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Pre-Paid Legal Services, Inc. (NYSE:PPD)

Q3 2010 Earnings Call Transcript

October 27, 2010 8:30 am ET

Executives

Randy Harp – Co-CEO, President, and COO

Steve Williamson – CFO

Operator

Good day, ladies and gentlemen, and welcome to the Pre-Paid Legal Services third quarter earnings results conference call. At this time, all participants are in a listen-only mode. (Operator Instructions) As a reminder, today's conference call is being recorded. I'd now like to turn your conference call over to your host, Mr. Randy Harp. Please go ahead.

Randy Harp

Well thank you, and good morning, everyone. This is Randy Harp, Co-CEO, President, and Chief Operating Officer of the company. And I want to welcome you to the 2010 third quarter earnings conference call for Pre-Paid Legal Services Inc. Joining me here at our home office is our CFO, Steve Williamson.

Before we begin, I want to remind everybody that the conference call will contain forward-looking statements, including our expectations of future results and future plans. Actual results might differ materially from those projected in these forward-looking statements. Additional information concerning risk factors that could cause the results to differ materially from these forward-looking statements are contained in our press release announcing our earnings as well from disclosures in our public reports on Forms 10-K, 10-Q, and 8-K and any amendments filed with the SEC; and always available at the SEC Edgar Web site as well as our own Pre-Paid Legal Services Web site.

We did file our 10-Q yesterday evening – yesterday afternoon. I think it was released this morning at 6 o'clock, so it is available. We'll point out a couple of updates to our contingencies, one, the FTC matter, which we had previously disclosed, but has been on a long-standing disclosure in our three-plus years, a long-standing disclosure in our documents. And just to remind everybody, on July the 28th, the FTC issued a closing letter with no findings against the company. So that disclosure will go away.

We're still the subject of an informal inquiry by the SEC. And the update there to that disclosure is really we continue to respond to the SEC's request and discussion with the staff to clarify previous requests, continue to cooperate with the staff of the SEC, and certainly expect to do so, and still unable to predict what the outcome of this inquiry maybe or when it might be resolved.

Also have, at least in great part, resolved the Canadian tax issue that's been disclosed. And Steve, if you would cover the Canadian tax update, and then step through any of the more significant financial highlights for the 2010 third quarter.

Steve Williamson

Okay. On the Canadian tax issue, if you'll recall, we did a blow-by-blow that we've had since back around 2006, as I recall, had G&A allocation questions that were resolved a few years ago. We're able to take all of those deductions on either the Canadian and the US tax return let – primarily be commission issue.

We went into settlement discussions the third quarter of last year with the Canadian taxing authorities. They said, "Yes, we'd like to get it settled." And just in the last couple of weeks, they said, yes, they did agree with the basis of the settlement offer that we had made. We were trying to come up with a way that makes sense within the kinds of discussions that we were having.

And basically, what it allowed is to all the conditions that we had taken as a deduction in years 1999 through 2002, they were going to allow a deduction in those years. And also, so everything closed in those same years. They moved around a little bit within the years. But one of the big things and as I said in the 10-Q that we believe this settlement provides a basis for a full deduction of commissions when paid in tax years 2003 and forward. And that's due to the settlement offer included in years 2001 and 2002 of full deductions. That was the – 2001 was the year that we did the REIT statement. And under Canadian Tax Law, they start with GAAP-based financial statements in order to provide the basis for deduction under their tax code.

We resolved that issue. It'll take us a while to taper it off. And then they'll push it through their systems to settle up. But we expect to receive the $3.2 million in cash taxes as refund for those years where we had already paid the taxes under those reassessments that they had.

Randy Harp

That $3.2 million we've been carrying in other assets is now a refundable income tax–

Steve Williamson

Right, just moved it up for an asset. But we'd expect to receive it in the next 90 days or so, just the amount of time that it takes for them to push it through their systems and compute the amount of tax that they'll owe back to us on that issue.

And again, don't expect that based on the basis of this settlement to have this issue any time in the future to – gone through the G&A allocation. We've gone through the commission issue. The benefit payments were never questioned. So I feel good that we should have a good understanding on both sides of the table whit the Canadian taxing authorities and us on how we push through our income statements on their tax returns.

And I'll start – really going through third quarter this year versus last year, and then a little summary – data on both the nine-month period and the sequential periods. So revenues for the third quarter '10 compared to '09 was down $1.9 million expenses. And this is in total, just a big picture summary. Expenses and taxes were down $6.9 million, which resulted in the $5 million increase net income. That's a 46% increase at 10% fewer shares outstanding, which resulted in the 63% increase in diluted earnings per share. Sequential numbers should be – were down about $180,000, so we're pretty much flat.

Third quarter '10 fees, compared – just membership fees only decreased $180,000, as I said, over last year. The social services revenue decreased $1.5 million. That's made up of a $2.6 million decrease in associate fees, primarily due to lower recruiting numbers. We recruited 36,000 this year, compared to 75,000 last year. If you'll recall, we had a lot of pretty aggressive bonuses on the table last year in the third quarter. And we also had the blast off initiative that created an awful lot of recruiting going on in that timeframe. That $2.6 million decrease was offset by a $1.3 million increase in e-service fees. We have seen, over the course of the last four or five quarters, an increase in the average number of e-service subscribers.

Other revenue, which is the $10 enrollment fee that we amortized in – over a three-year period, it's about $191,000 to $697,000.

Membership benefits decreased 2.3% for the 2010 versus '09 period. And that's a 2.3% decrease versus the flat membership fees that we talked about. And primarily that's just due to the fact that we have a lower cost for the benefit on the ID theft memberships. So that ratio will stand. The benefit ratio was 33.4% for 2010 and 34.1% for 2009.

Commissions were down 26% to $29.1 million due to the 27% decline in average annual premiums sold. Commissions per member were around $21 higher this quarter, compared to last year's third quarter. And that's primarily due to a no-charge-back month. We did that this quarter. And that resulted in about $1.3 million more in commissions that were paid. And we explained that in Q as well. The percentage of membership premiums sold – how the commission's compared to that, that came in around about 70%, which is about where you expect it a little bit higher due to the no-charge-backs.

The associate service costs were higher than associate services revenue by $490,000 for the third quarter of '09 versus $203,000 excess costs for '09. And associate services costs for the third quarter of '10, we had lower bonuses. And the lower cost of new associate materials, of course, since we had fewer associates recruited this year versus last year.

G&A decreased $284,000 primarily due to a decrease in consulting fees, some bank service charge decreases, telco decreases. We did have some increases in employee costs, director fees, and legal fees compared to the prior year's third quarter.

Other expenses increased $129,000 in the third quarter of '10 due to the $110,000 – or $101,000 decrease in interest expense, had a $134,000 decrease in depreciation. And that was partially offset due to about $112,000 decrease in interest income.

Provision for taxes was about 40% for this quarter, compared to 41% for last year's quarter. That resulted in a net income of $50.9 million or 46% increase from the prior year. And as I've said before, we had a 10% decline in diluted earnings per share, our diluted earnings – our diluted shares outstanding due to the buyback. Third quarter diluted EPS for this year's up 63%, compared to last year to a $1.61.

For the first nine months 2010, net income was up 17% for that nine-month period of '10 versus '09. The EPS, of course, due to the buyback reducing those shares was actually up 30% getting this to a $5.13 nine-month number for the diluted EPS, compared with $3.95 of last year's nine-month period.

On the sequential basis, third quarter of '10 versus second quarter of 2010, we had $2.1 million less revenue, $1.9 million. And that's in total revenue, $1.9 million less expenses and $452,000 more taxes, which resulted at about $619,000 decline in net income, which got us to an EPS of $1.61 for the third quarter versus $1.64 for the second quarter of 2010.

Again, very tight margins, pre-tax margins – pre-tax margins on the sequential basis were exactly the same at 25%, that the benefit ratio for those two periods were right at 33.5%, plus or minus 0.01%. Commissions came in at 27.5%, plus or minus 1%. G&A came in at exactly 11.7% for both periods, so very tight margins as we've talked about before with the fixed-type – almost fixed business model that we have.

We used $8.5 million in cash to purchase 163,000 shares at $52.49 for the third quarter of 2010, which left 9.76 million or $8.5 million. I think you got a decimal out of there; resulting in about 9.76 million shares that's outstanding as of 10/21/2010. We've got a lot of cash in investments and unplaced investments that total $75.2 million.

A pretty small amount of debt at $23.6 million total debt, of course still the $4.6 million per quarter principal payments interest is incredibly low. We've got our average LIBOR or margins in the 30-day LIBOR of 1.35%. So our average full cost of funds is 1.95%. We are in compliance with all of our covenants. We've got about $32 million available under those covenants to buy back stock or do what we want to do with that cash.

And in summary of how we utilized the cash for the nine-month period, we had $53 million worth of cash flow that we generated for the nine months 2010, $1.8 million in CapEx expenditures that remains to be a pretty low number, $18.7 million in debt repayments, bought back $13.9 million worth of stock. And that leaves us about an increase $18.7 million in cash investments.

And with that, I'll turn it back to you, Randy.

Randy Harp

We're very consistent, obviously, with the second quarter, with the exception of the one-month charge-backs that we forgave. It was almost a lay-down. And that's the consistency I think that the business model continues to produce.

Before we go to email questions, I want to address an announcement that we made on Monday, October 25th that we were evaluating strategic alternatives, including the possible sale of the company and alternatives that did not involve the sale to enhance shareholder value. We have established a special committee comprised entirely of independent directors that are in control of this process. And as part of that process, the special committee has been evaluating an offer that we received, an unsolicited offer that we received to acquire all the outstanding shares at $60 per share.

And I think that, again my interpretation only of the special committee process, basically, they have three choices they can do. And I think – and let us continue as we have. They could accept the current offer that we received. Or they could consider all strategic alternatives. And the third one is what the special committee has chosen, which will certainly lead them to evaluate any other offers, if any, that we receive as well as dividend strategy, share repurchase strategy, et cetera. I think all strategic alternatives that would lead to enhanced shareholder value around the table. And that process will continue for the coming months. And the special committee has no definitive timetable or won't be – update as we go along unless and until the special committee makes a decision to pursue one of the strategic alternatives.

Question-and-Answer Session

Randy Harp

So moving to questions that we received for the call, we actually only received one this time. And the question is, "Can you talk about any changes to – made to improve production from the Dallas conference held in September? Are you seeing a positive impact from these changes or is it too early?"

If you look at all the numbers that Steve went over with you, what you see is very, very consistent production and cancellations. The active base of memberships has been around 1.5 million families now for a number of years. And we have, during that timeframe, certainly tried lots of different incentives to ratchet up the number of new memberships, to ratchet up the retention characteristics of those memberships; and have really – with some exceptions, really not come up with a long-term incentive that has produced the type of results that we believe we're capable.

And so, lots of suggestions that we get from the field on a daily basis, some solicited, most not. But we always evaluate anything we hear from the field. The best ideas always come from the field. And so, we did get a lot of suggestions about what we needed to do. And really rather than test any individual theory, what we have chosen to do and what announced at the Dallas conference in September is going back to a structure and an environment very similar to what we had in 2001 and 2002 with mandated training for all new associates. We will have a fast-start to success training platform that we had back during that timeframe.

It is effective from – it really begins – I guess the effect of that begins November 1st. The new associate fee will be $149. And the sponsors of the new associates are incented to get their new recruits; get them into the fast-start training program; help them get their first check, the check that we've always called the belief check. And there's incentive for them as well to do that.

And we also put some – the advancement through our commission structure, we also, in essence, put more spread in the top plan. The rank advancement as you move through the top plan takes more production of new memberships now. And again, all in a step to move back to the time when we were seeing much higher productivity per new associate.

Steve Williamson

And I'm going to jump in here, Randy, real quick and quantify some things that we were looking at. First of all, as Randy said, we went through this period where we're discussing what should we do. And fast-start came up. For those of you that may not recall that timeframe, it was from – what I have right in front of me is from '99 to 2003, which was the timeframe when we were at either $249 or around the $149 price.

And the productivity numbers out of that timeframe was much better than what we're doing currently and have done since 2003. We were recruiting in over at six-month – or six-year timeframe from '99 to 2003. The average number of units produced per new recruit was 5.9. And our average price of entry was $190.

And then, even to push that just a little bit further, if you look at just the three-year period when we're really closer to that overall $249, and that's from '99, 2000, 2001. That was the $240 price. And the productivity measurement was 6.2, so 6.2 memberships per new recruit. And if you just look at the – what we dropped down to the $149 price and really the average over the three-year period '02, '03, '04 was $140. But we still got 5.7 as far as the productivity measure.

So the thought was $149 is a price, one that we liked relative to the – what the economy's like, but still would get that buy-in from the associate where they're a little bit more financially committed compared to the average pricing we've been seeing somewhere around the $70 range. They're going to write a check for over twice as much, so they're more committed. We also know that the retention characteristics of those associates that come in at that higher price or better.

So one, it was just the facts of – and the extra training and material that we did for fast-start. But also, we went back and actually quantified that, not only did all of us did and looked at it and said, "Hey, it makes a lot of sense." We were getting much more productive associates in that timeframe.

So I wanted to fill that in there to quantify some of the reasons.

Randy Harp

Well, to answer the second part of that question, "Have we seen any results or is it too early?" The short answer is it's too early. The new product, the new platform, the new training and comp plan, that although we said in fact November 1 is really about a 90-day transition, we phase into that. So it will be the first part of 2011 before we're really up to the point that we want to be. And again, it simply requires more membership production to advance to the comp plan and requires the mandated training.

Steve Williamson

Also, we implemented the – going back to counting memberships for the ED level, for many of you that may not know, it's on the call. The requirement to make executive director is 75. When we introduced the identity theft plan back in 2003, we allowed that dual ID theft play-in for $995 to be a counter to account towards that 75.

We've effectively going towards – starting with 2001, we'll start counting only memberships. And the transition period that Randy's referring to will transition over the course – the couple of months – two to three months, where you will have to get actually 75 memberships. So if they sell a legal plan that has the identity theft plan, that only counts as one, where previously it counted at two, so effectively raising the bar.

So not only are we putting forth more training, before our training, we'll actually start – or start that beginning in November that we're raising the bar on a number of counters that is required. And we're also putting forth the old fast-start half 45-day window, where you had to reach that qualification period, which is sell three memberships and recruit somebody within the first 45 days of your life as an associate. So we've added that sense of urgency. And also, due to that 45 days, it'll take a little while for that to actually show up in the production results.

Randy Harp

I also want to – as we start to wrap up, I want you to point you to an article that was in the Huffington Post earlier this month. The title of it is "Access to Justice in the US at Third World Levels." And we encourage you to find that article and read it. It certainly, I think, makes a lot of good points. But certainly, I know even the President – in fact, the article says, "Unequal access to the legal system is also a problem that the Obama administration has publicly acknowledged and is trying to address."

In March, Attorney General Eric Holder appointed prominent Harvard Law Professor Larry Tribe to serve as Senior Counselor in-charge of the new Access to Justice Initiative. His goal is to work with judges and lawyers across the country to find ways to help people who cannot afford lawyers. It sounds very familiar to what Mr. and Mrs. Stonecipher have been saying now for 38-plus years. There're a lot of good facts. I won't bore you with my reading of the article, but would point it out. I think it makes an excellent case as almost any newspaper on any day. It makes an excellent case for this product.

So I want to wrap-up. Again, I always want to wrap-up, I hope, by reminding everyone of the value proposition that we believe our membership represents, a win-win-win approach. It's what I love about this business model is that our sales associates, our provider law firms, and our shareholders all are measured by the exact same metric. The active base of membership determines for our sales associates the amount of commissions they're going to receive over time. It certainly determines, on a monthly basis, what we pay our provider law firms. And certainly, on a daily basis and certainly monthly, weekly, and annual basis, it directly dictates virtually every item of our revenue, and cash flow, and net income, et cetera.

So everybody, all three of those constituencies, if you will, are rowing the boat in the same direction. And our focus is if you think about the middle point of that – of those three constituencies, it's the fee-paying member in the middle. And we always – all three legs always have to focus on that fee-paying member in the middle. They always have to receive more in value each month than they pay us in cash. That translates to – they always, when they pick up the phone and call the provider law firms, they must receive high quality legal services in a customer-friendly manner on a consistent basis each and every time they talk to our law firms. And I have no doubt that the level of service delivered by our provider law firms today is as good as it's ever been, but not as good as it will be a year from now. That's certainly been the model in my – or the progression of the model in my 21 years here.

And I wanted to just point out. We have a thousand of these – at least thousands of these on our Web site. But again, I just – I'm never – I've always been frustrated I guess that we haven't made the most of these. But we, on a regular basis, almost a daily basis, receive unsolicited praise letters. These are not our surveys. These are not in response to something that we asked our members. Our survey results are excellent and just continue to get better. But these are unsolicited, what we call, praise letters where somebody has been so impacted by our membership that they have taken the time to sit down and write us a letter telling us how having our membership has changed their lives.

And I don't know that every company – I might be wrong. I may be just naïve. But I don't think every company gets those kinds of letters, where together, again, the three constituencies, my staff here in Ada, and Duncan, and Antlers, Oklahoma; our field force all across North America; our provider law firm network all across North America, together we're changing lives. We're impacting lives positively. We get reminded of that virtually on a daily basis by these unsolicited praise letters.

So again, I think it is – it just keeps us very focused and keeps us feeling very good about what we do, and then we see these types of surveys and articles. And now, the administration thinks there is a – publicly acknowledged that there's a problem with that equal access to justice. And so that, again, just I think refortifies our belief in what we do. We have a great company. We have a great opportunity in front of us all because we have a great product. And we always have to remember that. That even 38 years later, this product will determine where we go, how quickly we get there.

So take a few minutes, if you would, to find that article. Again Huffington Post, the title of it is, "Access to Justice in US at Third World Levels." It's kind of embarrassing as no one could be prouder to be a citizen of this great country than I am, but what has occurred in our justice system is embarrassing. And we've been trying to assist in – for 38 years in correcting that and making it better.

So again, we, Steve and I, appreciate certainly your continued participation and confidence. We never take it for granted. We understand you're only as good as your last quarter from a public company standpoint. And we strongly believe that we continue to have a model that'll produce results that you can be proud of. I think you can be proud of what we do, the product, the impact that we have on changing lives all across North America on a daily basis.

We appreciate you. We appreciate you being on the call today. Look forward to our next call, which will be in late February to go over the fourth quarter and 2010 year-end results. Thank you very much.

Operator

Ladies and gentlemen, that does conclude today's conference. You may all disconnect and have a wonderful day.

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