UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2002
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____________ to ____________
Commission File Number: 1-9293
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PRE-PAID LEGAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1016728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
321 East Main
Ada, Oklahoma 74820
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (580) 436-1234
Securities registered pursuant to Section 12(b) of the Exchange Act:
Name of each exchange on
Title of each class which registered
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Common Stock, $0.01 Par Value New York Stock Exchange
Securities registered under Section 12 (g) of the Exchange Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K ( ).
State the aggregate market value of the voting stock held by non-affiliates
of the registrant. The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked prices of
such stock, as of a specified date within the past 60 days prior to the date of
the filing: As of March 7, 2003 - $203,210,000.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act) Yes |X| No [ ]
State the aggregate market value of the voting and non-voting common equity
held by non-affiliates computed by reference to the price at which the common
equity was last sold, or the average bid and asked prices of such common equity,
as of the last business day of the registrant's most recently completed second
fiscal quarter. As of June 30, 2002---$285,577,000
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: As of March 7, 2003
there were 17,866,510 shares of Common Stock, par value $.01 per share,
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the Company's definitive proxy statement for its 2003 annual
meeting of shareholders are incorporated into Part III of this Form 10-K by
reference.
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
For the year ended December 31, 2002
TABLE OF CONTENTS
PART I.
ITEM 1. DESCRIPTION OF BUSINESS
General
Industry Overview
Description of Memberships
Specialty Legal Service Plans
Provider Law Firms
Marketing
Operations
Quality Control
Competition
Regulation
Employees
Foreign Operations
Availability of Information
ITEM 2. DESCRIPTION OF PROPERTY
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Market Price of and Dividends on the Common Stock
Recent Sales of Unregistered Securities
Equity Compensation Plans
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
Measures of Member retention
Results of Operations:
Comparison of 2002 to 2001
Comparison of 2001 to 2000
Liquidity and Capital Resources
Forward-Looking Statements
Risk Factors
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
PART III. **
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PART IV.
ITEM 14. CONTROLS AND PROCEDURES
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K
SIGNATURES
** Information required by Part III is incorporated by reference from the
Company's definitive proxy statement for its 2003 annual meeting of
shareholders.
PRE-PAID LEGAL SERVICES, INC.
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2002
PART I.
ITEM 1. DESCRIPTION OF BUSINESS
General
Pre-Paid Legal Services, Inc. (the "Company") was one of the first
companies in the United States organized solely to design, underwrite and market
legal expense plans. The Company's predecessor commenced business in 1972 and
began offering legal expense reimbursement services as a "motor service club"
under Oklahoma law. In 1976, the Company was formed and acquired its predecessor
in a stock exchange. The Company began offering Memberships independent of the
motor service club product by adding a legal consultation and advice service,
and in 1979 the Company implemented a legal expense benefit that provided for
partial payment of legal fees in connection with the defense of certain civil
and criminal actions. The Company's legal expense plans (referred to as
"Memberships") currently provide for a variety of legal services in a manner
similar to medical plans. In most states and provinces, standard plan benefits
include preventive legal services, motor vehicle legal defense services, trial
defense services, IRS audit services and a 25% discount off legal services not
specifically covered by the Membership for an average monthly Membership fee of
approximately $21. Additionally, in approximately 39 states, the Legal Shield
rider can be added to the standard plan for only $1 per month and provides
members with 24-hour access to a toll-free number for attorney assistance if the
member is arrested or detained.
Plan benefits are generally provided through a network of independent
provider law firms, typically one firm per state or province. Members have
direct, toll-free access to their provider law firm rather than having to call
for a referral. At December 31, 2002, the Company had 1,382,306 Memberships in
force with members in all 50 states, the District of Columbia and the Canadian
provinces of Ontario, British Columbia, Alberta and Manitoba. Approximately 90%
of such Memberships were in 29 states.
Industry Overview
Legal service plans, while used in Europe for more than one hundred years
and representing more than a $4 billion European industry, were first developed
in the United States in the late 1960s. Since that time, there has been
substantial growth in the number of Americans entitled to receive various forms
of legal services through legal service plans. According to the latest estimates
developed by the National Resource Center for Consumers of Legal Services
("NRC") for 2002, there were 164 million Americans without any type of legal
service plan. The NRC estimates that 122 million Americans were entitled to
service through at least one legal service plan in 2002 although more than half
are "free" plans that generally provide limited benefits on an automatic
enrollment without any direct cost to the individual. The 122 million Americans
compares to 4 million in 1981, 58 million in 1990 and 115 million in 2000. The
legal service plan industry continues to evolve and market acceptance of legal
service plans, as indicated by the continuing growth in the number of
individuals covered by plans, is increasing.
Legal service plans are offered through various organizations and marketing
methods and contain a wide variety of benefits. Free plans include those
sponsored by labor unions, elder hotlines, the American Association of Retired
Persons and the National Education Association according to NRC estimates, and
accounted for approximately 56% of covered persons in 2002. The NRC estimates
that an additional 27% are covered by employee assistance plans that are also
automatic enrollment plans without direct cost to participants designed to
provide limited telephonic access to attorneys for members of employee groups.
Free plans and employee assistance plans therefore comprise approximately 83% of
covered persons in 2002. Employer paid plans pursuant to which more
comprehensive benefits are offered by the employer as a fringe benefit and the
Armed Forces are each estimated by the NRC to account for approximately 5% of
covered persons in 2002.
According to the NRC, the remaining covered persons in 2002 were covered by
individual enrollment plans, other employment based plans, including voluntary
payroll deduction plans, and miscellaneous plans. These plans were estimated by
the NRC to account for approximately 8% of the market in 2002 and represent the
market segment in which the Company primarily competes. According to the NRC,
these plans typically have more comprehensive benefits, higher utilization,
involve higher costs to participants, and are offered on an individual
enrollment or voluntary basis.
Of the current work force covered by legal service plans, only 7% were
estimated by the NRC to be covered by plans having full coverage. The Company
believes these plans include benefits comparable to those provided by the
Company's Memberships. Accordingly, the Company believes that significant
opportunities exist for successful marketing of the Company's Memberships to
employee groups and other individual consumers.
According to the latest estimates of the census bureaus of the United
States and Canada, currently the two geographic areas in which the Company
operates, the number of households in the combined area exceeds 127 million.
Since the Company has always disclosed its members in terms of Memberships and
individuals covered by the Membership include the individual who purchases the
Membership together with his or her spouse and never married children living at
home up to age 21 or up to age 23 if the children are full time college
students, the Company believes that its market share should be viewed as a
percentage of households. Historically, the Company's primary market focus has
been the "middle" eighty percent of such households rather than the upper and
lower ten percent segments based on the Company's belief that the upper ten
percent may already have a relationship with an attorney or law firm and the
lower ten percent may not be able to afford the cost of a legal service plan. As
a percentage of this defined "middle" market of approximately 100 million
households, the Company currently has an approximate 1.4% share of the estimated
market based on its existing 1.4 million active memberships and, over the last
30 years, an additional 3% of households have previously purchased, but no
longer own, memberships. The Company routinely remarkets to previous members and
reinstated approximately 57,000 and 54,000 Memberships during 2002 and 2001,
respectively.
Description of Memberships
The Memberships sold by the Company generally allow members to access legal
services through a network of independent law firms ("provider law firms") under
contract with the Company. Provider law firms are paid a monthly fixed fee on a
capitated basis to render services to plan members residing within the state or
province in which the provider law firm attorneys are licensed to practice.
Because the fixed fee payments by the Company to provider law firms do not vary
based on the type and amount of benefits utilized by the member, this capitated
arrangement provides significant advantages to the Company in managing claims
risk. At December 31, 2002, Memberships subject to the capitated provider law
firm arrangement comprised approximately 99% of the Company's active
Memberships. The remaining Memberships, approximately 1%, were primarily sold
prior to 1987 and allow members to locate their own lawyer ("open panel") to
provide legal services available under the Membership with the member's lawyer
being reimbursed for services rendered based on usual, reasonable and customary
fees, or are in states where there is no provider law firm in place and the
Company's referral attorney network is utilized.
Family Legal Plan
The Family Legal Plan currently marketed in most jurisdictions by the
Company consists of five basic benefit groups that provide coverage for a broad
range of preventive and litigation-related legal expenses. The Family Legal Plan
accounted for more than 91% of the Company's Membership fees in 2002 and
approximately 90% of the outstanding Memberships at December 31, 2002. In
addition to the Family Legal Plan, the Company markets other specialized legal
services products specifically related to employment in certain professions
described below.
In 12 states, the Company's plans are available in the Spanish language.
For the Spanish language plans, the provider law firms have both bilingual staff
and lawyers and the Company has bilingual staff for both customer service and
marketing service functions. The Company will continue to evaluate making its
plans available in additional languages in markets where demand for such a
product is expected to be sufficient to justify this additional cost.
In exchange for a fixed monthly, semi-annual or annual payment, members are
entitled to specified legal services. Those individuals covered by the
Membership include the individual who purchases the Membership along with his or
her spouse and never married children living at home up to age 21 or up to age
23 if the children are full time college students. Also included are children up
to age 18 for whom the member is legal guardian and any dependent child,
regardless of age, who is mentally or physically disabled. Each Membership,
other than the Business Owners' Legal Solutions Plan, is guaranteed renewable,
except in the case of fraud or nonpayment of Membership fees. Historically, the
Company has not raised rates to existing members. If new benefits become
available, existing members may choose the newer, more comprehensive plan at a
higher rate or keep their existing Memberships. Memberships are automatically
renewed at the end of each Membership period unless the member cancels prior to
the renewal date or fails to make payment on a timely basis.
The basic legal service plan Membership is sold as a package consisting of
five separate benefit groups. Memberships range in cost from $14.95 to $26.00
per month depending in part on the schedule of benefits, which may vary from
state or province in compliance with regulatory requirements. Benefits for
domestic matters, bankruptcy and drug and alcohol related matters are limited in
most Memberships.
Preventive Legal Services. These benefits generally offer unlimited
toll-free access to a member's provider law firm for advice and consultation on
any legal matter. These benefits also include letters and phone calls on the
member's behalf, review of personal contracts and documents, each up to 10 pages
in length, last will and testament preparation for the member and annual will
reviews at no additional cost. Additional wills for spouse and other covered
members may be prepared at a cost of $20.
Automobile Legal Protection. These benefits offer legal assistance for
matters resulting from the operation of a licensed motor vehicle. Members have
assistance available to them at no additional cost for: (a) defense in the court
of original jurisdiction of moving traffic violations deemed meritorious, (b)
defense in the court of original jurisdiction of any charge of manslaughter,
involuntary manslaughter, vehicular homicide or negligent homicide as the result
of a licensed motor vehicle accident, (c) up to 2.5 hours of assistance per
incident for collection of minor property damages (up to $2,000) sustained by
the member's licensed motor vehicle in an accident, (d) up to 2.5 hours of
assistance per incident for collection of personal injury damages (up to $2,000)
sustained by the member or covered family member while driving, riding or being
struck as a pedestrian by a motor vehicle, and (e) up to 2.5 hours of assistance
per incident in connection with an action, including an appeal, for the
maintenance or reinstatement of a member's driver's license which has been
canceled, suspended, or revoked. No coverage under this benefit of the basic
legal service plan is offered to members for pre-existing conditions, drug or
alcohol related matters, or for commercial vehicles over two axles or operation
without a valid license.
Trial Defense. These benefits offer assistance to the member and the
member's spouse through an increasing schedule of benefits based on Membership
year. Up to 60 hours are available for the defense of civil or job-related
criminal charges by the provider law firm in the first Membership year. The
criminal action must be within the scope and responsibility of employment
activities of the member or spouse. Up to 2.5 hours of assistance are available
prior to trial, and the balance is available for actual trial services. The
schedule of benefits under this benefit area increases by 60 hours each
Membership year to: 120 hours in the second Membership year, 3 hours of which
are available for pre-trial services; 180 hours in the third Membership year,
3.5 hours of which are available for pre-trial services; 240 hours in the fourth
Membership year, 4 hours of which are available for pre-trial services, to the
maximum limit of 300 hours in the fifth Membership year, 4.5 hours of which are
available for pre-trial services. This benefit excludes domestic matters,
bankruptcy, deliberate criminal acts, alcohol or drug-related matters, business
matters, and pre-existing conditions.
In addition to the pre-trial benefits of the basic legal plan described
above, there are additional pre-trial hours available as an option, or add-on,
to the basic plan. These optional benefits cost $9.00 per month and add 15 hours
of pre-trial services during the first year of the Membership increasing 5
additional hours each Membership year to the maximum limit of 35 hours in the
fifth Membership year and increases total pre-trial and trial defense hours
available pursuant to the expanded Membership to 75 hours during the first
Membership year to 335 hours in the fifth Membership year. These pre-trial hours
are in addition to those hours already provided by the basic plan so that the
member, in the first year of the Membership, has a combined total of 17.5
pre-trial hours available escalating to a combined total of 39.5 pre-trial hours
in the fifth Membership year. The Company has experienced increased sales of
this option during the last three years.
IRS Audit Protection Services. This benefit offers up to 50 hours of legal
assistance per year in the event the member, spouse or dependent children
receive written notification of an Internal Revenue Service ("IRS") audit or are
summoned in writing to appear before the IRS concerning a tax return. The 50
hours of assistance are available in the following circumstances: (a) up to 1
hour for initial consultation, (b) up to 2.5 hours for representation in
connection with the audit if settlement with the IRS is not reached within 30
days, and (c) the remaining 46.5 hours of actual trial time if settlement is not
achieved prior to litigation. Coverage is limited to audit notification received
regarding the tax return for years during which the Membership is effective.
Representation for charges of fraud or income tax evasion, business and
corporate tax returns and certain other matters are excluded from this benefit.
With pre-trial benefits limited to 2.5 hours to 4.5 hours based on the
Membership year for trial defense (without the pre-trial option described) and
3.5 hours for the IRS audit benefit, these benefits do not ensure complete
pre-trial coverage. In order to receive additional pre-trial IRS audit or trial
defense benefits, a matter must actually proceed to trial. The costs of
pre-trial preparation that exceed the benefits under the Membership are the
responsibility of the member. Provider law firms under the closed panel
Membership have agreed to provide to members any additional pre-trial services
beyond those stipulated in the Membership at a 25% discount from the provider
law firm's customary and usual hourly rate. Retainer fees for these additional
services may be required.
Preferred Member Discount. Provider law firms have agreed to provide to
members any legal services beyond those stipulated in the Membership at a fee
discounted 25% from the provider law firm's customary and usual hourly rate.
This "customary and usual hourly rate" is a fixed single hourly rate for each
provider firm that is generally an average of the firm's various hourly rates
for its attorneys which typically vary based on experience and expertise.
Legal Shield Benefit
In approximately 39 states, the Legal Shield plan can be added to the
standard or expanded Family Legal Plan for $1 per month and provides members
with 24-hour access to a toll-free number for provider law firm assistance if
the member is arrested or detained. The Legal Shield member, if detained, can
present their Legal Shield card to the officer that has detained them to make it
clear that they have access to legal representation and that they are requesting
to contact a lawyer immediately. The benefits of the Legal Shield plan are
subject to conditions imposed by the detaining authority, which may not allow
for the provider law firm to communicate with the member on an immediate basis.
There were approximately 613,000 Legal Shield subscribers at December 31, 2002
compared to approximately 591,000 at December 31, 2001.
Canadian Family Plan
The Family Legal Plan is currently marketed in the Canadian provinces of
Ontario, British Columbia, Alberta and Manitoba. The Company began operations in
Ontario and British Columbia during 1999, Alberta in February 2001 and Manitoba
in August 2001. Benefits of the Canadian plan include expanded preventive
benefits including assistance with Canadian Government agencies, warranty
assistance and small claims court assistance as well as the preferred member
discount. Canadian Membership fees collected during 2002 were approximately $3.7
million in U.S. dollars compared to $4.3 million collected in 2001 and $3.8
million collected in 2000. The Company plans to expand operations in other
provinces and territories of Canada.
Specialty Legal Service Plans
In addition to the Family Legal Plan described above, the Company also
offers other specialty or niche legal service plans. These specialty plans
usually contain many of the Family Legal Plan benefits adjusted as necessary to
meet specific industry or prospective member requirements. In addition to those
specialty plans described below, the Company will continue to evaluate and
develop other such plans as the need and market allow.
Business Owners' Legal Solutions Plan
The Business Owners' Legal Solutions plan was developed during 1995 and
provides business oriented legal service benefits for small businesses with 99
or fewer employees. This plan was developed and test marketed in selected
geographical areas and more widely marketed beginning in 1996 at a monthly rate
of $69.00. This plan provides small businesses with legal consultation and
correspondence benefits, contract and document reviews, debt collection
assistance and reduced rates for any non-covered areas. During 1997, the
coverage offered pursuant to this plan was expanded to include trial defense
benefits and Membership in GoSmallBiz.com, an unrelated Internet based service
provider. Through GoSmallBiz.com, members may receive unlimited business
consultations from business consultants and have access to timely small business
articles, educational software, Internet tools and more. This expanded plan is
currently marketed at a monthly rate ranging from $75 to $125 depending on the
number of employees and provides business oriented legal service benefits for
any for-profit business with 99 or fewer employees. This plan is available in 40
states and represented approximately 4.0%, 3.8% and 5.5% of the Company's
Membership fees during 2002, 2001 and 2000, respectively.
Law Officers Legal Plan
The Law Officers Legal Plan, developed in 1991 and marketed to law
enforcement officers, provides 24-hour job-related emergency toll-free access to
a provider law firm and provides legal services associated with administrative
hearings. This plan was designed to meet the legal needs of persons in the law
enforcement profession and is currently marketed at the monthly rate of $16.00
or at a group rate of $14.95. The Company has members covered under the Law
Officers Legal Plan in 27 states. The Law Officers Legal Plan offers the basic
family legal plan benefits described above without the motor vehicle related
benefits. These motor vehicle benefits are available in the Law Officers Legal
Plan only for defense of criminal charges resulting from the operation of a
licensed motor vehicle. Additionally, at no charge to the member, a 24-hour
emergency hotline is available to access the services of the provider law firm
in situations of job-related urgency. The Law Officers Legal Plan also offers
representation at no additional charge for up to ten hours (five hours per
occurrence) for two administrative hearings or inquiries per year and one
pre-termination hearing per Membership year before a review board or arbitrator.
Preparation and/or counsel for post-termination hearings are also available to
members as a schedule of benefits, which increases with each Membership year.
The schedule of benefits is similar to that offered under the Family Legal Plan
Trial Defense, including the availability of the optional pre-trial hours
described above for an additional $9.00 per month. During the years ended
December 31, 2002, 2001 and 2000, the Law Officers Legal Plan accounted for
approximately 1.4%, 1.5% and 4.8%, respectively, of the Company's Membership
fees.
Commercial Driver Legal Plan
The Commercial Driver Legal Plan, developed in 1986, is designed
specifically for the professional truck driver and offers a variety of
driving-related benefits, including coverage for moving and non-moving
violations. This plan provides coverage on a closed panel plan basis for persons
who drive a commercial vehicle. This legal service plan is currently offered in
45 states. In certain states, the Commercial Driver Legal Plan is underwritten
by the Road America Motor Club, an unrelated motor service club. During the
years ended December 31, 2002, 2001 and 2000, this plan accounted for
approximately 1.3%, .9% and 2.5%, respectively, of Membership fees. The Plan
underwritten by the Road America Motor Club is available at the monthly rate of
$35.95 or at a group rate of $32.95. Plans underwritten by the Company are
available at the monthly rate of $32.95 or at a group rate of $29.95. Benefits
include the motor vehicle related benefits described above, defense of
Department of Transportation violations and the 25% discounted rate for services
beyond plan scope, such as defense of non-moving violations. The Road America
Motor Club underwritten plan includes bail and arrest bonds and services for
family vehicles.
Home-Based Business Rider
The Home-Based Business plan was designed to provide small business owners
access to commonly needed legal services. It can be added to the Expanded Family
Legal Plan in approved states. To qualify, the business and residence address
must be the same with three or fewer employees and be a for-profit business that
is not publicly traded. Benefits under this plan include unlimited business
telephone consultation, review of three business contracts per month, three
business and debt collection letters per month and discounted trial defense
rates. This plan also includes Membership in GoSmallBiz.com. This plan is
available in 35 states and represented approximately 1.7%, 1.5% and .6% of the
Company's Membership fees during 2002, 2001 and 2000, respectively.
Comprehensive Group Legal Services Plan
The Company introduced in late 1999 the Comprehensive Group plan, designed
for the large group employee benefit market. This plan provides all the benefits
of the Family Legal Plan as well as mortgage document preparation, assistance
with uncontested legal situations such as adoptions, name changes, separations
and divorces. Additional benefits include the preparation of health care power
of attorney and living wills or directives to physicians. Although the Company
has not experienced any significant sales of this plan, the Company expects this
plan to improve its competitive position in the large group market.
Other than additional benefits such as the Legal Shield benefit described
above, the basic structure and design of the Membership benefits has not
significantly changed over the last several years. The consistency in plan
design and delivery provides the Company consistent, accurate data about plan
utilization which enables the Company to mange its benefit costs through the
capitated payment structure to provider firms.
Provider Law Firms
The Company's Memberships generally allow members to access legal services
through a network of independent provider law firms under contract with the
Company generally referred to as "provider law firms." Provider law firms are
paid a fixed fee on a per capita basis to render services to plan members
residing within the state or province as provided by the contract. Because the
fixed fee payments by the Company to provider law firms in connection with the
Memberships do not vary based on the type and amount of benefits utilized by the
member, this arrangement provides significant advantages to the Company in
managing its cost of benefits. Pursuant to these provider law firm arrangements
and due to the volume of revenue directed to these firms, the Company has the
ability to more effectively monitor the customer service aspects of the legal
services provided and the financial leverage to help ensure a customer friendly
emphasis by the provider law firms. Generally, due to the volume of revenue that
may be directed to particular provider law firms, the Company has access to
larger, more diversified law firms. The Company, through its members, is
typically the largest client base of its provider law firms.
Provider law firms are selected to serve members based on a number of
factors, including recommendations from provider law firms and other lawyers in
the area in which the candidate provider law firm is located and in neighboring
states, investigation by the Company of bar association standing and client
references, evaluation of the education, experience and areas of practice of
lawyers within the firm, on-site evaluations by Company management, and
interviews with lawyers in the firm who would be responsible for providing
services. Most importantly, these candidate law firms are evaluated on the
firm's customer service philosophy.
The majority of provider law firms are connected to the Company via
high-speed digital links to the Company's management information systems,
thereby providing real-time monitoring capability. This online connection offers
the provider law firm access to specially designed software developed by the
Company for administration of legal services by the firm. These systems provide
statistical reports of each law firm's activity and performance and allow
approximately 98% of members to be monitored on a near real-time basis. The few
provider law firms that are not online with the Company typically have a small
Membership base and must provide various weekly reports to the Company to assist
in monitoring the firm's service level. The combination of the online
statistical reporting and weekly service reports for smaller provider law firms
allows quality control monitoring of over 15 separate service delivery
benchmarks. In addition, the Company regularly conducts extensive random surveys
of members who have used the legal services of a provider law firm. The Company
surveys members in each state every 60 days, compiles the results of such
surveys and provides the provider law firms with copies of each survey and the
overall summary of the results. If a member indicates on a survey the service
did not meet their expectation, the member is contacted immediately to resolve
the issue.
Each month, provider law firms are presented with a comprehensive report of
ratings related to the Company's online monitoring, member complaints, member
survey evaluations, telephone reports and other information developed in
connection with member service monitoring. If a problem is detected, immediate
remedial actions are recommended by the Company to the provider law firms to
eliminate service deficiencies. In the event the deficiencies of a provider law
firm are not eliminated through discussions and additional training with the
Company, such deficiencies may result in the termination of the provider law
firm. The Company is in constant communication with its provider law firms and
meets with them frequently for additional training, to encourage increased
communications with the Company and to share suggestions relating to the timely
and effective delivery of services to the Company's members.
Each attorney member of the provider law firm rendering services must have
at least two years of experience as a lawyer, unless the Company waives this
requirement due to special circumstances such as instances when the lawyer
demonstrates significant legal experience acquired in an academic, judicial or
similar capacity other than as a lawyer. The Company provides customer service
training to the provider law firms and their support staff through on-site
training that allows the Company to observe the individual lawyers of provider
law firms as they directly assist the members.
Agreements with provider law firms: (a) generally permit termination of the
agreement by either party upon 60 days prior written notice, (b) permit the
Company to terminate the Agreement for cause immediately upon written notice,
(c) require the firm to maintain a minimum amount of malpractice insurance on
each of its attorneys, in an amount not less than $100,000, (d) preclude the
Company from interference with the lawyer-client relationship, (e) provide for
periodic review of services provided, (f) provide for protection of the
Company's proprietary information and (g) require the firm to indemnify the
Company against liabilities resulting from legal services rendered by the firm.
The Company is precluded from contracting with other law firms to provide the
same service in the same geographic area, except in situations where the
designated law firm has a conflict of interest, the Company enrolls a group of
500 or more members, or when the agreement is terminated by either party.
Provider law firms are precluded from contracting with other prepaid legal
service companies without Company approval. Provider law firms receive a fixed
monthly payment for each member who are residents in the service area and are
responsible for providing the Membership benefits without additional
remuneration. If a provider law firm delivers legal services to an open panel
member, the law firm is reimbursed for services rendered according to the open
panel Membership. As of December 31, 2002, provider law firms averaged
approximately 60 employees each and on average are evenly split between support
staff and lawyers.
The Company has had occasional disputes with provider law firms, some of
which have resulted in litigation. The toll-free telephone lines utilized and
paid for by the provider law firms are owned by the Company so that in the event
of a termination, the members' calls can be rerouted very quickly. Nonetheless,
the Company believes that its relations with provider law firms are generally
very good. At the end of 2002 and 2001, the Company had provider law firms
representing 45 states and three provinces compared to 43 states and two
provinces at the end of 2000. During the last three calendar years, the
Company's relationships with a total of five provider law firms were terminated
by the Company or the provider law firm. As of December 31, 2002, 14 provider
law firms have been under contract with the Company for more than eight years
with the average tenure of all provider law firms being approximately 6 1/2
years.
The Company has an extensive database of referral lawyers who have provided
services to its members for use by members when a designated provider law firm
is not available. Lawyers with whom members have experienced verified service
problems, or are otherwise inappropriate for the referral system, are removed
from the Company's list of referral lawyers.
Marketing
Multi-Level Marketing
The Company markets Memberships through a multi-level marketing program
that encourages individuals to sell Memberships and allows individuals to
recruit and develop their own sales organizations. Commissions are paid only
when a Membership is sold and no commissions are paid based solely on
recruitment. When a Membership is sold, commissions are paid to the associate
making the sale, and to other associates (on average, 17 others at December 31,
2002 compared to 16 others at December 31, 2001) who are in the line of
associates who directly or indirectly recruited the selling associate. The
Company provides training materials, organizes area-training meetings and
designates personnel at the home office specially trained to answer questions
and inquiries from associates. The Company offers various communication avenues
to its sales associates to keep such associates informed of any changes in the
marketing of its Memberships. The primary communication vehicles utilized by the
Company to keep its sales associates informed include extensive use of email, an
interactive voice-mail service, The Connection monthly magazine, the weekly
Communication Show that may be heard via the Company's Internet webcasts, an
interactive voice response system, a monthly DVD (digital video disc) program
and the Company's website, prepaidlegal.com.
Multi-level marketing is primarily used for marketing based on personal
sales since it encourages individual or group face-to-face meetings with
prospective members and has the potential of attracting a large number of sales
personnel within a short period of time. The Company's marketing efforts towards
individuals typically target the middle income family or individual and seek to
educate potential members concerning the benefits of having ready access to
legal counsel for a variety of everyday legal problems. Memberships with
individuals or families sold by the multi-level sales force constituted 73% of
the Company's Memberships in force at December 31, 2002 compared to 74% and 73%
at December 31, 2001 and 2000, respectively. Although other means of payment are
available, approximately 73% of fees on Memberships purchased by individuals or
families are paid on a monthly basis by means of automatic bank draft or credit
card.
The Company's marketing efforts towards employee groups, principally on a
payroll deduction payment basis, are designed to permit its sales associates to
reach more potential members with each sales presentation and strive to
capitalize on, among other things, what the Company perceives to be a growing
interest among employers in the value of providing legal service plans to their
employees. Memberships sold through employee groups constituted approximately
27% of total Memberships in force at December 31, 2002 compared to 26% and 27%
at December 31, 2001 and 2000, respectively. The majority of employee group
Memberships are sold to school systems, governmental entities and businesses. No
group accounted for more than 1% of the Company's consolidated revenues from
Memberships during 2002, 2001 or 2000. Substantially all group Memberships are
paid on a monthly basis. The Company has recently begun a legislative lobbying
effort to enhance the ability of the Company to market to public employee groups
and to encourage Congress to reenact legislation to permit legal service plans
to qualify for pre-tax payments under tax qualified employee cafeteria plans.
Sales associates are generally engaged as independent contractors and are
provided with training materials and are given the opportunity to participate in
Company training programs. Sales associates are required to complete a specified
training program prior to marketing the Company's Memberships to employee
groups. All advertising and solicitation materials used by sales associates must
be approved by the Company prior to use. At December 31, 2002, the Company had
341,116 "vested" sales associates compared to 286,488 and 242,085 "vested" sales
associates at December 31, 2001 and 2000, respectively. A sales associate is
considered to be "vested" if he or she has personally sold at least three new
Memberships per quarter or if he or she retains a personal Membership. A vested
associate is entitled to continue to receive commissions on prior sales after
all previous commission advances have been recovered. However, a substantial
number of vested associates do not continue to market the Membership, as they
are not required to do so in order to continue to be vested. During 2002, the
Company had 103,112 sales associates who personally sold at least one
Membership, of which 65,383 (63%) made first time sales. During 2000 and 1999
the Company had 81,613 and 73,826 sales associates producing at least one
Membership sale, respectively, of which 46,687 (57%) and 43,169 (58%),
respectively, made first time sales. During 2002, the Company had 12,738 sales
associates who personally sold more than ten Memberships compared to 13,749 and
11,055 in 2001 and 2000, respectively. A substantial number of the Company's
sales associates market the Company's Memberships on a part-time basis only.
The Company derives revenues from its multi-level marketing sales force,
principally from a one-time enrollment fee of $65 from each new sales associate
for which the Company provides initial marketing supplies and enrollment
services to the associate. In January 1997, the Company implemented a new
combination classroom and field training program, titled Fast Start to Success
("Fast Start"), aimed at increasing the level of new Membership sales per
associate. The Fast Start program provides a direct economic incentive to
existing associates to help train new recruits. Associates who successfully
complete the program by writing three new Memberships and recruiting three new
sales associates or by personally selling five new Memberships within 60 days of
the associate's start date advance through the various commission levels at a
faster rate and qualify for advance commissions. Associates in states that
require the associate to become licensed will have 60 days from the issue date
on their license to complete the same requirements. The program typically
requires a fee ranging from $34 to $184 per new associate, depending on special
promotions the Company implements from time to time, that is earned by the
Company upon completion of the training program. Upon successful completion of
the program (including the required sales of memberships), the sponsoring
associates may be paid certain training bonuses. Amounts collected from sales
associates are intended primarily to offset the Company's costs incurred in
recruiting and training and providing materials to sales associates and are not
intended to generate profits from such activities. Other revenues from sales
associates represent the sale of marketing supplies and promotional materials.
The Company's compensation plan for the multi-level marketing force is
under continuous review by the Company to assure that the various financial
incentives in the plan encourage the Company's desired goals. The Company offers
various incentive programs from time to time and frequently adjusts the program
to maintain appropriate incentives and to improve membership production and
retention.
Regional Vice Presidents
The Company has a group of employees that serve as Regional Vice Presidents
("RVPs") responsible for associate activity in a given geographic region and
with the ability to appoint independent contractors as Area Coordinators within
the RVP's region. The RVPs have weekly reporting requirements as well as
quarterly sales and recruiting goals. The RVP and Area Coordinator program
provides a basis to effectively monitor current sales activity, further educate
and motivate the sales force and otherwise enhance the relationships between the
associates and the Company. New products and initiatives will continue to be
channeled through the RVPs and Area Coordinators. At December 31, 2002, the
Company had 63 RVPs in place.
Pre-Paid Legal Benefits Association
The Pre-Paid Legal Benefits Association was founded in 1999 with the intent
of providing sales associates the opportunity to have access, at their own
expense, to health insurance and life insurance benefits. Membership in the
Association allows a sales associate to become eligible to enroll in numerous
benefit programs, as well as take advantage of attractive affinity agreements.
Membership in this association is open to sales associates that reach a certain
level within the Company's marketing programs who also maintain an active
personal legal services Membership. The Benefits Association is a separate
association not owned or controlled by the Company and is governed by a 16
member Board of Directors, including four officer positions. None of the
officers or directors of the Benefits Association serve in any such capacity
with the Company. The Benefits Association employs a Director of Associate
Benefits as well as a third-party benefits administration company, both paid by
the Association. Affinity programs available to members of the Benefits
Association include credit cards, long-distance plans including paging, wireless
services and Internet service provider offerings, real estate planning programs
and a travel club. As determined by its Board of Directors, some of the revenue
generated by the Benefits Association through commissions from vendors of the
benefit and affinity programs or contributed to the Benefits Association by the
Company may be used to make open-market purchases of the Company's stock for use
in awards to Benefit Association members based on criteria established by the
Benefits Association. Since inception and through December 31, 2002,
approximately 21,000 shares had been purchased by the Benefits Association for
future awards to its members. In 2002, the Benefits association decided to offer
cash in lieu of stock awards and the shares purchased by the Benefits
Association were sold to the Company on January 2, 2003 at the stock's closing
price to fund such awards.
Cooperative Marketing
The Company has in the past, and may in the future, develop marketing
strategies pursuant to which the Company seeks arrangements with insurance and
service companies that have established sales forces. Under such arrangements,
the agents or sales force of the cooperative marketing partner market the
Company's Memberships along with the products already marketed by the partner's
agents or sales force. Such arrangements allow the cooperative marketing partner
to enhance its existing customer relationships and distribution channels by
adding the Company's product to the marketing partner's existing range of
products and services, while the Company is able to gain broader Membership
distribution and access to established customer bases.
The Company has a cooperative marketing agreement with Atlanta-based
Primerica Financial Services ("PFS"), a subsidiary of Citigroup, Inc. PFS is one
of the largest financial services marketing organizations in North America with
more than 100,000 personal financial analysts across the U.S. and Canada. The
PFS cooperative marketing agreement resulted in approximately 15,000 and 13,000
Memberships during 2002 and 2001, respectively.
The Company has had limited success with cooperative marketing arrangements
in the past and is unable to predict with certainty what success it
will achieve, if any, under its existing or future cooperative marketing
arrangements.
Operations
The Company's corporate operations involve Membership application
processing, member-related customer service, various associate-related services
including commission payments, receipt of Membership fees, related general
ledger accounting, and managing and monitoring the provider law firm
relationships.
The Company utilizes a management information system to control operations
costs and monitor benefit utilization. Among other functions, the system
evaluates benefit claims, monitors member use of benefits, and monitors
marketing/sales data and financial reporting records. Dominant company concerns
in the architecture of private networks and web systems include security,
capacity to accommodate peak traffic, disaster recovery, and scalability. The
Company believes its management information system has substantial capacity to
accommodate increases in business data before substantial upgrades will be
required. The Company believes this excess capacity will enable it to experience
a significant increase in the number of members serviced with less than a
commensurate increase of administrative costs.
The Company has built a strong Internet presence to strengthen the services
provided to both members and associates. The Company's Internet site, at
www.prepaidlegal.com, welcomes the multifaceted needs of our members, sales
force, investors, and prospects. It has also reduced costs associated with
communicating critical information to the associate sales force.
The Company's operations also include departments specifically responsible
for marketing support and regulatory and licensing compliance. The Company has
an internal production staff that is responsible for the development of new
audio and video sales materials.
Quality Control
In addition to the Company's quality control efforts for provider law firms
described above, the Company also closely monitors the performance of its home
office personnel, especially those who have telephone contact with members or
sales associates. The Company records home office employee telephone calls with
its members and sales associates to assure that Company policies are being
followed and to gather data about recurring problems that may be avoided through
modifications in policies. The Company also uses such recorded calls for
training and recognition purposes.
Competition
The Company competes in a variety of market segments in the prepaid legal
services industry, including, among others, individual enrollment plans,
employee benefit plans and certain specialty segments. According to 2002
estimates by NRC, an estimated 35% of the total estimated market in the segments
in which the Company competes is served by a large number of small companies
with regional areas of emphasis or union-based automatic enrollment plans. The
remaining 65% of such market are served primarily by the Company and five other
principal competitors: Hyatt Legal Plans (a MetLife company), ARAG Group
(formerly Midwest Legal Services), LawPhone/ACS, National Legal Plan and Legal
Services Plan of America (a GE Financial Assurance Partnership Marketing Group
company, formerly the Signature Group). For employment-based plans other than
employer paid, union-based automatic enrollment plans and employee assistance
plans and for individual enrollment plans, the Company represents approximately
51% of the market share garnered by this group according to the NRC.
If a greater number of companies seek to enter the prepaid legal services
market, the Company will experience increased competition in the marketing of
its Memberships. However, the Company believes its competitive position is
enhanced by its actuarial database, its existing network of provider attorney
law firms and its ability to tailor products to suit various types of
distribution channels or target markets. The Company believes that no other
competitor has the ability to monitor the customer service aspect of the
delivery of legal services to the same extent the Company does. Serious
competition is most likely from companies with significant financial resources
and advanced marketing techniques.
Regulation
The Company is regulated by or required to file with or obtain approval of
State Insurance Departments, Secretaries of State, State Bar Associations and
State Attorney General offices depending on individual state opinions of
regulatory responsibility for legal expense plans. The Company is also required
to file with similar government agencies in Canada. While some states or
provinces regulate legal expense plans as insurance or specialized legal expense
products, others regulate them as services.
As of December 31, 2002, the Company or one of its subsidiaries was
marketing new Memberships in 35 states or provinces that require no special
licensing or regulatory compliance. The Company's subsidiaries serve as
operating companies in 16 states that regulate Memberships as insurance or
specialized legal expense products. The most significant of these wholly owned
subsidiaries are Pre-Paid Legal Casualty, Inc. ("PPLCI") and Pre-Paid Legal
Services, Inc. of Florida ("PPLSIF"). Of the Company's total Memberships in
force as of December 31, 2002, 34% were written in jurisdictions that subject
the Company or one of its subsidiaries to insurance or specialized legal expense
plan regulation.
The Company began selling Memberships in the Canadian provinces of Ontario
and British Columbia during 1999, Alberta during February 2001 and Manitoba
during August 2001. The Memberships currently marketed by the Company in such
provinces do not constitute an insurance product and therefore are exempt from
insurance regulation.
In states with no special licensing or regulatory requirements, the Company
commences operations only when advised by the appropriate regulatory authority
that proposed operations do not constitute conduct of the business of insurance.
There is no assurance that Memberships will be exempt from insurance regulation
even in states or provinces with no specific regulations. In these situations,
the Company or one of its subsidiaries would be required to qualify as an
insurance company in order to conduct business.
PPLCI serves as the operating company in most states where Memberships are
determined to be an insurance product. PPLCI is organized as a casualty
insurance company under Oklahoma law and as such is subject to regulation and
oversight by various state insurance agencies where it conducts business. These
agencies regulate the Company's forms, rates, trade practices, allowable
investments and licensing of agents and sales associates. These agencies also
prescribe various reports, require regular evaluations by regulatory
authorities, and set forth-minimum capital and reserve requirements. The
Company's insurance subsidiaries are routinely evaluated and examined by
representatives from the various regulatory authorities in the normal course of
business. Such examinations have not and are not expected to adversely impact
the Company's operations or financial condition in any material way. The Company
believes that all of its subsidiaries meet any required capital and reserve
requirements. Dividends paid by PPLCI are restricted under Oklahoma law to
available surplus funds derived from realized net profits.
The Company is required to register and file reports with the Oklahoma
Insurance Commissioner as a member of a holding company system under the
Oklahoma Insurance Holding Company System Regulatory Act. Transactions between
PPLCI and the Company or any other subsidiary must be at arms-length with
consideration for the adequacy of PPLCI's surplus, and must have prior approval
of the Oklahoma Insurance Commissioner. Payment of any extraordinary dividend by
PPLCI to the Company requires approval of the Oklahoma Insurance Commissioner.
During 2001, PPLCI declared a $5 million dividend payable to the Company which
was paid in 2002. During 2002, PPLCI declared a $6 million dividend which was
paid in December of 2002. Any change in control of the Company, defined as
acquisition by any method of more than 10% of the Company's outstanding voting
stock, including rights to acquire such stock by conversion of preferred stock,
exercise of warrants or otherwise, requires approval of the Oklahoma Insurance
Commissioner. Holding company laws in some states in which PPLCI operates, such
as Texas, provide for comparable registration and regulation of the Company.
Certain states have enacted special licensing or regulatory requirements
designed to apply only to companies offering legal service products. These
states most often follow regulations similar to those regulating casualty
insurance providers. Thus, the operating company may be expected to comply with
specific minimum capitalization and unimpaired surplus requirements; seek
approval of forms, Memberships and marketing materials; adhere to required
levels of claims reserves, and seek approval of premium rates and agent
licensing. These laws may also restrict the amount of dividends paid to the
Company by such subsidiaries. PPLSIF is subject to restrictions of this type
under the laws of the State of Florida, including restrictions with respect to
payment of dividends to the Company.
As the legal plan industry matures, additional legislation may be enacted
that would affect the Company and its subsidiaries. The Company cannot predict
with any accuracy if such legislation would be adopted or its ultimate effect on
operations, but expects to continue to work closely with regulatory authorities
to minimize any undesirable impact.
The Company's operations are further impacted by the American Bar
Association Model Rules of Professional Conduct ("Model Rules") and the American
Bar Association Code of Professional Responsibility ("ABA Code") as adopted by
various states. Arrangements for payments to a lawyer by an entity providing
legal services to its members are permissible under both the Model Rules and the
ABA Code, so long as the arrangement prohibits the entity from regulating or
influencing the lawyer's professional judgment. The ABA Code prohibits lawyer
participation in closed panel legal service programs in certain circumstances.
The Company's agreements with provider law firms comply with both the Model
Rules and the ABA Code. The Company relies on the lawyers serving as the
designated provider law firms for the closed panel benefits to determine whether
their participation would violate any ethical guidelines applicable to them. The
Company and its subsidiaries comply with filing requirements of state bar
associations or other applicable regulatory authorities.
The Company also is required to comply with state, provincial and federal
laws governing the Company's multi-level marketing approach. These laws
generally relate to unfair or deceptive trade practices, lotteries, business
opportunities and securities. The Company has experienced no material problems
with marketing compliance. In jurisdictions that require associates to be
licensed, the Company receives all applications for licenses from the associates
and forwards them to the appropriate regulatory authority. The Company maintains
records of all associates licensed, including effective and expiration dates of
licenses and all states in which an associate is licensed. The Company does not
accept new Membership sale applications from any unlicensed associate in such
jurisdictions.
Employees
At December 31, 2002, the Company and its subsidiaries employed 660
individuals on a full-time basis, exclusive of independent agents and sales
associates who are not employees. None of the Company's employees are
represented by a union. Management considers its employee relations to be good.
Foreign Operations
The Company began operations in the Canadian provinces of Ontario and
British Columbia during 1999, Alberta in February 2001 and Manitoba in August
2001 and derived aggregate revenues, including Membership fees and revenues from
associate services, from Canada of $4.0 million in U.S. dollars during 2002
compared to $4.4 million and $4.9 million in 2001 and 2000, respectively. Due to
the relative stability of the United States and Canadian foreign relations and
currency exchange rates, the Company believes that any risk of foreign
operations or currency valuations is minimal and would not have a material
effect on the Company's financial condition, liquidity or results of operations.
Availability of Information
The Company files periodic reports and proxy statements with the Securities
and Exchange Commission. The public may read and copy any materials the Company
files with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. The public may obtain information about the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. The Company
files its reports with the SEC electronically. The SEC maintains an Internet
site that contains reports, proxy and information statements, and other
information regarding issuers that file electronically with the SEC. The address
of this site is http://www.sec.gov.
The Company's Internet address is www.prepaidlegal.com. The Company makes
available on its website free of charge copies of its annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments
to those reports filed or furnished pursuant to Section 13(a) of the Exchange
Act as soon as reasonably possible after the Company electronically files such
material with, or furnishes it to, the SEC.
ITEM 2. DESCRIPTION OF PROPERTY
The executive and administrative offices of the Company and its
subsidiaries are located at 321 East Main Street, Ada, Oklahoma. These offices,
containing approximately 40,000 square feet of office space, are owned by the
Company. Additionally, the Company completed construction during 1999, of a new
facility containing approximately 17,000 square feet of office and warehouse and
shipping space. The Company now has three buildings on its property located
approximately five miles from the Company's executive and administrative
offices. The Company previously completed construction of its Customer Care
facility during 1998 that contains approximately 10,000 square feet of office
and call center space. The Customer Care facility is adjacent to the material
distribution center constructed during 1997 containing 8,600 square feet that is
now used for general office space. The Company currently fully utilizes these
three existing facilities with combined square footage of more than 35,000
square feet and has begun construction of a new home office complex in Ada
located approximately five miles from its current location. The new home office
is being constructed on approximately 87 acres contributed to the Company by the
City of Ada in 2001 as part of an economic development incentive package. The
Company began construction in November 2001 and scheduled completion of the
estimated $30 million complex, which will include a sales associate Hall of Fame
and six-story tower, is September 2003. Costs incurred through December 31, 2002
of approximately $12.6 million, including $120,000 in capitalized interest
costs, have been paid from existing resources and $8.3 million outstanding on
its $20 million line of credit for its new office construction. The Company has
entered into construction contracts in the amount of $28.4 million with the
general contractor pertaining to the new office complex. Total remaining costs
of construction from January 1, 2003 are estimated at approximately $17.4
million.
In addition to the property described above that is owned by the Company,
the Company opened an additional Customer Care facility in Antlers, Oklahoma
during March 2000, in building space provided by the City of Antlers at no cost
to the Company. In conjunction with a rural economic development program
coordinated by the City of Antlers, a new facility was built at no cost to the
Company that can accommodate approximately 100 customer service representatives.
The Company leased the facilities from the City of Antlers upon completion of
the construction in November 2002.
ITEM 3. LEGAL PROCEEDINGS
The Company and various of its executive officers have been named as
defendants in a putative securities class action originally filed in the United
States District Court for the Western District of Oklahoma in early 2001 seeking
unspecified damages on the basis of allegations that the Company issued false
and misleading financial information, primarily related to the method the
Company used to account for commission advance receivables from sales
associates. On March 5, 2002, the Court granted the Company's motion to dismiss
the complaint, with prejudice, and entered a judgment in favor of the
defendants. Plaintiffs thereafter filed a motion requesting reconsideration of
the dismissal which was denied. The plaintiffs have appealed the judgment and
the order denying their motion to reconsider the judgment to the Tenth Circuit
Court of Appeals, and as of February 28, 2003, the case was in the briefing
stage. The Company is unable to predict when a decision will be made on this
appeal. In August 2002, the lead institutional plaintiff withdrew from the case,
leaving two individual plaintiffs as lead plaintiffs on behalf of the putative
class. The ultimate outcome of this case is not determinable.
On June 7, 2001 and August 3, 2001, shareholder derivative actions were
filed by alleged company shareholders, Bruce A. Hansen and Donna L. Hansen, and
Roger Strykowski, respectively, against all of the directors of the Company
seeking unspecified actual and punitive damages on behalf of the Company based
on allegations of breach of fiduciary duty, corporate waste and mismanagement by
the defendant directors. On March 1, 2002, plaintiffs filed a consolidated
amended derivative complaint. The amended complaint alleges that the defendant
directors caused the Company to violate generally accepted accounting principles
and federal securities laws by improperly capitalizing commission expenses,
caused the Company to allegedly pay increased salaries and bonuses based upon
financial performance which was allegedly improperly inflated, and caused the
Company to expend significant dollars in connection with the defense of its
accounting policy, including cost incurred in connection with the defense of the
securities class action described above, and in connection with the repurchase
of its own shares on the open market at allegedly artificially inflated prices.
This derivative action is related to the putative securities class action
described above, which has been dismissed with prejudice. After the Pre-Paid
defendants moved to dismiss the consolidated amended derivative complaint, the
plaintiffs filed a voluntary dismissal of the case in August 2002 without
prejudice. The Pre-Paid defendants objected to the voluntary dismissal, but the
court approved the dismissal subject to plaintiffs' publishing notice to
shareholders and allowing a 30-day objection period regarding their proposed
dismissal without prejudice. Plaintiffs' notice was published on January 28,
2003 and the deadline for objections was February 28, 2003. On March 13, 2003
the case was dismissed without prejudice.
Beginning in the second quarter of 2001 and through December 31, 2002,
multiple lawsuits were filed against the Company, certain officers, employees,
sales associates and other defendants in various Alabama and Mississippi state
courts by current or former members seeking actual and punitive damages for
alleged breach of contract, fraud and various other claims in connection with
the sale of memberships. As of December 31, 2002, the Company was aware of 28
separate lawsuits involving approximately 298 plaintiffs that have been filed in
multiple counties in Alabama. One suit involving two plaintiffs which was filed
as a class action has been dismissed with prejudice as to the class allegations
and without prejudice as to the individual claims. As of December 31, 2002, the
Company was aware of 14 separate lawsuits involving approximately 428 plaintiffs
in multiple counties in Mississippi. Certain of the Mississippi lawsuits also
name the Company's provider attorney in Mississippi as a defendant. Proceedings
in the eleven cases which name the Company's provider attorney as a defendant
have been stayed for at least 90 days as to the provider attorney due to the
rehabilitation proceeding involving the provider law firm's insurer. At least
two complaints have been filed on behalf of certain of the Mississippi
plaintiffs and others with the Attorney General of Mississippi in March 2002 and
December 2002. The Company has responded to the Attorney General's requests for
information with respect to both complaints, and as of February 28, 2003, the
Company was not aware of any further actions being taken by the Attorney
General. In Mississippi, the Company has filed lawsuits in the United States
District Court for the Southern and Northern Districts of Mississippi in which
the Company seeks to compel arbitration of the various Mississippi claims under
the Federal Arbitration Act and the terms of the Company's membership
agreements, and has appealed the state court rulings in favor of certain of the
plaintiffs on the arbitration issue to the Mississippi Supreme Court. These
cases are all in various stages of litigation, including trial settings
beginning in Alabama in May, 2003, and seek varying amounts of actual and
punitive damages. While the amount of membership fees paid by the plaintiffs in
the Mississippi cases is $500,000 or less, certain of the cases seek damages of
$90 million. Additional suits of a similar nature have been threatened. The
ultimate outcome of any particular case is not determinable.
On April 19, 2002, counsel in certain of the above-referenced Alabama suits
also filed a similar suit against the Company and certain of its officers in the
District Court of Creek County, Oklahoma on behalf of Jeff and Jana Weller
individually and doing business as Hi-Tech Auto making similar allegations
relating to the Company's memberships and seeking unspecified damages on behalf
of a "nationwide" class. The Company's preliminary motions in this case have
been denied, and, as of February 28, 2003, the Company's appeal of the denial of
its motion to compel arbitration is pending before the Oklahoma Supreme Court.
The ultimate outcome of this case is not determinable.
On June 29, 2001, an action was filed against the Company in the District
Court of Canadian County, Oklahoma. In 2002, the petition was amended to add
five additional named plaintiffs and to add and drop certain claims. This action
is a putative class action brought by Gina Kotwitz, George Kotwitz, Rick Coker,
Richard Starke, Jeff Turnipseed and Aaron Bouren on behalf of all sales
associates of the Company. The amended petition seeks injunctive and declaratory
relief, with such other damages as the court deems appropriate, for alleged
violations of the Oklahoma Uniform Consumer Credit Code in connection with the
Company's commission advances, and seeks injunctive and declaratory relief
regarding the enforcement of certain contract provisions with sales associates.
The impact of the claims alleged under the Consumer Credit Code and the
assertion of entitlement to injunctive relief could exceed $315 million if
plaintiffs are successful both in their request for class certification and on
the merits. The plaintiffs' request for class certification is set for hearing
on July 22, 2003. The ultimate outcome of this case is not determinable.
On March 1, 2002, an action was filed in the United States District Court
for the Western District of Oklahoma by Caroline Sandler, Robert Schweikert, Sal
Corrente, Richard Jarvis and Vincent Jefferson against the Company and certain
executive officers. This action is a putative class action seeking unspecified
damages filed on behalf of all sales associates of the Company and alleges that
the marketing plan offered by the Company constitutes a security under the
Securities Act of 1933 and seeks remedies for failure to register the marketing
plan as a security and for violations of the anti-fraud provisions of the
Securities Act of 1933 and the Securities Exchange Act of 1934 in connection
with representations alleged to have been made in connection with the marketing
plan. The complaint also alleges violations of the Oklahoma Securities Act, the
Oklahoma Business Opportunities Sales Act, breach of contract, breach of duty of
good faith and fair dealing and unjust enrichment and violation of the Oklahoma
Consumer Protection Act and negligent supervision. This case is subject to the
Private Litigation Securities Reform Act. Pursuant to the Act, the Court has
approved the named plaintiffs and counsel and an amended complaint was filed in
August 2002. The Company filed motions to dismiss the complaint and to strike
the class action allegations on September 19, 2002. All discovery in the action
is stayed pending a ruling on the motion to dismiss. As of February 28, 2003,
all briefs had been filed by the parties on the motion to dismiss and a decision
on the motion will be made by the Court. The Company is unable to predict when a
decision will be made. The ultimate outcome of this case is not determinable.
In December 2002, the West Virginia Supreme Court reversed a summary
judgment which had been granted by the Circuit Court of Monangalia County, West
Virginia in favor of the Company in connection with the claims of a former
member, Georgia Poling and her daughters against the Company and a referral
lawyer with respect to a 1995 referral. That action was originally filed in
March 2000, and alleges breach of contract and fraud against the Company in
connection with the referral. The case is now scheduled for trial in August
2003, and plaintiffs seek actual and punitive damages in unspecified amounts.
The ultimate outcome of this case is not determinable.
On January 30, 2003, the Company announced that it had received a subpoena
from the office of the United States Attorney for the Southern District of New
York requesting information relating to trading activities in the Company's
stock in advance of the January 2003 announcement of recruiting and membership
production results for the fourth quarter of 2002. The Company also received
notice from the Securities and Exchange Commission that it is conducting an
informal inquiry into the same subject. The Company is cooperating fully in
responding to these requests. The ultimate outcome of these matters is not
determinable.
The Company is a defendant in various other legal proceedings that are
routine and incidental to its business. The Company will vigorously defend its
interests in all proceedings in which it is named as a defendant. The Company
also receives periodic complaints or requests for information from various state
and federal agencies relating to its business or the activities of its marketing
force. The Company promptly responds to any such matters and provides any
information requested.
While the ultimate outcome of these proceedings is not determinable, the
Company does not currently anticipate that these contingencies will result in
any material adverse effect to its financial condition or results of operation,
unless an unexpected result occurs in one of the cases. The Company has
established an accrued liability it believes will be sufficient to cover
estimated damages in connection with various cases, which at December 31, 2002
was $3.3 million. If an unexpected result were to occur in one or more of the
pending cases, the amount of damages awarded could differ significantly from
management's estimates. The Company believes it has meritorious defenses in all
pending cases and will vigorously defend against the plaintiffs' claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Market Price of and Dividends on the Common Stock
At March 7, 2003, there were 5,529 holders of record (including brokerage
firms and other nominees) of the Company's common stock, which is listed on the
New York Stock Exchange under the symbol "PPD." The following table sets forth,
for the periods indicated, the range of high and low sales prices for the common
stock, as reported by the New York Stock Exchange.
High Low
2003:
1st Quarter (through March 7).. ..................... $ 26.80 $ 15.87
2002:
4th Quarter ......................................... $ 30.49 $ 17.04
3rd Quarter.......................................... 24.29 16.68
2nd Quarter...................... .................. 30.45 18.50
1st Quarter.......................................... 31.75 18.76
2001:
4th Quarter.......................................... $ 22.25 $ 15.05
3rd Quarter........................ ................. 22.48 15.80
2nd Quarter.......................................... 24.75 10.04
1st Quarter.......................................... 28.63 10.05
The Company has never declared a cash dividend on its common stock. For the
foreseeable future, it is anticipated that earnings generated from the
operations of the Company will be used to finance the Company's growth and to
purchase shares of its stock and that cash dividends will not be paid to holders
of the common stock. Additionally, the Company has lines of credit with Bank of
Oklahoma, N.A. as described in "Management's Discussion and Analysis - Liquidity
and Capital Resources," which prohibit payment of cash dividends on its common
stock. Any decision by the Board of Directors of the Company to pay cash
dividends in the future will depend upon, among other factors, the Company's
earnings, financial condition, capital requirements and approval from its
lender. In addition, the Company's ability to pay dividends is dependent in part
on its ability to derive dividends from its subsidiaries. The payment of
dividends by PPLCI is restricted under the Oklahoma Insurance Code to available
surplus funds derived from realized net profits and requires the approval of the
Oklahoma Insurance Commissioner for any dividend representing more than 10% of
such accumulated available surplus or an amount representing more than the
previous years' net profits. During 2002 and 2001, PPLCI declared a $6 million
and a $5 million dividend payable to the Company. Both the 2001 and 2002
dividends were paid during 2002. Additionally, during 2001, the Company received
a $2.8 million dividend from UFL after receiving all necessary regulatory
approvals. PPLSIF is similarly restricted pursuant to the insurance laws of
Florida. At December 31, 2002, PPLSIF did not have funds available for payment
of substantial dividends without the prior approval of the insurance
commissioner while PPLCI had approximately $3.5 million in surplus funds
available for payment of an ordinary dividend in December 2003. At December 31,
2002 the amount of restricted net assets of consolidated subsidiaries was $11.2
million.
Recent Sales of Unregistered Securities
None.
Equity Compensation Plans
The following table provides information with respect to the Company's
equity compensation plans as of December 31, 2002, (other than its tax qualified
Employee Stock Ownership Plan designed to provide retirement benefits).
Number of securities
remaining available for
Number of securities future issuance under
to be issued upon Weighted average equity compensation
exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected in
warrants and rights warrants and rights column (a))
Plan Category ----------------------- -------------------- -------------------------
(a) (b) (c)
Equity compensation plans approved by
security holders (1)................. 1,192,752 $26.69 15,250 (1)
Equity compensation plans not approved
by security holders (2).............. 305,640 23.72 - (2)
----------------------- -------------------- -------------------------
Total.................................. 1,498,392 $26.09 15,250
----------------------- -------------------- -------------------------
- -----------
(1) These stock options have been issued pursuant to the Company's Stock Option
Plan which has been approved by security holders. At the Company's next
Annual Meeting of Shareholders on May 29, 2003, the Company expects to ask
security holders to approve the amendment of the Company's Stock Option
Plan to increase the maximum number of shares of Common Stock in respect of
which options may be granted under the Stock Option Plan from 2,000,000
shares to 3,000,000 shares.
(2) These stock options have been issued to the Company's Regional Vice
Presidents ("RVPs") (described above) in order to encourage stock ownership
by its RVPs and to increase the proprietary interest of such persons in its
growth and financial success. These options have been granted periodically
to RVPs since 1996. Options are granted at fair market value at the date of
the grant and are generally immediately exercisable for a period of three
years or within 90 days of termination, whichever occurs first. There were
244,679, 131,288 and 90,892 total options granted to RVPs in the years
ended December 31, 2002, 2001 and 2000, respectively. The Company has not
adopted any limit for the number of options that may be granted to RVPs.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial and statistical data for
the Company as of the dates and for the periods indicated. As a result of the
1998 fourth quarter acquisition of TPN, Inc. ("TPN") that was accounted for as a
pooling of interests, the 1998 period has been restated to include the operating
results of TPN. This information is not necessarily indicative of the Company's
future performance. The following information should be read in conjunction with
the Company's Consolidated Financial Statements and Notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operation included elsewhere herein.
Year Ended December 31,
------------------------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
Income Statement Data: (In thousands, except ratio, per share and Membership amounts)
Revenues:
Membership fees...................................... $ 308,401 $ 263,514 $ 211,763 $ 153,918 $ 107,393
Associate services................................... 37,418 36,485 30,372 22,816 17,255
Product sales (2).................................... - 60 1,016 5,888 27,779
Other................................................ 4,804 3,602 3,232 3,809 2,901
---------- ---------- ---------- ---------- ----------
Total revenues..................................... 350,623 303,661 246,383 186,431 155,328
---------- ---------- ---------- ---------- ----------
Costs and expenses:
Membership benefits.................................. 103,761 87,429 69,513 51,089 35,465
Commissions.......................................... 119,371 111,060 96,614 74,333 50,652
Associate services and direct marketing.............. 32,566 29,879 23,251 15,815 14,738
General and administrative expenses.................. 33,256 28,243 21,524 19,280 21,902
Product costs (2).................................... - 33 675 4,174 17,967
Other, net........................................... 6,685 5,884 4,403 3,226 2,152
---------- ---------- ---------- ---------- ----------
Total costs and expenses........................... 295,639 262,528 215,980 167,917 142,876
---------- ---------- ---------- ---------- ----------
Income from continuing operations before income taxes and
cumulative effect of change in accounting principle.... 54,984 41,133 30,403 18,514 12,452
Provision for income taxes............................. 18,970 13,519 9,550 6,480 1,013
---------- ---------- ---------- ---------- ----------
Income from continuing operations before cumulative
effect of change in accounting principle............. 36,014 27,614 20,853 12,034 11,439
Income (loss) from operations of discontinued UFL segment
(net of applicable income tax benefit (expense) of
$0, $387 and ($444) for years 2001, 2000 and 1999,
respectively)........................................ - (504) 649 826 -
---------- ---------- ---------- ---------- ----------
Income before cumulative effect of change in accounting
principle............................................ 36,014 27,110 21,502 12,860 11,439
Cumulative effect of adoption of SAB 101 (net of
applicable income tax benefit of $546)............... - - (1,013) - -
---------- ---------- ---------- ---------- ----------
Net income............................................... 36,014 27,110 20,489 12,860 11,439
Less dividends on preferred shares..................... - - 4 10 10
---------- ---------- ---------- ---------- ----------
Net income applicable to common stockholders............. $ 36,014 $ 27,110 $ 20,485 $ 12,850 $ 11,429
---------- ---------- ---------- ---------- ----------
Basic earnings per common share from continuing operations
before cumulative effect of accounting change ......... $ 1.83 $ 1.28 $ .93 $ .52 $ .49
Basic earnings per common share from discontinued operations - (.02) .03 .04 -
---------- ---------- ---------- ---------- ----------
Basic earnings per common share before cumulative effect of
change in accounting principle....................... 1.83 1.26 .96 .56 .49
Cumulative effect of adoption of SAB 101................. - - (.05) - -
---------- ---------- ---------- ---------- ----------
Basic earnings per common share.......................... $ 1.83 $ 1.26 $ .91 $ .56 $ .49
---------- ---------- ---------- ---------- ----------
Diluted earnings per common share from continuing
operations before cumulative effect of accounting change $ 1.82 $ 1.28 $ .92 $ .51 $ .48
Diluted earnings per common share from discontinued
operations........................................... - (.02) .03 .04 -
---------- ---------- ---------- ---------- ----------
Diluted earnings per common share before cumulative
effect of accounting change.......................... 1.82 1.26 .95 .55 .48
Cumulative effect of adoption of SAB 101................. - - (.05) - -
---------- ---------- ---------- ---------- ----------
Diluted earnings per common share........................ $ 1.82 $ 1.26 $ .90 $ .55 $ .48
---------- ---------- ---------- ---------- ----------
Pro forma amounts assuming adoption of SAB 101 is retroactively applied:
Net income...................................................................... $ 21,502 $ 12,786 $ 11,155
Basic earnings per common share................................................. $ .96 $ .55 $ .48
Diluted earnings per common share............................................... $ .95 $ .55 $ .47
Weighted average number of common shares
outstanding - basic.................................. 19,674 21,504 22,504 23,099 23,456
Weighted average number of common shares
outstanding - diluted................................ 19,764 21,544 22,679 23,374 23,906
Membership Benefit Cost and Statistical Data:
Membership benefits ratio (1).......................... 33.6% 33.2% 32.8% 33.2% 33.0%
Commissions ratio (1).................................. 38.7% 42.1% 45.6% 48.3% 47.2%
General & administrative expense ratio (1)............. 10.8% 10.7% 10.2% 12.5% 20.4%
Product cost ratio (1)................................. - 55.0% 66.4% 70.9% 64.7%
Commission cost per new Membership sold................ $ 154 $ 152 $ 144 $ 141 $ 129
New Memberships sold................................... 773,767 728,295 670,118 525,352 391,827
Period end Memberships in force........................ 1,382,306 1,242,908 1,064,805 827,979 603,017
Cash Flow Data:
Net cash provided by continuing operating activities..... $ 52,073 $ 37,801 $ 23,201 $ 17,031 $ 11,295
Net cash (used in) provided by continuing investing
activities............................................ (11,074) (6,963) (7,965) 12,070 (33,531)
Net cash (used in) provided by continuing financing
activities............................................ (34,431) (27,414) (13,714) (26,687) 1,444
Balance Sheet Data:
Total assets........................................... $ 96,836 $ 85,720 $ 77,766 $ 58,156 $ 68,789
Total liabilities...................................... 61,864 43,496 35,999 25,518 23,218
Stockholders' equity .................................. 34,972 42,224 41,767 32,638 45,571
- -----------
(1) The Membership benefits ratio, the commissions ratio and the general and
administrative expense ratio represent those costs as a percentage of
Membership fees. The product cost ratio represents product costs as a
percentage of product sales for those years in which the Company sold
products. These ratios do not measure total profitability because they do
not take into account all revenues and expenses.
(2) During the fourth quarter of 1998, the Company completed the acquisition of
TPN. Since its inception in late 1994, TPN had marketed personal and home
care products, personal development products and services together with
PRIMESTAR(R) satellite subscription television service to its members
through a network marketing sales force. Product sales declined and were
eventually eliminated following the TPN acquisition due to the
concentration on Membership sales as opposed to the sale of goods and
services.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
Critical Accounting Policies
The Company's financial statements and accompanying notes are prepared in
accordance with accounting principles generally accepted in the United States of
America. Preparing financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses. These estimates and assumptions are affected by
management's application of accounting policies. If these estimates or
assumptions are incorrect, there could be a material change in the Company's
financial condition or operating results. Many of these "critical accounting
policies" are common in the insurance and financial services industries; others
are specific to the Company's businesses and operations. The Company's critical
accounting policies include revenue recognition related to membership and
associate fees, deferral of membership and associate related costs, accrual of
membership benefits liability, expense recognition related to commissions to
associates and accounting for legal contingencies.
Revenue recognition - Membership and Associate Fees
The Company's principal revenues are derived from Membership fees, most of
which are collected on a monthly basis. Memberships are generally guaranteed
renewable and non-cancelable except for fraud, non-payment of Membership fees or
upon written request. Membership fees are recognized in income ratably over the
related service period in accordance with Membership terms, which generally
require the holder of the Membership to remit fees on an annual, semi-annual or
monthly basis. Approximately 95% of members remit their Membership fees on a
monthly basis, of which approximately 71% are paid in advance and, therefore,
are deferred and recognized over the following month.
The Company also charges new members, who are not part of an employee
group, a $10 enrollment fee. This enrollment fee and related incremental direct
and origination costs are deferred and recognized in income over the estimated
life of a Membership in accordance with SEC Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements," ("SAB 101"). The Company computes
the expected Membership life using over 20 years of actuarial data as explained
in more detail in the Measures of Membership Retention section of MD&A. At
December 31, 2002, management computed the expected Membership life to be
approximately 3 years. If the expected membership life were to change
significantly, which management does not expect in the short term, the deferred
Membership enrollment fee and related costs would be recognized over a longer or
shorter period.
The Company derives revenues from services provided to its marketing sales
force from a one-time non-refundable enrollment fee of $65 from each new sales
associate for which the Company provides initial sales and marketing supplies
and enrollment services to the associate. Revenue from, and costs of, the
initial sales and marketing supplies (approximately $11) are recognized when the
materials are delivered to the associates. The remaining $54 of revenues and
related incremental direct and origination costs are deferred and recognized
over the estimated average active service period of associates which at December
31, 2002 is estimated to be approximately six months. Management estimates the
active service period of an associate periodically based on the average number
of months an associate produces new Memberships including those associates that
fail to write any Memberships. If the active service period of associates
changes significantly, the deferred revenue and related costs will be recognized
over the new estimated active service period.
The Company also encourages participation in a training program ("Fast
Start") that allows an associate who successfully completes the program to
advance through the various commission levels at a faster rate. Associates
participating in this training program typically pay a fee ranging from $34 to
$184, depending on special promotions the Company implements from time to time.
The fee covers the additional training and materials used in the training
program, and is recognized in income upon completion of the training. Associate
services also includes revenue recognized on the sale of marketing supplies and
promotional material to associates and includes fees related to the Company's
eService program for associates. The eService program provides subscribers
Internet based back office support such as reports, on-line documents, tools, a
personal email account and up to three personalized web sites with "flash" movie
presentations.
Member and Associate Costs
Deferred costs represent the incremental direct and origination costs the
Company incurs in enrolling new Members and new associates related to the
deferred revenue discussed above, and that portion of payments made to provider
law firms and associates related to deferred Membership revenue. Deferred costs
for enrolling new members include the cost of the Membership kit and salary and
benefit costs for employees who process Membership enrollments. Deferred costs
for enrolling new associates include training and success bonuses paid to
individuals involved in recruiting the associate and salary and benefit costs of
employees who process associate enrollments. Such costs are deferred to the
extent of the lesser of actual costs incurred or the amount of the related fee
charged for such services. Deferred costs are amortized to expense over the same
period as the related deferred revenue as discussed above. Deferred costs that
will be recognized within one year of the balance sheet date are classified as
current and all remaining deferred costs are considered noncurrent. Associate
related costs are reflected as associate services and direct marketing, and are
expensed as incurred if not related to the deferred revenue discussed above.
These costs include providing materials and services to associates, Fast Start
bonuses, associate introduction kits, the associate incentive program, group
marketing and marketing services departments (including costs of related travel,
marketing events, leadership summits and international sales convention).
Membership Benefits Liability
Approximately 99% of active Memberships at December 31, 2002 have benefits
delivered by a designated provider law firm with whom the Company has arranged
for the services to be provided in a particular geographic area, typically a
state or province. Provider law firms receive a fixed monthly payment for each
member in their service area and are responsible for providing the Membership
benefits without additional remuneration. The fixed cost aspect of this
arrangement provides significant advantages to the Company in managing its
claims risk. Amounts due the provider law firms at period end under these
"capitated" agreements are included in the Membership benefits liability.
Membership benefit costs relating to non-provider Memberships ("open panel"
Memberships primarily sold prior to 1987 or Memberships in states where a
provider law firm is not in place), which constituted approximately 1% of
Memberships in force at December 31, 2002, are based on the usual, reasonable
and customary fee for providing the required services. Such costs are generally
paid on a current basis, as most costs are certain in amount and require only
limited investigation. The Company maintains a reserve for estimated incurred
but not reported open panel Membership benefit costs as well as costs which are
in the payment process. These reserves, which are recorded in the Membership
benefits liability, are reviewed annually by an independent actuary as necessary
in conjunction with the preparation and filing of financial statements and other
reports with various state insurance regulatory authorities. Underwriting risks
associated with the open panel Memberships are managed primarily through
contractual benefit limitations and, as a result, underwriting decisions are not
necessarily based on individual Membership purchases.
Commissions to Associates
Beginning with new Memberships written after March 1, 1995, the Company
implemented a level commission schedule (approximately 27% per annum at December
31, 2001) with up to a three-year advance commission payment. Prior to March 1,
1995, the Company's commission program provided for advance commission payments
to associates of approximately 70% of first year Membership premiums on new
Membership sales and commissions were earned by the associate at a rate of
approximately 16% in all subsequent years. Effective March 1, 2002, and in order
to offer additional incentives for increased Membership retention rates, the
Company returned to a differential commission structure with rates of
approximately 80% of first year Membership premiums on new Memberships written
and variable renewal commission rates ranging from five to 25% per annum based
on the first 12 month Membership retention rate of the associate's personal
sales and those of his organization. Prior to March 1, 2002, the Company had a
level Membership commission schedule of approximately 27% of Membership fees,
with up to a three-year advance commission payment on new Membership sales.
Prior to January 1997 the Company advanced commissions at the time of sale
of all new Memberships. In January 1997, the Company implemented a policy
whereby the associate receives only earned commissions on the first three sales
unless the associate has successfully completed the Fast Start training program.
For all sales beginning with the fourth Membership or all sales made by an
associate successfully completing the Fast Start training program, the Company
currently advances commission payments at the time of sale of a new Membership.
The amount of cash potentially advanced upon the sale of a new Membership, prior
to the recoupment of any charge-backs (described below), represents an amount
equal to up to one-year commission earnings. Although the average number of
marketing associates receiving an advance commission payment on a new Membership
is 18, the overall initial advance may be paid to more than thirty different
individuals, each at a different level within the overall commission structure.
The commission advance immediately increases an associate's unearned advance
commission balance to the Company.
Although the Company, prior to March 1, 2002, advanced its sales associates
up to three years commission when a membership is sold and subsequent to March
1, 2002, up to one years commission, the average commission advance paid to its
sales associates as a group is actually less than the maximum amount possible
because some associates choose to receive less than a full advance and the
Company pays less than a full advance on some of its specialty products. In
addition, the Company may from time to time place associates on a less than full
advance basis if there are problems with the quality of the business being
submitted or other performance problems with an associate. Also, any residual
commissions due an associate (defined as commission on an individual membership
after the advance has been earned) are retained to reduce any remaining unearned
commission advance balances prior to being paid to that sales associate. The
commission cost per new Membership sold has increased over each of the last
three years by 1%, 6% and 2% for 2002, 2001 and 2000, respectively, and varies
depending on the compensation structure that is in place at the time a new
membership is sold and the amount of any charge-backs (recoupment of previous
commission advances) that are deducted from amounts that would otherwise be paid
to the various sales associates that are compensated for the membership sale.
Should the Company add additional commissions to its compensation plan or reduce
the amount of chargebacks collected from its associates, the commission cost per
new Membership will increase accordingly. The average commission advance in 2002
for the period subsequent to March 1, 2002 was 0.77 years and for the period
prior to March 1, 2002 was 2.06 years compared to the 2001 and 2000 averages of
approximately 2.18 years and 2.31 years, respectively.
The Company expenses advance commissions ratably over the first month of
the related membership. As a result of this accounting policy, the Company's
commission expenses are all recognized over the first month of a Membership and
there is no commission expense recognized for the same Membership during the
remainder of the advance period. The Company tracks its unearned advance
commission balances outstanding in order to ensure the advance commissions are
recovered before any renewal commissions are paid and for internal purposes of
analyzing its commission advance program. While not recorded as an asset,
unearned advance commission balances from associates for the following years
ended December 31 were:
2002 2001 2000
---- ---- ----
(Amounts in 000's)
Beginning unearned advance commission balances (1)............... $ 211,609 $ 167,193 $ 125,257
Advance commissions, net......................................... 118,917 110,211 97,500
Earned commissions applied....................................... (101,030) (63,870) (48,255)
Advance commission write-offs (2)................................ (2,412) (1,925) (7,309)
----------- ----------- -----------
Ending unearned advance commission balances before estimated
unrecoverable balances (1)..................................... 227,084 211,609 167,193
Estimated unrecoverable advance commission balances (1)(3)....... (25,156) (15,868) (11,055)
----------- ----------- -----------
Ending unearned advance commission balances, net (1)............. $ 201,928 $ 195,741 $ 156,138
----------- ----------- -----------
(1) These amounts do not represent fair value, as they do not take into
consideration timing of estimated recoveries.
(2) In 2000, the Company began writing off unearned advanced commission
balances rather than increasing the estimated unrecoverable balance when
the associate had no remaining active memberships since the associate would
no longer have any future commission earnings.
(3) Estimated unrecoverable advances increased as a percentage of ending
advances from 7% at December 31, 2001 to 11% at December 31, 2002 due to
the change in the compensation structure described above from a 36-month
possible advance to a 12-month possible advance. This change allows the
advances to be earned more quickly by the associate so the increase in
advances before estimated unrecoverable balances increased 7% from 2001 to
2002 compared to an increase of 27% from 2000 to 2001.
The ending unearned advance commission balances, net, above includes net
unearned advance commission balances of non-vested associates of $26.0 million,
$20.0 million and $14.2 million at December 31, 2002, 2001 and 2000,
respectively. As such, at December 31, 2002 future commissions and related
expense will be reduced as unearned advance commission balances of $175.9
million are recovered. Commissions are earned by the associate as Membership
premiums are earned by the Company, usually on a monthly basis. The Company
reduces unearned advance commission balances or remits payment to an associate,
as appropriate, when commissions are earned. Should a Membership lapse before
the advances have been recovered for each commission level, the Company
generates an immediate "charge-back" to the applicable sales associate to
recapture up to 50% of any unearned advance on Memberships written prior to
March 1, 2002, and 100% on any Memberships written thereafter. This charge-back
is deducted from any future advances that would otherwise be payable to the
associate for additional new Memberships. In order to encourage additional
Membership sales, the Company waived chargebacks for associates that met certain
criteria in December 2002 and March 2003, which effectively increases the
Company's commission expense. Any remaining unearned advance commission balance
may be recovered by withholding future residual earned commissions due to an
active associate on active Memberships. Additionally, even though a commission
advance may have been fully recovered on a particular Membership, no additional
commission earnings from any Membership are paid to an associate until all
previous advances on all Memberships, both active and lapsed, have been
recovered. The Company also has reduced chargebacks from 100% to 50% for certain
senior marketing associates who have demonstrated the ability to maintain
certain levels of sales over specified periods. The Company may adjust
chargebacks from time to time in the future in order to encourage certain
production incentives.
Prior to March 1, 2002, the Company charged associates a fee on unearned
advance commission balances relating to lapsed Memberships ("Membership lapse
fee"). The fee that was recorded on the associates unearned commission balance
was determined by applying the prime interest rate to the unearned advance
commission balance pertaining to lapsed Memberships. The Company realized and
recognized this fee only when the amount of the calculated fee was collected by
withholding from cash commission payments due the associate. The fees collected
reduced commission expense. The Company's ability to recover these fees was
primarily dependant on the associate selling new Memberships, which qualify for
commission advances. The Company eliminated the Membership lapse fee for
Memberships sold after March 1, 2002 in conjunction with the change in the
commission structure described above.
The Company has the contractual right to require associates to repay
unearned advance commission balances from sources other than earned commissions
including cash (a) from all associates either (i) upon termination of the
associate relationship, which includes but is not limited to when an associate
becomes non-vested or (ii) when it is ascertained that earned commissions are
insufficient to repay the unearned advance commission payments and (b) upon
demand, from agencies or associates who are parties to the associate agreements
signed between October 1989 and July 1992 or July 1992 to August 1998,
respectively. The sources, other than earned commissions, that may be available
to recover associate unearned advance commission balances are potentially
subject to limitation based on applicable state laws relating to creditors'
rights generally. Historically, the Company has not demanded repayments of the
unearned advance commission balances from associates, including terminated
associates, because collection efforts would likely increase costs and have the
potential to disrupt the Company's relationships with its sales associates. This
business decision by the Company has a significant effect on the Company's cash
flow by electing to defer collection of advance payments of which approximately
$25.2 million were not expected to be collected from future commissions at
December 31, 2002. However, the Company regularly reviews the unearned advance
commission balance status of associates and will exercise its right to require
associates to repay advances when management believes that such action is
appropriate.
Non-vested associates are those that are no longer "vested" because they
fail to meet the Company's established vesting requirements by selling at least
t