Pre-Paid Legal Services, Inc. Q1 2008 Earnings Call Transcript

| About: Pre-Paid Legal (PPD)

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

Q1 2008 Earnings Call

April 30, 2008 8:30 am ET


Randy Harp - Chief Operating Officer

Steve Williamson - Chief Financial Officer


Good day, and welcome to the Pre-Paid Legal First Quarter 2008 Earnings Results Conference Call. As a reminder, today’s conference is being recorded. There will be a replay of today’s conference beginning today, April 30 at 10:30 a.m. Central Time running through May 7 at 11:30 p.m. Central Time. To access the replay please dial 888-203-1112 for domestic, or 719-457-0820 for international callers. Enter your access code of 1173479. Again, that was 888-203-1112 or 719-457-0820, access code 1173479.

And now I would like to turn the conference over to the Chief Operations Officer, Mr. Randy Harp. Please go ahead sir.

Randy Harp

Thank you, operator, and good morning. This is Randy Harp, Chief Operating Officer of the company. I want to welcome you to the 2008 First Quarter Earnings Conference Call for Pre-Paid Legal Services. Joining me here at home office in 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 of these forward-looking statements. Additional information concerning risk factors that could cause the results to differ materially from those forward-looking statements are contained in our press release announcing our earnings, as well as some other disclosures in our public reports on Forms 10-K, 10-Q, and 8-K that are filed with the SEC and available on the SEC Edgar web site, as well as our own web site.

So we’ll move quickly this morning through our comments and Steve is going through an analytical flux analysis of the numbers, because we have quite a few questions we have received and want to address as quickly as possible.

I do want to mention to those of you that might not have received our most recent annual report, I just wanted to remind you that we have included in the back of the annual report a compilation DVD that contains the first four episodes of our national media campaign, Justice For All: Accessing The Promise, that we began in September. It has been broadcast on Court TV, which is now True TV.

The latest episode aired Saturday, April 19, and the next installment will be on True TV on Saturday, May 17, so we want to certainly encourage you to tune in and if you haven’t seen those, would encourage you to put the DVD in.

Again, something that we’re proud of and I think never intended to be, necessarily, a sales tool, but we think it provides tremendous third-party credibility and that was our goal and we’re proud of what we’ve been able to put together there.

At this time I will ask our Chief Financial Officer, Steve Williamson, to step through the more significant financial highlights and analysis for the 2008 first quarter.

Steve Williamson

First quarter of 2008 membership fees increased 5% over the first quarter of 2007 to a total of $109.1 million. Associate Services revenue was down $1 million to $6 million primarily due to fewer new associates that were recruited. Other revenue was pretty much unchanged at $1.1 million for both quarters. Of course, that’s primarily the $10 enrollment fee that we amortize into income. That brings total revenue up 4% to $116.2 million for the first quarter of 2008.

Membership benefits came in at 34.2% of membership fees for 2008, down from the 35.4% for the prior year. Of course, that’s due to what we’ve talked about before, a $0.25 per member per month decrease in our IT membership cost to provide those benefits. The estimated benefit ratio will continue to be near this level for the balance of the 2008 quarters and then, of course, in the beginning of 2009 and the beginning of 2010 we will have another $0.25 savings per member per month, which should push the total benefit ratio down by about 50 basis points each time.

Commissions were up slightly, about $292,000 to $30.8 million for 2008. We had fewer membership sales: 140,000 versus 161.5, which were partially offset by higher average premiums sold, 321 versus 310. The membership times average premium gets you to the premiums written that we’ve talked about quite a bit as a leading indicator of what commissions are going to be. That premiums written number was down about 10%.

And again, as we discussed in the last quarter earnings call, beginning in the second quarter of 2007 we began advancing commissions from the first membership sale for all new associates, and that increased that average commissions paid per member. That change, coupled with a $1.2 million decrease in deferred membership commissions resulted in the net increase of about $292,000.

And you will remember on the deferred commissions, we defer or amortize that expense over the course of the first month that that membership is sold. So, effectively half of the last month of each quarter is deferred for commissions and that fluctuation will make slight changes, and sometimes large changes, depending on the level of commission paid in the last month of any given quarter.

Associates services and direct marketing costs, $5.6 million for 2008. That’s down $771,000 from 2007 levels, primarily due to increased costs of our incentive programs.

The G&A cost came in at 11.5%, the membership fees for 2008 versus 12.3% for 2007. The 12.3% for 2007 equals 11.5% when you exclude the income taxes that were reclassified below the line for this period and also for the fourth quarter of 2007. And so pretty much unchanged overall, although we did have several improvements in several areas like employee costs, bank service charges, and teleco costs. Those saving were offset by an increase in legal fees.

You also recall that in the fourth quarter of 2007 G&A rose to 9.8%, or was at 9.8%. It was lowered by the $2.1 million reclass, which lowered G&A, where we took the state incomes taxes that were classified previously in G&A and put them to below the line with federal income taxes so that all the income-based taxes are below the line. And that reclassification brought the G&A level for the fourth quarter of 2007 to 11.7% when presented on the same basis as the first quarter of 2008. So G&A remains in the pretty tight range there of about 11.5%.

Other net includes $2.2 million of depreciation in 2008 versus $2.1 million last year. Interest expense of $1.3 million for this quarter. $320,000 of that was interest associated with the state income tax liability that we paid. Interest expense overall, including the state tax interest, was down $1.9 million, of course, due to lower debt and much significantly lower interest rates.

Premium taxes were slightly lower at $422,000. Plus also, we had an increase in the litigation reserve, $925,000, bringing it to $1 million balance on the balance sheet for that litigation reserve.

All these expenses were offset by interest income of approximately $700,000 for the first quarter of 2008, which is the same level that we had in last year’s first quarter.

Provision for taxes came in at 38.1% for 2008 versus 32.9%. Of course, the 2008 includes the state income taxes that I talked about in the G&A section and we would expect that the overall roll in the federal and state income tax to remain at about that 38% level through the balance of the year.

Net income results came in at $15.9 million for 2008, an 8% increase over 2007. And also an all time record high for net income.

Diluted earnings per share decreased 9% due to our treasury stock purchases. We picked up another 280,000 shares at an average price of $46.08 per share, total cost of $12.9 million during the first quarter of 2008. Only 52,500 options remain at March 31. We ended the year with 12.2 million shares outstanding. First quarter diluted earnings per share was up $0.29, that’s a 19% increase over the $1.08 we had for 2007.

Cash flow from operations was $20.8 million for 2008 versus $24.1 million for 2007. Of course, that was down due to we had about $8 million of state income tax payments due to the matters we discussed before, so if you take that out it would have been a slight increase, as you would expect.

Total CapEx was about $2 million for 2008. We still feel that our total CapEx for the year should be in that $4 million-$6 million range for 2008.

Notes payable, $69.2 million, principal payments $4.6 million per quarter, always tied to LIBOR average costs [inaudible] LIBOR was 1.42. that puts us at right around 4.5% or less and it matures in the year 2011. We are in compliance with all of our debt covenants. Under the most restrictive covenants we would have about $14 million to spend on our stock buy-back program.

At March 31, 2008, we had consolidated cash and [inaudible] investments of about $60 million. We also did request and receive a $9 million dividend from our insurance club that we do each year. $1.6 million of that was paid up to the parent company in March. The $7.4 million balance was paid in April. And we do plan to continue our long-standing stock buy-back program when the market opens today.

And I’ll turn it back over to Randy.

Randy Harp

We do want to respond to the e-mail questions that we have received and have quite a few and will certainly take our best shot. Some of these we just received a few minutes ago so certainly will be just off-the-cuff remarks that we’ve not had time to research. But we will go through those.

Question-and-Answer Session

Question 1

‘Can you talk about steps being taken by the company to increase recruiting? What’s the current cost for the associate to join Pre-Paid?’

Randy Harp

In all of our quarterly production press releases we always disclose the average cost for enrollment. It is currently $99; has been all of 2008. We have no immediate plans to change that but certainly if you looked over the last two or three years at the quarterly averages, we’re certainly not afraid to move that up and down as we think may be best.

The focus, I think, is the biggest step to increase recruiting. And as goes recruiting, so goes membership sales. So we are very focused. I will tell you the theme of our international convention at Oklahoma City was very much recruit, recruit, recruit, and don’t get it out of order.

It’s very easy with an independent sales force to get off on tangents and trying to corral and direct a sales force of independent agents is certainly more of an art than it is a science, but we’ve tried to make the message very clear, from stage anyway, that we need to get back to the basics. We need to get back to recruiting; we need to get back to sharing the opportunity with as many people as we possibly can.

And it’s just very easy to deviate from that because of other issues, so much media attention on identity theft, so much media attention on mortgage crisis, etc., a lot of distractions that all arguably are helpful to us but sometimes we can get so much information that it gets distracting and so the biggest step, I think, to increase recruiting is just to make sure that everyone understands that we’re laser-focused on recruiting and that is our number one goal because as recruiting increases, then we have access to a much larger, warm market and historically if you look back over a long period of time, production is always going to move hand-in-hand with recruiting.

So we are very focused on trying to simplify the business. One of the things that we want to do is certainly increase the number of associates coming on board and we want to decrease the time between the time they sign up and when they get that first check, what we call the belief check. And so very focused on getting new people and focused on getting them in the field very quickly, as soon as possible, and getting a check in their hand. Again, kind of back to the basics but very laser-focused on recruiting right now and helping people develop an additional source of income.

Certainly challenging economic times right now for a tremendous portion of the U.S. and North America and we historically have seen that network marketing companies do well in difficult times because people are looking for additional sources of income.

So trying to get back to the basics, focus on recruiting, get a check in their hands as quickly as possible.

Question 2

‘Why were commissions higher in the March 2008 quarter compared to the March 2007 quarter?’

Steve Williamson

I will kind of go through what are the things I look at when I’m analyzing commissions. There are some things that change. One, has there been any change in the compensation plan, if you will. And there were some differences in the March 2007 versus March 2008. You will recall that the beginning of the second quarter of 2007 we began advancing on the first membership sales and so in that first quarter of 2008 you had that new advance. That drove the average advance per membership up, compared to the 2007 quarter.

The other thing that I always check and I think everybody probably understands that right now, is the average units sold, of course, was higher in 2008 versus 2007. $321 was the average annual premium versus $310 for the 2007 quarter.

Then of course, the units. And I will typically take those units times that average and develop what I call premium written. Premium written was $50 million for 2007, $45 million for 2008. Of course, that would make you think that commissions would go up, but of course you had the change in the first advance.

And then the other thing that you need to keep in mind is that we do defer a portion of the commissions. You will recall that we expense commissions in the first month that that membership is written. That effectively means that half of the commission that are paid in the last month of the quarter are deferred into the next quarter. And that’s going to make some fluctuations in what hits the actual expense account.

In 2007, due to a very large month for March of 2007, therefore a lot of commissions were paid in cash and increased the deferral, we had a reduction, if you will, of expense, or a change in that deferral of $1.7 million that lowered that expense; put more of it into the second quarter of 2007.

For March 2008 the exact opposite occurred, where we actually had an additional $310,000 worth of expense that effectively hit there when you kind of compare apples to apples.

So, to kind of reiterate, you need to look at changes in the comp plan. We did have that advance from the first membership in the 2008 versus the 2007 quarter, look at the average units tied to the number of units, and then kind of look at the deferrals. So I think those are the items that made that change where we actually had an increase versus decrease.

But, to your point, we did have a decrease in the cash paid on commission advances for the first quarter of 2008 versus 2007.

Question 3

‘Why was G&A $2 million higher in the March 2008 compared to the December 2007 quarter?’

Steve Williamson

I hit that kind of lightly when we were talking about G&A. When you look at the way we treated the state income tax before your call we had a pretty complicated or strange taxing structure. Some of our memberships in some states were considered to be insurance, therefore we don’t pay income taxes, we pay premium taxes. This led to a little bit of a confusing, we’re not just all premium taxes or all income taxes.

And previously we had included both premium taxes and state income taxes in the G&A line item, and decided to move that below the line in the fourth quarter of 2007. So effectively, we had a reduction in G&A expenses in the fourth quarter of 2007 of about $2.1 million that moved that state income taxes for the first three quarters of 2007 down to below the line. So that explains that fluctuation of G&A.

Question 4

‘Are we seeing a reduced response level from the TV advertising, the DVD marketing tool?’

Randy Harp

I don’t know that we ever really saw, in terms of new sales, much of a response, nor did we expect much of a response. The Justice for All effort, to produce that was, again, aimed at just building the belief level of our existing associates and third-party credibility and exposing more people to the concept of legal service plans and identity theft.

And so, it’s hard to say if we’ve seen a reduced response level because we never really saw much of any kind of fly up in sales. But, again, the comments that we get from the field and comments that we get from people, what we are seeing are more and more of our associates are using those episodes continuing to air them in their own local markets and softening the market, if you will, or exposing their local markets to the concept. Not only the concept of legal service plans but specifically Pre-Paid Legal Services.

So we are still seeing our associates embrace those episodes but never expected and certainly never saw any kind of fly up in new sales.

Question 5

‘What do we think about TV advertising going forward? More or less or flat?’

Randy Harp

I would guess, at this point in time, certainly not more. At least by Oklahoma terms it is still a fairly expensive process. We will continue. Now we have a May and a June show already produced and in the can, so those will air. We have yet to decide whether we will continue those. I don’t know doing those monthly is necessary. We may certainly evaluate other, maybe doing it quarterly, etc. Just trying to get all the pricing and making a cost benefit decision there.

Question 6

‘As gas prices have risen is there reduced sales activity from agents that are selling individual memberships?’

Randy Harp

Again, going back to previous comments, typically, and not necessarily just gas prices, but typically during stressful economic times direct sales network marketing companies do well because people are looking for additional sources of income because of the additional pressures. So I don’t think we can blame our recruiting results and membership production results on gas prices.

We were not satisfied, obviously, with our production or recruiting, doing everything we can to increase both and not going to blame it on the economy. We think ultimately these products: Life Event Legal Plan, Identity Theft Plan, these products survive any kind of economic conditions. These products are needed in any king of economic condition and certainly the opportunity that we offer for independent sales associates is I think unlimited opportunity in any economic environment.

So, yes, it does cost our associates more to go to attend weekly meetings, to take guests to briefings, etc., but again, I think that’s probably offset by the need for additional sources of income. So we’re not going to use economic times or situations as any kind of excuse.

Question 7

‘Commissions for new membership sales appear to be higher than the 213 that you guided on the fourth quarter of 2007 conference call. What’s driving this metric to the higher than expected level?’

Steve Williamson

Really, instead of a dollar amount, I mean, we used to kind of talk about commissions per membership. I think a more accurate metric, I know I hit it but maybe didn’t stress it well enough, would be the percentage of premiums sold, which is running about 67%-68% of premiums sold.

Remember, that’s the units times the average premium. It ran about 69%, just a little bit higher than 68% this quarter compared to 67% last quarter. Again, the main reason for that increase is the change in the deferral of commissions. That’s always going to create a fluctuation and that fluctuation is going to be driven by how big the month was, the closing month of every quarter. But in a general range, 67%-68%, plus or minus a percent, should be a good range to model for the future.

Question 8

‘How many people are employed in the Duncan call center?’

Randy Harp

I don’t have an exact number. I will tell you it is very consistent with where we’ve been. Our employee count actually is down slightly overall. We’ve replaced some of the turnover we’ve had in Ada at Duncan, so Duncan may be slightly higher than it was this time last quarter, but any increase there has been offset by a reduction here. So staffing levels overall are down slightly and we don’t expect any kind of significant fluctuations in the upcoming quarter one way or the other.

We’re always focused on continuing to do one of two things, and hopefully both. That is to improve the efficiency of the employees that we have and deliver a higher level of service to our members. Certainly continue to ramp up our MAS efforts in delivering more and more services to our members on behalf of our associates.

Steve Williamson

Some of the CapEx that we had and I think I may have mentioned on a prior call in previous quarters, but certainly some of the expenditures we’ve had in CapEx were for software initiatives that would lead to across the board in all departments more efficiencies in our employee base. And we certainly have seen that. We’ve had some reductions, of course, this particular quarter, first quarter of 2008, total employee cost was down from the same quarter for 2007. So that’s also kind of driving some of those efficiency metrics.

Question 9

‘Help us understand why there was a marked decline in new legal service memberships after what appeared to be a very successful fourth quarter of 2007.’

Randy Harp

Simple answer that I would offer up is just recruiting. If you look at legal service memberships, it went from 139 to 132, recruiting went from 95 to 81, so percentage-wise less of a drop in legal plans than there was in . . . I’m looking at the wrong one.

The same thing’s true, the 139 to 132 recruiting actually went from 36 to 25 or almost 26. So again, less of a change percentage-wise in legal service memberships than there are associates recruited. So again, we’re focused on recruiting because, again, high, high percentage, we don’t require new associates to be a member, but virtually every new associate is a member. So as we get more recruits, we do get more memberships by definition, but more importantly, we get access to those new associates, more markets.

And that’s where we’ve really got to get back to the basics and focus on getting those new associates on board, getting their membership processed, and working with them to sell memberships to their warm market, and getting a check into the new associates’ hands as quickly as possible.

Steve Williamson

Probably the other thing I would mention, and we’ll talk about it again, down in another question, but that this whole quarter was at $99. and the prior quarter, the fourth quarter was at a $49 price of entry. And there’s always just that mental hurdle that a few have to go over because the people that are recruiting $49, now they’re trying to recruit somebody at $99. So there’s always a transition period and again, last year’s quarter, although the average was the same, it was actually a little bit lower at around $99 for the average price of insuring new recruits, versus what we had for the first quarter of 2007.

The first quarter of 2007 we actually one $49 price of entry for January and February, and then put in at convention, or near convention last year, the $49 entry and that excitement, it was just an incredible March, it was what kind of pushed that.

So there is always a transition period whenever you’re moving to another level. And we’re trying to work through that.

Randy Harp

And, as Steve said, the first quarter of 2007 was one of our best production quarters in a long time and so every time you have a great quarter and you’re into the following year, it’s a tough comp and we combine that this time with an increased recruiting fee.

Question 10

‘Initiatives to improve agent growth and retention?’

Randy Harp

And again, I think, as I’ve said, just back to the basics. Getting the new associates, they’re most excited on the day that they decide to become an associate, we’ve got to take that excitement level, get a check in their hand, get them in the field, let them see how it’s done, demonstrate how to do it, a private business reception, and get a check in their hand. So our initiatives are just to get back to the basics and reduce the amount of time between an associate writing us a check, a new associate writing us a check to become an associate, and us writing them a commission check. Trying to reduce that to the shortest length of time possible.

Question 11

First quarter of 2008, new associates recruited fell year-over-year and sequentially after we increased the enrollment fee and decreased it slightly. What do we attribute to continued difficulty selling agents to?

Randy Harp

I think Steve addressed that. The associates that come in, they only know what they paid when they came in. So any time you have a transition there is a time frame there, kind of a buffer, if you will, that you just have to work through, because if you go from $49, like we were in the fourth quarter of 2007, to $99, like we were in the first quarter of 2008, then those folks are having to sell on a higher price entry fee than they paid. You just have to work through that.

Consequently, again, as Steve explained, last year in 2007 we got the benefit of going from a higher priced to a lower price. So just timing and the transition that takes place when we do change pricing.

Question 12

‘What’s our strategy for the enrollment fee for the remainder of 2008?’

Randy Harp

Again, we have no immediate plans to change. We’ve been at $99 all year, the first four months of 2008. I’m not aware of any plans to change that. But having said that, if we don’t see the trend, get the recruiting numbers moving in the direction and to the extent we believe they should, then we’re going to continue to make changes. We can’t continue to do the same thing and expect different results. So no immediate plans to change, but certainly wouldn’t take that off the table, by any stretch.

Question 13

‘As we continue to take cash off the balance sheet to repurchase shares and pay down debt, what’s our comfort level for cash?’

Randy Harp

In the early 2000s our cash balances were in the $20 million range. Steve, I’ll let you address that one.

Steve Williamson

To try to kind of paint a picture of where all the cash lies on the balance sheet and then how I look at it from my comfort level of cash is concerned, we had total cash and investment balances of $65 million. $4 million of that is pledged, so that gets you down to about $61 million. The insurance subsidiaries that are required to keep a certain amount of capital, typically a 3/1 premium ratio, had $39 million at March 31. That gets you down to $22 million that’s available at the parent level.

That I kind of like, don’t really want to get below, you know, $10 million or so because as each month turns around we’re going to pay the providers. That’s normally $10 million-$12 million per month so I like to have that kind of ready cash available to go.

If you recall, at March 31 although we had about $22 million or so at the parent, we also received from one of the subs in April a dividend of a little over $6 million, so about $28 million at March 31. I think I mentioned $10 million-$15 million is about as low as I like to go. But I have a high comfort level if we’re going to generate a ton of cash in the future.

You can see the cash flow that we’ve generated over the last three or four years and it’s a very consistent metric. Not a huge amount of CapEx needs and not a huge amount of debt requirement. $4.5 million per quarter is our debt requirement so another $1.5 million so we’ve got about $6 million that I need kind of in excess of those other recurring items. So a high comfort level with cash but probably won’t see it much lower than this quarter’s level.

Randy Harp

And if you look at our EBITDA, especially over any kind of broad period of time, it’s just amazingly consistent to me. I mean, I know we have some timing fluctuation, but up into the ride a very consistent, very significant amount.

And again, it just kind of proves the last point I’ll make on the call today is since we began in April of 1999 buying back treasury stock and paying dividends, we’ve returned, just in those two processes, $390 million to shareholders. The building that we’re in, $32 million to construct it. At March 31 we had $60 million in cash and investment, that’s unpledged cash and investments, so almost $0.5 billion, about $482 million in total uses, if you will, and only have less than $70 million in debt at March 31.

So $482 million going out, only $69 million in debt, I think clearly demonstrates the soundness of our financial model. We continue to believe that our ability to deliver what we think is a high-quality Life Events Legal Plan product and still produce what we think is significant free cash flow, very, very important. It’s the foundation of this business model that we think will allow us to grow this company to levels, not to where we’re at today, but certainly significantly higher than where we’re at. We all believe, continue to believe, this company ought to be a multiple of what it is today.

So I think we’ve proven the business model, cash flow model, the consistency and significance of the EBITDA over the last several years, I think we’ve got the right machine; it’s been built, it’s been tested, it’s been fine tuned. We’ve just got to pour more fuel in it in terms of new sales associates.

So, again, Steve and I appreciate your continued confidence. We enjoy talking to you when you call. We don’t take your support and your confidence for granted. We believe that we have a model and have demonstrated that the model can produce results that we’re all proud of. Not satisfied with by any stretch of the imagination, but we do think the machine is built and we’re just ready to take it to a new level now.

So, appreciate your being on the call today. As always, Steve and I look forward to any time you want to call, call us and we’ll look forward to talking to you on next quarter’s earnings call in late July.


Thank you. That does conclude today’s conference call.

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