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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One) FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009
[ ] 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 incorporation or organization) (I.R.S. Employer 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:
Title of each class Name of each exchange on 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 requiredto be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No | |
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). Yes | | 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, a non-accelerated filer, or a
smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company"
in Rule 12b-2 of the Exchange Act.
Large accelerated filer | | Accelerated filer |X| Non-accelerated filer | | Smaller reporting Company | |
(do not check if a smaller
reporting company)
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, 2009: $320,034,000
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 12, 2010, there were 10,045,068 shares of Common Stock, par value $.01 per share, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of our definitive proxy statement for our 2010 annual meeting of shareholders are incorporated into Part III of this
Form 10-K by reference.
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PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
For the Year Ended December 31, 2009
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............................................................................ 6
Identity Theft Shield Provider................................................................ 9
Marketing..................................................................................... 10
Operations.................................................................................... 13
Quality Control............................................................................... 13
Competition................................................................................... 14
Regulation.................................................................................... 14
Employees..................................................................................... 16
Foreign Operations............................................................................ 16
Availability of Information................................................................... 16
ITEM 1A. RISK FACTORS...................................................................................... 16
ITEM 1B. UNRESOLVED STAFF COMMENTS......................................................................... 19
ITEM 2. PROPERTIES........................................................................................ 19
ITEM 3. LEGAL PROCEEDINGS................................................................................. 20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................... 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............................................. 21
Recent Sales of Unregistered Securities....................................................... 22
Issuer Purchases of Equity Securities......................................................... 22
Shareholder Return Performance Graph.......................................................... 23
ITEM 6. SELECTED FINANCIAL DATA........................................................................... 24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview of our Financial Model............................................................... 25
Critical Accounting Policies.................................................................. 26
Other General Matters......................................................................... 31
Measures of Member Retention.................................................................. 32
Results of Operations
Comparison of 2009 to 2008................................................................ 35
Comparison of 2008 to 2007................................................................ 36
Liquidity and Capital Resources............................................................... 37
Forward Looking Statements.................................................................... 40
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........................................ 40
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................................................... 42
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.............. 69
ITEM 9A. CONTROLS AND PROCEDURES........................................................................... 69
ITEM 9B. OTHER INFORMATION................................................................................. 69
PART III (Information required by Part III is incorporated by reference from our definitive proxy
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statement for our 2010 annual meeting of shareholders.)
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES........................................................... 70
SIGNATURES...................................................................................................... 71
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2009
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 47
states and 4 Canadian provinces, 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,
2009, we had 1,547,585 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 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, "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, "the challenge (and
opportunity) for the legal profession is to make lawyers more accessible and
less threatening to consumers who might need them."
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
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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 141 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 113 million
households, we currently have an approximate 1.3% share of the estimated market
based on our existing 1.5 million active Memberships and, over the last 30
years, an additional 6% of households have previously purchased, but no longer
own, Memberships. We routinely remarket to previous members and reinstated
approximately 95,000, 82,000 and 83,000 Memberships during 2009, 2008 and 2007,
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, 2009,
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 2009, our provider law firms processed more than 2.3 million
requests for service, an average of 1.6 per Member. A request for service
represents a member's request for assistance on a specific legal matter. These
requests 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 to the provider law firm, provider law firms
representing approximately 99% of our Membership base reported that on average,
approximately 1% of these requests for service resulted in additional fees being
paid by the member to the provider law firm.
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 92% of our Membership fees (including the add-on identity theft
shield benefit, 72% and 75%, respectively, excluding such add-ons) in 2009 and
2008. 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. In almost every case, additional wills for spouse
and other covered members may be prepared at a cost of $20 or less.
Motor Vehicle Legal Protection. These benefits offer legal assistance for
matters resulting from the operation of a licensed motor vehicle. Members have
assistance available to them at no additional cost for: (a) defense in the court
of original jurisdiction of moving traffic violations deemed meritorious, (b)
defense in the court of original jurisdiction of any charge of manslaughter,
involuntary manslaughter, vehicular homicide or negligent homicide as the result
of a licensed motor vehicle accident, (c) up to 2.5 hours of assistance per
incident for collection of minor property damages (up to $2,000) sustained by
the member's licensed motor vehicle in an accident, (d) up to 2.5 hours of
assistance per incident for collection of personal injury damages (up to $2,000)
sustained by the member or covered family member while driving, riding or being
struck as a pedestrian by a motor vehicle, and (e) up to 2.5 hours of assistance
per incident in connection with an action, including an appeal, for the
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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 479,000 subscribers of
this benefit at December 31, 2009 compared to 487,000 at December 31, 2008.
IRS Audit Protection Services. This benefit offers up to 50 hours of legal
assistance per year in the event the member, spouse or dependent children
receive written notification of an Internal Revenue Service ("IRS") audit or are
summoned in writing to appear before the IRS concerning a tax return. The 50
hours of assistance are available in the following circumstances: (a) up to 1
hour for initial consultation, (b) up to 2.5 hours for representation in
connection with the audit if settlement with the IRS is not reached within 30
days, and (c) the remaining 46.5 hours of actual trial time if settlement is not
achieved prior to litigation. Coverage is limited to audit notification received
regarding the tax return for years during which the Membership is effective.
Representation for charges of fraud or income tax evasion, business and
corporate tax returns and certain other matters are excluded from this benefit.
With pre-trial benefits limited to 2.5 hours to 4.5 hours based on the
Membership year for trial defense (without the pre-trial option described) and
3.5 hours for the IRS audit benefit, these benefits do not ensure complete
pre-trial coverage. In order to receive additional pre-trial IRS audit or trial
defense benefits, a matter must actually proceed to trial. The costs of
pre-trial preparation that exceed the benefits under the Membership are the
responsibility of the member. Provider law firms under the closed panel
Membership have agreed to provide to members any additional pre-trial services
beyond those stipulated in the Membership at a 25% discount from the provider
law firm's customary and usual hourly rate. Retainer fees for these additional
services may be required.
Preferred Member Discount for All Other Services. Provider law firms have
agreed to provide to members any legal services beyond those stipulated in the
Membership at a fee discounted 25% from the provider law firm's customary and
usual hourly rate. This "customary and usual hourly rate" is a fixed single
hourly rate for each provider firm that is generally an average of the firm's
various hourly rates for its attorneys which typically vary based on experience
and expertise.
Legal Shield Benefit
In 47 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
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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 1,110,000 Legal Shield subscribers at December 31, 2009 compared
to approximately 1,091,000 at December 31, 2008.
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 were 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 804,000 and 771,000 subscribers at December 31, 2009 and 2008,
respectively, comprised of 711,000 and 681,000 subscribers at $9.95 per month
and 93,000 and 90,000 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 2009 were approximately $7.9 million (including foreign
currency translation adjustments) in U.S. dollars compared to $8.2 million
collected in 2008 and $7.6 million collected in 2007.
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,
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 45 states and three Canadian provinces and represented
approximately 5.2%, 5.4% and 5.3% of our Membership fees during 2009, 2008 and
2007, 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
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coverage by a provider law firm for persons who drive a commercial vehicle. This
legal service plan is currently offered in 44 states. In certain states, the
Commercial Driver Legal Plan is underwritten by the Road America Motor Club, an
unrelated motor service club. During 2009, this plan accounted for approximately
0.7% of Membership fees compared to approximately .8% and .9% of Membership fees
during 2008 and 2007. 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 38 states and three Canadian provinces and represented
approximately 1.9% of our Membership fees during 2009 compared to approximately
1.9% and 1.8% during 2008 and 2007.
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 (2,735
Memberships, 2,599 Memberships and 2,735 Memberships during 2009, 2008 and 2007,
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 that enables us to manage our benefit costs through
the capitated payment structure to provider firms. We frequently evaluate and
consider other plan benefits that may include other services complimentary to
the basic legal service plan.
Provider Law Firms
Our Memberships generally allow members to access legal services through a
network of independent provider law firms under contract with us generally
referred to as "provider law firms." Provider law firms are paid a fixed fee on
a per capita basis to render services to plan members residing within the state
or province as provided by the contract. Because the fixed fee payments by us to
provider law firms in connection with the Memberships do not vary based on the
type and amount of benefits utilized by the member, this arrangement provides
significant advantages to us in managing our cost of benefits. Pursuant to these
provider law firm arrangements and due to the volume of revenue directed to
these firms, we have the ability to more effectively monitor the customer
service aspects of the legal services provided, the financial leverage to help
ensure a customer friendly emphasis by the provider law firms and access to
larger, more diversified law firms. Through our members, we are typically the
largest client base of our provider law firms.
Provider law firms are selected to serve members based on a number of
factors, including recommendations from provider law firms and other lawyers in
the area in which the candidate provider law firm is located and in neighboring
states, our investigation of bar association standing and client references,
evaluation of the education, experience and areas of practice of lawyers within
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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.
All of our 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
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, 2009,
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, 2009 and year 2009 requests for service by state/province. As
reflected in the table below, the average number of requests for service per
member during 2009 was 1.6.
7
Memberships Requests
State/Province Provider Firm Memberships Attorney per attorney for Service
-------------- --------------------------------------------- ----------- -------- ------------ -------------
Alabama The Anderson Law Firm, LLC 18,264 8 2,283 22,074
Alaska No designated provider law firm - services
provided by referral attorneys - - - -
Alberta Nickerson, Roberts, Holinski & Mercer 4,042 10 404 3,658
Arizona Davis Miles, PLLC 43,408 55 789 90,244
Arkansas Lisle Rutledge, P.A. 13,690 8 1,711 20,088
British Columbia Watson, Goepel & Maledy 4,447 35 127 8,143
California Parker Stanbury 220,610 66 3,343 433,255
Colorado Riggs, Abney, Neal, Turpen, Orbison & Lewis 35,468 31 1,144 52,039
Connecticut Willinger, Willinger & Bucci, P.C. 8,482 13 652 13,357
Delaware Mattleman, Weinroth & Miller 4,631 6 772 7,038
Florida DeBeaubien, Knight, Simmons, Mantzaris & Neal 54,476 46 1,184 94,205
Florida Glantz & Glantz 41,488 32 1,297 89,568
Georgia Deming, Parker, Hoffman, Campbell & Daly 59,593 56 1,064 112,725
Hawaii Bervar & Jones 12,416 10 1,242 21,111
Idaho The Huntley Law Firm, PLLC 8,648 12 721 12,013
Illinois Evans, Loewenstein, Shimanovsky & Moscardini, 42,454 22 1,930 81,153
Ltd.
Indiana O'Koon Hintermeister, PLLC 23,321 15 1,555 38,087
Iowa McEnroe, Gotsdiner, Brewer, Steinbach & 6 927 4,837
Henrichsen, P.C. 5,563
Kansas Riling, Burkhead & Nitcher 13,989 13 1,076 16,177
Kentucky O'Koon Hintermeister, PLLC 9,154 5 1,831 12,467
Louisiana Provosty, Sadler, deLaunay, Fiorenza & Sobel 22,443 20 1,122 22,692
Maine Robinson, Kriger & McCallum 4,033 14 288 5,308
Manitoba Tapper Cuddy 1,540 23 67 1,240
Maryland/D.C. Weinstock, Friedman & Friedman, P.A. 41,671 38 1,097 66,509
Massachusetts Framme Law Firm 3,139 2 1,570 5,646
Michigan Powers, Chapman, DeAgostino, Meyers & Milia 43,310 21 2,062 77,907
Minnesota Wagner, Falconer & Judd, LTD 18,934 23 823 31,507
Mississippi Nixon, Ray & Framme, PLLC 9,789 3 3,263 13,212
Missouri Dubail Judge 24,330 21 1,159 31,598
Montana Rimel & Mrkich, PLLP 4,596 2 2,298 4,226
N. Carolina Merritt, Flebotte, Wilson, Webb & Caruso 57,666 27 2,136 87,467
N. Dakota Wagner, Falconer & Judd, LTD 301 3 100 196
Nebraska Morrow, Poppe, Watermeier & Lonowski, P.C. 2,480 8 310 3,398
Nevada Dempsey, Roberts & Smith 17,848 15 1,190 38,104
New Hampshire Framme Law Firm 3,223 2 1,612 5,428
New Jersey Mattleman, Weinroth & Miller 31,399 19 1,653 40,129
New Mexico Davis Miles, PLLC 18,926 9 2,103 26,215
New York Feldman, Kramer & Monaco, P.C. 48,564 49 991 74,443
Ohio Maguire & Schneider, LLP 41,808 26 1,608 67,108
Oklahoma Riggs, Abney, Neal, Turpen, Orbison & Lewis 41,302 108 382 40,417
Ontario Mills & Mills 17,800 24 742 27,500
Oregon Kivel & Howard, LLP 22,915 13 1,763 36,037
Pennsylvania Welch, Gold & Siegel, P.C. 33,939 22 1,543 50,763
Rhode Island Framme Law Firm 1,201 1 1,201 1,493
S. Carolina Merritt, Flebotte, Wilson, Webb & Caruso 20,921 16 1,308 32,211
S. Dakota Demersseman Jensen 2,321 6 387 1,633
Tennessee Merritt, Flebotte, Wilson, Webb & Caruso 23,775 8 2,972 31,883
Texas Ross & Matthews, P.C. 137,442 97 1,417 181,754
Utah Smart, Schofield, Shorter & Lunceford 14,908 12 1,242 23,577
Vermont Framme Law Firm 487 2 244 625
Virginia Framme Law Firm 37,898 21 1,805 52,854
W. Virginia Caldwell & Riffee 4,044 5 809 2,854
Washington Lombino - Martino, PS 43,403 27 1,608 80,698
Wisconsin Wagner, Falconer & Judd, LTD 11,930 10 1,193 23,103
Wyoming Smart, Schofield, Shorter & Lunceford 1,881 2 941 1,089
----------- -------- ------------ -------------
Total Closed Panel Memberships 1,436,311 1,148 1,279Avg. 2,323,063
-------- ------------ -------------
"Stand-alone" IDT Memberships 92,924
Open Panel Memberships 10,110
Commercial Driver Legal Plan Memberships 8,240
-----------
Total Memberships 1,547,585
-----------
8
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
2009, we had provider law firms representing 49 states and four provinces,
compared to 47 states and four provinces at the end of 2008 and 2007. During the
last three calendar years, our relationships with a total of three provider law
firms were terminated by the provider law firm or us. As of December 31, 2009,
30 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 12 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.
9
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, 2009, 2008 and
2007) 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 73% of
our Memberships in force at December 31, 2009, compared to 74% at December 31,
2008 and 75% at December 31, 2007. Although other means of payment are
available, approximately 71% 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
27% of total Memberships in force at December 31, 2009, compared to 26% and 25%
at December 31, 2008 and 2007, 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 2009, 2008 or 2007. 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 meet the program requirements
and have been through the required training, they can begin to offer businesses
template forms they can work from to begin their security program. We encourage
businesses to host mandatory employee meetings and training sessions on identity
theft and privacy compliance including reviewing the employer's privacy policy
with employees. 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. We developed ADRS to enhance our
group marketing efforts and we intend to continue to utilize this program in
2010.
10
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, 2009, we had 477,208 "vested" sales
associates compared to 425,018 and 442,361 "vested" sales associates at December
31, 2008 and 2007, 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
pre-cancel 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 down line, level, counters and qualifications and
forfeits any pending advanced commission, earnings and bonuses.
During 2009, we had 95,303 sales associates who personally sold at least
one Membership, of which 56,736 (59%) made first time sales. During 2008 and
2007 we had 81,731 and 90,123 sales associates producing at least one Membership
sale, respectively, of which 43,674 (53%) and 49,117 (55%), respectively, made
first time sales. During 2009, we had 7,448 sales associates who personally sold
more than ten Memberships compared to 6,996 and 9,047 in 2008 and 2007,
respectively. A substantial number of our sales associates market our
Memberships on a part-time basis only. For the year 2009, new sales associates
enrolled increased 52 to 186,064 with an average enrollment fee of $87 from the
122,255 enrolled in 2007 with an average enrollment fee of $72.
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
------- -------------- -------------- -------------- ---------- ------------
Q1/08 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
Q1/09 60 179 22,805 389,135 412,179
Q2/09 85 227 23,676 377,062 401,050
Q3/09 158 678 38,615 408,733 448,184
Q4/09 273 1,012 38,097 437,826 477,208
(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.
(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.
11
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 the RVPs and us
and the frequency and the amount of reporting both from and to, the RVPs. At
December 31, 2009, we had 31 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.
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
12
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, 2009, approximately 47,300 shares were purchased by the
PPLBA for awards to its members. The PPLBA awarded approximately 1,400, 1,900
and 2,075 shares of stock to Association members representing the 2009, 2008 and
2007 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 18,000 new Membership sales during 2009 compared to
24,000 and 25,000, respectively for 2008 and 2007.
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
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
13
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.
As of December 31, 2009, the regulatory environment for us and our wholly
owned subsidiaries is reflected in the table below. The most significant of
these 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, 2009, 36% were
written in jurisdictions that subject us or one of our subsidiaries to insurance
or specialized legal expense plan regulation (24% 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.
Number of
Regulatory Environment: Jurisdictions
No special regulatory classification and no required licensing for sales associates.................. 34
Insurance company classification with required licensing for sales associates........................ 12
Insurance company classification but no required licensing for sales associates...................... 3
Other (non-insurance company) regulatory classification with required licensing for sales associates. 3
No special regulatory classification but required licensing for sales associates..................... 1
Required reporting to insurance department but no licensing of sales associates...................... 1
No legal plan offered - only Identity Theft Shield available for sale................................ 1
-------------
Total jurisdictions (50 states, District of Columbia and 4 Canadian provinces)....................... 55
-------------
14
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 affect 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 2009, PPLCI declared and after obtaining all necessary
regulatory approvals, paid extraordinary dividends to us of $6.7 million
compared to the $14.9 million and $7.4 million paid to us during 2008 and 2007,
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, 2010, none of PPLCI, PPLSIF or LSPV had funds
available for payment of substantial dividends without the prior approval of the
insurance commissioner. LSPV declared and paid us a $1.8 million dividend during
2009 compared to $4.1 million during 2008 and $1.6 million during 2007.
As the legal plan industry continues to mature, additional legislation may
be enacted that would affect us and our subsidiaries. We cannot predict with any
accuracy if such legislation would be adopted or its ultimate effect on
operations, but expect to continue to work closely with regulatory authorities
to minimize any undesirable impact and, as noted above, to reduce regulatory
cost and burden where possible.
Our operations are further impacted by the American Bar Association Model
Rules of Professional Conduct ("Model Rules") and the American Bar Association
Code of Professional Responsibility ("ABA Code") as adopted by various states.
Arrangements for payments to a lawyer by an entity providing legal services to
its members are permissible under both the Model Rules and the ABA Code, so long
15
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, 2009, we employed 719 individuals, 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 2009 compared to $8.7 million and $7.9 million in 2008 and 2007,
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 positive foreign currency translation adjustments of
$1.5 million during 2009 and have a cumulative positive foreign currency
translation adjustment balance of $1.1 million at December 31, 2009. 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.,
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:
16
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.
------------------------------
Our year end active Memberships decreased 0.7% from December 31, 2008 to
December 31, 2009, decreased 1.1% during 2008 and increased 2.4% during 2007.
Changes in net income for the same three years were (8%), 18% and (1%),
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
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
17
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 ("FTC") 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. See Item 3, Legal Proceedings for further
information pertaining to current inquiries by the FTC and the SEC.
The business in which we operate is competitive.
------------------------------------------------
There are a number of existing and potential competitors that have the
ability to offer competing products that could adversely affect our ability to
grow. In addition, we may face competition from a growing number of Internet
based legal sites with the potential to offer legal and related services at
competitive prices. Increased competition could have a material adverse effect
on our financial condition and results of operations. See "Description of
Business - Competition."
We are dependent upon the success of our marketing force.
---------------------------------------------------------
Our principal method of product distribution is through multi-level
marketing. The success of a multi-level marketing force is highly dependent upon
our ability to offer a commission and organizational structure and sales
training and incentive program that enable sales associates to recruit and
develop other sales associates to create an organization. There are a number of
other products and services that use multi-level marketing as a distribution
method and we must compete with these organizations to recruit, maintain and
grow our multi-level marketing force. In order to do so, we may be required to
increase our marketing costs through increases in commissions, sales incentives
or other features, all of which could adversely affect our future earnings. In
addition, the level of confidence of the sales associates in our ability to
perform is an important factor in maintaining and growing a multi-level
marketing force. Adverse financial developments concerning us, including
negative publicity or common stock price declines, could adversely affect our
ability to maintain the confidence of our sales force.
Our stock price may be affected by short sellers of our stock.
--------------------------------------------------------------
As of January 15, 2010, the New York Stock Exchange reported that
approximately 2.0 million shares of our stock were sold short, which constitutes
approximately 20% of our outstanding shares and 30% of our public float. During
2009, the number of shares sold short typically 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, 2009, group memberships
represented 27% of total Memberships compared to 26% at December 31, 2008 and
25% at December 31, 2007. 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.
18
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 16
million shares through subsequent board actions. At December 31, 2009, we had
purchased 15.1 million treasury shares under these authorizations in both open
market and non-open market transactions for a total consideration of $457.9
million, an average price of $30.32 per share. The repurchase program of $457.9
million combined with $17.1 million in dividends has resulted in our returning
$475 million to shareholders since April 1999 and represents more than 100% of
our net earnings during the same timeframe. We have reduced the number of shares
outstanding by approximately 57% from 23.6 million at March 31, 1999 to 10.1
million outstanding at year-end. 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 affect 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
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 affecting 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
19
approximately 100 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.
---------------------------
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 and fraud. On May 15, 2006, the trial
court dismissed plaintiff's complaint in its entirety. Plaintiff amended the
complaint to allege fraud and breach of fiduciary duty on June 12, 2006 and
filed a notice of appeal on June 13, 2006. 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. On June 24, 2009, the trial court granted
our motion for summary judgment and dismissed plaintiff's action against us in
its entirety. Plaintiff appealed the summary judgment, oral arguments have been
held, and we are awaiting the ruling of the appellate court. The ultimate
outcome of this matter is not determinable.
On March 23, 2007, we received a Civil Investigative Demand ("CID") from
the Federal Trade Commission ("FTC") requesting information relating to our
Identity Theft Shield and Affirmative Defense Response System ("ADRS") Program.
On April 20, 2009, we received a letter from the FTC alleging misrepresentations
in sales materials used in our Identity Theft Shield and ADRS program such that
we made false and misleading claims about the effectiveness of ADRS for helping
organizations comply with government data security requirements. Revisions to
the marketing materials originally provided to the FTC have been made subsequent
to the initial communication with the FTC. We attempted to resolve this matter
with the FTC between May 2009 and November 2009; however on November 18, 2009,
the FTC forwarded a staff recommendation to the Commission with a proposed
complaint seeing injunctive relief and disgorgement of funds received for sales
of the identity theft shield and legal plan products at ADRS presentations. We
met with the FTC on February 3, 2010 to explain our disagreement with the FTC
and to reach a mutually agreeable solution. The FTC could decide to commence
administrative or federal court proceedings for purposes of determining whether
there has been a violation and might seek a variety of remedies, including
injunctive relief. The ultimate outcome of the matter is not determinable but we
will vigorously defend our interests in this matter.
On October 5, 2009, we received a subpoena from the Division of Enforcement
of the Securities and Exchange Commission ("SEC"). The subpoena requires us to
produce a variety of documents pertaining to our treasury stock repurchase
program; our ADRS program and other marketing practices; membership statistical
information; segment reporting; the FTC contingency disclosure; and other
operational practices. This investigation is a fact-finding inquiry and does not
mean that the SEC has reached any conclusions. We are cooperating with the staff
of the SEC and providing the requested information and expect to continue to do
so. We are not able to predict what the outcome of this inquiry may be or when
it will be resolved.
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 believe that we have meritorious defenses in all pending cases and
will vigorously defend against the claims and have not established an accrued
liability for any estimated damages in connection with these various cases.
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.
20
Canadian taxing authorities are challenging portions of our commission and
general and administrative deductions for tax years 1999 - 2002 and have tax
assessments that aggregate $5.7 million. During 2007, we reached a settlement
with Canadian taxing authorities regarding the general and administrative
deductions that 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
and U.S. tax returns have been amended to reflect the changes in our general and
administrative expense and credits/refunds for the associated taxes, penalty and
interest. 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 and 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. In addition, 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. 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. During the 3rd quarter 2009, the Canadian
taxing authorities indicated they are amenable to a settlement regarding the
commission issue. We have paid all the assessed tax, penalty and interest
relating to the commission issue and at December 31, 2009 have $3 million
recorded in Other Assets, Current which represents the amount of previously paid
tax, penalty and interest for tax years 1999 through 2002 we expect to
ultimately receive. It is possible that an adverse outcome could have an adverse
effect upon our financial condition, operating results or cash flows in
particular quarterly or annual periods.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
-------------------------------------------------------------
We did not submit any matters to a vote of our stockholders during the
fourth quarter of 2009.
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 12, 2010, there were 1,584 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
---- ---
2010:
1st Quarter (through February 12)............... $ 43.69 $ 38.90
2009:
4th Quarter..................................... $ 53.05 $ 30.68
3rd Quarter..................................... 52.92 41.83
2nd Quarter..................................... 45.22 28.17
1st Quarter..................................... 38.23 26.45
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
No dividends were declared in 2009, 2008 or 2007. 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:
21
Dividends Paid
------------------------------------------------------ Expected Dividends
Regulated Subsidiary 2009 2008 2007 1/1/2010
-------------------------------- ---------------- ---------------- -------------- -------------------
Pre-Paid Legal Casualty, Inc. $ 6.7 million $ 14.9 million $ 7.4 million $ -
Legal Service Plans of Virginia 1.8 million 4.1 million 1.6 million -
At December 31, 2009, the amount of restricted net assets of consolidated
subsidiaries was $25.5 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.
Issuer Purchases of Equity Securities
The following table provides information about our purchases of stock
during the fourth quarter of 2009.
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 2009.......... 88,024 $ 40.37 88,024 714,750
November 2009......... 633,998 39.82 633,998 1,080,752
December 2009......... 180,675 39.19 180,675 900,077
--------------------- --------------------- ---------------------
Total ................ 902,697 $ 39.75 902,697
--------------------- --------------------- ---------------------
-----------
(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. On occasion we purchase shares from related parties but
transactions between the company and all related parties constitute
less than one tenth of one percent of total share transactions since
the company began its share repurchase program. The Board of Directors
has subsequently from time to time increased such authorization from
500,000 shares to 16 million shares. The most recent authorization was
for 1 million additional shares on November 30, 2009. There has been
no time limit set for completion of the repurchase program.
22
Shareholder Return Performance Graph
The following graph compares the cumulative total shareholder returns of
our Common Stock during the five years ended December 31, 2009 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, 2005 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]
12/31/2004 12/31/2005 12/31/2006 12/31/2007 12/31/2008 12/31/2009
---------- ---------- ---------- ---------- ---------- ----------
Pre-Paid Legal Services, Inc. $100.00 $103.42 $105.91 $149.81 $100.93 $111.44
Personal Services Industry Index $100.00 $104.55 $123.76 $121.82 $80.66 $102.58
Russell 2000 Index $100.00 $104.13 $114.77 $117.37 $76.05 $92.21
23
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,
------------------------------------------------------------
2009 2008 2007 2006 2005
---------- ---------- ---------- ---------- ------------
Income Statement Data: (In thousands, except ratio, per share and Membership
amounts)
Revenues:
Membership fees.................................... $ 426,429 $ 436,778 $ 427,428 $ 412,200 $ 389,255
Associate services................................. 28,352 23,534 25,112 26,857 28,963
Other.............................................. 3,696 4,177 4,549 4,967 5,162
---------- ---------- ---------- ---------- ------------
Total revenues................................... 458,477 464,489 457,089 444,024 423,380
---------- ---------- ---------- ---------- ------------
Costs and expenses:
Membership benefits................................ 145,128 150,318 148,792 145,771 137,150
Commissions........................................ 130,601 126,758 130,593 126,762 141,631
Associate services and direct marketing............ 31,921 23,582 28,875 29,493 30,453
General and administrative expenses................ 51,594 53,021 50,474 50,078 49,015
Other, net......................................... 8,558 13,413 13,841 12,232 10,456
---------- ---------- ---------- ---------- ------------
Total costs and expenses......................... 367,802 367,092 372,575 364,336 368,705
---------- ---------- ---------- ---------- ------------
Income before income taxes............................. 90,675 97,397 84,514 79,688 54,675
Provision for income taxes............................. 35,537 37,225 33,312 27,890 18,863
---------- ---------- ---------- ---------- ------------
Net income............................................. $ 55,138 $ 60,172 $ 51,202 $ 51,798 $ 35,812
---------- ---------- ---------- ---------- ------------
Basic earnings per common share........................ $ 5.05 $ 5.05 $ 3.89 $ 3.54 $ 2.31
---------- ---------- ---------- ---------- ------------
Diluted earnings per common share...................... $ 5.04 $ 5.04 $ 3.88 $ 3.51 $ 2.29
---------- ---------- ---------- ---------- ------------
Dividends declared per common share.................... $ - $ - $ - $ - $ .60
Weighted avg. no. of common shares outstanding - basic. 10,918 11,916 13,151 14,642 15,470
Weighted avg. no. of common shares outstanding - diluted 10,932 11,934 13,197 14,739 15,652
Membership Benefits Cost and Statistical Data:
Membership benefits ratio (1)........................ 34.0% 34.4% 34.8% 35.4% 35.2%
Commissions ratio (1)................................ 30.6% 29.0% 30.6% 30.8% 36.4%
General and administrative expense ratio (1)......... 12.1% 12.1% 11.8% 12.1% 12.6%
Commission cost per new Membership sold.............. $ 230 $ 229 $ 213 $ 207 $ 202
New Memberships and stand-alone IDT plans sold....... 568,095 552,327 612,096 612,726 700,727
Period end Memberships & stand-alone IDT plans in force. 1,547,585 1,559,154 1,575,802 1,538,740 1,542,789
New add-on IDT memberships sold...................... 348,607 344,869 381,419 389,157 441,108
Period end add-on IDT memberships in force........... 711,131 680,862 631,910 540,253 461,094
Average annual Membership fee........................ $ 303 $ 301 $ 298 $ 293 $ 287
Cash Flow Data:
Net cash provided by operating activities.............. 67,794 64,317 67,178 54,385 50,131
Net cash provided by (used in) investing activities.... 6,822 (4,411) 30,064 (52,613) (15,545)
Net cash used in financing activities................. (68,240) (58,319) (84,332) (23,698) (26,601)
Balance Sheet Data:
Total assets......................................... $ 157,988 $ 162,843 $ 167,632 $ 188,547 $ 164,865
Total long-term obligations.......................... 36,556 53,708 70,623 87,230 36,237
Total liabilities.................................... 119,661 131,036 149,793 157,687 113,471
Stockholders' equity................................. 38,327 31,807 17,839 30,860 51,394
Income Statement Data:
Depreciation and amortization expense................ $ 8,187 $ 8,756 $ 8,532 $ 8,260 $ 7,489
Interest expense..................................... 1,173 4,221 6,678 5,726 2,682
-----------
24
(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 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: 2009 Revenue Year 2008 Revenue Year 2007 Revenue Year
--------- -------- ------- --------- -------- ------- --------- --------- ---------
Membership fees............ $ 426,429 93.0 (2.4) $ 436,778 94.0 2.2 $ 427,428 93.5 3.7
Associate services......... 28,352 6.2 20.5 23,534 5.1 (6.3) 25,112 5.5 (6.5)
Other...................... 3,696 0.8 (11.5) 4,177 0.9 (8.2) 4,549 1.0 (8.4)
--------- -------- ------- --------- -------- ------- --------- --------- ---------
458,477 100.0 (1.3) 464,489 100.0 1.6 457,089 100.0 2.9
--------- -------- ------- --------- -------- ------- --------- --------- ---------
Costs and expenses:
Membership benefits........ 145,128 31.6 (3.5) 150,318 32.4 1.0 148,792 32.6 2.1
Commissions................ 130,601 28.5 3.0 126,758 27.3 (2.9) 130,593 28.6 3.0
Associate services and
direct marketing......... 31,921 7.0 35.4 23,582 5.1 (18.3) 28,875 6.3 (2.1)
General and administrative. 51,594 11.2 (2.7) 53,021 11.4 5.0 50,474 11.0 0.8
Other, net................. 8,558 1.9 (36.2) 13,413 2.9 (3.1) 13,841 3.0 13.2
--------- -------- ------- --------- -------- ------- --------- --------- ---------
367,802 80.2 0.2 367,092 79.1 (1.5) 372,575 81.5 2.3
--------- -------- ------- --------- -------- ------- --------- --------- ---------
Provision for income taxes... 35,537 7.8 (4.5) 37,225 8.0 11.7 33,312 7.3 19.4
--------- -------- ------- --------- -------- ------- --------- --------- ---------
Net income................... $ 55,138 12.0 (8.4) $ 60,172 12.9 17.5 $ 51,202 11.2 (1.2)
--------- -------- ------- --------- -------- ------- --------- --------- ---------
The following table reflects certain data concerning our Membership sales
and associate recruiting:
% Change % Change
from from
New Memberships: 2009 Prior Year 2008 Prior Year 2007
---------------- ---------- ---------- ----------- ---------- -----------
New legal service Membership sales................. 541,138 3.8 521,522 (8.6) 570,637
New "stand-alone" IDT Membership sales............. 26,957 (12.5) 30,805 (25.7) 41,459
---------- ---------- ----------- ---------- -----------
Total new Membership sales......................... 568,095 2.9 552,327 (9.8) 612,096
---------- ---------- ----------- ---------- -----------
New "add-on" IDT Membership sales.................. 348,607 1.1 344,869 (9.6) 381,419
Average annual Membership fee...................... $322.77 (0.5) $324.52 1.0 $321.18
Active Memberships:
-------------------
Active legal service memberships at end of period.. 1,454,661 (1.0) 1,469,315 (1.5) 1,492,341
Active "stand-alone" IDT memberships at end of period 92,924 3.4 89,839 7.6 83,461
---------- ---------- ----------- ---------- -----------
Total active memberships at end of period.......... 1,547,585 (0.7) 1,559,154 (1.1) 1,575,802
---------- ---------- ----------- ---------- -----------
Active "add-on" IDT memberships at end of period... 711,131 4.4 680,862 7.7 631,910
New Sales Associates:
---------------------
New sales associates recruited..................... 186,064 52.2 122,255 (17.8) 148,802
Average enrollment fee paid by new sales associates $87.41 22.2 $71.53 26.0 $56.75
Average Membership fee in force:
--------------------------------
Average Annual Membership fee...................... $302.51 0.6 $300.80 1.1 $297.62
25
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 affecting 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, it 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.
Our Membership fees declined during 2009, the first such decline in 17
years. Even in each of the previous 16 years before 2009, 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 2010 will continue to be on improved training of our
associates, enhancing the quality of sales tools provided to new and existing
associates, providing incentives for associates to write consistent, quality
business and continued emphasis on improving the basic retention characteristics
of our Memberships.
Critical Accounting Policies
Our financial statements and accompanying notes are prepared in accordance
with accounting principles generally accepted in the United States of America.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses. These estimates and assumptions are affected by management's
application of accounting policies. If these estimates or assumptions are
incorrect, there could be a material change in our financial condition or
operating results. Many of these "critical accounting policies" are common in
the insurance and financial services industries; others are specific to our
business and operations. Our critical accounting policies include estimates
relating to revenue recognition related to Membership and associate fees,
deferral of Membership and associate related costs, expense recognition related
to commissions to associates, accrual of incentive awards payable and accounting
for legal contingencies.
26
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 96% 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, 2009, 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, 2009, the deferred revenue associated with the
Membership fees was $20.8 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 Financial Accounting Standards Board ("FASB")
Accounting Standards Codification ("ASC") Section 605, Revenue Recognition. At
December 31, 2009, the deferred revenue associated with the Membership
enrollment fees was $4.7 million, of which $2.7 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, 2009, we computed the expected Membership life
to be approximately three years, which is unchanged from year-end 2008. If the
expected Membership life were to change significantly, which we do 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 $87, $72 and $57 for 2009, 2008 and 2007, respectively. Revenue from, and
costs of, the initial sales and marketing supplies (approximately $17) 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, 2009 is estimated to be approximately five months, which is
unchanged from year-end 2008. At December 31, 2009, the deferred revenue
associated with sales associate enrollment fees was $2.3 million, which is
classified as a current liability. We estimate 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 we do not expect in the short term, the deferred revenue and related costs
would be recognized over the new estimated active service period.
Member and Associate Costs
Deferred costs represent the incremental direct and origination costs we
incur in enrolling new Members and new associates related to the deferred
revenue discussed above, and that portion of payments made to provider law firms
($6.8 million deferred at December 31, 2009 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 $4.7
million at December 31, 2009, of which $2.7 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 $916,000
at December 31, 2009, and are classified as a current asset. Such costs are
deferred to the extent of the lesser of actual costs incurred or the amount of
the related fee charged for such services. Deferred costs are amortized to
expense over the same period as the related deferred revenue as discussed above.
Deferred costs that will be recognized within one year of the balance sheet date
are classified as current and all remaining deferred costs are considered
noncurrent. Associate related costs are reflected as associate services and
direct marketing, and are expensed as incurred if not related to the deferred
revenue discussed above. These costs include providing materials and services to
associates, associate introduction kits, associate incentive programs, group
marketing and marketing services departments (including costs of related travel,
marketing events, leadership summits and international sales convention).
27
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 that have historically
demonstrated below average retention characteristics. In addition, 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%, 88% and 82% during 2009, 2008 and 2007,
respectively. The commission cost per new Membership sold has increased over the
prior year by .2%, 8% and 3% for 2009, 2008 and 2007, respectively, and varies
depending on the compensation structure that is in place at the time a new
Membership is sold, the monthly Membership fee of the Membership sold and the
amount of any charge-backs (recoupment of previous commission advances) that are
deducted from amounts that would otherwise be paid to the various sales
associates that are compensated for the Membership sale. Should we add
additional products, such as the Identity Theft Shield described above or add
additional commissions to our compensation plan or reduce the amount of
chargebacks collected from our associates, the commission cost per new
Membership will increase accordingly.
We expense advance commissions ratably over the first month of the related
Membership. At December 31, 2009, advance commissions deferred were $5.7 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
28
our commission advance program. While not recorded as an asset, unearned advance
commission balances from associates for the following years ended December 31
were:
2009 2008 2007
------------ ----------- ------------
(Amounts in 000's)
Beginning unearned advance commission balances (1).................. $ 174,371 $ 184,531 $ 188,647
Advance commissions, net of chargebacks and other................... 132,764 120,908 126,880
Earned commissions applied.......................................... (124,244) (127,496) (126,836)
Advance commission write-offs....................................... (4,228) (3,572) (4,160)
------------ ------------ ------------
Ending unearned advance commission balances before estimated
unrecoverable balances (1).......................................... 178,663 174,371 184,531
Estimated unrecoverable advance commission balances (1)............. (47,192) (44,526) (42,850)
------------ ------------ ------------
Ending unearned advance commission balances, net (1)................ $ 131,471 $ 129,845 $ 141,681
------------ ------------ ------------
(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 $68 million,
$62 million and $56 million at December 31, 2009, 2008 and 2007, respectively.
As such, at December 31, 2009 future commissions and related expense will be
reduced as unearned advance commission balances of $63 million are recovered.
Commissions are earned by the associate as Membership fees are earned by us,
usually on a monthly basis. We reduce unearned advance commission balances or
remit payments to associates, as appropriate, when commissions are earned.
Should a Membership lapse before the advances have been recovered for each
commission level, we, except as described below, generate an immediate
"charge-back" to the applicable sales associate to recapture up to 50% of any
unearned advance on Memberships written prior to March 1, 2002, and 100% on any
Memberships written thereafter. Beginning in August 2003, we allowed the
associate to choose between the level commission structure and up to three-year
commission advance and up to 50% chargebacks or the differential commission
structure with a one-year commission advance and up to 100% chargebacks. This
charge-back is deducted from any future advances that would otherwise be payable
to the associate for additional new Memberships. In order to encourage
additional Membership sales, we waived chargebacks for associates that met
certain criteria in December 2002 and March 2003, which effectively increased
our commission expense. Any remaining unearned advance commission balance may be
recovered by withholding future residual earned commissions due to an active
associate on active Memberships. Additionally, even though a commission advance
may have been fully recovered on a particular Membership, no additional
commission earnings from any Membership are paid to an associate until all
previous advances on all Memberships, both active and lapsed, have been
recovered. We also have reduced chargebacks from 100% to 50% for certain senior
marketing associates who have demonstrated the ability to maintain certain
levels of sales over specified periods and maintain certain Membership retention
levels. We may adjust chargebacks from time to time in the future in order to
encourage certain production incentives.
We have the contractual right to require associates to repay unearned
advance commission balances from sources other than earned commissions including
cash (a) from all associates either (i) upon termination of the associate
relationship, which includes but is not limited to when an associate becomes
non-vested or (ii) when it is ascertained that earned commissions are
insufficient to repay the unearned advance commission payments and (b) upon
demand, from agencies or associates who are parties to the associate agreements
signed between October 1989 and July 1992 or July 1992 to August 1998,
respectively. The sources, other than earned commissions, that may be available
to recover associate unearned advance commission balances are potentially
subject to limitation based on applicable state laws relating to creditors'
rights generally. Historically, we have not demanded repayments of the unearned
advance commission balances from associates, including terminated associates,
because collection efforts would likely increase costs and have the potential to
disrupt our relationships with our sales associates. This business decision by
us has a significant effect on our cash flow by electing to defer collection of
advance payments of which approximately $47.2 million were not expected to be
collected from future commissions at December 31, 2009. 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.
29
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 $372 at December 31, 2009.
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.
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, 2009, the accrued
amount payable was $2.5 million. Changes to any of these assumptions would
directly affect the amount accrued but we do not expect any of the significant
trends affecting this account to change significantly in the near term.
30
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. The FASB ASC
Section 450, 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. 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 believe that we have meritorious defenses in all pending cases and
will vigorously defend against the claims and have not established an accrued
liability for any estimated damages in connection with these various cases.
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. 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 96% 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,
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.
31
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.
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.
32
Memberships Produced Memberships Canceled Active Memberships
-------------------------------- ------------------------------------- -----------------------------------
Assoc Assoc s Assoc
Year Non-Asso Assocs Total % Non-Assocs Assocs Total % Non-Assoc Assocs Total %
----- -------- ------- ------- ----- ---------- -------- --------- ----- --------- -------- --------- -----
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
2009 423,433 144,662 568,095 25.5 (477,395) (102,269) (579,664) 17.7 1,088,184 459,401 1,547,585 29.7
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
10.5% and annual retention is 89.5%. The following table shows as of December
31, 2009 and 2008 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, 2009 As of December 31, 2008
----------------------------------- ---------------------------------
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 49.3% 50.7% 50.7
32.2% 67.8% 34.4 2 32.2% 67.8% 34.4
24.0% 76.0% 26.1 3 23.7% 76.3% 26.2
18.8% 81.2% 21.2 4 18.1% 81.9% 21.5
14.7% 85.3% 18.1 5 15.0% 85.0% 18.3
12.6% 87.4% 15.8 6 12.5% 87.5% 16.0
10.5% 89.5% 14.1 7 8.5% 91.5% 14.6
Membership Persistency
Our Membership persistency rate is a specific computation that measures the
number of Memberships in force at the end of a year as a percentage of the total
of (i) Memberships in force at the beginning of such year, plus (ii) new
Memberships sold during such year. From 1981 through the year ended December 31,
2009, our annual Membership persistency rates, using the foregoing method, have
averaged approximately 72.0%.
Beginning New Ending
Year Memberships Memberships Total Memberships Persistency
----------- ------------ ---------------- --------- ----------- -----------
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%
2009 1,559,154 568,095 2,127,249 1,547,585 72.8%
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.
33
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 2009 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 4.9 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, 2009, based on the historical data described
above, the current expected remaining Membership life of the actual population
is approximately 7 years per Membership. This measure is used by us to estimate
the future revenues expected from Memberships currently in place.
Expected Membership life measures are based on more than 25 years of
historical Membership retention data, unlike the Membership persistency rate
described above which is computed from, and determined by, the most recent
one-year period only. Both or these measures however include data from
Memberships of all Membership ages and hence are referred to as "blended"
measures.
Actions that May Impact Retention in the Future
The potential impact on our future profitability and cash flow due to
future changes in Membership retention can be significant. While blended
retention rates have not changed dramatically over the past five years, we have
implemented several initiatives aimed at improving the retention rate of both
new and existing Memberships. Such initiatives include an optional revised
compensation structure featuring variable renewal commission rates ranging from
five to 25% per annum based on the 12 month Membership retention rate of the
associate's personal sales and those of his organization and implementation of a
"non-taken" administrative fee to sales associates of $35 for any Membership
application that is processed but for which a payment is never received. We have
designed and implemented an enhanced member "life cycle" communication process
aimed at both increasing the overall amount of communication from us to the
members as well as more specific target messaging to members based on the length
of their Membership as well as utilization characteristics.
During 2006, we began providing an additional service focused on Membership
retention, Member Advantage Services, to our associates for a one-time fee of
$5.95 per Membership. This service consists of several out-bound calls, emails
and letters by our employees during the first year of the Membership as well as
out-bound calls to the member any time the Membership moves into pre-cancel
status throughout the life of the Membership. We verify the Membership data in
our files on the very first call and make any necessary changes immediately as
well as fully explain the Membership benefits and answer any questions the
member may have, essentially reselling the Membership. We provide Provider law
firm contact information and make sure the member understands how to contact
their Provider. We encourage our members to immediately begin the process of
having their will prepared and 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, 2009, approximately 659,000
Memberships were part of our Member Advantage Services.
34
Results of Operations
Comparison of 2009 to 2008
Net income for 2009 decreased 8% to $55.1 million from $60.2 million for
2008. Diluted earnings per share for 2009 remained constant at $5.04 per share
due to decreased net income of 8% and an approximate 8% 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 increased 3%
during 2009 to 568,095 from 552,327 during 2008. At December 31, 2009, there
were 1,547,585 active Memberships in force compared to 1,559,154 at December 31,
2008, a decrease of 1%. However, the average annual fee per Membership has
increased from $301 for all Memberships in force at December 31, 2008 to $303
for all Memberships in force at December 31, 2009, a 1% increase, primarily
because of an increase in the percentage of members with our Identity Theft
Shield Membership. These changes resulted in a 2% decrease in Membership fees
for 2009 to $426.4 million from $436.8 million for 2008 marking the first
decline in Membership fees in 17 years.
Associate services revenue increased 20% from $23.5 million for 2008 to
$28.4 million during 2009 primarily because of more associates recruited due to
increased bonuses and incentives. The eService fees totaled $11.0 million during
2009 compared to $12.1 million for 2008, a decrease of 9%. We recognized revenue
from associate fees of approximately $15.9 million during 2009 compared to $9.2
million during 2008, an increase of 73%. New associates typically pay a fee
ranging from $49 to $249, depending on special promotions we implement from time
to time. New enrollments of sales associates increased 52% during 2009 to
186,064 from 122,255 for 2008 and the average associate fee paid during 2009 was
$87 compared to $72 for 2008, an increase of 22% 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 12%, from $4.2 million to $3.7 million primarily
due to the decrease in revenue recognized from Membership enrollment fees.
Primarily because of the decrease in Membership fees, total revenues
decreased to $458.5 million for 2009 from $464.5 million during 2008, a decrease
of 1%.
Membership benefits, which primarily represent payments to provider law
firms and Kroll, totaled $145.1 million for 2009 compared to $150.3 million for
2008 and represented 34% of Membership fees for both years. 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 reductions effective beginning
January 1, 2008, 2009 and 2010.
Commissions to associates increased 3% from $126.8 million for 2008 to
$130.6 million for 2009, and represented 29% and 31% 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 2009 totaled 568,095, a 3% increase from the 552,327
sold during 2008, and the "add-on" IDT Membership sales, which are not included
in these totals, increased 1% to 348,607 for 2009 from 344,869 for 2008. New
Membership fees written during 2009 increased 2% with commissions to associates
increasing 3%.
Associate services and direct marketing expenses increased $8.3 million to
$31.9 million for 2009 from $23.6 million for 2008. We had a $754,000 decrease
in direct marketing and marketing services costs, a $7.6 million increase in
training fees and bonuses, a $123,000 increase in Player's Club costs and a $1.1
million increase in the cost of associate kits. 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
35
expenses include the costs of providing associate services and marketing
expenses as discussed under Member and Associate Costs.
General and administrative expenses during 2009 and 2008 were $51.6 million
and $53.0 million, respectively, and represented 12% of Membership fees for such
years. The $1.4 million decrease in general and administrative expenses was due
to decreases in advertising, telecommunication fees, employee expenses, and
legal fees, partially offset by increases in our bank service charges and
consulting costs during 2009.
Other expenses, net, which includes depreciation and amortization,
litigation accruals, premium taxes and interest expense reduced by interest
income, decreased 36% to $8.6 million for 2009 from $13.4 million for 2008.
Depreciation and amortization decreased to $8.2 million for 2009 from $8.8
million for 2008. Litigation settlements and change in litigation accrual was
($450,000) for 2009 compared to $906,000 during 2008. Premium taxes were $1.8
million for 2009 and 2008. Interest expense decreased to $1.2 million for 2009
compared to $4.2 million for the prior year. Interest income decreased to $2.1
million for 2009 from $2.2 million for 2008.
The provision for income taxes decreased during 2009 to $35.5 million
compared to $37.2 million for 2008, representing 39.2% and 38.2%, respectively,
of income before income taxes. The 2009 and 2008 provisions include state income
taxes of $4.2 million and $3.8 million, respectively, net of federal benefits,
representing 4.7% and 4.0%, respectively, of income before income taxes.
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
because 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 because 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.
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 because 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%.
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.
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
36
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 that 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 settlements and change in litigation accrual 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.
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
37
have generated significant cash flow from operations of approximately $68
million, $64 million and $67 million in 2009, 2008 and 2007, 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. 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.
Because 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 purchase equipment and to
accelerate our treasury stock purchase program.
General
Consolidated net cash provided by operating activities was $67.8 million,
$64.3 million and $67.2 million for 2009, 2008 and 2007, respectively. Net cash
provided by operating activities increased approximately $3.5 million primarily
due to membership activities being unchanged, a $3.2 million reduction in
interest payments due to lower debt levels and lower interest rates, a $4.1
million decrease in income tax payments partially offset by a $2.4 million
decrease in associate activities. Member activities were unchanged with a $8.4
million decrease in cash received from our members due to a lower number of
Memberships in force during the year which was offset by a $5.4 million decrease
in payments to our Membership benefit providers, a $1.9 million decrease in
commission payments to our associates and a $1.4 million decrease in general and
administrative expenses. Associate activities decreased by $2.4 million due to a
$7.3 million increase in associate fees collected due to the increase in new
recruits driven in part by increased bonuses and other incentives offset by a $1
million decrease in eService fees collected and an $8.7 million increase in
associate services cost primarily due to the increase in bonuses and incentive
payments.
Net cash provided by (used in) investing activities was $6.8 million,
$(4.4) million and $30.1 million for 2009, 2008 and 2007, respectively. Capital
expenditures were $3.4 million, $5.3 million and $5.9 million during 2009, 2008
and 2007, respectively. Sales and maturities of available-for-sale investments
exceeded the purchases of such investments by $10.2 million, $843,000 and $35.9
million during 2009, 2008 and 2007.
Net cash used in financing activities was $68.2 million, $58.3 million and
$84.3 million for 2009, 2008 and 2007, respectively. This $9.9 million change
during 2009 was primarily comprised of a $6.0 million increase in purchases of
treasury stock and a $5.0 million decrease in proceeds from issuance of debt.
We had a consolidated working capital deficit of $10.8 million at December
31, 2009, an increase of $8.5 million compared to a consolidated working capital
deficit of $2.3 million at December 31, 2008. The increase was primarily due to
the $9.8 million decrease in available-for-sale investments and the $6.4 million
decrease in cash and cash equivalents partially offset by the $833,000 decrease
in the current portion of notes payable, a $643,000 increase in refundable
income taxes, a $1.8 million increase in deferred revenue and fees and a $2.9
million increase in accounts payable and accrued expenses. The $10.8 million
working capital deficit at December 31, 2009 would have been $1.5 million in
excess working capital excluding the $12.3 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 ($67.8 million during 2009), 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 2009, we paid advance commissions to associates
of $132.8 million on new Membership sales compared to $120.9 million for 2008.
Since approximately 96% 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.
38
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 16
million shares during subsequent board meetings. The most recent authorization
was for 1 million additional shares on November 30, 2009. At December 31, 2009,
we had purchased 15.1 million treasury shares under these authorizations for
$457.9 million, an average price of $30.32 per share, including $50.7 million of
purchases in 2009. Treasury stock purchases will be made at prices that are
considered attractive by management and at such times, that management believes
will not unduly affect our liquidity, however, due to restrictions contained in
our debt agreements with lenders, we are limited in our treasury stock
purchases. At December 31, 2009, we had approximately $1.4 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, 2009 of $56.4 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
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 a rolling 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, 2009. 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
39
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, 2010, none of PPLCI, PPLSIF
or LSPV had funds available for payment of substantial dividends without the
prior approval of the insurance commissioner. At December 31, 2009, the amount
of restricted net assets of consolidated subsidiaries was $25.5 million,
representing amounts that may not be paid to us as dividends either under the
applicable regulations or without regulatory approval.
Contractual Obligations
The following table reflects our contractual obligations as of December 31,
2009.
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.................................... $ 42,251 $ 23,241 $ 14,470 $ 1,912 $ 2,628
Purchase obligations(1)........................... 9,901 3,836 6,065 - -
Deferred compensation plan........................ 9,190 - - - 9,190
Capital leases.................................... 1,131 245 56 62 768
Operating leases.................................. 647 139 222 80 206
Interest payments on outstanding debt(2).......... 782 457 203 81 41
----------- ----------- ---------- ----------- ----------
Total(3).......................................... $ 63,902 $ 27,918 $ 21,016 $ 2,135 $ 12,833
----------- ----------- ---------- ----------- ----------
(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) Interest payments on our long-term debt have been calculated using the
interest rates as of December 31, 2009 applied to the projected loan
balances assuming principal payments according to the terms of each loan
(3) 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. Capital lease
obligation above does not include any interest.
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, 2009 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
40
Our consolidated balance sheets include a certain amount of assets and
liabilities whose fair values are subject to market risk. Due to our significant
investment in fixed-maturity investments, interest rate risk represents the
largest market risk factor affecting our consolidated financial position.
Increases and decreases in prevailing interest rates generally translate into
decreases and increases in fair values of those instruments. Additionally, fair
values of interest rate sensitive instruments may be affected by the
creditworthiness of the issuer, prepayment options, relative values of
alternative investments, liquidity of the instrument and other general market
conditions.
As of December 31, 2009, our investments consisted of the following:
Description Fair Value
--------------------------------------------------------------------- ----------------
Obligations of state and political subdivisions...................... $ 21,992
Certificates of deposit.............................................. 4,911
Corporate obligations................................................ 416
Auction Rate Securities.............................................. 296
U. S. Government obligations......................................... 85
Total investments.................................................... ---------------
$ 27,700
---------------
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, 2009 (1).... $ 22,500 100 bp increase $ 21,406
200 bp increase 20,375
50 bp decrease 23,017
100 bp decrease 23,551
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
(1) Excluding short-term investments in certificates of deposit and auction
rate certificates with a fair value of $5.2 million at December 31, 2009
and short-term investments in certificates of deposit with a fair value of
$6.1 million at December 31, 2008.
The table above illustrates, for example, that an instantaneous 200
basis point increase in market interest rates at December 31, 2009 would
reduce the estimated fair value of our fixed-maturity investments by
approximately $2.1 million at that date. At December 31, 2008, and based on
the fair value of fixed-maturity investments of $31.4 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 $2.9 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, 2009, we had $42.3 million in notes payable outstanding at interest
rates indexed to the 30-day LIBOR rate that exposes us to the risk of increased
41
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 $423,000. As of December 31, 2009, we had not entered into any
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 positive foreign currency translation adjustments of $1.5 million
during 2009 and have a cumulative positive foreign currency translation
adjustment balance of $1.1 million at December 31, 2009. 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..................................................... 43
Management's Annual Report on Internal Control over Financial Reporting...................................... 45
Consolidated Financial Statements
---------------------------------
Consolidated Balance Sheets - December 31, 2009 and 2008..................................................... 46
Consolidated Statements of Income - For the years ended December 31, 2009, 2008 and 2007..................... 47
Consolidated Statements of Cash Flows - For the years ended December 31, 2009, 2008 and 2007................. 48
Consolidated Statements of Changes In Stockholders' Equity and Other Comprehensive Income -
For the years ended December 31, 2009, 2008 and 2007....................................................... 49
Notes to Consolidated Financial Statements................................................................... 50
Financial Statement Schedules
-----------------------------
Schedule I - Condensed Financial Information of the Registrant............................................... 72
(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.)
42
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) and
subsidiaries' internal control over financial reporting as of December 31, 2009,
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. and subsidiaries maintained, in
all material respects, effective internal control over financial reporting as of
December 31, 2009, 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 of
Pre-Paid Legal Services, Inc. and subsidiaries as of December 31, 2009 and 2008,
and the related consolidated statements of income, cash flows and changes in
stockholders' equity and other comprehensive income for each of the three years
in the period ended December 31, 2009 and our report dated February 25, 2010
expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 25, 2010
43
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 (the Company) as of
December 31, 2009 and 2008, and the related consolidated statements of income,
cash flows and changes in stockholders' equity and other comprehensive income
for each of the three years in the period ended December 31, 2009. Our audits of
the basic financial statements included Schedule I as of December 31, 2009 and
2008 and for each of the three years in the period ended December 31, 2009.
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, 2009 and 2008, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2009 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 and
subsidiaries' internal control over financial reporting as of December 31, 2009,
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 25, 2010 expressed an unqualified opinion on the
effectiveness of the Company's internal control over financial reporting.
/s/ GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 25, 2010
44
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, 2009,
based on criteria in Internal Control-Integrated Framework issued by COSO. The
effectiveness of our internal control over financial reporting as of December
31, 2009, 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.
45
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts and shares in 000's, except par values)
ASSETS
December 31,
---------------------------
2009 2008
------------- -------------
Current assets:
Cash and cash equivalents............................................................ $ 32,904 $ 26,528
Available-for-sale investments, at fair value........................................ 2,959 12,812
Membership fees receivable........................................................... 6,286 6,639
Inventories.......................................................................... 1,266 1,285
Refundable income taxes.............................................................. 1,330 687
Deferred member and associate service costs.......................................... 16,074 15,737
Deferred income taxes................................................................ 5,370 5,151
Other assets......................................................................... 6,123 6,200
------------- -------------
Total current assets............................................................. 72,312 75,039
Available-for-sale investments, at fair value.......................................... 20,529 20,637
Investments pledged.................................................................... 4,212 4,039
Property and equipment, net............................................................ 49,100 53,445
Deferred member and associate service costs............................................ 2,065 2,003
Cash value of life insurance policies.................................................. 8,263 6,538
Other assets........................................................................... 1,507 1,142
------------- -------------
Total assets................................................................... $ 157,988 $ 162,843
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits payable.......................................................... $ 11,987 $ 12,013
Deferred revenue and fees............................................................ 28,383 26,556
Current portion of capital leases payable............................................ 245 24
Current portion of notes payable..................................................... 23,241 22,408
Accounts payable and accrued expenses................................................ 19,249 16,327
------------- -------------
Total current liabilities.......................................................... 83,105 77,328
Capital leases payable............................................................... 886 910
Notes payable........................................................................ 19,010 37,251
Deferred revenue and fees............................................................ 2,065 2,003
Deferred income taxes................................................................ 5,405 5,646
Deferred compensation liabilities.................................................... 9,190 7,898
------------- -------------
Total liabilities................................................................ 119,661 131,036
------------- -------------
Stockholders' equity:
Common stock, $.01 par value; 100,000 shares authorized; 14,904 and
16,254 issued at December 31, 2009 and 2008, respectively.......................... 149 163
Retained earnings.................................................................... 135,401 130,832
Accumulated other comprehensive income............................................... 1,805 (160)
Treasury stock, at cost; 4,852 shares held at December 31, 2009
and 2008, respectively............................................................. (99,028) (99,028)
------------- -------------
Total stockholders' equity....................................................... 38,327 31,807
------------- -------------
Total liabilities and stockholders' equity..................................... $ 157,988 $ 162,843
------------- -------------
The accompanying notes are an integral part of these financial statements.
46
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in 000's, except per share amounts)
Year Ended December 31,
------------------------------------------
2009 2008 2007
------------- ------------- ------------
Revenues:
Membership fees...................................................... $ 426,429 $ 436,778 $ 427,428
Associate services................................................... 28,352 23,534 25,112
Other................................................................ 3,696 4,177 4,549
------------- ------------- ------------
458,477 464,489 457,089
------------- ------------- ------------
Costs and expenses:
Membership benefits.................................................. 145,128 150,318 148,792
Commissions.......................................................... 130,601 126,758 130,593
Associate services and direct marketing.............................. 31,921 23,582 28,875
General and administrative........................................... 51,594 53,021 50,474
Other, net........................................................... 8,558 13,413 13,841
------------- ------------- ------------
367,802 367,092 372,575
------------- ------------- ------------
Income before income taxes............................................. 90,675 97,397 84,514
Provision for income taxes............................................. 35,537 37,225 33,312
------------- ------------- ------------
Net income............................................................. $ 55,138 $ 60,172 $ 51,202
------------- ------------- ------------
Basic earnings per common share........................................ $ 5.05 $ 5.05 $ 3.89
------------- ------------- ------------
Diluted earnings per common share...................................... $ 5.04 $ 5.04 $ 3.88
------------- ------------- ------------
Weighted average number of shares:
Basic................................................................ 10,918 11,916 13,151
------------- ------------- ------------
Diluted.............................................................. 10,932 11,934 13,197
------------- ------------- ------------
The accompanying notes are an integral part of these financial statements.
47
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in 000's)
Year Ended December 31,
----------------------------------
2009 2008 2007
---------- ---------- ----------
Cash flows from operating activities:
Net income........................................................... $ 55,138 $ 60,172 $ 51,202
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for deferred income taxes................................ (460) 385 (552)
Depreciation and amortization...................................... 8,187 8,756 8,532
Decrease (increase) in accrued Membership fees receivable.......... 353 (808) (313)
Decrease (increase) in inventories................................. 19 226 (174)
(Increase) decrease in refundable income taxes..................... (643) 1,566 (1,600)
(Increase) decrease in deferred member and associate
service costs.................................................... (399) 1,150 (375)
Increase in other assets........................................... (2,013) (84) (1,062)
(Decrease) increase in Membership benefits payable................. (26) (142) 160
Increase (decrease) in deferred revenue and fees................... 1,889 (1,092) 975
Increase in other non-current liabilities.......................... 1,292 1,354 1,337
(Decrease) increase in income taxes payable........................ - (5,590) 5,590
Increase (decrease) in accounts payable and accrued expenses....... 4,457 (1,576) 3,458
---------- ---------- ----------
Net cash provided by operating activities........................ 67,794 64,317 67,178
---------- ---------- ----------
Cash flows from investing activities:
Additions to property and equipment................................ (3,396) (5,254) (5,858)
Purchases of investments - available-for-sale...................... (15,865) (64,983) (270,435)
Maturities and sales of investments - available-for-sale........... 26,083 65,826 306,357
---------- ---------- ----------
Net cash provided by (used in) investing activities.............. 6,822 (4,411) 30,064
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of debt..................................... 5,000 10,000 9,556
Repayments of debt................................................. (22,408) (24,074) (27,793)
Proceeds from exercise of stock options............................ 108 338 (84)
Tax benefit on exercise of stock options........................... 14 156 790
Purchases of treasury stock........................................ (50,705) (44,717) (66,460)
Repayment of capital lease obligations............................. (249) (22) (341)
---------- ---------- ----------
Net cash used in financing activities............................ (68,240) (58,319) (84,332)
---------- ---------- ----------
Net increase in cash and cash equivalents............................ 6,376 1,587 12,910
Cash and cash equivalents at beginning of year....................... 26,528 24,941 12,031
---------- ---------- ----------
Cash and cash equivalents at end of year............................. $ 32,904 $ 26,528 $ 24,941
---------- ---------- ----------
Supplemental disclosure of cash flow information:
Cash paid for interest............................................. $ 1,232 $ 4,443 $ 6,541
---------- ---------- ----------
Cash paid for income taxes......................................... $ 38,070 $ 42,142 $ 30,937
---------- ---------- ----------
Non-cash activities - capital lease obligation incurred.............. $ 446 $ - $ -
---------- ---------- ----------
The accompanying notes are an integral part of these financial statements.
48
PRE-PAID LEGAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
AND OTHER COMPREHENSIVE INCOME (Amounts and
shares in 000's, except dividend rates and par
values)
Common Stock Treasury Stock
------------------ Retained Accum. ------------------
Shares Amount Earnings OCI(1) Shares Amount Total
--------- -------- ---------- -------- -------- ---------- --------
January 1, 2007............................ 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
Exercise of stock options and other........ 4 - 108 - - - 108
Income tax benefit related to exercise
of stock options........................... - - 14 - - - 14
Net income................................. - - 55,138 - - - 55,138
Other comprehensive income(1).............. - - - 1,965 - - 1,965
Treasury shares purchased.................. - - - - 1,354 (50,705) (50,705)
Treasury shares retired.................... (1,354) (14) (50,691) - (1,354) 50,705 -
--------- -------- ---------- -------- -------- ---------- --------
December 31, 2009.......................... 14,904 $ 149 $ 135,401 $1,805 4,852 $(99,028) $38,327
--------- -------- ---------- -------- -------- ---------- --------
(1) Other Comprehensive Income Year Ended December 31,
----------------------------
2009 2008 2007
-------- -------- --------
Net income.......................................................................... $55,138 $60,172 $51,202
Other comprehensive income, net of tax:
Foreign currency translation adjustment........................................... 1,535 (2,028) 1,206
-------- -------- --------
Unrealized gains (losses) on investments, net of tax:
Unrealized holding gains arising during period.................................. 656 21 182
Less: reclassification adjustment for (gains) losses included in net income... (226) 26 143
-------- -------- --------
430 47 325
-------- -------- --------
Other comprehensive income, net of income taxes of $301, $25 and $207 in 2009,
2008 and 2007, respectively................................................. 1,965 (1,981) 1,531
-------- -------- --------
Comprehensive income.......................................................... $57,103 $58,191 $52,733
-------- -------- --------
The accompanying notes are an integral part of these financial statements.
49
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, 2009, 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, 2009, we had 1,547,585 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. Significant
estimates include our legal contingencies accrual, member and associate revenue
and cost deferrals, income tax accruals and the fair value of our financial
instruments.
Fair Value of Financial Instruments
Our financial instruments consist primarily of cash, certificates of
deposit, short-term investments, debt and equity securities, Membership fees
receivable, Membership benefits payable, notes payable and accounts payable and
accrued expenses. Fair value estimates have been determined by us, using
available market information and appropriate valuation methodologies. Fair
values of actively traded debt securities are based on quoted market prices.
50
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 representative of their respective fair value, due to
the short-term nature of these instruments. The carrying value of notes payable
is considered 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
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 2009, 2008 and 2007 are deferred and recognized in
51
income over the estimated life of a Membership in accordance with FASB ASC
Section 605, Revenue Recognition. We compute the expected Membership life using
more than 25 years of actuarial data. At December 31, 2009, 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 $87, $72 and $57 for 2009, 2008 and 2007, respectively. Revenue
from, and costs of, the initial sales and marketing supplies (approximately $17)
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, 2009 is estimated to be approximately five months, unchanged
from year end 2008. 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 $2.1 million, $1.7 million and $1.9
million in 2009, 2008 and 2007, 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
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
52
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 recognize the tax benefit from an uncertain tax position only if it is
more likely than not the tax position will be sustained on examination by the
taxing authorities, based on the technical merits of the position. The tax
benefits recognized in the financial statements from such positions are then
measured based on the largest benefit that has a greater than 50% likelihood of
being realized upon settlement.
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
2005 - 2009 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
2001 through 2009 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 2005 - 2009 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.
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
53
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 affecting this account to change significantly in the
near term.
Legal Contingencies
Our accounting for legal contingencies 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.
Treasury Stock
We immediately retire all our treasury stock purchases at cost. We retired,
at cost, 1,354,183, 1,053,614 and 1,318,721 shares of common stock during 2009,
2008 and 2007, 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 June 2009, the FASB issued guidance on the FASB Accounting Standards
Codification(TM) ("Codification") and the Hierarchy of Generally Accepted
Accounting Principles. This guidance establishes the Codification as the single
official source of authoritative United States accounting and reporting
standards for all non-governmental entities (other than guidance issued by the
SEC). The Codification changes the referencing and organization on financial
standards and is effective for interim and annual periods ending on or after
September 15, 2009. We have applied the Codification to our disclosures
beginning with our third quarter of fiscal 2009. As Codification is not intended
to change the existing accounting guidance, its adoption did not have an impact
on our financial statements.
In September 2006, the Financial Accounting Standards Board ("FASB") issued
authoritative guidance that defined fair value, established a framework for
measuring fair value, and expanded disclosures about fair value measurements. We
adopted the guidance on January 1, 2008, as required for our financial assets
and financial liabilities. However, the FASB deferred the effective date 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 the guidance for our financial
assets and financial liabilities did not have a material impact on our
consolidated financial statements. The adoption of the guidance for our
nonfinancial assets and nonfinancial liabilities had no impact on our
consolidated financial statements.
In February 2007, the FASB issued guidance on the fair value option for
financial assets and financial liabilities. This guidance 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. The
guidance also established presentation and disclosure requirements designed to
facilitate comparisons between entities that choose different measurement
attributes for similar types of assets and liabilities. This guidance 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. We did not elect the fair value option for eligible
54
items that existed as of January 1, 2008. As such, the adoption of this guidance
did not have any impact on our consolidated financial position, results of
operations or cash flows.
In December 2007, the FASB issued guidance on noncontrolling interests in
consolidated financial statements which 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. The guidance also establishes disclosure requirements that
clearly identify and distinguish between the interests of the parent and the
interests of the noncontrolling owners. This guidance is effective for us
beginning January 1, 2009 and the adoption of this guidance had no impact on our
consolidated financial position, results of operations or cash flows.
In October 2008, the FASB issued guidance on determining the fair value of
a financial asset when the market for that asset is not active which clarified
how to determine the fair value of a financial asset when the market for that
financial asset is inactive. This guidance was effective upon issuance,
including prior periods for which financial statements had not been issued. The
implementation of this guidance did not have an impact on our consolidated
financial position, results of operations or cash flows.
In January 2009, the FASB 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. This
guidance was effective for us prospectively beginning October 1, 2008. We
considered this additional guidance when classifying respective additional
impairments as "temporary" or "other-than-temporary" beginning with the fourth
quarter of 2008. This guidance had no impact on such classifications on our
consolidated financial position, results of operations or cash flows.
On April 9, 2009, the FASB issued guidance on the interim disclosures about
fair value of financial instruments to require disclosures about fair value of
financial instruments in interim financial statements as well as in annual
financial statements. The guidance required those disclosures in all interim
financial statements. This guidance is effective for interim periods ending
after June 15, 2009 and we adopted them in second quarter 2009.
In August 2009, the FASB further updated the fair value measurement
guidance to clarify how an entity should measure liabilities at fair value. The
update reaffirms fair value is based on an orderly transaction between market
participants, even though liabilities are infrequently transferred due to
contractual or other legal restrictions. However, identical liabilities traded
in the active market should be used when available. When quoted prices are not
available, the quoted price of the identical liability traded as an asset,
quoted prices for similar liabilities or similar liabilities traded as an asset,
or another valuation approach should be used. This update also clarifies that
restrictions preventing the transfer of a liability should not be considered as
a separate input or adjustment in the measurement of fair value. We adopted the
provisions of this update for fair value measurements of liabilities effective
October 1, 2009, which did not have a material impact on our consolidated
financial statements.
55
Note 2 - Investments
A summary of the amortized cost, unrealized gains and losses and fair
values of our investments at December 31, 2009 and 2008 follows:
December 31, 2009
---------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale and pledged investments Cost Gains Losses Value
------------------------------------------ ------------ ---------- --------- --------------
U.S. Government obligations................... $ 85 $ - $ - $ 85
Corporate obligations......................... 344 72 - 416
Obligations of state and political subdivisions 20,895 1,101 (4) 21,992
Auction Rate Certificates..................... 325 - (29) 296
Certificates of deposit....................... 4,911 - - 4,911
------------ ---------- --------- --------------
Total......................................... $ 26,560 $ 1,173 $ (33) $ 27,700
------------ ---------- --------- --------------
December 31, 2008
----------------------------------------------------
Amortized Gross Unrealized Fair
Available-for-Sale and pledged investments 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
------------ ---------- --------- --------------
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, 2009, we had two
out of 263 securities (primarily municipal securities) with unrealized losses in
four consecutive quarters with combined market losses of $1,400. 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, 2009 by maturity date
follows:
Amortized
Cost Fair Value
------------ -------------
One year or less................................... $ 5,236 $ 5,238
Two years through five years....................... 5,216 5,555
Six years through ten years........................ 10,989 11,585
More than ten years................................ 5,119 5,322
------------ -------------
Total.............................................. $ 26,560 $ 27,700
------------ -------------
Our investment securities are included in the accompanying consolidated
balance sheets at December 31, 2009 and 2008 as follows:
December 31,
---------------------------
2009 2008
------------ -------------
Available-for-sale investments (current)........... $ 2,959 $ 12,812
Available-for-sale investments (non-current)....... 20,529 20,637
Investments pledged................................ 4,212 4,039
------------ -------------
Total.............................................. $ 27,700 $ 37,488
------------ -------------
56
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,
---------------------------
2009 2008
------------ -------------
Certificates of deposit............................ $ 2,055 $ 1,917
Obligations of state and political subdivisions.... 2,072 1,889
U. S. Government obligations....................... 85 233
------------ -------------
Total.............................................. $ 4,212 $ 4,039
------------ -------------
Proceeds from sales of investments during 2009, 2008 and 2007 were $25.7
million, $14.4 million and $14.2 million, respectively, and resulted in gross
realized gains of $425,000, $109,000 and $248,000 and gross realized losses of
$54,000, $72,000 and $13,000, respectively.
Note 3 - Property and Equipment
Property and equipment is comprised of the following:
December 31,
Estimated ---------------------------
Useful Life 2009 2008
----------- ------------ -------------
Equipment, furniture and fixtures.......... 3-10 years $ 47,719 $ 44,967
Computer software.......................... 3 years 17,621 16,660
Buildings.................................. 20-40 years 39,450 39,420
Automotive and aviation equipment.......... 3-10 years 14,142 14,152
Land....................................... N/A 445 445
------------ -------------
119,377 115,644
Accumulated depreciation.............................. (70,277) (62,199)
------------ -------------
Property and equipment, net........................... $ 49,100 $ 53,445
------------ -------------
As of December 31, 2009 and 2008, capitalized interest of $706,000 was
included in the cost of the building. No interest was capitalized during 2009,
2008 or 2007.
Note 4 - Other Assets, Current
Other Assets, current, are comprised of the following:
December 31,
-------------------------
2009 2008
----------- -----------
Prepaid Canadian income taxes...................... $ 3,089 $ 3,161
Other prepaid expenses, current portion............ 1,976 1,969
Accrued interest receivable........................ 363 489
Other.............................................. 695 581
----------- -----------
Total.............................................. $ 6,123 $ 6,200
----------- -----------
57
Note 5 - Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses are comprised of the following:
December 31,
-------------------------
2009 2008
----------- -----------
Accounts payable................................... $ 3,550 $ 4,003
Commissions........................................ 3,880 -
Marketing bonuses payable.......................... 3,518 3,399
Incentive awards payable........................... 2,476 3,080
Litigation accrual................................. - 500
Other.............................................. 5,825 5,345
----------- -----------
Total.............................................. $ 19,249 $ 16,327
----------- -----------
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,
2009, we had fully used the Revolving Facility. 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.
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, 2009 was
1.74%. 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 0.43 to 1 at December 31, 2009. 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; At December 31, 2009, we had approximately
$1.4 million of availability pursuant to this limitation.
* a prohibition on prepayment of other debt;
* a requirement to maintain consolidated EBITDA (Earnings before
Interest, Taxes, Depreciation and Amortization) for a rolling 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;
58
* 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, 2009.
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, 2009 was 1.74% 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, 2009 was 1.13% 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
points. This loan was repaid in its entirety pursuant to its terms.
A schedule of outstanding balances as of December 31, 2009 is as follows:
Senior loan................................ $ 28,750
Real estate loan........................... 6,095
Aircraft loan.............................. 7,406
---------
Total notes payable........................ 42,251
Less: Current portion of notes payable..... (23,241)
---------
Long term portion.......................... $ 19,010
---------
A schedule of future maturities as of December 31, 2009 is as follows:
Repayment Schedule commencing
January 2010:
Year 1..................................... $ 23,241
Year 2..................................... 13,514
Year 3..................................... 956
Year 4..................................... 956
Year 5..................................... 956
Thereafter................................. 2,628
---------
Total notes payable........................ $ 42,251
---------
Note 7 - Income Taxes
The provision for income taxes consists of the following:
Year Ended December 31,
----------------------------------
2009 2008 2007
---------- --------- ----------
Current.................................... $ 35,997 $ 36,840 $ 33,864
Deferred................................... (460) 385 (552)
---------- --------- ----------
Total provision for income taxes........... $ 35,537 $ 37,225 $ 33,312
---------- --------- ----------
59
A reconciliation of the statutory Federal income tax rate to the effective
income tax rate is as follows:
Year Ended December 31,
--------------------------------
2009 2008 2007
--------- --------- ----------
Statutory Federal income tax rate.......... 35.0% 35.0% 35.0%
Tax exempt interest........................ (.5) (.6) (1.0)
Wage tax credits........................... (.3) (.3) (.4)
Prior years, state income taxes, net....... - - 2.4
State income tax expense, net.............. 4.7 4.0 3.8
Other...................................... .3 .1 (.4)
--------- --------- ----------
Effective income tax rate.................. 39.2% 38.2% 39.4%
--------- --------- ----------
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.
Deferred tax liabilities and assets at December 31, 2009 and 2008 are
comprised of the following:
December 31,
-----------------------
2009 2008
--------- ----------
Deferred tax liabilities relating to:
Deferred member and associate service costs... $ 7,074 $ 6,919
Property and equipment........................ 8,710 8,693
Unrealized investment gains................... 457 159
--------- ----------
Total deferred tax liabilities................ 16,241 15,771
--------- ----------
Deferred tax assets relating to:
Expenses not yet deducted for tax purposes.... 4,318 4,028
Deferred revenue and fees..................... 11,875 11,138
Other......................................... 13 110
--------- ----------
Total deferred tax assets..................... 16,206 15,276
--------- ----------
Net deferred tax liability.................... $ (35) $ (495)
--------- ----------
Our deferred tax assets and liabilities are included in the accompanying
consolidated balance sheets at December 31, 2009 and 2008 as follows.
December 31,
-----------------------
2009 2008
--------- ----------
Deferred income taxes (current asset).............. $ 5,370 $ 5,151
Deferred income taxes (non-current liability)...... (5,405) (5,646)
--------- ----------
Net deferred tax liability......................... $ (35) $ (495)
--------- ----------
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 16
million shares during subsequent board meetings. At December 31, 2009, we had
purchased 15.1 million treasury shares under these authorizations for a total
consideration of $457.9 million, an average price of $30.32 per share. We
60
purchased and formally retired 1,354,183 shares of our common stock during 2009
for $50.7 million, or an average price of $37.44 per share, reducing our common
stock by $13,541 and our retained earnings by $50.7 million. At December 31,
2009 and 2008, we had 10.1 million and 11.4 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 affect our
liquidity.
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 2009, PPLCI declared and, after obtaining
all necessary regulatory approvals, paid extraordinary dividends to us of $6.7
million compared to the $14.9 million dividend paid to us during 2008. During
2009, LSPV paid us an ordinary dividend of $1.8 million compared to $4.1 million
during 2008. At December 31, 2009, the amount of restricted net assets of
consolidated subsidiaries was $25.5 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,
-----------------------------------
2009 2008 2007
----------- ----------- -----------
Depreciation and amortization.......................... $ 8,187 $ 8,756 $ 8,532
Premium taxes.......................................... 1,765 1,776 1,956
Interest expense....................................... 1,173 4,221 6,678
Litigation settlements and change in litigation accrual (450) 906 15
Interest income........................................ (2,117) (2,246) (3,340)
----------- ----------- -----------
Total Other expenses, net.............................. $ 8,558 $ 13,413 $ 13,841
----------- ----------- -----------
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
and Other Comprehensive Income under the caption "Accumulated OCI." As of
December 31, accumulated other comprehensive income, as reflected in the
Consolidated Statements of Changes in Stockholders' Equity, was comprised of the
following:
2009 2008
----------- -----------
Foreign currency translation adjustments............................. $ 1,110 $ (425)
Unrealized losses on investments, net of income taxes
of $443 and $159................................................... 695 265
----------- -----------
Accumulated other comprehensive income (loss)........................ $ 1,805 $ (160)
----------- -----------
61
Note 11 - Related Party Transactions
As part of the share repurchase program described previously, we may from
time to time make such purchases from related parties. The table below reflects
all such transactions during 2009, 2008 and 2007:
Transaction No. of Transaction Acquired
Date shares Price Amount Basis of Price From Relationship
------------- --------- ------- ----------- ------------------ ---------------- --------------------------
3/16/2007 825 $ 53.45 $ 44,096 Prior day close Steve Williamson Chief Financial Officer
4/25/2007 33,469 59.70 1,998,099 Lower of close or Randy Harp Chief Operating Officer
Volume-Weighted
Average Price
4/25/2007 100,000 59.70 5,970,000 Lower of close or Harland Chief Executive Officer
Volume-Weighted Stonecipher
Average Price
7/5/2007 900 66.91 60,219 Prior day close John Hail Director
8/2/2007 500 52.26 26,130 Prior day close TVC Inc. Director John Hail controlled
entity
8/25/2008 6,500 44.39 288,535 Prior day close Randy Harp Chief Operating Officer
8/25/2008 2,000 44.39 88,780 Prior day close Steve Williamson Chief Financial Officer
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
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 12 - Leases
At December 31, 2009, we were committed under noncancelable operating and
capital leases, principally for buildings and equipment. Aggregate rental
expense under all operating leases was $133,000, $122,000 and $111,000 in 2009,
2008 and 2007, respectively.
Future commitments commencing January 2010 related to noncancelable
operating leases are as follows:
Year Ended December 31,
2010............................................... $ 139
2011............................................... 138
2012............................................... 84
2013............................................... 53
2014............................................... 27
Thereafter......................................... 206
-----------
Total operating lease commitments.................. $ 647
-----------
Future minimum lease payments commencing in January 2010 related to capital
leases are as follows:
Year Ended December 31,
2010............................................... $ 308
2011............................................... 81
2012............................................... 81
2013............................................... 81
2014............................................... 81
Thereafter......................................... 1,244
-----------
Total minimum lease payments....................... 1,876
Less: Imputed interest............................. (745)
-----------
Present value of net minimum lease payments........ 1,131
Less: Current portion.............................. (245)
-----------
Noncurrent portion of capital leases payable....... $ 886
-----------
62
We have entered into capital leases to acquire equipment and buildings that
expire at various dates through 2033. The capital lease assets are included in
property and equipment as follows at December 31, 2009 and December 31, 2008.
December 31,
-------------------------
2009 2008
------------ -----------
Equipment, furniture and fixtures.................. $ 1,175 $ 729
Buildings and improvements......................... 314 314
------------ -----------
1,489 1,043
Less: accumulated amortization..................... (340) (225)
------------ -----------
Net capital lease assets........................... $ 1,149 $ 818
------------ -----------
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 and fraud. On May 15, 2006, the trial
court dismissed plaintiff's complaint in its entirety. Plaintiff amended the
complaint to allege fraud and breach of fiduciary duty on June 12, 2006 and
filed a notice of appeal on June 13, 2006. 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. On June 24, 2009, the trial court granted
our motion for summary judgment and dismissed plaintiff's action against us in
its entirety. Plaintiff appealed the summary judgment, oral arguments have been
held, and we are awaiting the ruling of the appellate court. The ultimate
outcome of this matter is not determinable.
On March 23, 2007, we received a Civil Investigative Demand ("CID") from
the Federal Trade Commission ("FTC") requesting information relating to our
Identity Theft Shield and Affirmative Defense Response System ("ADRS") Program.
On April 20, 2009, we received a letter from the FTC alleging misrepresentations
in sales materials used in our Identity Theft Shield and ADRS program such that
we made false and misleading claims about the effectiveness of ADRS for helping
organizations comply with government data security requirements. Revisions to
the marketing materials originally provided to the FTC have been made subsequent
to the initial communication with the FTC. We attempted to resolve this matter
with the FTC between May 2009 and November 2009; however on November 18, 2009,
the FTC forwarded a staff recommendation to the Commission with a proposed
complaint seeing injunctive relief and disgorgement of funds received for sales
of the identity theft shield and legal plan products at ADRS presentations. We
met with the FTC on February 3, 2010 to explain our disagreement with the FTC
and to reach a mutually agreeable solution. The FTC could decide to commence
administrative or federal court proceedings for purposes of determining whether
there has been a violation and might seek a variety of remedies, including
injunctive relief. The ultimate outcome of the matter is not determinable but we
will vigorously defend our interests in this matter.
On October 5, 2009, we received a subpoena from the Division of Enforcement
of the Securities and Exchange Commission ("SEC"). The subpoena requires us to
produce a variety of documents pertaining to our treasury stock repurchase
program; our ADRS program and other marketing practices; membership statistical
information; segment reporting; the FTC contingency disclosure; and other
operational practices. This investigation is a fact-finding inquiry and does not
mean that the SEC has reached any conclusions. We are cooperating with the staff
of the SEC and providing the requested information and expect to continue to do
so. We are not able to predict what the outcome of this inquiry may be or when
it will be resolved.
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
63
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 believe that we have meritorious defenses in all pending cases and
will vigorously defend against the claims and have not established an accrued
liability for any estimated damages in connection with these various cases.
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 that aggregate $5.7 million. During 2007, we reached a settlement
with Canadian taxing authorities regarding the general and administrative
deductions that 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
and U.S. tax returns have been amended to reflect the changes in our general and
administrative expense and credits/refunds for the associated taxes, penalty and
interest. 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 and 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. In addition, 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. 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. During the 3rd quarter 2009, the Canadian
taxing authorities indicated they are amenable to a settlement regarding the
commission issue. We have paid all the assessed tax, penalty and interest
relating to the commission issue and at December 31, 2009 have $3 million
recorded in Other Assets, Current which represents the amount of previously paid
tax, penalty and interest for tax years 1999 through 2002 we expect to
ultimately receive. It is possible that an adverse outcome could have an adverse
effect upon our financial condition, operating results or cash flows in
particular quarterly or annual periods.
Note 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
64
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 2009, 2008 or 2007.
A summary of the status of our total stock option activity as of December
31, 2009, 2008 and 2007, and for the years ended on those dates is presented
below:
2009 2008 2007
------------------------ ------------------------ ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------- ----------- ----------- ----------- ------------ -----------
Outstanding at beginning of year....... 42,500 $ 19.70 58,500 $ 20.08 273,040 $ 23.26
Granted................................ - - - - - -
Exercised.............................. (4,500) 23.93 (16,000) 21.09 (208,943) 24.17
Terminated............................. - - - - (5,597) 22.87
----------- ----------- ----------- ----------- ------------ -----------
Outstanding at end of year............. 38,000 $ 19.20 42,500 $ 19.70 58,500 $ 20.08
----------- ----------- ----------- ----------- ------------ -----------
Options exercisable at year end........ 38,000 $ 19.20 42,500 $ 19.70 58,500 $ 20.08
----------- ----------- ----------- ----------- ------------ -----------
Aggregate intrinsic value of
outstanding options.................... $ 831 $ 748 $ 2,063
----------- ----------- -----------
Intrinsic value of options exercised... $ 40 $ 398 $ 6,821
----------- ----------- -----------
Fair value of options vested during
period................................. $ - $ - $ -
----------- ----------- -----------
Weighted average grant date fair
value per share........................ N/A N/A N/A
----------- ----------- -----------
The following table summarizes information about stock options outstanding
and exercisable at December 31, 2009:
Weighted Average
Remaining Weighted Average
Exercise Price Number Outstanding Contractual Life Exercise Price
-------------- ------------------ ----------------- -----------------
$19.20 38,000 1.16 $19.20
-------------- ------------------ ----------------- -----------------
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 $512,000, $544,000 and $486,000 for 2009, 2008 and
2007 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
65
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, 2009 and 2008, we had an aggregate deferred
compensation liability of $9.2 million and $7.9 million, respectively, which is
included in other non-current liabilities. At December 31, 2009 and 2008, the
cash value of the underlying insurance policies owned by us was $8.3 million and
$6.5 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: 2009 2008 2007
--------- --------- ---------
Earnings:
Income........................................................................ $ 55,138 $ 60,172 $ 51,202
--------- --------- ---------
Shares:
Weighted average shares outstanding........................................... 10,918 11,916 13,151
--------- --------- ---------
Diluted Earnings Per Share:
Earnings:
Income........................................................................ $ 55,138 $ 60,172 $ 51,202
--------- --------- ---------
Shares:
Weighted average shares outstanding........................................... 10,918 11,916 13,151
Assumed exercise of options................................................... 14 18 46
--------- --------- ---------
Weighted average number of shares, as adjusted................................ 10,932 11,934 13,197
--------- --------- ---------
Options to purchase shares of common stock are excluded from the
calculation of diluted earnings per share when their inclusion would have an
anti-dilutive effect on the calculation. No options were excluded from the
diluted earnings per share calculation for the years ended December 31, 2009,
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, 2009 and 2008.
Selected Quarterly Financial Data(1)
(In thousands, except per share amounts)
2009 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
------------------------------------------------------------ ----------- ----------- ----------- -----------
Revenues.................................................... $ 113,120 $ 112,393 $ 113,947 $ 119,017
Net income.................................................. 17,101 15,791 10,831 11,415
Basic income per common share - Net Income.................. $ 1.53 $ 1.44 $ .99 $ 1.08
Diluted income per common share - Net Income................ $ 1.52 $ 1.44 $ .99 $ 1.08
2008
------------------------------------------------------------
Revenues.................................................... $ 116,203 $ 116,855 $ 116,523 $ 114,908
Net income.................................................. 15,942 15,056 14,442 14,732
Basic income per common share - Net Income.................. $ 1.29 $ 1.25 $ 1.23 $ 1.28
Diluted income per common share - Net Income................ $ 1.29 $ 1.25 $ 1.23 $ 1.27
(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.
66
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 2009, 2008 and 2007 were $8.7 million,
$8.7 million and $7.9 million, respectively. We have no significant long-lived
assets located in Canada.
Note 18 - Fair Value Measurement
On January 1, 2008, we adopted FASB ASC 820, Fair Value Measurements and
Disclosures, which defines fair value, establishes a framework for using fair
value to measure assets and liabilities, and expands disclosures about fair
value measurements. The Statement applies whenever other statements require or
permit assets or liabilities to be measured at fair value. ASC 820 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 obligations of state and
political subdivisions, government guaranteed bank debt, auction rate
certificates and corporate obligations.
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 ASC 820 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, 2009 and
2008 by level within the fair value hierarchy:
December 31,
Available for Sale Investments --------------------------
Fair Value Measurements Using: 2009 2008
----------- ------------
Level 1 inputs.............................. $ - $ -
Level 2 inputs.............................. 27,700 37,488
Level 3 inputs.............................. - -
----------- ------------
Total....................................... $ 27,700 $ 37,488
----------- ------------
For securities without a readily ascertainable market value (Level 2), we
utilize pricing services and broker quotes. Our pricing service's evaluations
are based on market data. Our pricing service utilizes evaluated pricing models
that vary by asset class and incorporate available trade, bid and other market
information. Because many fixed income securities do not trade on a daily basis,
our pricing service's evaluated pricing applications apply available information
67
as applicable through processes such as benchmark curves, benchmarking of like
securities, sector groupings, and matrix pricing, to prepare evaluations. 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.
Our financial instruments consist primarily of cash, certificates of
deposit, short-term investments, debt and equity securities, Membership fees
receivable, Membership benefits payable, notes payable and accounts payable and
accrued expenses. Fair value estimates have been determined by us, using
available market information and appropriate valuation methodologies. 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 above.
68
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
------------------------------------------------------------------------
FINANCIAL DISCLOSURE.
---------------------
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES.
---------------------------------
Controls and Procedures
Our principal executive officer (Chairman, Chief Executive Officer and
President) and principal financial officer (Chief Financial Officer) have
evaluated our disclosure controls and procedures as of December 31, 2009, 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.
Management's Annual Report on Internal Control over Financial Reporting
The report of management required under this Item 9A is contained in Item 8
of Part II of this Annual Report on Form 10-K under the heading "Management's
Annual Report on Internal Control over Financial Reporting."
Attestation Report of Independent Registered Public Accounting Firm
The attestation report required under this Item 9A is contained in Item 8
of Part II of this Annual Report on Form 10-K under the heading "Report of
Independent Registered Public Accounting Firm on Internal Control over Financial
Reporting."
Changes in Internal Control Over Financial Reporting
During the fourth quarter of 2009, 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.
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.
69
PART III
In accordance with the provisions of General Instruction G (3), information
required by Items 10 through 14 of Form 10-K are incorporated herein by
reference to our Proxy Statement for the Annual Meeting of Shareholders to be
filed prior to April 30, 2010.
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 42 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.
70
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PRE-PAID LEGAL SERVICES, INC.
Date: February 24, 2010 By: /s/ Randy Harp
-----------------------------------------------
Randy Harp
Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Position Date
---- -------- ----
/s/ Harland C. Stonecipher Chairman of the Board of Directors February 24, 2010
---------------------------------------------------- (Principal Executive Officer)
Harland C. Stonecipher
/s/ Randy Harp Chief Operating Officer February 24, 2010
----------------------------------------------------
Randy Harp
/s/ Steve Williamson Chief Financial Officer February 24, 2010
---------------------------------------------------- (Principal Financial and
Steve Williamson Accounting Officer)
/s/ Orland G. Aldridge Director February 24, 2010
----------------------------------------------------
Orland G. Aldridge
/s/ Martin H. Belsky Director February 24, 2010
----------------------------------------------------
Martin H. Belsky
/s/ Peter K. Grunebaum Director February 24, 2010
----------------------------------------------------
Peter K. Grunebaum
/s/ John W. Hail Director February 24, 2010
----------------------------------------------------
John W. Hail
/s/ Duke R. Ligon Director February 24, 2010
----------------------------------------------------
Duke R. Ligon
/s/ Thomas W. Smith Director February 24, 2010
----------------------------------------------------
Thomas W. Smith
71
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,
-----------------------
2009 2008
---------- ----------
Current assets:
Cash and cash equivalents............................................................ $ 23,365 $ 19,434
Available-for-sale investments, at fair value........................................ - 11,789
Membership fees receivable........................................................... 4,936 5,149
Inventories.......................................................................... 1,266 1,285
Refundable income taxes.............................................................. 1,330 687
Deferred member and associate service costs.......................................... 14,742 14,348
Other assets......................................................................... 2,718 2,744
---------- ----------
Total current assets............................................................. 48,357 55,436
Available-for-sale investments, at fair value.......................................... 324 684
Investments pledged.................................................................... 345 307
Property and equipment, net............................................................ 48,532 52,844
Investments in and amounts due to/from subsidiaries, net............................... 52,394 47,946
Deferred member and associate service costs............................................ 1,894 1,826
Other assets........................................................................... 9,735 8,213
---------- ----------
Total assets................................................................... $ 161,581 $ 167,256
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Membership benefits payable.......................................................... $ 11,549 $ 11,640
Deferred revenue and fees............................................................ 24,065 22,146
Current portion of capital leases payable............................................ 245 24
Current portion of notes payable..................................................... 23,241 22,408
Accounts payable and accrued expenses................................................ 17,922 14,526
---------- ----------
Total current liabilities.......................................................... 77,022 70,744
Capital leases payable............................................................... 886 910
Notes payable........................................................................ 19,010 37,251
Deferred revenue and fees............................................................ 1,751 1,670
Deferred income taxes................................................................ 15,395 16,976
Other non-current liabilities........................................................ 9,190 7,898
---------- ----------
Total liabilities................................................................ 123,254 135,449
---------- ----------
Stockholders' equity:
Common stock......................................................................... 149 163
Retained earnings.................................................................... 135,401 130,832
Accumulated other comprehensive income............................................... 1,805 (160)
Treasury stock, at cost.............................................................. (99,028) (99,028)
---------- ----------
Total stockholders' equity....................................................... 38,327 31,807
---------- ----------
Total liabilities and stockholders' equity..................................... $ 161,581 $ 167,256
---------- ----------
72
PRE-PAID LEGAL SERVICES, INC. (Parent Company)
CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
STATEMENTS OF INCOME
(Amounts in 000's)
Year Ended December 31,
-----------------------------------------
2009 2008 2007
------------ ------------ ------------
Revenues:
Membership fees...................................................... $ 327,826 $ 332,772 $ 323,254
Associate services................................................... 27,773 23,266 24,888
Other................................................................ 2,853 3,276 3,474
------------ ------------ ------------
358,452 359,314 351,616
------------ ------------ ------------
Costs and expenses:
Membership benefits.................................................. 111,367 114,624 113,045
Commissions.......................................................... 104,870 98,857 101,700
Associate services and direct marketing.............................. 31,717 23,484 28,875
General and administrative........................................... 33,208 33,236 39,770
Other, net........................................................... 7,851 12,427 13,402
------------ ------------ ------------
289,013 282,628 296,792
------------ ------------ ------------
Income before income taxes and equity in net income of subsidiaries.... 69,439 76,686 54,824
Provision for income taxes............................................. 27,663 29,049 17,373
------------ ------------ ------------
Income before equity in net income of subsidiaries..................... 41,776 47,637 37,451
Equity in net income of subsidiaries................................... 13,362 12,535 13,751
------------ ------------ ------------
Net income............................................................. $ 55,138 $ 60,172 $ 51,202
------------ ------------ ------------
73
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,
-----------------------------------------
2009 2008 2007
------------ ------------ ------------
Net cash provided by operating activities.............................. $ 63,026 $ 71,600 $ 64,494
------------ ------------ ------------
Cash flows from investing activities:
Additions to property and equipment.................................. (3,396) (5,170) (5,817)
Purchases of investments - available-for-sale........................ (101) (61,774) (220,355)
Maturities and sales of investments - available-for-sale............. 12,642 53,387 256,475
------------ ------------ ------------
Net cash (used in) provided by investing activities................ 9,145 (13,557) 30,303
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from exercise of stock options.............................. 108 338 (84)
Tax benefit on exercise of stock options............................. 14 156 790
Decrease in capital lease obligations................................ (249) (22) (341)
Purchases of treasury stock.......................................... (50,705) (44,717) (66,460)
Proceeds from issuance of debt....................................... 5,000 10,000 9,556
Repayments of debt................................................... (22,408) (24,074) (27,793)
------------ ------------ ------------
Net cash used in financing activities.............................. (68,240) (58,319) (84,332)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents................... 3,931 (276) 10,465
Cash and cash equivalents at beginning of year......................... 19,434 19,710 9,245
------------ ------------ ------------
Cash and cash equivalents at end of year............................... $ 23,365 $ 19,434 $ 19,710
------------ ------------ ------------
Supplemental disclosure of cash flow information:
Cash paid for interest............................................... $ 1,172 $ 4,074 $ 6,536
------------ ------------ ------------
Cash paid for income taxes........................................... $ 29,940 $ 35,029 $ 30,588
------------ ------------ ------------
Non-cash activities - capital lease obligation incurred.............. $ 446 $ - $ -
------------ ------------ ------------
74
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 2009, PPLCI declared and, after obtaining all
necessary regulatory approvals, paid extraordinary dividends to us of $6.7
million compared to the $14.9 million and $7.4 million dividends paid to us
during 2008 and 2007, respectively. During 2009, LSPV paid us an ordinary
dividend of $1.8 million compared to $4.1 million during 2008 and $1.6 million
during 2007.
75
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)
76
INDEX TO EXHIBITS
Exhibit No. Description
----------- -----------
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)
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
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
--------------------
* Constitutes a management contract or compensatory plan or arrangement required
to be filed as an exhibit to this report.
77