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

Q2 2008 Earnings Call

July 30, 2008 8:30 am ET

Executives

Randy Harp – Chief Operating Officer

Steve Williamson – Chief Financial Officer

Operator

Welcome to the Pre-Paid Legal second quarter 2008 earnings result conference call. (Operator’s Instructions) At this time I’d like to turn the conference over to the Chief Operations Officer Mr. Randy Harp.

Randy Harp

This is Randy Harp, Chief Operating Officer of the company. I want to welcome you to the 2008 second quarter earnings conference call for Pre-Paid Legal Services. Joining me here at our home office is Steve Williamson, our Chief Financial Officer. Before we begin, I want to remind everybody that this 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 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 from disclosures in our public reports on Form 10K, Q, 8K, etc. filed with the SEC and available on the SEC Edgar website as well as our own website www.PrepaidLegal.com.

At this time I would ask our Chief Financial Officer Steve Williamson to step through the more significant financial highlights for the 2008 second quarter.

Steve Williamson

To start out second quarter 2008 with membership fees up 2.4% over the 07 quarter resulting in $109.5 million increased of course due to the increase in the average annual fee went to $300 from $295 and also had an increase in the membership base. 2008 associate services revenue is up $335,000 to $6.3 million primarily due to the increased average associate fee. The average was around $99 compared to $45 for 07 which more than offset the lower number of new recruits that we had. eService fees which is included in this line item as well were unchanged at about $3.1 million for both periods. Other revenue declined slightly, actually about $60,000 from $1.2 million to $1.1 million and as you may recall we’ve talked before, this other revenue is primarily the revenue that we recognize on the $10 enrollment fee that we get from a portion of the memberships and recognize the income over three years. It brings total revenues up $2.8 million to $116.9 million for the second quarter of 08.

Membership benefits were 34.6% of membership fees for the second quarter of 08, up slightly from 34.5%. The $0.25 per member per month reduction in the IDT memberships was more than offset due to some cost related to an upgrade of our provider WAN network. It’s really the connectivity that we have been the home office here in Ada and each one of our providers. We got about half of those done in the second quarter, we’ll get another half done in the third quarter so we would expect about the same margins for the third quarter and then back to the normal somewhere around 34.1% or 34.2% for the fourth quarter. Then, we roll in to the future savings, we’ll pick up an addition $0.25 savings per member per month January 1 of 09 and then again January 1 of 2010. Expect these changes to lower the benefit ratio about 50 basis points each time as we roll in to those incremental savings in 09 and 2010.

Commissions were down $3 million to $31.2 million for 2008 second quarter. We had fewer membership sales, 134,000 versus 146,000 that is partially offset by a higher average premium sold, $329 was the average annual premium for the 08 quarter, $326 was the number for the 07 quarter. Memberships times average premium gives you what we call premium written, that was down about 7% so to a certain degree almost in line with the reduction in the actual commissions paid.

Associate service costs were $7 million for 2008 up $347,000 from 07 primarily due to increased cost of our incentive programs and the CFT qualification bonuses that are paid on the $99 entry fee which again, remember we started the $99 entry fee January 1 of this year. G&A was 12.6% of membership fees for 08, 12.5% for 07. The 12.5% for 07 when you back out the state taxes and you’ll recall that we have state income taxes recorded below the line for the 08 periods compared to the 07 periods, so if you back out the state tax it was 11.8% for the 07 period so higher G&A costs were primarily due to increased legal fees, advertising, the last show actually ran in June so expect that cost to come down third and fourth quarter. Consulting fees, primarily due to PCI compliance and you may recall, we’ve talked about this before, that’s Payment Card Industry, the folks that are kind of in charge of Visa and MasterCard, those folks that elect dollars using credit cards have to comply with some of these standards and they’re much more difficult than even some of the SOX standards that we have. It requires a lot of intrusion testing and a lot of additional assistance from consulting so that generated some extra cost in the second quarter. Expect that to continue probably in the third quarter and then probably have that complete by the fourth quarter hopefully.

The postage also was higher in the second quarter. We did our privacy mailing in the second quarter of 08, again that’s a one-time a year deal so we would expect that cost not to be present the third and fourth quarter. Employee cost and primarily it was health cost, were higher as well and it seems a little odd that it would be higher just or continually automatically go up so I think actuarially we’d expect some of those costs to come back down to normal levels in the future quarters. And, we did see lower bank service charges and will expect those to continue to be lower as we lowered our credit card costs during the second quarter, during the last part of the second quarter so we would expect lower costs on bank service charges for the third and fourth quarter as well.

The other line item, other net includes $2.2 million in depreciation for 08, unchanged from the 07 level. Interest expense was down $800,000 from $1.8 million in the prior year of course, less debt and much lower interest rate environment. Premium taxes were unchanged, right around $480,000 for both periods and those were offset by interest income of $500,000 for 08, we had $1.2 million for 07. We’re sitting on more cash that we had not yet spent for the stock buyback and had higher interest rate environment then as well. The provision for taxes, taxes were 37.5% for 08 versus 32.5% for 07. The 08 rate of course includes the state income taxes that we talked about before. We would expect the overall provision for tax rate to be right around that 38% mark for the balance of the year plus or minus a percent.

That resulted in net income of $15.1 million for 08, a 14% increase over the 07 second quarter. The diluted shares outstanding decreased by 10% due to the stock buybacks. During the second quarter we bought 343,000 shares at an average cost of $43.33. We spent about $14.9 million. Only 52,500 options remain and we ended the quarter with 11.8 million shares outstanding. Second quarter diluted EPS was $1.25, that’s a 26% increase over the $0.99 that we had in 07. For the first six months of 08, cash flow from operations was $27 million down from $34.9 million for 07. A big part of the decrease was due to that additional tax payment that we had for state income taxes in the first quarter. Also, we paid more federal income taxes this year due to the higher net income so taxes were a big reason for that change. We’re a little bit ahead of the game, if you will, on some of the state income taxes and the federal tax payments have some refunds booked. We would expect the third and fourth quarter to be a little lower than what we’ve had in the first two quarters all things remaining equal.

Total cap ex was about $1.1 million for the second quarter. That brings us to about $3.2 million for the first six months, pretty much in line with the $6 million spend range that we’ve had recently. Total notes payable $73.8 million. Our principle payments were $7.1 million per quarter now. You will all remember that we borrowed an additional $10 million from BOK to accelerate our buyback. All that debt is tied to LIBOR, the average cost is about LIBOR plus 1.45% which puts us about 3.9% cost right now with a 2.46% LIBOR. That all matures in 2011 or by 2011. The $10 million we borrowed from BOK is a pretty quick payback, it’s just a one year term so we have payments of $833,000 per month. We’re in compliance with all of our debt covenants under most restrictive and we’re going to have about the same amount of money we had the last quarter to spend. If you recall, we went in to the quarter with around $14 million to spend, we’re going to be about that level this quarter and our cash balances are about $56 million cash and investments that are unpledged. A total of $56 million and once again as we’ve done since 1999, we will continue to use our excess cash to buy back shares in the open market and we’ll start that today.

With that, I’ll turn it back to you Randy.

Randy Harp

Again, obviously the additional $10 million reflects our willingness to go out and acquire additional debt to buy back shares at these prices. Again, with pre-tax rate in the 3% range, our after tax effective rate on the debt obviously substantially lower than that so certainly a very efficient capital structure we think and depending on prices and cash flow, etc. we certainly are always considering additional alternatives on our corporate finance structure.

I do want to respond to email questions that Steve didn’t address possibly in his flex analysis or in any of our previous public filings. We did file our 10Q for the second quarter yesterday so that’s available on the Edgar website, also available on PrepaidLegal.com. We have received, I think four questions, that we’ll respond to and again, as we always do using our respective strengths, I’ll read the questions and let Steve answer them. The first question, can you talk about any new programs to increase recruiting and production? Certainly, let me say up front we are always focused on anything we can do to increase recruiting and production. We do believe those go hand-in-hand. We do believe that we have to continue to focus on recruiting in order to continue to drive production. Historically, a very, I think close relationship in the number of new recruits and the ultimate production on a go forward. Steve, you might update them on the latest.

Steve Williamson

I guess I’ll hit a couple of things one, we did launch in June a program that effectively would pay additional dollars to associates, bonus dollars based on their increase in certain levels. Under the theory, we’re paying for the growth of their organization and very early the first payments went out after the June production so too early to tell what the results will be from there. But, certainly have some dollars on the table that incentivize the associates to move from the director to the ED all the way up to platinum and levels of diamond and have some good financial incentives. The way I’ve explained it to the associates and would explain it the same way to the investment public is we’re paying for growth, that’s the underlying theory of that program and we’ll be looking forward to talking to you about that during the next quarter after we see the third quarter results.

The other and the one that’s had probably the more immediate impact is we just recently announced that we went from a $99 program to the $49 opportunity, extend that for only a short period of time through the end of tomorrow, the end of this month.

Randy Harp

And I announced that last Friday so really less than a one week promotion.

Steve Williamson

In conjunction with that for the bean counters in the room like myself and Randy, we did at the same time pull back what we called the champion bonus. You may recall the old fast start bonus, as the new associates qualified we would pay $150 bonus to those associates. To be able to fund the $99 to $49 we did eliminate that particular bonus but we have seen a remarkable increase in production, albeit a short period of time. Certainly the price of entry does get the folks moving so I look forward to seeing what the results will be. And, the announcement was if you do a good job in this first few days that we have this opportunity available we will look to extending that in to the month of August. So, based on two days it looks like they’ve stepped up so we would expect that to continue.

Randy Harp

The next question, can you talk or compare some of the expense items in the quarter with the first quarter sequential analysis? Let me just say and I’ll let Steve provide the meaningful answer but it seems like our expenses are relatively tight. I can tell you as we go through them each quarter not only on a historical look back basis but on a proactive go forward basis there may be areas that always seem to – in this quarter it was healthcare expenses increased and we’re certainly continuing to look at that from an actuarial standpoint. But, all-in-all I would tell you that our expenses are very tight and that there are very few surprises. It just seems like either it was Sarbanes compliance cost or for the last 18 months it’s been PCI compliance costs and as Steve mentioned earlier in his comments, we should see our PCI compliance costs continue to decline as we get closer to the end of the year. But, probably something else along those lines that we don’t have today. So, we do expect continual, gradual, very steady state, very potentially a gradual decline in general and administrative expenses as a percentage of contract premium on a go forward basis but it seems like every quarter we have something although not a complete surprise in the nature of the expense, sometimes a surprise in the amount such as healthcare. Steve, I’ll let you talk about Q1 versus Q2.

Steve Williamson

I’ll just identify some of the items on a sequential basis that kind of have a flux analysis here. Accounting and professional really that’s our audit related costs. The second quarter was down from the first quarter, not unexpected, that’s the normal trend. We actually, the first quarter of the year is always the highest because that’s when we are racking up the year-end audit and then you get in to the Q environment when it’s not quite as intense. So, we had $160,000 less in accounting fees. Bank service costs were down as well sequentially. Again, we talked about part of really the later part of the quarter we did see some improvement due to renegotiating our costs associated with credit card processing. The consulting fees sequentially were up, a pretty good chunk, close to $200,000. Employee costs, $560,000 up, a lot of that healthcare costs as we talked about. And, the other thing that I would point out on healthcare, in looking at the numbers and I’m looking at a trend line from the first quarter of 07 all the way to the second quarter of 08, the first quarter of 08 was low and was a little lower than normal and was a little lower than normal for the healthcare cost so the sequential part may be because maybe we’re a little high in the second quarter but the first quarter was also a little lower than normal.

Later on in the year we’ll see how that trends out. But, we do-do a very detailed analysis of all the claims and have a real good feel for kind of what the reserve needs to be. And also, on the healthcare costs, we are self insured up to $100,000 so any really large items typically will go to the self insurance so any of those big claims that we have we’ll have that smoothed out with the reinsurance that we have. Postage again, was up. Again, first quarter of 08 was lower than the second quarter by about $130,000 which is almost exactly the cost associated with mailing that privacy notice. Telephone costs were sequentially higher second quarter over first quarter probably $125,000. Again, it was a little higher than normal but also first quarter was a little lower than normal. Then, legal fees were down as well but then again, the first quarter was considerably higher than what our trend line has been so we would expect the level for the second quarter to be more the norm. That’s pretty much the details for the items that have changed.

Randy Harp

As Steve mentioned in his first set of comments, we have also kind of a PCI related expense, the wide area network that we have between our facilities here and our provider law firms across the nation and in to Canada, we have extended in essence that point of demarcation from Pre-Paid here in Ada, Oklahoma out to the provider law firms so we now control, maintain, secure each and every, or we will by the end of the third quarter, each of the digital communication lines between Pre-Paid and our provider firms. In order to become PCI compliant we needed to secure those and encrypt that information so again, I think additional efforts on our part that usually get expensed and ultimately will impact us in a very positive way from an efficiency and a data security standpoint. I do believe we continue to – we’re very proud of the system that we have and I think we continue to improve that almost each and every day.

The next question, are there any new or different programs that the company has initiated to help associates in recruiting and production? And again, I think Steve’s talked about the significant increase in recruiting we’ve seen just in the last two days by dropping the entry point from $99 to $49 and also dropping the $150 bonuses that were on the table. That has resulted in again, it’s just two days, I don’t want to mislead you certainly but, a very significant increase in the number of new sales associates.

The last question that we have today, what impact has the slower economy had on Pre-Paid? No doubt that as certainly gas prices and the mortgage crisis and everything else that the country is dealing with does have an impact negatively to us but, it also has a positive impact to us in that tough times people only have legal needs and problem in two types of economic times, those are good times and bad times so we do see an increase certainly in some areas, landlord tenant issues, etc. during tough economic times. And, from an associate standpoint as people get continued layoffs and gas prices increase there is more and more people looking for additional income either on a full-time or part-time basis so not unusual for us or other companies that employ a direct sales distribution methodology to see an increase in recruiting which certainly helps to offset some of the economic downward pressure that we might have.

Steve Williamson

To that point, and I’ve talked about this to several investors since we released the production numbers at the first of the month, surprisingly we didn’t see an increase in cancellations. And, I say surprisingly with the dire straits that the economy is in it would not have surprised me to see a sequential bump in the cancellations. Even though the production has been down, I feel like the cancellations really are lower than what you would expect us to have in this type of economic time. You have to go back to second quarter of 2002 before you will actually see a number of cancellations that’s lower than the current levels. I mean, we had 134,000 in cancellations and you have to go all the way back to 2002 so I’m certain there were some incremental cancellations in the particular quarter due to financial conditions that the households are dealing with but, thank goodness we have a lot of folks working on retention efforts with Melanie kind of heading that up and talking to the sales force, educating them on things to do with Linda Brown’s Mass division, Member Advantage Services making outbound calls to all the folks whenever they go in to pre-cancellation. I think we’ve made a very good effort to help offset some of these bad economic environments so that it really didn’t impact us as much as really I would have expected it would.

Steve Williamson

I think we continually improve our business model and the related cost containment in that business model. We feel very good about what we’ve done from a corporate finance standpoint. Clearly, to anyone on this call, I think the only missing ingredient is increased membership productions and we believe that will come through increased recruiting and again, in order to kind of test the waters there, we announced a short lived reduction in the associate fee and certainly again, two days doesn’t make a trend but the results in the first two days have been very significant.

Again, the business model itself and kind of our corporate finance structure, we’re very proud of what we have done. By no means would we try to tell you that we can’t continue to improve and we focus on that each and every day. But, as kind of overall proof of the business model again, we’ve now since April of 99 we’ve now returned more than $407 million to shareholders through mostly, about $390 of that through share repurchases and about $17 million of that through dividends. That combined total represents more than 115% of our net income for the same period. We’ve also obviously built a new $32 million home office, we have $55 million in cash at June 30. So almost closing in on a half billion worth of uses if you will, and only have $74 million in debt. In crossing the $400 million returning to shareholders we’ve also reduced the number of shares outstanding just about exactly in half. We’ve now crossed the 50% threshold, we had nearly 24 million outstanding in April of 99, we’re now at 11.8 million, we crossed that 50% threshold during the second quarter so again, very proud of what we’ve been able to do on the business model side and on the corporate finance side.

And to have close to half a billion in uses and only $74 million of debt at June 30, I think clearly demonstrates the soundness of our financial model. We feel good about the fact that we can continue to improve that and continue to increase our efficiencies and believe our ability to deliver what we believe is very high quality life events legal plan and still produce significant cash flow is pretty important to us and hopefully pretty important to each of you.

In closing I’d just tell you Steve and I appreciate your continued confidence. It’s not something that either of us take for granted. I strongly believe that we have a business model that can continue to produce results that you and our other shareholders can be proud of. We do look forward to ratcheting up certainly our recruiting efforts and production of new memberships and we believe that’s kind of the final piece to the puzzle if you will. I appreciate you being on the call today, we look forward to the third quarter earnings call which will be in late October and as always, as many of you do, certainly feel free to call Steve or I if you have questions. With that, I’ll talk to you in October.

Question-and-Answer Session

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