Pre-Paid Legal Services, Inc. (NYSE:PPD)
Q3 2009 Earnings Call
October 28, 2009 8:30 am ET
Randy Harp - COO
Steve Williamson - CFO
Welcome to the Pre-Paid Legal Services third quarter earnings results conference. Today’s conference is being recorded. A replay of this call will be available starting today, October 28, 2009 at 10:30 a.m. CT and end on November 4, 2009 at 11:59 a.m. CT. (Operator Instructions) At this time, I would like to turn the call over to Mr. Randy Harp. Please go ahead sir.
Thank you. Good morning. This is Randy Harp, Chief Operating Officer of the company. I want to welcome you to the 2009 third quarter earnings call for Pre-Paid Legal Services, Inc. Joining me here at our home office in Ada, Oklahoma is Steve Williamson, our Chief Financial Officer.
Before we begin, I want to remind everybody that the conference call will contain forward-looking statements including our expectations of future results and our future plans. Actual results might differ materially from those projected in any such forward-looking statement.
Additional information concerning risk factors that could cause the results to differ materially from any forward-looking statements are contained in our press release announcing these earnings, as well as from disclosures in our public reports on Forms 10-K, 10-Q, 8-K, etc., filed with the SEC and are available on the SEC Edgar website as well as our own website.
At this time, I would ask our Chief Financial Officer, Steve Williamson to step through some of the more significant financial highlights for the third quarter of 2009. Steve?
Thanks Randy. I will first just kind of hit the big picture point of view. We had total revenue for the third quarter of 2009 compared to 2008 at about $2.6 million down. The expenses were up about $1 million which netted us to about a $3.6 million or 25% decrease in net income with 7% fewer shares. The diluted earnings per share was down 20%. Of course, and I will explain this more, the reason for that decline was primarily due to the increased new membership sales that we had.
On a sequential basis, membership fees were virtually unchanged. A big improvement from the prior two quarters where we saw 2 million and 1.4 million sequential declines in membership fees. So we have moved up that membership base and are looking forward to getting back to the growth curve.
Stepping into the numbers, third quarter 2009 membership fees decreased 4% over the third quarter of 2008 due to the decrease in average premiums we had in force. Associate services revenue increased $1.7 million due to the big increase we have had in new recruits. That is partially offset by a decrease in e-service fees for the quarter.
New recruits were up 99% to 75,400. They came in at an average entry price of $70. That compares to the prior year’s quarter of about 37,800 associates that came in at an average fee of $56. Other revenue declined $81,000. That is the amortization of the $10 enrollment fee we bring into revenue over a three-year period, the average life of new membership. Third quarter benefits came in at a decrease of 4.2% compared to the third quarter 2008 levels. That is a larger decrease than the 3.5% decline in membership fees that we saw. The decline or increased decline is due to the accrual payment we had reduced by $0.25 per month that began sharing of reductions. One of which was on January of 2009. We have one more in January 2010 to go which we will see another $0.25 per member, per month decline in our costs for the Identity Theft memberships.
The benefit ratio was 34.1% this quarter compared to last year’s third quarter of 34.4%. Commissions increased 9% due to a 21% increase in new memberships sold. Commissions didn’t increase by the same percentage of new membership sales primarily due to higher levels of reinstated members which received a smaller advance and also an increase in deferred commissions. You will recall from previous conference calls that we defer half of the commissions paid in the last quarter or the last month of any quarter which equates to that one month amortization of those commission payments. Given the higher levels of production, we had higher levels of production in September of 2009 than we did in 2008, which effectively pushes back, if you will, some of the expenses into the next quarter.
Commissions per member came in at $23 decrease per member down to $210. Associate services costs were up $2.5 million primarily due to increased fast-start bonus payments as our associates were qualifying at a higher rate. Marketing service costs were also up but we did see a decline in the player’s club expenses.
On G&A, virtually unchanged and represented 12% of membership fees for the third quarter 2009, unchanged from a sequential standpoint. From a year-over-year standpoint in referencing 12% of membership fees this quarter compared to 12.5% in the 2008 quarter. The G&A ratio decline was primarily due to decreases in employee costs and legal fees that were partially offset by increases in bank service fees which the bank service fee increase is driven just primarily by the increased levels of payments we collected and the associated cost to collect those for the credit card fees and ACH fees.
We also saw increases in consulting fees although a sub-set of those as we have talked about before is the PCI Consulting fees and these were all year-over-year changes. On a sequential basis, we did as we have talked about in previous quarters, we did see a decline in the consulting fees associated with our PCI efforts as we extended those efforts out over a longer period of time to lessen the burden.
Other expenses decreased $682,000 primarily because of the reduced interest expense which has lower debt levels and also lower interest rates. Provisions for taxes were about 41% for both quarters. A little higher sequentially as we completed our state income tax returns during the third quarter and evaluated the accrual associated with that. Some of the states have changed the methodology you go through to calculate the taxes. A lot of them do different factors but effectively it increased our state tax burden due to some new state tax laws that were put in place during 2008 and we built that into our accrual for this quarter that pushed that up.
Net income was down 25% to $10.8 million. As I talked about before, we had a 7% decrease in diluted shares outstanding that resulted in diluted EPS being down 20% or $0.24 per share as it came in at $0.99. Cash flow was $12.8 million for 2009 versus $16.7 million for 2008, down $3.8 million primarily due to the reduced membership fees. We purchased during the quarter around 16,000 shares at an average price of $48.62. At 10/20/09 our shares outstanding were 10.952 million shares. Cash and cash equivalents at the end of the quarter were $73.5 million. That is the unpledged portion versus debt of $41.8 million.
Our quarterly debt payments we have, the principal portion is about $4.6 million per quarter. Our average interest rate, all of it is tied to LIBOR, all of our debt is. Two pieces at LIBOR plus 150, one at LIBOR plus 89. This equates to an average of about LIBOR plus 140 that gives us an average pre-tax interest rate cost of 1.69. We are in compliance with all of our debt covenants. The most restrictive of those debt covenants that we have that says how much cash we can use to buy back shares shows around $26 million we have available we could use for our buyback program and we will be making open market purchases again today, continuing our long standing buyback program.
With that I will turn it back over to you, Randy.
Thanks Steve. Another quarter of our reporting model continues to I think reflect what we have told you to expect in that higher current production will lead to lower current earnings. The more significant earnings increase is to our active base then the more significant the impact is to our current earnings. So a nice increase in premiums written on the membership side.
Question and Answer Session
Now I want to respond to email questions that we have received that Steve hasn’t previously addressed this morning or that have been addressed in our public filings. Again, I will read the questions and Steve and I will do our best to answer those.
Reading these in the order they were received, the first one is “very few shares bought back for the second quarter in a row. It certainly appears to be a policy change or something else. Please explain. The explanation at the end of the second quarter just does not seem logical, two quarters in a row after the last 10 years of activity.”
I think I answered it last time. There is a lot of factors that we consider when we decide whether or not we are going to buy back shares. I think I highlighted some of those in previous quarters. Those include just our own business metrics, the level of cancellations, the level of production, are we growing or not, as well as some big picture things like the economy. Of course the price of the shares. In explaining the reason we kind of backed off, if you will, in some of the results for the second quarter and third quarter which had 13.3 and 15.7 thousand shares purchased respectively, we saw a pretty quick increase in the price once we announced the first quarter earnings. We decided to kind of back off when it started running.
The other reason is, if you look at the cancellation trends we have had, we did have like a lot of other folks when the world seemed to be afraid everything was coming to an end, higher cancellation rates. Certainly in the first quarter and the second quarter. I am glad to report that the results that we saw in the third quarter were very good. We came in a little bit less than 136,000 cancellations. So that certainly is one factor that has helped a lot. We have got more production. We grew the membership base by almost 40,000 memberships during the third quarter. So I just have to say there is a lot of things different this quarter that puts us in a position where we feel much better about getting out in the market place and that is we are going to do.
Suffice it to say we think every purchase we have ever made has been accretive for shareholders but more clearly accretive when the stock is in the mid 30’s as it was in the first quarter versus the higher average V we have seen in the second and third quarters.
So next question, are loans and balloon payments coming due? If so do you expect to pay down or refinance terms?
At this time what we have is the Treasury stock buyback notes that we had with Wells and a group of banks. It started out at a total of $80 million which we funded with $75 million and are making payments of $1.250 million per month and have amortized that down and would expect to continue to do that. On the building, though, it does have monthly payments of $190,000 and it has a balloon payment in August of 2011. On the equipment financing, the one at LIBOR plus 0.89, that one doesn’t come due, it is a 10-year note, about $80,000 per month principal payments and we expect to amortize that one out.
It is kind of hard in my mind to accelerate the payments on these when the cost of funds, as you can see we have more interest income than we have interest expense. It is pretty inexpensive debt. We are compliant on our certificates we have to file and abide by are not too onerous in any of the items, we have the ability to use 100% of our excess cash flow. So a really good set of documents we have to work with and debt covenants. Don’t expect to pay them off early depending on market prices and our appetite for shares and our ability to use the existing cash we have on the balance sheet right now we may consider additional financing but at this time we are certainly not working on anything like that.
Suffice it to say if refinance terms were different than we are currently on we absolutely would not refinance. We are sitting on $70 million plus of unpledged cash and equipment and $41 million of cash and investments.
Certainly the important [place] has changed. The timing when we renegotiated, you may recall, we had a provision in our debt covenant that allowed us to use 50% of our excess cash and we were priced at LIBOR plus 250. We renegotiated that a year ago or so. A little over a year ago. The timing, we were lucky. We weren’t prophetic, we just got lucky on timing. Then we have a great set of documents as far as the rate and compliance. Those deals aren’t out there anymore as everybody knows on this call. So it is hard for us to go out and reprice $40 million worth of debt considerably higher especially given the fact that we have a lot of cash in hand. So if we can get another deal like this I would tell you we would probably do it. But these deals are gone.
Next question. “When did the company first become aware of the SEC interest and what are they specifically looking at today after all this time has passed?”
I will actually address the timing in just a moment. Let me read the rest of the question.
“Did the company actually consult with law firms along the way on the whole buyback program? Did the company specifically consult with outside council regarding the purchase of Mr. Smith’s shares last winter?”
The answer is definitively yes on both of those. Our SEC law firm has been doing our work for 30 plus years now. They have drafted all of the documents that have been utilized in any of the share repurchases; all the board of director authorizations, etc. We did enter into a special letter agreement in regard to the purchase of Mr. Smith’s shares back in January of this year.
“What is the current new internet marketing program achieving to date?”
Assuming they are talking about our relationship with Blast Off Networks. I can tell you it has created a lot of excitement. Officially, Pizza Hut kicked off their cooperative marketing program with Blast Off yesterday so if you go to PizzaHut.com you will also see the Blast Off platform prominently highlighted and again, our whole focus on this was to expose more people to our company and our suite of products. We can certainly tell you there has been a lot of activity as it relates to Blast Off.
We have had over 100,000 sales associates that have set up their Blast Off accounts. Another 75,000 people have signed up. So we are approaching 200,000 people that have signed up. Again, it is free. Emails sent. Invitations sent, if you will, approaching 2.9 million last night. We believe that platform is certainly going to continue to expand very rapidly. We are excited about the co-marketing effort that Pizza Hut brings to the table and thing that Blast Off will continue to be growing at a very rapid pace.
How many new associates do we have? How many new members do we have that specifically came about as a result of Blast Off, we don’t have the ability to really delineate that. Any time we can have excitement and activity in the field and we have people out talking about our company and our product good things are going to happen to us. I think we saw that with the 21% increase in new business written in the third quarter. Part of that for certain was attributable to kicking off the joint marketing effort with Blast Off. Part of it was also due to some bonus activity, especially in August.
So we continue to be very excited about the relationship with Blast Off and expect more third party, credible companies such as Pizza Hut to continue to utilize that platform and I think it bodes well for all of us.
“Regarding a quote from Steve Williamson, our CFO, on the second quarter conference call can you explain more fully what you meant by non-market purchases of your stock from folks who have physical stock certificates? Are these purchases documented in the 10-Q and how large were they? “
Steve you might just recap kind of the three buckets of share repurchases we have done for a long time.
I think we started these back in 2006 as a way for the most part these are virtually 98% of these transactions are small in nature. We have an Associate Investment Club that allows associates that want to purchase shares through this Associate Investment Club they can set up an ACH payment that comes into the Associate Investment Club and they acquire these shares. One transaction per month, they aggregate all the dollars and it kind of lessens the burden, or the cost if you will, of those transactions to the associates. Then when they want to divest of their stock we have a form they sign and we actually purchase those shares from them based on closing market price. That is one bucket.
The next bucket are individuals that have physical stock certificates. Again, this is on the backdrop of 10 years worth of buying shares. We had a lot of individuals that held physical stock certificates, most of them small and dated. They were older stock certificates. They had a desire to sell and we were sending them to stock brokers and finally thought well we really ought to try and help these folks out. We are in the market buying shares on a regular basis. Why don’t we set up a form they can sign. They go through all the notarization and we buy those as well. So that is the second bucket.
The third is the employees that participate in our 401K plan that choose to diversify. Again, the stock certificates are done all at the closing market price. The last is the 401K purchases which in the same theory it allows them to sell the shares at market price without any commission.
The whole tenor or the reason for the transactions were to help the shareholders so they could get rid of these because a lot of brokers didn’t want to process a two-share. We have a lot of single digit transactions and I can understand that doesn’t fit their model very well.
The last question, are these purchase documents in the 10-Q and how large are they? Yes, they are documented in the 10-Q. You see Item 2, Issuer Purchases of Equity Securities and detail those. The last two quarters you can look at that detail. We break it down by month showing the number of shares and the average price. We were not making open market purchases in the second and third quarter so you can get a feel for what the average is as far as the dollar amount and number of shares we have purchased from these three different groups. All of our purchases have always been summarized in our…
The Associate Investment Club has been around 30 years, or certainly 25 plus years, longer than I have been around. All of our stock repurchases, every stock repurchase has been documented in 10 years worth of 10-Q’s, 10 years worth of quarterly production releases and 10 years of quarterly earnings releases. Not even counting all the earnings conference calls such as the one we are participating on now we have talked about share repurchases on each of those.
“I am curious if at all the inquiry by the SECs Division of Enforcement and Division of Corp Fin has affected the share buyback program? Have you continued to buy shares since these developments? Has the SEC said it is okay for you to continue with the program even as they examine it?”
Certainly we have visited with our SEC counsel, two different folks, and they feel like we are certainly in a position to continue to buy. We were in a blackout period up until today so our open market purchases can begin after this earnings call today. So we will be in the market again today. The non-market transactions, the three different buckets that were referred to before are not impacted by that. We have continued to make those purchases.
No, the SEC hasn’t said it is okay and we haven’t asked for that and don’t expect to receive that assurance from them. The rules are very specific. As long as we keep the investing public informed, which we did in the press release relative to the Division of Enforcement and the Corp. Fin Division then we have talked to counsel and we feel very good about moving forward with the purchase program.
“The recent quarter was your best in a long time regarding new membership sales and recruiting. Given the overall difficult economic environment what factors do you believe caused the increase in production and recruiting?”
Certainly in August we were terminating our expansion bonus program which had been an incentive program in place for a little over a year. Certainly people taking advantage of the expiration of that bonus program really drove production and recruiting in August which led us into September with our conference, our event in Las Vegas that we have in the fall where the Blast Off relationship and the demonstration of the Blast Off platform was rolled out and the excitement related to Blast Off I think certainly continued the positive trends through the month of September.
Probably a couple of other things we also did that helped is after we ended the expansion bonus program and double bonus in August we rolled into a lower price of entry of around $70 entry and we also paid much smaller bonuses, I think it was 500 to the ED. So we had several bonus programs like we do from time to time and that lower price of entry and those bonuses continue I think through the end of this particular month.
“Are the positive trends in recruiting and production continuing in October?”
I have those notes. I had Melody run them through the day before yesterday. We do continue to see some positive trends as it relates to production through the day before yesterday. On the membership side we are up about 22%. On the recruiting side we are up about 63%. So we are certainly happy with the fact we do seem to have momentum and we see some of those trends continuing. We will do our best to keep that going.
“What is the company doing to get the new associates more productive and remain active in Pre-Paid Legal Services?”
Certainly that is a lifelong challenge that we will always be facing. Again, excitement in Blast Off helped keep people focused and again our approach in Blast Off is to expose our company and our products to more and more people. As we do that a very important and continual focus of ours is to get that first check, what many have called the “belief” check out to our new sales associates as quickly as possible and continuing to focus on the private business receptions, the same things…many of the same things that have built the company over the 37 years. It is getting our new folks in contact with their warm markets. Getting the information about our company and our product in front of as many people as efficiently as possible.
And doing calls that help support those new associates. We had some of our leaders, kind of following up on something very specific in Randy’s comments on getting the new folks in front of their warm market. We have some folks that record some calls that are available for the brand new associates that kind of explain make a list of the top ten people that are most likely to be receptive to this idea. Just very specific things like that. Training is really the summary in trying to make sure they know how to block and tackle so we can convert all these new associates into productive associates.
We want to continue to enhance our online training platform. I think one of the things you will see in the coming months is increased use of our provider law firms. A tremendous asset we have in the form of our provider law firms and recently we have had several associate related events at the law firm and it just seems to be a great way to increase each other’s belief levels in what the two respective parties are doing.
Associates get to meet and greet our provider lawyers that are delivering services each and every day to our members. Our provider lawyers get to meet and greet the sales associates in their local area. We just think the better relationship those two groups can have the better it will be for all of us. Most importantly the better it will be for our members.
The last set of questions we have.
“Did the SEC subpoena for company documents start as an informal investigation and then upgrade it or is the subpoena the first contact you had with this particular investigation?”
Companies including Pre-Paid, we receive correspondence from regulators, the SEC included, on a routine basis. What triggered the public disclosure this time was the SEC’s subpoena that was issued. I think clearly, at least my opinion that has certainly been criticized by others, but I think our collective opinion is when you receive a subpoena from a Federal Agency that is probably noteworthy and we moved to disclose that subpoena. We had been working, again as disclosed in the press release we had already been working with the Division of Corporate Finance on our review of our 10-K.
Again, a very normal, expected procedure. We have had, I think, success in moving down the path with the Division of Corporation Finance and we expect to finalize that piece of the puzzle in the coming weeks. The subpoena asks for documents which we think are well documented. We have complied and will continue to comply with the SECs request which kind of leads to the next question.
“If the enforcement division of the SEC concludes their investigation with no action taken, will the SEC inform the company so that shareholders can be notified?”
Counsel tells us that is the case. Over my 20 years here we have had numerous projects with the SEC and I don’t know in those 20 years we have received any kind of formal notification the review process has ended but counsel tells us that has changed and that yes indeed we will come to some conclusion with the SEC. As we did when we received the subpoena, we will immediately notify our investors when we receive that type of whatever type of decision we receive from the SEC.
Final question that we received at least before the call started.
“Can you comment on Blast Off’s going live and how their operations are faring? Are your associates benefiting from the Blast Off Launch with additional Pre-Paid membership sales?”
Again, the launch did go. We went from zero to 100,000 subscribers very quickly. I think we have even surprised Blast Off to some extent with not only the on rush of our associates but the email contacts they brought with them. So there has been very quickly we went to 3 million invitations that have been sent. So we expect again now with the advent of the Pizza Hut promotion everyone that whether they go to Blast Off or through Pre-Paid or through Pizza Hut there is a legal help icon on each and every one of those pages. When you click on that icon then you learn more about our company and our products.
I will just jump out there and explain that Pizza Hut has a relationship similar to ours with Blast Off. For those that aren’t aware, they are working to tell the world and their customers about Blast Off and how it can benefit their customers. Just like we are telling all the folks that we know the benefits of Blast Off.
Blast Off has shared with us, which I won’t mention on this call because none of them are active at this point in time, but ongoing discussions with a significant number of well known companies that would be similar, at least some of the similar in statute to Pizza Hut. So I think…
It leads me, there may be some folks that aren’t even familiar on the call with Blast Off. It is a relationship that allows us to get our name out in front of a lot of different people and an Internet presence where you would sign up with Blast Off is free. It doesn’t cost anybody anything to join Blast Off. It gives you the ability to shop online and receive cash back on those purchases. People you invite, if they purchase you receive commissions on that. That is just another revenue stream, if you will, for our associates.
From our standpoint what we see the upside to is the branding. The ability for us to get our name out in front of a lot of different people because on the Blast Off homepage there are a series of ads, if you will, on the top right hand side that rotate and one of them is Pre-Paid Legal. There is also a “Legal Help” button that individuals that can go to the Blast Off homepage can click on. Hopefully we will get the name out. It is a branding effort. It is another smaller cash flow stream for our associates.
We just wanted to make sure folks understood exactly what Blast Off was and what the benefits were to us as a company and associates.
In wrapping up, given the share repurchases that we made in the third quarter of 2009, that brings our total to $439 million we have returned to shareholders since April 1999 through share repurchases and dividends. That is more than 100% of our net income for that same period. We have also build a $32 million home office building that Steve and I have the privilege of being in. Again, we have more than $73.5 million unpledged cash and investments.
All told well over $0.5 billion of uses, if you will and almost 13 times, actually more than 13 times our existing debt. I think that is just clearly, at least in my mind, demonstrates the soundness of our financial model, our ability to deliver high quality life events, legal plan and identity theft and still produce some very significant, at least in Ada, Oklahoma those amounts are very significant free cash flow. We think it is very important.
Steve and I appreciate your continued confidence. We certainly never take it for granted. We believe that we will continue to produce results you can all be proud of. We appreciate your time today. We look forward to the next quarter’s earnings call which will be in late February for the fourth quarter.
Until then you know how to get in contact with both of us. If there is anything we can do or any questions you want assistance with don’t hesitate to call. Thank you very much.
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