted cash and cash
equivalents) greater than or equal to $12,500,000; and
* an event of default occurs if Harland Stonecipher ceases to be our
Chairman and Chief Executive Officer for a period of 120 days unless
replaced with a person approved by Wells Fargo.
We were in compliance with these covenants at December 31, 2008.
Our $20 million real estate loan was fully funded in 2002 to finance our
new headquarters building in Ada, Oklahoma and has a final maturity of August
2011. This loan, with interest at the 30 day LIBOR rate plus 150 basis points
adjusted monthly, is secured by a mortgage on our headquarters. The interest
rate at December 31, 2008 was 3.41%, but decreased to 1.94% effective January 1,
2009, with monthly principal payments of $191,000 plus interest with the balance
of approximately $2.3 million due at maturity. The real estate loan's financial
covenants conform to those of the Senior Loan.
During 2007, we entered into a term loan agreement with Wells Fargo
Equipment Finance, Inc. to refinance $9.6 million indebtedness related to our
aircraft. This loan, with interest at the 30 day LIBOR rate plus 89 basis points
adjusted monthly, is secured by a mortgage on the aircraft and engines. The
interest rate at December 31, 2008 was 2.79%, but decreased to 1.33% effective
January 1, 2009, with monthly principal payments of $80,000 plus interest.
During June 2008 we received additional financing from Bank of Oklahoma for
$10 million on an unsecured basis repayable in 12 equal monthly payments
beginning June 30, 2008, together with interest at LIBOR plus 162.5 basis
61
points. The interest rate at December 31, 2008 was 3.54%, but decreased to 2.06%
effective January 1, 2009, with monthly principal payments of $833,000 plus
interest.
A schedule of outstanding balances as of December 31, 2008 is as
follows:
Senior loan................................ $ 38,750
Real estate loan........................... 8,381
Aircraft loan.............................. 8,361
Unsecured stock repurchase loan............ 4,167
----------
Total notes payable........................ 59,659
Less: Current portion of notes payable..... (22,408)
----------
Long term portion.......................... $ 37,251
----------
A schedule of future maturities as of December 31, 2008 is as follows:
Repayment Schedule commencing
January 2009:
Year 1..................................... $ 22,408
Year 2..................................... 18,241
Year 3..................................... 13,515
Year 4..................................... 956
Year 5..................................... 956
Thereafter................................. 3,583
----------
Total notes payable........................ $ 59,659
----------
Note 7 - Income Taxes
The provision for income taxes consists of the following:
Year Ended December 31,
------------------------------------
2008 2007 2006
---------- ----------- -----------
Current................................. $ 36,840 $ 33,864 $ 27,116
Deferred................................ 385 (552) 774
---------- ----------- -----------
Total provision for income taxes...... $ 37,225 $ 33,312 $ 27,890
---------- ----------- -----------
A reconciliation of the statutory Federal income tax rate to the effective
income tax rate is as follows:
Year Ended December 31,
---------------------------------
2008 2007 2006
--------- --------- ---------
Statutory Federal income tax rate.......... 35.0% 35.0% 35.0%
Tax exempt interest........................ (.6) (1.0) (.7)
Wage tax credits........................... (.3) (.4) (.3)
Prior years, state income taxes, net....... - 2.4 -
State income tax expense, net.............. 4.0 3.8 -
Other...................................... .1 (.4) 1.0
--------- --------- ---------
Effective income tax rate.................. 38.2% 39.4% 35.0%
--------- --------- ---------
The prior year's state income taxes reflected above is due to a fourth
quarter 2007 charge. During the 2007 fourth quarter we discovered and corrected
a clerical error in the amount of net operating loss reported in a 2003 state
income tax return which resulted in nonpayment of income taxes in that state for
several years. This 2.4% represents the $2.0 million charge pertaining to 2006
and prior years. See Note 16 - Selected Quarterly Financial Data (Unaudited) for
62
additional information related to this charge. The state income tax expense,
4.0% and 3.8% net, represents current year state income taxes, net of federal
tax benefit for 2008 and 2007, respectively. No state income taxes were recorded
in the provision for income taxes for 2006. $2.7 million of state income tax
expense was included in general and administrative expenses for 2006.
Deferred tax liabilities and assets at December 31, 2008 and 2007 are
comprised of the following:
December 31,
---------------------
2008 2007
---------- ---------
Deferred tax liabilities relating to:
Deferred member and associate service costs...... $ 6,919 $ 7,367
Property and equipment........................... 8,693 7,829
Unrealized investment gains...................... 159 131
---------- ---------
Total deferred tax liabilities................ 15,771 15,327
---------- ---------
Deferred tax assets relating to:
Expenses not yet deducted for tax purposes....... 4,028 3,552
Deferred revenue and fees........................ 11,138 11,564
Other............................................ 110 101
---------- ---------
Total deferred tax assets..................... 15,276 15,217
---------- ---------
Net deferred tax liability....................... $ (495) $ (110)
---------- ---------
Our deferred tax assets and liabilities are included in the accompanying
consolidated balance sheets at December 31, 2008 and 2007 as follows.
December 31,
---------------------
2008 2007
---------- ---------
Deferred income taxes (current asset).............. $ 5,151 $ 5,163
Deferred income taxes (non-current liability)...... (5,646) (5,273)
---------- ---------
Net deferred tax liability......................... $ (495) $ (110)
---------- ---------
A significant portion of the deferred tax assets recognized relate to
deferred revenue and fees. A valuation allowance was not recorded since we
believe that there is sufficient positive evidence to support our conclusion not
to record a valuation allowance. We believe that we will realize the tax benefit
of these deferred tax assets in the future because of our history of pre-tax
income. However, there can be no assurance that we will generate taxable income
or that all of our deferred tax assets will be utilized.
Note 8 - Stockholders' Equity
We announced on April 6, 1999, a treasury stock purchase program
authorizing management to acquire up to 500,000 shares of our common stock. The
Board of Directors has increased such authorization from 500,000 shares to 14
million shares during subsequent board meetings. At December 31, 2008, we had
purchased 13.7 million treasury shares under these authorizations for a total
consideration of $407.1 million, an average price of $29.62 per share. We
purchased and formally retired 1,053,614 shares of our common stock during 2008
for $44.7 million, or an average price of $42.44 per share, reducing our common
stock by $10.5 million and our retained earnings by $44.7 million. At December
31, 2008 and 2007, we had 11.4 million and 12.4 million common shares
outstanding, respectively, net of treasury shares. Given the current interest
rate environment, the nature of other investments available and our expected
cash flows, we believe that purchasing treasury shares enhances shareholder
value and may seek alternative sources of financing to continue or accelerate
the program. Any additional treasury stock purchases will be made at prices that
we consider attractive and at such times that we believe will not unduly impact
our liquidity.
63
Our ability to pay dividends is dependent in part on our ability to derive
dividends from our subsidiaries. The payment of dividends by PPLCI is restricted
under the Oklahoma Insurance Code to available surplus funds derived from
realized net profits and requires the approval of the Oklahoma Insurance
Commissioner for any dividend representing more than the greater of 10% of such
accumulated available surplus or the previous years' net profits. PPLSIF is
similarly restricted pursuant to the insurance laws of Florida. During 2008,
PPLCI declared and, after obtaining all necessary regulatory approvals, paid
extraordinary dividends to us of $14.9 million compared to the $7.4 million
dividend paid to us during 2007. During 2008, LSPV paid us an ordinary dividend
of $4.1 million compared to $1.6 million during 2007. At December 31, 2008 the
amount of restricted net assets of consolidated subsidiaries was $24.2 million,
representing amounts that may not be paid to us as dividends either under the
applicable regulations or without regulatory approval.
Note 9 - Other Expenses, net
The components of other expenses, net are as follows:
Year Ended December 31,
----------------------------------
2008 2007 2006
--------- --------- ----------
Depreciation and amortization.............. $ 8,756 $ 8,532 $ 8,260
Premium taxes.............................. 1,776 1,956 1,840
Interest expense........................... 4,221 6,678 5,726
Litigation expense......................... 906 15 (710)
Interest income............................ (2,246) (3,340) (2,884)
--------- --------- ----------
Total Other expenses, net................ $ 13,413 $ 13,841 $ 12,232
--------- --------- ----------
Note 10 - Comprehensive Income
Comprehensive income is comprised of two subsets - net income and other
comprehensive income. Included in other comprehensive income for us are foreign
currency translation adjustments and unrealized gains on investments. These
items are accumulated within the Statements of Changes in Stockholders' Equity
under the caption "Accumulated Other Comprehensive Income." As of December 31,
accumulated other comprehensive income, as reflected in the Consolidated
Statements of Changes in Stockholders' Equity, was comprised of the following:
2008 2007
--------- ----------
Foreign currency translation adjustments................ $ (425) $ 1,603
Unrealized losses on investments, net of income taxes
of $159 and $131...................................... 265 218
--------- ----------
Accumulated other comprehensive income................ $ (160) $ 1,821
--------- ----------
Note 11 - Related Party Transactions
John W. Hail, one of our directors, served as our Executive Vice President,
Director and Agency Director from July 1986 through May 1988 and also served as
Chairman of the Board of Directors of TVC Marketing, Inc., which was our
exclusive marketing agent from April 1984 through September 1985. Pursuant to
agreements between Mr. Hail and us entered into during the period in which Mr.
Hail was one of our executive officers, Mr. Hail receives override commissions
from renewals of certain Memberships initially sold by us during such period.
During 2008, 2007 and 2006, such override commissions on renewals together with
new commission advances totaled $117,000, $68,000 and $71,000, respectively. Mr.
Hail also owns interests ranging from 12% to 100% in corporations not currently
affiliated with us, including TVC Marketing, Inc., but which were engaged in the
marketing of our legal service Memberships and which earn renewal commissions
from Memberships previously sold. These entities earned renewal commissions of
$491,000, $515,000 and $519,000 during 2008, 2007 and 2006, respectively, of
which $257,000, $274,000 and $273,000, respectively, was passed through as
commissions to their sales agents.
64
Note 12 - Leases
At December 31, 2008, we were committed under noncancelable operating and
capital leases, principally for buildings and equipment. Aggregate rental
expense under all operating leases was $122,000, $111,000 and $143,000 in 2008,
2007 and 2006, respectively.
Future commitments commencing January 2009 related to noncancelable
operating leases are as follows:
Year Ended December 31,
2009............................................... $ 119
2010............................................... 117
2011............................................... 101
2012............................................... 63
2013............................................... 40
Thereafter......................................... 224
----------
Total operating lease commitments.................. $ 664
----------
Future minimum lease payments commencing in January 2009 related to capital
leases are as follows:
Year Ended December 31,
2009............................................... $ 81
2010............................................... 81
2011............................................... 81
2012............................................... 81
2013............................................... 81
Thereafter......................................... 1,325
----------
Total minimum lease payments....................... 1,730
Less: Imputed interest............................. (796)
----------
Present value of net minimum lease payments........ 934
Less: Current portion.............................. (24)
----------
Noncurrent portion of capital leases payable....... $ 910
----------
We have entered into capital leases to acquire equipment and buildings
which expire at various dates through 2033. The capital lease assets are
included in property and equipment as follows at December 31, 2008 and December
31, 2007.
December 31,
------------------------
2008 2007
----------- ----------
Equipment, furniture and fixtures.................. $ 729 $ 729
Buildings and improvements......................... 314 314
----------- ----------
1,043 1,043
Less: accumulated amortization..................... (225) (185)
----------- ----------
Net capital lease assets........................... $ 818 $ 858
----------- ----------
65
Note 13 - Commitments and Contingencies
On March 27, 2006 we received a complaint filed by Blackburn & McCune PLLC,
a former provider attorney law firm, in the Second Circuit Court of Davidson
County, Tennessee seeking compensatory and punitive damages on the basis of
allegations of breach of contract. On May 15, 2006 the trial court dismissed
plaintiff's complaint in its entirety. Plaintiff filed a notice of appeal on
June 13, 2006, and on August 24, 2007 the Court of Appeals reversed the ruling
of the trial court and remanded the suit to the trial court for further
proceedings. This matter is currently set for trial in May 2009. The ultimate
outcome of this matter is not determinable.
On March 23, 2007 we received a Civil Investigative Demand from the Federal
Trade Commission requesting information relating to our Identity Theft Shield
and ADRS Program. We are working with the Federal Trade Commission to resolve
the matter and responded to all requests. The ultimate outcome of the matter is
not determinable.
We are a defendant in various other legal proceedings that are routine and
incidental to our business. We will vigorously defend our interests in all
proceedings in which we are named as a defendant. We also receive periodic
complaints or requests for information from various state and federal agencies
relating to our business or the activities of our marketing force. We promptly
respond to any such matters and provide any information requested. While the
ultimate outcome of these proceedings is not determinable, we do not currently
anticipate that these contingencies will result in any material adverse effect
to our financial condition or results of operation, unless an unexpected result
occurs in one of the cases. The costs of the defense of these various matters
are reflected as a part of general and administrative expense, or Membership
benefits if fees relate to Membership issues, in the consolidated statements of
income. We have established an accrued liability, we believe will be sufficient
to cover estimated damages in connection with various cases (exclusive of
ongoing defense costs which are expensed as incurred), which at December 31,
2008 was $500,000. We believe that we have meritorious defenses in all pending
cases and will vigorously defend against the claims. However, it is possible
that an adverse outcome in certain cases or increased litigation costs could
have an adverse effect upon our financial condition, operating results or cash
flows in particular quarterly or annual periods.
Canadian taxing authorities are challenging portions of our commission and
general and administrative deductions for tax years 1999 - 2002 and have tax
assessments which aggregate $5.7 million. The Canadian taxing authorities
contend commission deductions should be matched with the membership revenue as
received, we contend these commissions are deductible when paid. Under Canadian
tax laws, our commission payments are treated as a prepaid expense. We base our
deduction of commission on the fact that all the services (the sale of the
membership) have been performed by the sales associate at the time of sale
therefore this prepaid expense (the commission payments) is deductible when
paid. Also, the commission payment is taxable to the sales associate when paid
and each year we issue a T4 (Canadian 1099 equivalent) to sales associates for
the total commission payments made during that year. In addition, Canadian
taxing authorities challenged our allocation of general and administrative
expenses to Canadian operations. We contended the allocation of general and
administrative expenses, based on the percentage of Canadian new memberships
written and the Canadian percentage memberships in force, was reasonable. During
July 2007 we received and later accepted a settlement offer from the Canadian
taxing authorities regarding the general and administrative deductions which
would allow us to claim a deduction on the Canadian tax return for over 70% of
these items. This settlement offer allowed us to amend our U.S. federal tax
returns and deduct the remaining 30% of these items. The Canadian taxing
authorities amended Canadian tax returns to reflect the changes in our general
and administrative expense and issued credits for the associated taxes, penalty
and interest. We did not prevail on the commission issue on our appeal to the
Canadian taxing authorities and on December 19, 2008 filed our Notice of Appeal
with the Tax Court of Canada. We have paid the tax, penalty and interest
relating to the commission issue and at December 31, 2008 have $3.3 million
recorded in Other Assets, Current. We have established an accrued liability we
believe will be sufficient to cover the estimated tax assessment in connection
with these items, which at December 31, 2008 was $511,000. As stated above, we
believe that we have reasonable basis for our tax position relative to these
items, however, it is possible that an adverse outcome could have an adverse
effect upon our financial condition, operating results or cash flows in
particular quarterly or annual periods.
66
Note 14 - Stock Options, Stock Ownership Plan and Benefit Plan
We have a stock option plan (the "Plan") under which the Board of Directors
(the "Board") or our Stock Option Committee (the "Committee") may grant options
to purchase shares of our common stock. The Plan permits the granting of options
to our directors, officers and employees to purchase our common stock at not
less than the fair value at the time the options are granted. The Plan provides
for option grants to acquire up to 3,000,000 shares and permits the granting of
incentive stock options as defined under Section 422 of the Internal Revenue
Code at an exercise price for each option equal to the market price of our
common stock on the date of the grant and a maximum term of 10 years. Options
not qualifying as incentive stock options under the Plan have a maximum term of
15 years. The Board or Committee determines vesting of options granted under the
Plan. No options may be granted under the Plan after December 12, 2012. We have
not granted options under the Plan since March 2004.
The Plan previously provided for automatic grants of options to our
non-employee directors. Under the Plan, each incumbent non-employee director and
any new non-employee director received options to purchase 10,000 shares of
common stock on March 1 of each year. The options granted each year were
immediately exercisable as to 2,500 shares and vested in additional increments
of 2,500 shares on the following June 1st, September 1st, and December 1st in
the year of grant, subject to continued service by the non-employee director
during such periods. Options granted to non-employee directors under the Plan
have an exercise price equal to the closing price of the common stock on the
date of grant. These automatic grants of options to non-employee directors were
eliminated effective January 1, 2005, and therefore no further grants to
non-employee directors have been made.
Also included below are stock options that were issued to our Regional Vice
Presidents ("RVPs") in order to encourage stock ownership by our RVPs and to
increase the proprietary interest of such persons in our growth and financial
success. These options have been granted periodically to RVPs since 1996.
Options were granted at fair market value at the date of the grant and were
generally immediately exercisable for a period of three years or within 90 days
of termination, whichever occurs first. There we no options granted to RVPs
during 2008, 2007 or 2006
A summary of the status of our total stock option activity as of December
31, 2008, 2007 and 2006, and for the years ended on those dates is presented
below:
During 1988, we adopted an employee stock ownership plan. Under the plan,
employees may elect to defer a portion of their compensation by making
contributions to the plan. Prior to December 31, 2006, up to seventy-five
percent of the contributions made by employees were used to purchase Company
common stock with the remaining twenty-five percent allocated to other
investment options within the plan. For plan years beginning after December 31,
2006, the plan allows participants to move any portion of their account that is
invested in our stock from that investment into other investment alternatives
under the plan. At our option, we may make matching contributions to the plan in
cash, and recorded expense of $544,000, $486,000 and $459,000 for 2008, 2007 and
2006 respectively.
2008 2007 2006
----------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------ ---------- ------------ --------- ----------- ----------
Shares
Outstanding at beginning of year....... 58,500 $ 20.08 273,040 $ 23.26 507,167 $ 20.94
Granted................................ - - - - - -
Exercised.............................. (16,000) 21.09 (208,943) 24.17 (226,719) 18.07
Terminated............................. - - (5,597) 22.87 (7,408) 23.29
------------ ---------- ------------ --------- ----------- ----------
Outstanding at end of year............. 42,500 $ 19.70 58,500 $ 20.08 273,040 $ 23.26
------------ ---------- ------------ --------- ----------- ----------
Options exercisable at year end........ 42,500 $ 19.70 58,500 $ 20.08 273,040 $ 23.26
------------ ---------- ------------ --------- ----------- ----------
Aggregate intrinsic value of outstanding
options................................ $ 748 $ 2,063 $ 4,332
------------ ------------ -----------
Intrinsic value of options exercised... $ 398 $ 6,821 $ 3,357
------------ ------------ -----------
Fair value of options vested during
period................................. $ - $ - $ -
------------ ------------ -----------
Weighted average grant date fair value
per share.............................. N/A N/A N/A
------------ ------------ -----------
67
The following table summarizes information about stock options outstanding
and exercisable at December 31, 2008:
Weighted Average
Range of Remaining Weighted Average
Exercise Prices Number Outstanding Contractual Life Exercise Price
--------------------------- ------------------------ ------------------------- ------------------------
$19.20 38,000 2.16 $ 19.20
$23.93 4,500 .16 23.93
------------------------ ------------------------- ------------------------
42,500 1.95 $ 19.70
------------------------ ------------------------- ------------------------
During 1988, we adopted an employee stock ownership plan. Under the plan,
employees may elect to defer a portion of their compensation by making
contributions to the plan. Prior to December 31, 2006, up to seventy-five
percent of the contributions made by employees were used to purchase Company
common stock with the remaining twenty-five percent allocated to other
investment options within the plan. For plan years beginning after December 31,
2006, the plan allows participants to move any portion of their account that is
invested in our stock from that investment into other investment alternatives
under the plan. At our option, we may make matching contributions to the plan in
cash, and recorded expense of $544,000, $486,000 and $459,000 for 2008, 2007 and
2006 respectively.
In November 2002, we adopted a deferred compensation plan, which permits
executive officers and key employees to defer receipt of a portion of their
compensation. Deferred amounts accrue hypothetical returns based upon investment
options selected by the participant. We have amended the deferred compensation
plan, effective January 1, 2009, to comply with new provisions of Section 409A
of the Internal Revenue Code. Deferred amounts are paid in cash based on the
value of the investment option and are generally payable following termination
of employment in a lump sum or in installments as elected by the participant,
but the plan provides for financial hardship distributions, distributions in the
event of total disability or death and distributions upon a change in control.
The plan also provides for a death benefit of $500,000 for each participant.
Although the plan is unfunded and represents an unsecured liability of ours to
the participants, we have purchased variable life insurance policies owned by us
to insure the lives of the group of participants and to finance our obligations
under the plan. As of December 31, 2008 and 2007, we had an aggregate deferred
compensation liability of $7.9 million and $6.5 million, respectively, which is
included in other non-current liabilities. At December 31, 2008 and 2007, the
cash value of the underlying insurance policies owned by us was $6.5 million and
$5.7 million, respectively, and was included in other assets.
Note 15 - Earnings Per Share
Basic earnings per common share are computed by dividing net income by the
weighted average number of shares of common stock outstanding during the year.
Diluted earnings per common share are computed by dividing net income by
the weighted average number of shares of common stock and dilutive potential
common shares outstanding during the year. The weighted average number of common
shares is also increased by the number of dilutive potential common shares
issuable on the exercise of options less the number of common shares assumed to
have been purchased with the proceeds from the exercise of the options pursuant
to the treasury stock method; those purchases are assumed to have been made at
the average price of the common stock during the respective period.
Year Ended December 31,
------------------------------
Basic Earnings Per Share: 2008 2007 2006
--------- --------- ---------
Earnings:.................................... $ 60,172 $ 51,202 $ 51,798
--------- --------- ---------
Shares:
Weighted average shares outstanding.......... 11,916 13,151 14,642
--------- --------- ---------
68
Diluted Earnings Per Share:
Earnings:
Income after assumed conversions............. $ 60,172 $ 51,202 $ 51,798
--------- --------- ---------
Shares:
Weighted average shares outstanding.......... 11,916 13,151 14,642
Assumed exercise of options.................. 18 46 97
--------- --------- ---------
Weighted average number of shares, as adjusted 11,934 13,197 14,739
--------- --------- ---------
Options to purchase shares of common stock are excluded from the
calculation of diluted earnings per share when their inclusion would have an
anti-dilutive effect on the calculation. Options to purchase 218,000 shares with
an average exercise price of $32.05 were excluded from the calculation of
diluted earnings per share for the year ended December 31, 2006. No options were
excluded from the diluted earnings per share calculation for the years ended
December 31, 2008 and 2007.
Note 16 - Selected Quarterly Financial Data (Unaudited)
Following is a summary of the unaudited interim results of operations for
the years ended December 31, 2008 and 2007.
Selected Quarterly Financial Data
(In thousands, except per share amounts)
2008 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
--------------------------------------------------- ----------- ----------- ----------- -----------
Revenues........................................... $ 116,203 $ 116,855 $ 116,523 $ 114,908
Net income......................................... 15,942 15,056 14,442 14,732
Basic income per common share (1):
Net Income....................................... $ 1.29 $ 1.25 $ 1.23 $ 1.28
Diluted income per common share (1):
Net Income....................................... $ 1.29 $ 1.25 $ 1.23 $ 1.27
2007
---------------------------------------------------
Revenues........................................... $ 112,084 $ 114,060 $ 114,877 $ 116,068
Net income......................................... 14,728 13,179 11,573 11,722
Basic income per common share (1):
Net Income....................................... $ 1.09 $ .99 $ .89 $ .92
Diluted income per common share (1):
Net Income....................................... $ 1.08 $ .99 $ .88 $ .92
(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.
In the 2007 fourth quarter, we discovered and corrected a clerical error in
the amount of net operating loss reported in a 2003 state income tax return
which resulted in nonpayment of income taxes in that state for several years.
The $2.9 million charge was comprised of $2.0 million pertaining to 2006 and
prior years and $900,000 pertaining to the first 3 quarters of 2007,
approximately $300,000 for each quarter. This charge was not individually
material to the 2007 prior quarters or 2006 or prior years.
69
Note 17 - Segment Information
We operate a consistent business model, marketing Memberships to our
customers in the United States and four Canadian provinces. We maintain regional
geographic management to facilitate local execution of our marketing strategies.
However, the most significant performance evaluations and resource allocations
made by our chief operating decision makers are made on a global basis. As such,
we have concluded that we maintain one operating and reportable segment.
Substantially all of our business is currently conducted in the United States.
Revenues from our Canadian operations for 2008, 2007 and 2006 were $8.7 million,
$7.9 million and $7.1 million, respectively. We have no significant long-lived
assets located in Canada.
Note 18 - Fair Value Measurement
On January 1, 2008, we adopted SFAS No. 157, "Fair Value Measurements," for
our financial assets and liabilities. SFAS 157 established the following fair
value hierarchy that prioritizes the inputs used to measure fair value:
Level 1: Quoted prices are available in active markets for identical assets
or liabilities as of the reporting date. Active markets are those in
which transactions for the asset or liability occur in sufficient
frequency and volume to provide pricing information on an ongoing
basis. Level 1 primarily consists of financial instruments such as
exchange-traded derivatives, listed equities and U.S. government
treasury securities.
Level 2: Pricing inputs are other than quoted prices in active markets
included in Level 1, which are either directly or indirectly
observable as of the reporting date. Level 2 includes those financial
instruments that are valued using models or other valuation
methodologies. These models are primarily industry-standard models
that consider various assumptions, including quoted forward prices for
commodities, time value, volatility factors, and current market and
contractual prices for the underlying instruments, as well as other
relevant economic measures. Substantially all of these assumptions are
observable in the marketplace throughout the full term of the
instrument, can be derived from observable data or are supported by
observable levels at which transactions are executed in the
marketplace. Instruments in this category include non-exchange-traded
derivatives such as over the counter forwards, options and repurchase
agreements.
Level 3: Pricing inputs include significant inputs that are generally less
observable from objective sources. These inputs may be used with
internally developed methodologies that result in management's best
estimate of fair value. At each balance sheet date, we perform an
analysis of all instruments subject to SFAS No. 157 and include in
Level 3 all of those whose fair value is based on significant
unobservable inputs.
The following table presents our financial assets and liabilities that were
accounted for at fair value on a recurring basis as of December 31, 2008 by
level within the fair value hierarchy (in thousands):
Fair Value Measurements Using
-------------------------------------
Level 1 Level 2 Level 3
---------- ---------- ---------
Available for sale investments......... $ - $ 37,488 $ -
Liabilities............................ $ - $ - $ -
For securities without a readily ascertainable market value (Level 2), we
utilize pricing services and broker quotes. Such estimated fair values do not
necessarily represent the values for which these securities could have been sold
at the dates of the balance sheets.
70
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
------------------------------------------------------------------------
AND FINANCIAL DISCLOSURE.
-------------------------
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES.
----------------------------------
Controls and Procedures
Our principal executive officer (Chairman, Chief Executive Officer and
President) and principal financial officer (Chief Financial Officer) have
evaluated our disclosure controls and procedures as of December 31, 2008, and
have concluded that these controls and procedures are effective to ensure that
information required to be disclosed by us in the reports that we file or submit
under the Securities Exchange Act of 1934 (15 U.S.C. ss. 78a et seq) is
recorded, processed, summarized, and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms. These disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by us in the
reports that we file or submit is accumulated and communicated to management,
including the principal executive officer and the principal financial officer,
as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
During the fourth quarter of 2008, no change occurred in our internal
control over financial reporting that materially affected, or is likely to
materially affect, our internal control over financial reporting.
Management's Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting. Under the supervision and with the
participation of our management, including the Chief Executive Officer and Chief
Financial Officer, we evaluated the effectiveness of the design and operation of
our internal control over financial reporting based on the framework in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our internal
control over financial reporting was effective as of December 31, 2008 as
reflected in our report included in Item 8 above.
Grant Thornton LLP, our independent registered public accounting firm,
audited the effectiveness of internal control over financial reporting and,
based on that audit, issued the report set forth in Item 8 above.
Certifications
Our Chief Executive and Chief Financial Officers have completed the
certifications required to be filed as an Exhibit to this Report (See Exhibits
31.1 and 31.2) relating to the design of our disclosure controls and procedures
and the design of our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION.
----------------------------
None.
71
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
-----------------------------------------------------------------
Directors
Our Board of Directors currently consists of seven members and is divided
into three classes as nearly equal in size as possible, with the term of office
of one class expiring each year.
The following is certain information about each of our directors:
Existing
Name Age Director Since Term Expires
---------------------------------- --- -------------- ------------
John W. Hail...................... 78 1998 2009
Thomas W. Smith................... 80 2004 2009
Orland G. Aldridge................ 70 2004 2010
Peter K. Grunebaum................ 75 1980 2010
Duke R. Ligon..................... 67 2007 2010
Martin H. Belsky.................. 64 1998 2011
Harland C. Stonecipher............ 70 1976 2011
John W. Hail
John W. Hail is the founder of AMS Health Sciences, Inc. (formerly
Advantage Marketing Systems, Inc.) ("AMS") and served as Chief Executive Officer
and Chairman of the Board of Directors of AMS since its inception in June 1988
until February 12, 2006. AMS sells natural nutritional supplements, weight
management products, and natural skincare products. AMS filed a voluntary
petition for relief under Chapter 11 of the United States Bankruptcy Code on
December 27, 2007. From July 1986 through May 1988, Mr. Hail served as our
Executive Vice President, Director and Agency Director and also served as
Chairman of the Board of Directors of TVC Marketing, Inc., which was our
exclusive marketing agent from April 1984 through September 1985. Mr. Hail also
serves as a director of InPlay Technologies, Inc. (NASDAQ: NPLA) (formerly
Duraswitch Industries, Inc.).
Thomas W. Smith
Mr. Smith is the largest outside shareholder of the Company and is the
managing partner of Prescott Investors, Inc, a private investment firm he
founded in 1973. He currently serves as a director of Copart, Inc. (NASDAQ-GS:
CPRT).
Orland G. Aldridge
Mr. Aldridge retired as a professor from Northeastern Oklahoma A & M
College in Miami, Oklahoma in 2002 where he had been an instructor since 1999
and has been and remains an independent insurance agent. He has served as a
director of our wholly-owned subsidiary, Pre-Paid Legal Casualty, Inc. since
1991.
Peter K. Grunebaum
Mr. Grunebaum, currently an independent investment banker and corporate
consultant, was the Managing Director of Fortrend International, an investment
firm headquartered in New York, New York, a position he held from 1989 until the
end of 2003. Mr. Grunebaum also serves as a director of StoneMor GP, LLC the
general partner of StoneMor Partners LP (NASDAQ-GM: STON) and Lucas Energy, Inc.
(AMEX: LEI).
Duke R. Ligon
Mr. Ligon retired in January 2007 as senior vice president and general
counsel for Devon Energy Corporation (NYSE:DVN) and brings more than 35 years of
legal expertise in corporate securities, litigation, governmental affairs and
mergers and acquisitions. Mr. Ligon is currently serving as executive director
of the Love's Entrepreneurial Center at Oklahoma City University as well as
strategic advisor to the Oklahoma based Love's Travel Stores. Prior to joining
Devon in 1997, he practiced law for 12 years and last served as a partner at the
72
law firm of Mayer, Brown & Platt in New York City. In addition, he was senior
vice president and managing director for investment banking at Bankers Trust Co.
in New York City for 10 years. Ligon received an undergraduate degree in
chemistry from Westminster College and a law degree from the University of Texas
School of Law. Mr. Ligon also serves as a director of Panhandle Oil & Gas (AMEX:
PHX), Quest Midstream Partners L.P., an affiliate of Quest Resource Corporation
(NASDAQ-GM: QRCP), TransMontaigne Partners, L.P. (NYSE:TLP), and SemGroup Energy
Partners G.P., L.L.C, the general partner of SemGroup Energy Partners, L.P.
(NASDAQ-GM: SGLP). Additionally, Ligon is a member of our Advisory Council;
appears as a spokesman on our videos and communicates with our associates in
connection with matters we determine material.
Martin H. Belsky
Mr. Belsky is currently Dean of the University of Akron School of Law, a
position he has held since January 2008. Previously, Mr. Belsky was Dean of the
University of Tulsa College of Law from 1995 to 2004. Subsequent to being Dean,
Mr. Belsky was a professor of Law at the University of Tulsa College of Law,
teaching courses in constitutional law, ethics, international law, and oceans
policy until accepting his current position at the University of Akron.
Harland C. Stonecipher
Mr. Stonecipher has been the Chairman of our Board of Directors since its
organization in 1976 and served as Chief Executive Officer until March 1996 and
since February 1997. Mr. Stonecipher also served as our President at various
times through January 1995 and since December 2002. Mr. Stonecipher also serves
as an executive officer of several of our subsidiaries and served as a director
of AMS Health Sciences, Inc. until December 5, 2005.
The Board has established an Audit Committee currently consisting of
Messrs. Aldridge, Belsky and Grunebaum. The Board has determined that none of
the members of the Audit Committee qualify as a "financial expert" as defined by
the rules of the SEC, because none of the members meet the requisite
qualifications for such designation.
Corporate Governance Guidelines
We adopted Corporate Governance Guidelines and a Code of Business Conduct
and Ethics in accordance with the rules of the NYSE in January 2004. The Code of
Business Conduct and Ethics is applicable to all employees and directors,
including our principal executive, financial and accounting officers. Copies of
the Corporate Governance Guidelines, Code of Business Conduct and Ethics and
committee charters are available at our website, www.prepaidlegal.com. In
addition, copies of these documents are available to any shareholder who
requests them from our Secretary. The Audit Committee reviewed its charter in
March 2007 and adopted an amended and restated charter. We intend to disclose
amendments to, or waivers from, our Code of Business Conduct and Ethics by
posting to our website.
Executive Officers
Our current executive officers are named below:
Name Age Position
--------------------------- --- ---------------------------------------
Harland C. Stonecipher..... 70 Chairman of the Board of Directors,
Chief Executive Officer and President
Steve Williamson 48 Chief Financial Officer
Mark Brown 55 Senior Vice President and Chief
Marketing Officer
Randy Harp 53 Chief Operating Officer
Kathleen S. Pinson......... 56 Vice President of Regulatory Compliance
and Secretary
For description of the business background and other information concerning Mr.
Stonecipher, see "Directors" above. All executive officers serve at the
discretion of the Board, subject to, in the case of Mr. Stonecipher, the terms
of his employment agreement described below.
73
Steve Williamson
Mr. Williamson was named our Chief Financial Officer in May 2000. From April
1997 until his employment with us in March 2000, Mr. Williamson served as the
Chief Financial Officer of Peripheral Enhancements, Inc., an electronic memory
assembly company. Prior to April 1997, Mr. Williamson served as Director in
Charge of Banking Practice for Horne & Company, a public accounting firm. Mr.
Williamson is a Certified Public Accountant.
Mark Brown
Mr. Brown was named Senior Vice President and Chief Marketing Officer in October
2006. Prior to his appointment to the new position, Mr. Brown was our National
Sales Director for Group Marketing and Senior Regional Vice President for most
of the State of Texas and has been one of our independent associates for more
than eleven years. Prior to his association with us, Mr. Brown owned his own
printing business for 18 years.
Randy Harp
Mr. Harp was named Chief Financial Officer in March 1990 and served in that
capacity until May 2000 and has served as Chief Operating Officer since March
1996. Mr. Harp served on the Board of Directors from March 1990 until May 2004
when he resigned from the Board of Directors as part of a corporate governance
initiative required by the rules of the NYSE to have independent, outside
directors comprise the majority of the Board. Mr. Harp is a Certified Public
Accountant.
Kathleen S. Pinson
Ms. Pinson was named our Controller in May 1989 and has been a Vice President of
ours since June 1982. Ms. Pinson served on the Board of Directors from April
1990 until August 2002 when she resigned from the Board of Directors together
with three other directors as part of a corporate governance initiative to have
outside directors comprise the majority of the Board. Ms. Pinson has been
employed by us since 1979 and currently serves as Vice President of Regulatory
Compliance and Secretary. Ms. Pinson is a Certified Public Accountant.
Significant Employee - Wilburn L. Smith
Wilburn Smith has been active in our marketing division since 1980. He served as
one of our directors from March 1993 to October 1995 and from April 1997 to
December 2001, during which time he also served as our President. Mr. Smith
currently serves as our National Marketing Director.
ITEM 11. EXECUTIVE COMPENSATION.
---------------------------------
Compensation Committee Interlocks and Insider Participation
Messrs. Belsky, Ligon and Smith were the members of our Compensation
Committee in 2008. None of them have ever been an officer or employee of ours or
any of our subsidiaries. Additionally, none of our executive officers serves on
the compensation committee of any entity that has one or more of such entity's
executive officers serving on our Board.
Compensation Discussion and Analysis
General
Our compensation philosophy and the objectives of our compensation programs
are to:
o Recognize that membership revenues and growth in membership revenues
are the most significant factors in our corporate objectives, since
the expense components of our business as a percentage of membership
revenues do not vary materially. Accordingly, incentive compensation
should be based on membership or membership revenue metrics.
o Pay compensation to our Chief Executive Officer primarily based on
incentive compensation tied to membership revenues, and secondarily as
required by long-standing written agreements with him.
74
o Pay our Chief Marketing Officer based solely on incentive compensation
tied to memberships written.
o Pay our other home office named executive officers primarily with
annual salaries competitive in the local market and in amounts
recognizing relative levels of responsibility, and secondarily with
incentive compensation based on growth of in-force membership revenues
due to their lesser level of influence over marketing efforts.
o Eliminate equity compensation as a component of executive
compensation, as it is inconsistent with our stock repurchase policy.
o Provide a non-qualified deferred compensation program to permit us and
our CEO to avoid the nondeductibility provisions of Section 162 of the
Internal Revenue Code for compensation in excess of $1 million, and to
permit supplemental retirement benefits for all named executive
officers in excess of amounts provided under our defined contributions
plan.
To maintain simplicity in our compensation, we have not historically
adopted any equity or long term compensation plans other than stock options,
which we discontinued granting to executive officers in 2002. We have not
evaluated gains from historical option exercises or potential gains from option
exercises in evaluating other executive officer compensation. We do not have any
specific equity ownership guidelines, but we strongly encourage our executive
officers to own our Common Stock.
We also do not have term employment agreements with anyone other than our
Chief Executive Officer, which was entered into in 1993 and is currently on a
year to year basis.
The Compensation Committee has not engaged in any benchmarking or peer
group comparisons in connection with any compensation decisions because of the
unique characteristics of the Company and the absence of any true peer groups.
For our incentive cash compensation plans that are based on the formulas
described, there have been no historical discrepancy adjustments to the amount
of such compensation, except as with respect to Mr. Stonecipher's incentive
compensation as described below.
The elements of our compensation for named executive officers vary,
depending on their position, and are described below. All of these elements,
other than those for which the Company is contractually obligated, are subject
to change if the Compensation Committee believes a change is appropriate. The
Compensation Committee has reviewed the relative compensation of all of the
named executive officers. The total compensation of the Chief Executive Officer,
which is significantly higher than our other named executive officers, reflects
his critical role in the founding, development of the Company, ongoing marketing
of the Company's memberships, and supervision of the marketing force. Likewise,
the compensation of our Chief Marketing Officer at potentially higher levels
than other named executive officers reflects our philosophy that marketing is
the most important factor in our Company's growth and success.
Because our compensation arrangements are relatively simple and we do not
have complex equity plans, or significant change of control or severance
obligations, the Compensation Committee does not use tally sheets in analyzing
executive officer compensation, but does review each element of compensation as
described in this Annual Report Statement in evaluating and approving our Chief
Executive Officer's total compensation and consulting with the Chief Executive
Officer with respect to the total compensation of other executive officers.
Individual Elements of Compensation
-----------------------------------
Chief Executive Officer
-----------------------
Incentive Compensation. The primary element of compensation paid to our
Chief Executive Officer is formula incentive compensation based on the level of
our membership fees (the "Membership Fee Plan"). Since 2004, and during 2008,
our Chief Executive Officer has been eligible to receive up to one-half of one
percent (.5%) of Membership fees collected. Payment of this 0.5% incentive has
been conditioned on our meeting certain monthly and quarterly Membership revenue
thresholds. Mr. Stonecipher receives a monthly bonus equal to 0.25% of monthly
Membership fees if the month's Membership fees are at least 85% of the
75
Membership fees for the same month of the prior year. Additionally, Mr.
Stonecipher receives a quarterly bonus equal to 0.25% of the quarter's
Membership fees, if the quarter's Membership fees are greater than the
Membership fees for the comparable quarter of the prior year. The aggregate
annual amount of these bonuses has been reduced by $500,000 since 2005 by reason
of our now owning and operating corporate aircraft, which aircraft services were
previously provided through aircraft partially owned by Mr. Stonecipher (the
"aircraft reduction"). The Membership Fee Plan is subject to annual review by
the Compensation Committee. During 2008, Mr. Stonecipher received $1,755,540 in
bonuses under this plan after the aircraft reduction. These amounts were between
the threshold and target levels reflected in the previous proxy statement. Mr.
Stonecipher also has historically received and is expected to continue to
receive incentive compensation equal to 2.5% of premiums received by unrelated
insurance companies that issue cancer and dread disease policies through PPL
Agency, a wholly owned subsidiary of ours which sells such policies through less
than five independent agents (the "PPL Agency Plan"). This incentive was
originated in 1982 when PPL Agency was organized to recognize Mr. Stonecipher's
efforts in organizing this agency. In 2008, Mr. Stonecipher received $28,326 in
compensation under this arrangement. In 2008, these incentive compensation
components represented 80% of Mr. Stonecipher's total cash compensation.
Salary and Member Override. The base salary of Mr. Stonecipher has been
established pursuant to an employment agreement which commenced in January 1993
and expired in 2003, but automatically extends for successive one-year periods
until either party elects to terminate the agreement at least 30 days prior to
the expiration date. At inception of the agreement, Mr. Stonecipher's base
salary was $157,755 and it has not been adjusted since that time as the
Compensation Committee prefers to provide compensation to Mr. Stonecipher
primarily in the form of incentive compensation described above. Pursuant to a
separate agreement with us entered into in 1986 originally intended to
incentivize growth in new memberships, Mr. Stonecipher is entitled to an
override commission, payable monthly, in an amount equal to $.025 per active
Membership, with a maximum payable of $20,000 per month (equivalent to 800,000
members) or $240,000 per year (the "Member Override Agreement"). At the time the
agreement was entered into in 1986, the Company had 133,816 members. The payment
of such commissions to Mr. Stonecipher continues during his lifetime and after
his death to his designated beneficiaries and their successors so long as the
Company sells legal expense plans. The Company intends to continue to abide by
this agreement but it is now considered to be the same as salary given the level
of the Company's memberships far exceeds the 800,000 members needed to generate
the maximum override commission.
Post Employment Compensation. Mr. Stonecipher is entitled to post
employment compensation under our defined contribution qualified retirement plan
in which he participates on the same basis as all other employees. He is also a
participant in our non-qualified deferred compensation plan which is described
below. He also receives a supplemental retirement benefit under his employment
agreement which is described below under "Other Potential Post-Employment
Payments." Finally, as noted above, he will continue to receive payments under
the Member Override Agreement.
Chief Marketing Officer
-----------------------
Incentive Compensation. Our Chief Marketing Officer receives solely cash
incentive compensation in various capacities. As a sales associate, he receives
commissions from sales of memberships both personally, and by members in his
personal sales organization on the same basis as all other sales associates
("Personal Commissions"). As head of our group marketing, he receives a 0.5%
override on group membership revenues received for memberships written after
April 15, 2002, the date on which this override was created ("Group Override").
As a regional vice president for Texas, he receives a 0.2% override on Texas
membership revenues received for memberships written after July 10, 1996, the
date on which the override was created ("RVP Override"). All of the foregoing
was in place before he became Chief Marketing Officer. As Chief Marketing
Officer, he receives a 0.13% override on membership revenues that are received
on memberships written after November 22, 2006, the date on which this override
was created ("Membership Fee Override").
Post Employment Compensation. Mr. Brown, like all other sales associates,
will continue to receive Personal Commissions after separation for employment so
long as he remains a vested associate, which requires him to maintain a personal
76
membership or sell at least three memberships per quarter and abide by the
applicable policies and procedures for our associates. He will also receive post
employment compensation under our defined contribution plan on the same basis as
all other employees.
Other Named Executive Officers
------------------------------
Salary. The other named executive officers receive salaries established by
our Chief Executive Officer in consultation with the Compensation Committee that
are based on their relative seniority, level of responsibility, an assessment of
each executive officer's performance and potential contribution to our financial
and operational objectives. Salary is the more significant portion of the other
named executive officers' compensation which represented 89% of their total
compensation in 2008.
Incentive Compensation. We have a non-equity incentive plan for the other
named executive officers under which they are entitled to quarterly bonuses
equal to a percentage of their salaries equal to the percentage increase in
active membership fee revenue in force as of the end of each quarter from the
end of the same quarter in the preceding year subject to such increase being
more than 2% (the "In Force Premium Bonus Plan").
Post Employment Compensation. Our other executive officers are entitled to
post employment compensation under our defined contribution qualified retirement
plan in which they participate on the same basis as all other employees. They
are also participants in our non-qualified deferred compensation plan which is
described below.
Personal Benefits and Perquisites
---------------------------------
We own two corporate airplanes that are used almost exclusively for
business purposes by our executive officers and other employees. On business
travel, Mrs. Stonecipher routinely accompanies Mr. Stonecipher. We believe this
practice is consistent with the family image we desire to present to our sales
force and employees. There is no incremental cost to us for Mrs. Stonecipher to
accompany Mr. Stonecipher on these trips. Occasionally, we permit Mr.
Stonecipher to use one of the planes for personal purposes. In these
circumstances, Mr. Stonecipher reimburses us at an hourly rate intended to fully
offset both our fixed and incremental cost of this travel, including fuel,
maintenance, personnel, insurance, etc. and any miscellaneous trip expense.
During 2008, Mr. Stonecipher used the corporate aircraft for personal purposes
11.8 hours (approximately 3.0% of the total aircraft usage) and reimbursed us
$17,530. We also provide automobiles (including fuel and maintenance) for Mr.
Stonecipher and Mr. Harp. The cost attributable to their personal use based on
the estimated lease value of the automobiles, plus fuel and maintenance, is
included in their taxable wages and unless the aggregate amount of personal
benefits is less than $10,000, is reflected in the summary compensation table
below. We also have a split dollar life insurance plan for Mr. Stonecipher and
his wife that was entered into in 1984 and is described below.
Impact of Regulatory Requirements on Executive Compensation Decisions
---------------------------------------------------------------------
Section 162(m) of the Internal Revenue Code provides that we may be limited
in deducting annual compensation in excess of $1 million paid to certain
executive officers. The Compensation Committee has considered the effect of
Section 162(m) on our compensation program. The deferred compensation plan
described below was adopted in 2002 in part to be responsive to the limitations
of Section 162, to permit the deferral of compensation that would not otherwise
be deductible under Section 162. In certain circumstances it may be in our
shareholders' best interests to retain the flexibility to pay compensation that
may not be deductible under Section 162. The Compensation Committee reviewed
this amount from a cost/benefit perspective and concluded that it was
acceptable.
Compensation Committee Report
In accordance with its written charter adopted by the Board of Directors
("Board"), the Compensation Committee of the Board is responsible for
establishing the compensation of our CEO, Mr. Stonecipher, and overseeing the
compensation process as it relates to our other executive officers to assure
they are compensated in a manner consistent with our overall objectives. The
Compensation Committee is also obligated to communicate to shareholders
information regarding the Company's compensation policies and the reasoning
behind such policies.
77
The Compensation Committee has reviewed and discussed the Compensation
Discussion and Analysis ("CD&A") with management. Based on this review and
discussions, the Compensation Committee recommended to the Board that the CD&A
be included in this annual report.
The preceding report is presented by the members of the Compensation
Committee.
/s/ Thomas W. Smith /s/ Martin H. Belsky /s/ Duke R. Ligon
-------------------- -------------------- -----------------
Thomas W. Smith Martin H. Belsky Duke R. Ligon
Committee Chairman Committee Member Committee Member
Summary Compensation Table
The following table sets forth the compensation paid by us for services
rendered during the years ended December 31, 2008, 2007 and 2006, respectively,
to the individuals identified below, who are referred to as our "named executive
officers."
Non-Equity All
Name and Principal Incentive Plan Other
Position Year Salary(1) Compensation(2) Compensation(3) Total(4)
-------------------------------------- ---- ---------- --------------- --------------- ------------
Harland C. Stonecipher................ 2008 $ 400,781 $ 1,783,866 $ 35,315 $ 2,219,962
Chairman, Chief Executive Officer 2007 397,747 1,748,475 36,112 2,182,334
and President 2006 397,755 1,694,315 31,361 2,123,431
Steve Williamson...................... 2008 161,629 10,616 11,140 183,385
Chief Financial Officer 2007 146,411 12,047 8,550 167,008
2006 129,352 30,902 14,500 174,754
Mark Brown............................ 2008 - 1,006,707 5,300 1,012,007
Chief Marketing Officer 2007 - 758,092 5,200 763,292
2006 - 699,072 5,200 704,272
Randy Harp............................ 2008 276,464 18,442 15,060 309,966
Chief Operating Officer 2007 250,394 21,841 13,200 285,435
2006 229,428 57,941 12,058 299,427
Kathleen S. Pinson.................... 2008 172,923 11,144 11,637 195,704
Vice President of Regulatory 2007 151,861 12,392 7,500 171,753
Compliance and Secretary 2006 134,692 32,190 6,250 173,132
--------------------
(1) The salary amount for Mr. Stonecipher includes salary payable under
his employment agreement and amounts payable under the Member Override
Agreement.
(2) Non-equity incentive plan compensation paid to Mr. Stonecipher
consists of: (i) $1,755,540, $1,690,964 and $1,636,056, in 2008, 2007
and 2006, respectively, payable under the Membership Fee Plan after
the aircraft reduction; and (ii) $28,326, $57,511 and $58,259, in
2008, 2007 and 2006, respectively, payable under the PPL Agency Plan.
For Mr. Brown, non-equity incentive compensation includes (i)
$353,857, $303,364 and $358,191, in 2008, 2007 and 2006, respectively,
payable as Personal Commissions; (ii) $374,444, $258,045 and $241,113,
in 2008, 2007 and 2006, respectively, payable as Group Override; (iii)
$84,201, $88,622 and $73,694, in 2008, 2007 and 2006, respectively,
payable as State Override; and (iv) $194,205, $108,061 and $26,074, in
2008, 2007 and 2006, respectively, payable as Membership Override.
For the other named executive officers, non-equity incentive
compensation consists of amounts payable under the In Force Premium
Plan.
78
For a description of these various incentives, see "Compensation
Discussion and Analysis - Individual Elements of Compensation"
beginning on page 76.
(3) All Other Compensation of Mr. Stonecipher includes $1,322, $1,721 and
$2,100, in 2008, 2007 and 2006, respectively, relating to the time
value of premiums paid pursuant to a certain split dollar life
insurance agreement that provides for such premiums to be refunded to
us upon Mr. Stonecipher's death, $21,191 in each of 2008, 2007 and
2006 automobile related cost attributable to personal use based on the
estimated lease value of the automobile and also includes $12,802,
$13,200 and $8,070, in 2008, 2007 and 2006, respectively, representing
vested contributions by us to deferred compensation plan and the
Employee Stock Ownership and Thrift Plan and Trust (the "ESOP"). All
Other Compensation of Messrs. Williamson, Brown and Harp and Ms.
Pinson consists of vested contributions by us to the deferred
compensation plan and the ESOP. (4) Annual compensation amounts
include amounts deferred at the election of the named executive
officers pursuant to a non-qualified deferred compensation plan which
we adopted in 2002, as described below under "Nonqualified Deferred
Compensation."
Plan-Based Awards
Under various incentive plans described above in the Compensation
Discussion and Analysis, our executive officers will be entitled to receive
incentive compensation in 2009 (and potentially future years if such plans
continue) based on the level of membership fees or annual in force membership
fees at the end of each quarter. The following table estimates the amount of
such payments based on the various assumptions contained in the table. There is
no assurance that any of such payments will be made if the criteria for payment
under such incentive plans are not achieved. In addition, there are no maximum
amounts payable under the plans listed, so if the performance criteria exceeds
the assumed maximum level reflected in the table, the amount of compensation
would also be greater.
Actual or Estimated Future Payouts Under
Non Equity Incentive Plan Awards
------------------------------------------
Name and Principal Position Plan Threshold Target Maximum
------------------------------------ --------------------------------- ------------- ------------- --------------
Harland C. Stonecipher,............. Membership Fee Plan-Monthly (1) $ 958,605 $ 1,184,159 $ 1,296,936
Chairman, Chief Executive Officer Membership Fee Plan-Quarterly (2) 627,770 659,159 721,936
and President PPL Agency Commission (3) 21,245 28,326 35,408
Steve Williamson,................... In Force Premium Bonus Plan ((4)) 18,002 30,004 60,008
Chief Financial Officer
Mark Brown,......................... Personal Commission ((5)) 300,778 371,550 406,936
Chief Marketing Officer Group Override ((6)) 318,277 393,166 430,611
State Override ((7)) 71,571 88,411 96,831
Membership Fee Override ((8)) 165,074 203,915 223,336
Randy Harp,......................... In Force Premium Bonus Plan ((4)) 31,947 53,245 106,490
Chief Operating Officer
Kathleen Pinson,.................... In Force Premium Bonus Plan ((4)) 18,601 31,002 62,005
Vice President of Regulatory
Compliance and Secretary
--------------------
(1) The Membership Fee Plan - Monthly estimated payouts for 2009 are based
on the following level of membership fees for each month of 2009
compared to the comparable month of 2008: Threshold 85%; Target 105%
and Maximum 115%. Specific revenue targets associated with these
levels would be $417 million, $469 million and $504 million,
respectively.
79
(2) The Membership Fee Plan - Quarterly estimated payouts, after the
aircraft reduction, for 2009 are based on the following level of
membership fees for each quarter of 2009 compared to the comparable
quarter of 2008: Threshold 100%; Target 105% and Maximum 115%.
Specific revenue targets associated with these levels would be $417
million, $469 million and $504 million, respectively.
(3) The PPL Agency Commission estimated payouts for 2009 are based on the
following levels of PPL Agency commission income compared to 2008:
Threshold 75%; Target 100% and Maximum 125%. Specific revenue targets
associated with these levels would be $850,000, $1.1 million and $1.4
million, respectively.
(4) The In-Force Premium Bonus Plan estimated payouts for 2009 are based
on the following levels of increases in annual in force premiums at
the end of each quarter of 2009 compared to the comparable quarter of
the prior year: Threshold 3%; Target 5% and Maximum 10%. There are no
payments made under this Plan unless the annual in force premium at
the end of each quarter of 2009 is more than 2% above the annual in
force premium as of the end of the comparable quarter of 2008.
Specific revenue targets associated with these levels would be $451
million, $465 million and $474 million, respectively.
(5) The Personal Commission estimated payouts for 2009 are based on the
following levels of personal commissions for 2009 compared to 2008:
Threshold 85%; Target 105%; Maximum 115%. Since these compensation
elements do not directly relate to overall company revenue, no
specific revenue targets are applicable.
(6) The Group Override estimated payouts for 2009 are based on the
following levels of group membership fees for 2009 compared to 2008:
Threshold 85%; Target 105%; Maximum 115%. Since these compensation
elements do not directly relate to overall company revenue, no
specific revenue targets are applicable.
(7) The State Override estimated payouts for 2009 are based on the
following levels as Texas membership fee revenue for 2009 compared to
2008: Threshold 85%; Target 105%; Maximum 115%. Since these
compensation elements do not directly relate to overall company
revenue, no specific revenue targets are applicable.
(8) The Membership Fee Override estimated payouts for 2009 are based on
the following levels of membership fees in 2009 compared to 2008:
Threshold 85%; Target 105%; Maximum 115%. Specific revenue targets
associated with these levels would be $417 million, $469 million and
$504 million, respectively.
Stock Options
There have been no grants of stock options under our Stock Option Plan to
any of the named executive officers since May 2002.
Outstanding Equity Awards
The following table reflects outstanding stock options held by our
executive officers as of December 31, 2008:
Option Awards
---------------------------------------------------------
Number of
Securities Underlying
Unexercised Option Option Option
------------------------------ Exercise Expiration
Name Exercisable Unexercisable Price Date
-------------------------------- ----------- -------------- -------- -----------
Harland C. Stonecipher.......... - - N/A N/A
Steve Williamson (1)............ 8,000 - $19.20 March 1, 2011
Mark Brown...................... - - N/A N/A
Randy Harp (1).................. 30,000 - 19.20 March 1, 2011
Kathleen S. Pinson.............. - - N/A N/A
(1) Option vesting date is May 23, 2005
80
Option Exercises
The following table reflects information concerning options exercised by
our named executive officers during 2008:
Option Awards
---------------------------------
Number of Value
Shares Acquired Realized on
Name on Exercise Exercise
------------------------------ ----------------- -------------
Harland C. Stonecipher........ - $ -
Steve Williamson.............. 2,000 50,380
Mark Brown.................... - -
Randy Harp.................... - -
Kathleen S. Pinson............ - -
Nonqualified Deferred Compensation
In 2002, we adopted, as part of our post-employment compensation policy for
executive officers and certain managers, an unfunded, nonqualified deferred
compensation plan, which permits our executive officers and other key employees
to defer receipt of a portion of their annual compensation. Deferred amounts
accrue hypothetical returns based on investment options selected by the
participant. Deferred amounts are paid in cash based on the value of the
investment option and are generally payable following termination of employment
in a lump sum or in installments as elected by the participant, but the plan
provides for distributions in the event of total disability or death and
distributions upon a change in control. The plan also provides a death benefit
of $500,000 payable to the beneficiary of each named executive officer
participant in the plan if such officer dies before he is entitled to receive
the benefits offered pursuant to such plan. Although the plan is unfunded and
represents an unsecured liability of ours to the participants, we have purchased
variable life insurance policies owned by us to insure the lives of the group of
participants and to finance our obligations under the plan.
A participant in the plan may elect to defer receipt of up to 75% of their
base salary and up to 100% of their bonus compensation. Amounts deferred accrue
hypothetical returns based upon investment options selected by the participant.
These investment options generally include mutual funds representing various
asset classes and each executive may change investment elections daily. Earnings
(losses) on these mutual funds ranged from 5.1% to (48.4)% during the 12 months
ended December 31, 2008. Under the plan, we promise to pay our executives the
amounts of their compensation that the executives elected to defer plus the
accrued returns. We may, in our sole discretion, make a discretionary make-up
matching contribution to the deferral account of each participant in the
deferred compensation plan who (1) had elective salary deferrals to the 401(k)
plan in the maximum amount permitted under the 401(k) plan for the prior plan
year, and (2) deferred an amount to the deferred compensation plan for the prior
plan year. The amount of the discretionary make-up matching contribution made to
the deferred compensation plan shall be determined to be any amount necessary
(a) to replace any lost benefit due to the participant's participation in the
deferred comp plan and (b) to restore any matching contribution that would have
been made on behalf of the participant under the 401(k) plan for such plan year
but which could not be made because of any reduction in matching contributions
under the 401(k) plan attributable to ADP testing limitations on the
Participant's elective salary deferrals to the 401(k) Plan. During 2008, we made
$32,580 in discretionary make-up matches and amounts attributable to our named
executive officers are included in the table below.
The participants in the plan are entitled to payments from the plan upon
the earlier of: (i) reaching the age of 65, or in the case of Mr. Stonecipher,
on November 6, 2012, (which was 10 years after adoption of the plan); (ii)
disability; (iii) death; (iv) a change in control; or (v) termination of
employment. Amounts payable to plan participants are payable in a lump sum or in
annual installments (5, 10 or 15) as elected by the executive, although we may,
at our discretion, pay the executive the lump sum to which such executive is
entitled.
We consider our nonqualified compensation plan as an important element of
compensation payable to our executive officers. Because the plan is voluntary
and primarily funded only by participant individual deferrals, we do not take
81
into consideration amounts payable to a participating executive officer under
the plan when making compensation decisions regarding such officer. The purpose
of the deferred compensation plan is to provide our officers with an additional
investment vehicle in which to achieve their long-term investment and other
income tax planning goals in recognition of certain limitations on such
individuals' participation in our defined contribution plan pursuant to federal
income tax rules and regulations applicable to highly compensated individuals.
Additionally, the plan was adopted to allow us to address the limitations on
executive compensation imposed by Section 162(m) of the Internal Revenue Code.
The following table sets forth activity under the plan in 2008:
Executive Registrant Aggregate Aggregate
Contributions Contributions Earnings in Aggregate Balance at
in Last Fiscal in Last Fiscal Last Fiscal Withdrawals/ Last Fiscal
Name Year (1) Year (1) Year(3) Distributions Year-End
---------------------------- -------------- -------------- ----------- ------------- -------------
Harland C. Stonecipher...... $ 954,691 $ 3,364 $ 251,017 $ - $ 5,843,094
Steve Williamson............ 11,965 1,702 (11,988) - 46,716
Mark Brown (2).............. - - - - -
Randy Harp.................. 89,894 5,622 (122,484) - 302,087
Kathleen S. Pinson.......... 15,803 2,199 (12,920) - 81,777
(1) Amounts deferred at the election of the named individuals and
discretionary make-up contributions by us pursuant to our nonqualified
deferred compensation plan are included in the Summary Compensation
Table above.
(2) Mr. Brown is not eligible to participate in the plan.
(3) Earnings are based on the hypothetical investment options selected by
each participant.
As of December 31, 2008, we had an aggregate deferred compensation
liability of $7.9 million, which is included in other non-current liabilities.
At December 31, 2008, the cash value of the underlying insurance policies owned
by us was $6.5 million and was included in other assets.
Defined Contribution Plan
We offer a tax qualified defined contribution "401K" plan to all of our
employees, including our executive officers, to provide a benefit payable to an
employee or his heirs upon retirement, total disability, or death. Under the
terms of the plan and subject to limitations of federal law, each of our
employees can elect to defer a portion of his compensation and direct such
deferrals to the investments offered under the plan, generally consisting of
mutual funds in various asset classes as well as our common stock. Subject to
the terms of the plan, we make discretionary matching cash contributions to the
plan on behalf of the participant employees. Participants are immediately vested
in their deferred contributions, but our contributions are subject to certain
vesting requirements. By permitting employee deferrals to be invested in our
common stock, we believe the interests of employees are aligned with the
interest of shareholders. The Plan permits employees to diversify their
investment in our common stock made with our contributions in accordance with
federal law. Executive officers participate in the plan on the same basis as all
other employees. Our 2008 contributions to the plan for the account of the named
executive officers are included in the Summary Compensation Table set forth
above.
Other Potential Post-Employment Payments
In addition to the other post-employment payments described above, our
Chief Executive Officer is entitled to certain additional compensation under
separate contractual arrangements as described below.
Under the terms of his 1993 employment agreement, Mr. Stonecipher is
entitled to a supplemental retirement benefit of $26,000 per year for ten years
or until the date of his death, if earlier. In order to receive such payments,
82
Mr. Stonecipher has agreed to make himself available to render advisory and
consulting services to us and not to compete with us.
In July 1984, we entered into a split dollar life insurance arrangement
with Shirley A. Stonecipher, Mr. Stonecipher's wife, whereby we agreed to pay
premiums on a life insurance policy covering Mr. Stonecipher. The face amount of
the policy is $600,000 and Mrs. Stonecipher is the owner and beneficiary. Mrs.
Stonecipher has an agreement with us whereby upon Mr. Stonecipher's death, the
proceeds of the policy will be paid to us in an amount sufficient to reimburse
premiums paid to date by us in addition to any supplemental retirement payments
made pursuant to Mr. Stonecipher's employment contract. The time value of
premiums paid pursuant to this agreement are included in Summary Compensation
Table set forth above. Our obligation to pay the supplemental retirement benefit
described above is subject to the continuation of split dollar life insurance
agreement between us and Mrs. Stonecipher. If this agreement is terminated for
any reason by either party, our obligation to pay the supplemental retirement
benefit also terminates.
Mr. Stonecipher's employment contract provides that if we terminate his
employment for any reason (other than for Mr. Stonecipher's death or disability)
or Mr. Stonecipher terminates his employment after a change of control of us (as
defined in the agreement) or due to an uncured material breach of the agreement
by us, we are required to pay Mr. Stonecipher a lump sum payment equal to the
present value, using a 3% discount rate, of the total salary for the remaining
term plus the supplemental retirement benefits, which are described in more
detail above. If Mr. Stonecipher's employment is terminated by us due to his
disability, we are required to pay the full amount of Mr. Stonecipher's salary
to him for twelve weeks and 75% of the amount of his salary for the remaining
term of the agreement subsequent to the initial twelve weeks. Additionally, if
Mr. Stonecipher dies during his employment, we are obligated to pay his estate
$5,000 plus the full amount of Mr. Stonecipher's salary for 26 weeks. As
described above, Mr. Stonecipher's salary under the employment agreement is
$157,755 and the maximum remaining term is one-year since the agreement is
annually renewable on a year by year basis.
Change of Control
There are no special benefits payable to the named executive officers by
reason of a change in control other than such an event entitles the named
executive officers who are participants in the deferred compensation plan to
commence to receive payments as described under "Nonqualified Deferred
Compensation."
Director Compensation
The following table summarizes the compensation of directors in 2008:
Fees Earned
or Paid in All Other
Name Cash (1) Compensation
---------------------------------- ------------ ------------
Orland G. Aldridge................ $ 44,000 $ -
Martin H. Belsky.................. 49,500 -
Peter K. Grunebaum................ 57,500 -
John W. Hail...................... 35,000 -
Duke R. Ligon (2)................. 40,000 50,000
Thomas W. Smith (1)............... - -
Harland C. Stonecipher (1)........ - -
(1) Our 2008 standard compensation for non-employee directors consisted of
a retainer in the amount of $7,500 per quarter in addition to the
payment of $1,000 per Board and committee meeting attended. The chairs
of the Compensation and Nominating Committees received an additional
$1,500 per meeting and the chair of the Audit Committee received an
additional $2,500 per meeting. No form of compensation other than cash
was provided to any director except as discussed below. Mr. Smith has
waived the receipt of any cash compensation in exchange for
reimbursement of expenses related to charter aircraft used for travel
to and from Board meetings. Such reimbursement paid to third parties
was $127,821 for 2008 and does not include any costs related to the
83
use of our aircraft to transport Mr. Smith. Mr. Stonecipher, as an
employee of ours, does not receive additional compensation for Board
service.
(2) Mr. Ligon received compensation during 2008 for his services as a
member of our Advisory Council. The Advisory Council is currently
comprised of four legal professionals with a wide range of experience
in law and business, including three former Attorneys General and Mr.
Ligon. Each member of the Advisory Council receives $50,000 annually,
paid monthly, for his participation.
As of December 31, 2008, the director listed below held options to purchase
shares of common stock which had been granted in prior years:
Weighted
Number Average Exercise
Director of Shares Price Expiration Date
Peter K. Grunebaum................ 4,500 $23.93 March 1, 2009
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
----------------------------------------------------------------------------
RELATED STOCKHOLDER MATTERS.
----------------------------
The following table sets forth certain information concerning the
beneficial ownership of our shares of Common Stock by each person (other than
our directors and executive officers) known by us to be the beneficial owner of
more than five percent of the issued and outstanding Common Stock. Unless
otherwise noted, the information is based on Schedules 13D or 13G filed by the
applicable beneficial owner with the SEC or other information provided to us by
the beneficial owner as of December 31, 2008, which is the date such beneficial
owners were required to report their ownership to the SEC.
Security Ownership of Certain Beneficial Owners
Beneficial Ownership
--------------------
Number Percent
of of
Name and Address of Beneficial Owner Shares Class
------------------------------------ --------- -------
Thomas W. Smith (1)......................................... 2,621,245 23.9
Scott J. Vassalluzzo (1).................................... 1,629,515 14.8
Steven M. Fischer (1) ...................................... 1,544,415 14.1
Prescott Associates (1)..................................... 1,014,675 9.2
Renaissance Technologies LLC and James H. Simons((2))....... 817,300 7.4
Robert S. Pitts, Jr. (3).................................... 805,604 7.3
Barclays Global Investors, NA. (4).......................... 615,804 5.6
---------------------
(1) Messrs. Smith and Vassalluzzo have the sole power to vote or to direct
the vote of 823,930 and 9,000 shares of Common Stock, respectively,
and to dispose or to direct the disposition of 1,011,830 and 20,100
shares of Common Stock, respectively. Mr. Fischer has the sole power
to vote or to direct the vote and to dispose or direct the disposition
of no shares. Idoya Partners and Prescott Associates have the sole
power to vote or to direct the vote and the sole power to dispose or
to direct the disposition of 488,434 and 1,014,675 shares of Common
Stock, respectively. Of the 2,024,845 shares of Common Stock owned by
the Managed Accounts, Messrs. Smith, Vassalluzzo and Fischer share the
power to vote or to direct the vote of and dispose or to direct the
disposition of 1,609,415, 1,609,415 and 1,544,415 shares of Common
Stock, respectively. Idoya Partners and Prescott Associates do not
share the power to vote or to direct the vote and dispose or to direct
the disposition of any Common Stock. The address of Smith,
Vassalluzzo, Fischer and Prescott is 323 Railroad Avenue, Greenwich CT
06830. Information is as of March 24, 2009.
(2) Included in the shares of Common Stock indicated as beneficially owned
by Renaissance Technologies LLC ("Renaissance") and its controlling
person, James H. Simons ("Simons") in Renaissance's capacity as an
investment advisor are 817,300 shares as to which they have sole
84
voting power and 817,300 shares as to which they have sole dispositive
power. The address of Renaissance and Simons is 800 Third Avenue, New
York, NY 10022.
(3) Included in the shares of Common Stock indicated as beneficially owned
by Robert S. Pitts, Jr. ("Pitts") are 699,079 shares beneficially
owned by Steadfast Capital Management LP, a Delaware limited
partnership (the "Investment Manager"), 106,525 shares beneficially
owned by Steadfast Advisors LP, a Delaware limited partnership (the
"Managing General Partner"), 106,525 shares beneficially owned by
Steadfast Capital, L.P., a Delaware limited partnership ("Steadfast
Capital"), 221,411 shares beneficially owned by American Steadfast,
L.P., a Delaware limited partnership ("American Steadfast"); 477,668
shares beneficially owned by Steadfast International Ltd., a Cayman
Island exempted company (the "Offshore Fund"); 699,079 shares
beneficially owned by Steadfast GP LLC, a Delaware limited liability
company (the "IM General Partner"); 106,525 shares beneficially owned
by Steadfast GP Holdings LLC, a Delaware limited liability company
(the "MGP General Partner"). The Investment Manager, the IM General
Partner and Mr. Pitts have shared power to vote or direct the vote of
699,079 shares of Common Stock. Steadfast Capital has shared power
with the Managing General Partner, the MGP General Partner and Mr.
Pitts to vote or direct the vote of the 106,525 shares of Common Stock
held by the Steadfast Capital. American Steadfast has shared power
with the Investment Manager, the IM General Partner and Mr. Pitts to
vote or direct the vote of the 221,411 shares of Common Stock held by
American Steadfast. The Offshore Fund has shared power with the
Investment Manager, the IM General Partner and Mr. Pitts to vote or
direct the vote of the 477,668 shares of Common Stock held by the
Offshore Fund. The business address of each of Pitts, the Investment
Manger, the Managing General Partner, Steadfast Capital and American
Steadfast is 767 Fifth Avenue, 6th Floor, New York, NY 10153. The
business address of the Offshore Fund is c/o Appleby Corporate
Services (Cayman) Limited, P. O. Box 1350 GT, George Town, Grand
Cayman, Cayman Islands.
(4) Included in the shares of Common Stock indicated as beneficially owned
by Barclays Global Investors, NA ("Barclays") are 294,086 shares
beneficially owned by Barclays as to which they have sole dispositive
power of which they have sole voting power for 257,599 shares. Also
included are 316,373 shares beneficially owned by Barclays Global Fund
Advisors ("Advisors") as to which they have sole dispositive power of
which they have sole voting power for 230,473 shares and 5,345 shares
beneficially owned by Barclays Global Investors, Ltd. ("Investors") as
to which they have sole dispositive power of which they have sole
voting power for 465 shares. The business address of Barclays and
Advisors is 400 Howard Street, San Francisco, CA 94105 and the
business address for Investors is 1 Royal Mint Court, London, EC3N
4HH.
The following table sets forth certain information concerning the
beneficial ownership of our shares of Common Stock as of March 24, 2009 by (a)
each of our directors or nominee for director (b) each of the named executive
officers, and (c) all of our directors, nominee and named executive officers as
a group.
Security Ownership of Directors and Named Executive Officers
Beneficial Ownership (1)
------------------------
Number Percent
of of
Name of Director or Named Executive Officer Shares Class
------------------------------------------- ------------- ---------
Harland C. Stonecipher, One Pre-Paid Way, Ada, Oklahoma 74820........... 897,796 (2) 8.2
Steve Williamson........................................................ 11,319 (3) *
Mark Brown.............................................................. 2,152 (4) *
Randy Harp.............................................................. 64,844 (5) *
Kathleen S. Pinson...................................................... 47,979 (6) *
Orland G. Aldridge...................................................... - -
Martin H. Belsky........................................................ 350 *
Peter K. Grunebaum...................................................... 1,400 *
John W. Hail............................................................ 512 *
Duke R. Ligon........................................................... - -
Thomas W. Smith......................................................... 2,621,245 ((7)) 23.9
All directors, nominees and executive officers as a group (11 persons).. 3,647,597 ((8)) 33.1
-----------------
* Less than 1%.
(1) Unless otherwise indicated in the footnotes to the table and subject
to community property laws where applicable, each of the shareholders
named in this table has sole voting and investment power with respect
to the shares indicated as beneficially owned. The percentage of
85
ownership for each person is calculated in accordance with rules of
the SEC without regard to shares of Common Stock issuable upon
exercise of outstanding stock options, except that any shares a person
is deemed to own by having a right to acquire by exercise of an option
are considered outstanding solely for purposes of calculating such
person's percentage ownership.
(2) Included in the shares of Common Stock indicated as beneficially owned
by Mr. Stonecipher are 874,877 shares as to which he has shared voting
and shared dispositive power with his wife and 22,919 shares owned
under the ESOP as to which Mr. Stonecipher has sole voting power, but
shared dispositive power.
(3) Includes 2,947 shares owned under the ESOP as to which Mr. Williamson
has sole voting power, but shared dispositive power, 372 shares held
in an individual retirement account and 8,000 shares issuable upon
exercise of outstanding options.
(4) Includes 2,152 shares owned under the ESOP as to which Mr. Brown has
sole voting power, but shared dispositive power.
(5) Includes 19,999 shares owned under the ESOP as to which Mr. Harp has
sole voting power, but shared dispositive power, and 30,000 shares
issuable upon exercise of outstanding options.
(6) Includes 21,286 shares owned under the ESOP as to which Ms. Pinson has
sole voting power, but shared dispositive power. Also, includes 4,672
shares owned under the ESOP by Ms. Pinson's husband, also one of our
employees, as to which he has sole voting power, but shared
dispositive power. Ms. Pinson disclaims beneficial ownership of shares
that are owned by her husband.
(7) See "Security Ownership of Certain Beneficial Owners" above.
(8) Includes 38,000 shares issuable upon exercise of outstanding options
and 73,975 shares owned under the ESOP as to which the respective
executive officers and directors have sole voting power, but shared
dispositive power.
Equity Compensation Plans
The following table provides information with respect to our equity
compensation plans as of December 31, 2008, (other than our tax qualified
Employee Stock Ownership Plan designed to provide retirement benefits).
Number of securities
remaining available for
Number of securities future issuance under
to be issued upon Weighted average equity compensation
exercise of exerciase price of plans (excluding
outstanding options, outstanding options securities reflected in
Plan Category warrants and rights warrants and rights column (a))
-------------------------------------- ---------------------- -------------------- -------------------------
Equity compensation plans approved by
security holders (1).................. 42,500 $ 19.70 1,346,252
Equity compensation plans not approved
by security holders................... - - -
Total................................. 42,500 $ 19.70 1,346,252
-----------
(1) These stock options have been issued pursuant to our Stock Option Plan
which has been approved by security holders. We do not expect to grant
any additional options under this plan.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
----------------------------------------------------------------------
INDEPENDENCE.
-------------
John W. Hail, one of our directors, served as our Executive Vice President,
Director and Agency Director from July 1986 through May 1988 and also served as
Chairman of the Board of Directors of TVC Marketing, Inc., which was our
exclusive marketing agent from April 1984 through September 1985. Pursuant to
86
agreements between Mr. Hail and us entered into during the period in which Mr.
Hail was one of our executive officers, Mr. Hail receives override commissions
from renewals of certain Memberships initially sold by us during such period.
During 2008, such override commissions on renewals together with new commission
advances totaled $117,000. Mr. Hail also owns interests ranging from 12% to 100%
in corporations not currently affiliated with us, including TVC Marketing, Inc.,
but which were engaged in the marketing of our legal service Memberships and
which earn renewal commissions from Memberships previously sold. These entities
earned renewal commissions of $491,000 during 2008 of which $257,000 was passed
through as commissions to their sales agents. We expect these arrangements will
continue in 2009 and thereafter.
Our new office building contains two apartments, one for use by certain of
our visitors and one for use by Mr. Stonecipher and his wife, for his
convenience as well as to entertain visitors using the visitor apartment. The
full Board, with Mr. Stonecipher abstaining, has approved the arrangements for
the use of this apartment which require Mr. Stonecipher to pay rent to us at a
rate of $1,000 per month, which exceeds the estimated fair market rental value
based on an outside appraisal. Additionally, the full Board, with the exception
of Mr. Stonecipher, has approved that Shirley Stonecipher, Mr. Stonecipher's
wife, can continue to rent and use the apartment subsequent to Mr. Stonecipher's
death.
As part of the share repurchase program authorized by our Board of
Directors, we may from time to time make such purchases from related parties.
The table below reflects all such transactions in excess of $120,000 since
January 1, 2008:
Treasury share purchases from Related Parties
-----------------------------------------------------------------------------------------------------------------------
Transaction No. of Transaction Acquired
Date shares Price Amount Basis of Price From Relationship
------------- ------- -------- ---------- ----------------- ------------ -------------------------------
8/25/2008 6,500 $ 44.39 $ 288,535 Prior day close Randy Harp Chief Operating Officer (Note
1)
12/8/2008 150,000 35.08 5,262,000 Negotiated below Idoya Partners Partnership jointly managed by
closing price Director Thomas W. Smith and
others (Note 2)
1/30/2009 200,000 33.57 6,714,000 Negotiated below Idoya Partners Partnership jointly managed by
closing price Director Thomas W. Smith and
others (Note 2)
Note (1) - transaction was approved in writing by our Audit Committee.
Note (2) - transaction was pursuant to a letter agreement executed by Idoya
Partners and our CEO.
We require that any situation, transaction or relationship that gives rise
to an actual or potential conflict of interest for our executive officers must
be disclosed to the Board in writing. We may permit the conflicted transaction
only if full disclosure is made and our interests are fully protected. We
consider conflicted transactions to consist of any transaction in which the
executive (1) causes us to engage in business transactions with relatives or
friends or companies controlled or owned by our executives; (2) uses nonpublic
information for personal gain by the executive, his relatives or his friends
(including securities transactions based on such information); (3) has more than
a nominal financial interest any entity with which we do business or compete;
(4) receives a loan, or guarantee of obligations, from us or a third party as a
result of his position with us; (5) competes, or prepares to compete, with us
while still employed by us; or (6) has a financial interest or potential for
gain in any transaction with us (other than compensation arrangements we have
approved).
The preceding policy and examples of conflicted transactions are provided
in our written Code of Business Conduct and Ethics and is available on our
website at www.prepaidlegal.com.
Corporate Governance Matters
The Board of Directors uses the independence standards under the New York
Stock Exchange ("NYSE") corporate governance rules for determining whether
directors are independent. The Board additionally follows the rules of the
Securities and Exchange Commission ("SEC") in determining independence for audit
committee members. The Board has determined that Messrs. Aldridge, Belsky,
Grunebaum, Ligon and Smith are independent under these NYSE and SEC rules for
87
purposes of service on the Board and on the nominating, compensation and audit
committees (except for Mr. Smith as to the audit committee due to his potential
status as an affiliate due to his level of ownership). Members of each committee
are elected annually by the Board and serve for one-year terms or until their
successors are elected and qualified.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
-------------------------------------------------
Audit and Other Fees
Grant Thornton served as our independent registered public accounting firm
during 2008 and 2007. The aggregate fees billed by Grant Thornton for 2008 and
2007 for various services are set forth below:
2008 2007
---- ----
Audit Fees........................ $ 430,630 $ 469,740
Audit Related Fees................ 21,000 21,750
Tax Fees.......................... - -
All Other Fees.................... - -
Fees for audit services include fees associated with the annual audit of us
and our subsidiaries (including audit fees related to Section 404 of the
Sarbanes-Oxley Act), the review of our quarterly reports on Form 10-Q and
required statutory audits. Audit-related fees principally include audits in
connection with our employee benefit plans, due diligence and accounting
consultations. Tax fees include tax compliance, tax advice and tax planning
related to Federal, state and international tax matters.
The Audit Committee has considered whether the provision of non-audit
services by Grant Thornton is compatible with maintaining auditor independence
and adopted in 2003 a policy that requires pre-approval of all audit and
non-audit services. Such policy requires the Committee to approve services and
fees in advance and requires documentation regarding the specific services to be
performed. All 2008 audit and non-audit services fees were approved in advance
in accordance with the Committee's policies.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
--------------------------------------------------
(a) The following documents are filed as part of this report:
(1) Financial Statements: See Index to Consolidated Financial Statements
and Consolidated Financial Statement Schedule set forth on page 44 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.
88
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PRE-PAID LEGAL SERVICES, INC.
Date: December 17, 2009 By: /s/ Randy Harp
----------------------------------------
Randy Harp
Chief Operating Officer
89
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,
-----------------------
2008 2007
---------- ----------
Current assets:
Cash and cash equivalents............................................................ $ 19,434 $ 19,710
Available-for-sale investments, at fair value........................................ 11,789 2,100
Membership fees receivable........................................................... 5,149 4,392
Inventories.......................................................................... 1,285 1,511
Refundable income taxes.............................................................. 687 2,253
Deferred member and associate service costs.......................................... 14,348 15,072
Other assets......................................................................... 2,744 2,093
---------- ----------
Total current assets............................................................. 55,436 47,131
Available-for-sale investments, at fair value.......................................... 684 2,022
Investments pledged.................................................................... 307 224
Property and equipment, net............................................................ 52,844 56,417
Investments in and amounts due to/from subsidiaries, net............................... 47,946 57,462
Deferred member and associate service costs............................................ 1,826 2,173
Other assets........................................................................... 8,213 7,522
---------- ----------
Total assets................................................................... $ 167,256 $ 172,951
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits payable.......................................................... $ 11,640 $ 11,737
Deferred revenue and fees............................................................ 22,146 23,186
Current portion of capital leases payable............................................ 24 22
Current portion of notes payable..................................................... 22,408 18,241
Income taxes payable................................................................. - 5,590
Accounts payable and accrued expenses................................................ 14,526 14,785
---------- ----------
Total current liabilities.......................................................... 70,744 73,561
Capital leases payable............................................................... 910 934
Notes payable........................................................................ 37,251 55,492
Deferred revenue and fees............................................................ 1,670 1,350
Deferred income taxes................................................................ 16,976 17,231
Other non-current liabilities........................................................ 7,898 6,544
---------- ----------
Total liabilities................................................................ 135,449 155,112
---------- ----------
Stockholders' equity:
Common stock......................................................................... 163 173
Retained earnings.................................................................... 130,832 114,873
Accumulated other comprehensive income............................................... (160) 1,821
Treasury stock, at cost.............................................................. (99,028) (99,028)
---------- ----------
Total stockholders' equity....................................................... 31,807 17,839
---------- ----------
Total liabilities and stockholders' equity..................................... $ 167,256 $ 172,951
---------- ----------
See accompanying notes to condensed financial statements.
90
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF INCOME
(Amounts in 000's)
Year Ended December 31,
-----------------------------------------
2008 2007 2006
------------ ------------ ------------
Revenues:
Membership fees...................................................... $ 332,772 $ 323,254 $ 309,765
Associate services................................................... 23,266 24,888 26,674
Other................................................................ 3,276 3,474 4,717
------------ ------------ ------------
359,314 351,616 341,156
------------ ------------ ------------
Costs and expenses:
Membership benefits.................................................. 114,624 113,045 110,415
Commissions.......................................................... 98,857 101,700 98,249
Associate services and direct marketing.............................. 23,484 28,875 29,381
General and administrative........................................... 33,236 39,770 31,362
Other, net........................................................... 12,427 13,402 9,626
------------ ------------ ------------
282,628 296,792 279,033
------------ ------------ ------------
Income before income taxes and equity in net income of subsidiaries.... 76,686 54,824 62,123
Provision for income taxes............................................. 29,049 17,373 21,746
------------ ------------ ------------
Income before equity in net income of subsidiaries..................... 47,637 37,451 40,377
Equity in net income of subsidiaries................................... 12,535 13,751 11,421
------------ ------------ ------------
Net income............................................................. $ 60,172 $ 51,202 $ 51,798
------------ ------------ ------------
See accompanying notes to condensed financial statements.
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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,
-----------------------------------------
2008 2007 2006
------------ ------------ ------------
Net cash provided by operating activities.............................. $ 71,600 $ 64,494 $ 52,899
------------ ------------ ------------
Cash flows from investing activities:
Additions to property and equipment.................................. (5,170) (5,817) (8,631)
Purchases of investments - available-for-sale........................ (61,774) (220,355) (164,309)
Maturities and sales of investments - available-for-sale............. 53,387 256,475 124,479
------------ ------------ ------------
Net cash (used in) provided by investing activities................ (13,557) 30,303 (48,461)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from exercise of stock options.............................. 338 (84) 485
Tax benefit on exercise of stock options............................. 156 790 703
Decrease in capital lease obligations................................ (22) (341) (320)
Purchases of treasury stock.......................................... (44,717) (66,460) (73,423)
Proceeds from issuance of debt....................................... 10,000 9,556 85,000
Repayments of debt................................................... (24,074) (27,793) (31,500)
Dividends paid....................................................... - - (4,643)
------------ ------------ ------------
Net cash used in financing activities.............................. (58,319) (84,332) (23,698)
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents................... (276) 10,465 (19,260)
Cash and cash equivalents at beginning of year......................... 19,710 9,245 28,505
------------ ------------ ------------
Cash and cash equivalents at end of year............................... $ 19,434 $ 19,710 $ 9,245
------------ ------------ ------------
Supplemental disclosure of cash flow information:
Cash paid for interest............................................... $ 4,074 $ 6,536 $ 5,536
------------ ------------ ------------
Cash paid for income taxes........................................... $ 35,029 $ 30,588 $ 28,710
------------ ------------ ------------
Purchases of treasury stock pursuant to tender offer................. $ - $ - $ 6,584
------------ ------------ ------------
See accompanying notes to condensed financial statements.
92
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 13 to the consolidated financial statements of Pre-Paid Legal
Services, Inc. relate to the Parent Company and therefore have not been repeated
in these notes to condensed financial statements.
Expense Advances and Reimbursements
Pursuant to management agreements with certain subsidiaries, which have been
approved by insurance regulators, commission advances are paid and expensed by
the Parent Company and the Parent Company is compensated for a portion of its
general and administrative expenses determined in accordance with the
agreements.
Dividends from Subsidiaries
Dividends paid to the Parent Company from its subsidiaries are accounted for by
the equity method. During 2008, PPLCI declared and, after obtaining all
necessary regulatory approvals, paid extraordinary dividends to us of $14.9
million compared to the $7.4 million and $13.4 million dividends paid to us
during 2007 and 2006, respectively. During 2008, LSPV paid us an ordinary
dividend of $4.1 million compared to $1.6 million during 2007 and none during
2006.
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INDEX TO EXHIBITS
Exhibit No. Description
----------- -----------
3.1 Amended and Restated Certificate of Incorporation of the Company, as amended (Incorporated by
reference to Exhibit 3.1 of the Company's Report on Form 8-K dated June 27, 2005)
3.2 Amended and Restated Bylaws of the Company (Incorporated by reference to Exhibit 3.1 of the
Company's Report on Form 10-Q for the period ended June 30, 2003)
*10.1 Employment Agreement effective January 1, 1993 between the Company and Harland C. Stonecipher (In-
corporated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-KSB for the year
ended December 31, 1992)
*10.2 Agreements between Shirley Stonecipher, New York Life Insurance Company and the Company regarding
life insurance policy covering Harland C. Stonecipher (Incorporated by reference to Exhibit 10.21 of
the Company's Annual Report on Form 10-K for the year ended December 31, 1985)
*10.3 Amendment dated January 1, 1993 to Split Dollar Agreement between Shirley Stonecipher and the
Company regarding life insurance policy covering Harland C. Stonecipher (Incorporated by reference
to Exhibit 10.3 of the Company's Annual Report on Form 10-KSB for the year ended December 31, 1992)
*10.4 Form of New Business Generation Agreement Between the Company and Harland C. Stonecipher (Incorpor-
ated by reference to Exhibit 10.22 of the Company's Annual Report on Form 10-K for the year ended
December 31, 1986)
*10.5 Amendment to New Business Generation Agreement between the Company and Harland C. Stonecipher
effective January, 1990 (Incorporated by reference to Exhibit 10.12 of the Company's Annual Report
on Form 10-KSB for the year ended December 31, 1992)
*10.6 Amendment No. 2 to New Business Generation Agreement between the Company and Harland C. Stonecipher
effective January, 1990 (Incorporated by reference to Exhibit 10.13 of the Company's Annual Report
on Form 10-K for the year ended December 31, 2002)
*10.7 Stock Option Plan, as amended effective May 2003 (Incorporated by reference to Exhibit 10.7 of the
Company's Annual Report on Form 10-K for the year ended December 31, 2004)
10.8 Loan agreement dated June 11, 2002 between Bank of Oklahoma, N.A. and the Company (Incorporated by
reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the six-months ended
June 30, 2002)
10.9 Form of Mortgage dated July 23, 2002 between Bank of Oklahoma, N.A. and the Company (Incorporated
by reference to Exhibit 10.3 of the Company's Quarterly Report on Form 10-Q for the six months
ended June 30, 2002)
*10.10 Deferred compensation plan effective November 6, 2002 (Incorporated by reference to Exhibit 10.14
of the Company's Annual Report on Form 10-K for the year ended December 31, 2002)
*10.11 Amended Deferred Compensation Plan effective January 1, 2005 (Incorporated by reference to
Exhibit 10.16 of the Company's Report on Form 10-K for the year ended December 31, 2004)
10.12 Credit Agreement dated June 23, 2006 among Pre-Paid Legal Services, Inc, the lenders signatory
thereto and Wells Fargo Foothill, Inc. as Arranger and Administrative Agent and Bank of Oklahoma,
N.A. (Incorporated by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K filed
June 27, 2006)
10.13 Security Agreement dated June 23, 2006 between Pre-Paid Legal Services, Inc and certain of its
subsidiaries and Wells Fargo Foothill, Inc., as Agent (Incorporated by reference to Exhibit 10.2 of
the Company's Current Report on Form 8-K filed June 26, 2006)
10.14 Guaranty Agreement dated June 23, 2006 between certain subsidiaries of Pre-Paid Legal Services,
Inc. and Wells Fargo Foothill, Inc., as Agent (Incorporated by reference to Exhibit 10.3 of the
Company's Current Report on Form 8-K filed June 27, 2006)
94
10.15 Mortgage, Assignment of Rents and Leases and Security Agreement by Pre-Paid Legal Services, Inc. in
favor of Wells Fargo Foothill, Inc as Agent (Incorporated by reference to Exhibit 10.4 of the
Company's Current Report on Form 8-K filed June 26, 2006)
10.16 First Amendment to Loan Agreement dated June 23, 2006 between Pre-Paid Legal Services, Inc. and
Bank of Oklahoma, N.A. (Incorporated by reference to Exhibit 10.5 of the Company's of the Company's
Current Report on Form 8-K filed June 26, 2006)
10.17 First Amendment to Credit Agreement dated September 10, 2007 between Pre-Paid Legal Services, Inc.
and the lenders named therein and Wells Fargo Foothill, Inc. as administrative agent (Incorporated
by reference to Exhibit 10.1 of the Company's of the Company's Current Report on Form 8-K filed
September 10, 2007)
10.18 Term Loan Agreement dated September 28, 2007 between Pre-Paid Legal Services, Inc. and Wells Fargo
Equipment Finance, LLC (Incorporated by reference to Exhibit 10.1 of the Company's of the Company's
Current Report on Form 8-K filed October 2, 2007)
10.19 Form of Aircraft Mortgage and Security Agreement between Pre-Paid Legal Services, Inc. and Wells
Fargo Equipment Finance, LLC (Incorporated by reference to Exhibit 10.2 of the Company's of the
Company's Current Report on Form 8-K filed October 2, 2007)
10.20 Second Amendment to Credit Agreement dated February 22, 2008 between Pre-Paid Legal Services, Inc.
and the lenders named therein and Wells Fargo Foothill, Inc. as administrative agent (Incorporated
by reference to Exhibit 10.20 of our Annual Report on Form 10-K for the year ended December 31,
2007)
10.21 Third Amendment to Credit Agreement dated June 5, 2008 between Pre-Paid Legal Services, Inc. and
the lenders named therein and Wells Fargo Foothill, Inc. as administrative agent (Incorporated by
reference to Exhibit 10.21 of the Company's Quarterly Report on Form 10-Q for the six-months ended
June 30, 2008)
10.22 Second Amendment to Loan Agreement dated June 6, 2008 between Pre-Paid Legal Services, Inc. and
Bank of Oklahoma, N.A. (Incorporated by reference to Exhibit 10.22 of the Company's Quarterly
Report on Form 10-Q for the six-months ended June 30, 2008)
**10.23 Share Repurchase Letter agreement between Pre-Paid Legal Services, Inc. and Idoya Partners dated
December 8, 2008
**10.24 Share Repurchase Letter agreement between Pre-Paid Legal Services, Inc. and Idoya Partners dated
January 30, 2009.
21.1 List of Subsidiaries of the Company
**23.1 Consent of Grant Thornton LLP
**31.1 Certification of Harland C. Stonecipher, Chairman, Chief Executive Officer and President, Pursuant
to Rule 13a-14(a) under the Securities Exchange Act of 1934
**31.2 Certification of Steve Williamson, Chief Financial Officer, Pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934
**32.1 Certification of Harland C. Stonecipher, Chairman, Chief Executive Officer and President, Pursuant
to 18 U.S.C. Section 1350
**32.2 Certification of Steve Williamson, Chief Financial Officer, Pursuant to 18 U.S.C. Section 1350
99.1 Financial Statements of Pre-Paid Legal Services, Inc. Employee Stock Ownership and Thrift Plan
--------------------
*Constitues a management contract or compensatory plan or arrangement required to be filed as an exhibit to this report.
**Filed herewith. All other exhibits have been previously filed.
95