Pre-Paid Legal Services, Inc, (NYSE:PPD)
Q4 2009 Earnings Call
February 24, 2010 9:00 am ET
Randy Harp – Chief Operation Officer
Steve Williamson – Chief Financial Officer
Welcome to the Pre-Paid Legal Services fourth quarter release. (Operator Instructions) I’d now like to turn the conference over to your host, Mr. Randy Harp, COO.
Good morning. This is Randy Harp, Chief Operating Officer of the company. We want to welcome you to the 2009 fourth quarter and year end conference call for Pre-Paid Legal Services Inc. Joining me here at our home office is Steve Williamson, our Chief Financial Officer.
Before we begin the call I want to remind everyone that the conference call might contain forward-looking statements including our expectations of future results and our future plans. Actual results might differ materially from those projected in those 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 Forms 10-K, Q and 8-K and in the amendments thereto with the SEC and all of those are available on the SEC website as well as our own Pre-PaidLegalServices.com website. We do expect to file the Form 10-K for 2009 today or tomorrow.
At this time, I would ask our Chief Financial Officer, Steve Williamson to step through the more significant highlights for both the fourth quarter and for the full year of 2009.
First I’ll give an overview for the year 2009. Revenue was down about $6 million compared to ’08 and we had expenses and taxes were down about $1 million which resulted in about $5 million in net income with 8% per shares in the diluted EPS calculation that brought us into $5.04 for both years ’08 and ’09 so unchanged.
To go over some of the details, our ’09 membership fees decreased 2% over ’08 due to the decease in average premium in force. We did see a quarterly sequential increase in membership fees of about $3.1 million when you look at the fourth quarter of ’09 compared to the third quarter of ’09 so saw a little bit of a pick up there in that last quarter.
’09 Associate Services revenue increased $4.8 million which included about $6 million increase in associate fees. That of course was due to higher levels of new recruits and that was somewhat offset by $1 million to $1.1 million decrease in e-service fees. The fourth quarter associate fees were up $900,000 and e-service fees increased about $1.1 million.
Other revenue which is primarily the amortization of that $10 enrollment fee over a three year life collected from non group members, that actually declined for the year $481,000. Fourth quarter was actually up slightly to $906,000 in total for the quarter.
Membership benefits decreased 3% more than the 2% decline in the membership revenue primarily due to the fact that the identify theft members had that additional savings of $0.25 per member per month that kicked in for 2009. It wasn’t present in 2008.
And again, one more time in January 2010 we had another decrease of $0.25 per member per month for the memberships. The ratio was 34% for 2009. The ratio of the benefits to the membership fee was 34.4% for ’08, so a little bit of a decline and I would expect it to be priced at 34% or a little bit less probably between 34.5% and 34% on a forward basis.
Commissions increased 3% mainly due to the 3% increase in new membership sales. Commissions per member were about the same for both years, around $230.00 and also if you look at it another way that I like to look at and evaluate it, is probably more a clear driver of commissions is the actual total membership fees written, which you get that by the new memberships written by the average annual premium of those new membership fees for 2008 and 2009. That came in at 71% number which represents 71% of the membership fees were in the form of commissions that went through the financial statements.
We did see in the fourth quarter of ’09 commissions were actually increased by about $3 million due to the change in the deferral. I’ll go into a little bit more detail. There’s a question that folks ask about that, but I’ll explain that deferral process later on the call when we get to questions.
Associate service cost was up about $3.6 million for 2009 or was over, associate services cost was higher than associate services revenue by about $3.6 million for 2009. In 2008 we were right about break even. I think there’s $48,000 worth of excess costs.
The increased cost for ’09 was primarily due to the increase of bonus payments to sales associates and also of course we had higher kit costs because we had a lot more new associates that we enrolled during 2009 versus ’08.
G&A decreased $1.4 million primarily due to the decreases in employee costs was the biggest change. We saw some slight decreases in advertising, legal fees and Telco costs and all of those were offset by some increases and none of them were huge, but increases in consulting fees, state service fees. Both years came in at 1% of the G&A ratio as compared to membership fees.
For the fourth quarter of ’09 that number came in at 11.7% and it represented the fourth consecutive quarterly decline. We’ve been very focused with the challenges we’ve had on the top line in focusing on cost control and a lot of the just normal things that you’d expect. We haven’t had any layoffs or anything but we have reduced our overtime from our staff and have even more changes that will help keep G&A in line for 2010 so feel pretty confident outside anything abnormal.
Again, we do have a couple of ongoing items with the SEC and FTC matters that generate some additional legal fees so put a little asterisk on what happens there. We do feel like the controllable costs that we have, we have that under control and I think that we can stay at that 12% or lower percentage on a go forward basis.
Other expenses decreased $4.9 million due to a $3 million reduction in interest expense. Of course we had lower debt levels and an incredibly low interest rate environment. All of our debt of course is verticals that we’ve been benefiting from that, and we also had about a $1.4 million reduction in expenses due to the litigation expense item. We reversed accrual that we didn’t need during 2009 so that helped that line item.
Depreciation was down $569,000 and interest income was down about $130,000. Provision for taxes came in at 39% for ’09 versus 38% for 2008 due to higher state income taxes. As many of you know, some of the state costs kind of had some challenges and we have seen some increased rates just from tax law changes from some of the states that resulted in a little bit heavier tax burden. On a go forward basis, I expect to be somewhere around that 39% range as far as our tax burden is concerned.
Net income resulted in an 8% decline, came in at $55.1 million for the year compared to $60.172 million for last year. With the 8% decline in the diluted earnings per share due to the buy back program that results in $5.04 for diluted EPS which is unchanged from the ’08 year.
A few other items on the balance sheet and other activities that we did purchase a pretty good chunk of shares, 1,354,000 shares at an average price of $37.44, brought us down to a shares outstanding level of right around the 10 million mark.
At 12/31/09 our cash and investments totaled $56.4 million versus debt of $42.3 million. Kind of looking at that debt, we did tap into our $5 million revolver we had available. We had paid that off since the end of the year and continue to do our normal amortization of debt on a monthly basis.
The debts are all priced at about LIBOR plus 1.40% would be the weighted average cost of bonds which results in about 1.64% gross before tax benefits on our actual interest rate. We are in compliance with all of our debt covenants under the most restrictive covenants.
We really used most of our availability for stock buy back which of course we were very aggressive during the fourth quarter of 2009, so we don’t have much left in our availability. We will generate quite a bit more I would expect during the first quarter of 2010 since at the end of the first quarter of 2010 one of the big cash kickers we get is we are not required to make our first Federal tax estimate payment until April 15 of 2010. So we tend to generate quite a bit more cash in the first quarter than other quarters.
In summary, what we did for 2009 and what I really kind of like to focus on is what we do with the cash. We generated about $68 million of cash during the year 2009 and what we used that for is we purchased equipment of $3.4 million. Again, we haven’t had any major equipment purchases in quite awhile so a lot of this was maintenance type CapEx so we’ve been down or below the $5 million for the last three years.
So we bought some equipment of $3.4 million. We reduced our debt by a net basis $17.4 million and we purchased about $50 million worth of stock during 2009.
And with that Randy, I’ll give it back to you.
Thank you Steve. We now want to respond to email questions that we’ve received that either Steve hasn’t previously addressed this morning or wants to elaborate on or have been contained in previous public filings and again, I expect to file our 10-K for 2009 today or tomorrow.
In the order that we received them, the first question is, can you speak to the progress the Blast Off initiative is having and its affect on membership and associates. At first glance it appears to have been a disappointment.
I don’t know that I would argue with that. I think we have been disappointed. We put a lot of effort into that launch, unfortunately not a lot of money, but we have generated well in excess of 100,000 non pre-paid associates that have joined Blast Off through our associates invitations and we at least now have the ability now to communicate with those folks, but as far as driving new associates or driving new memberships, I don’t think we ever expected it to be a significant driver of new memberships.
I would agree that I think as we described it early on, it had a lot of upside, not much downside and would continue to look at it that way. We continue to work with Blast Off to make things at least in our opinion better and more oriented towards Pre-Paid and think we still have a very good concept and have been impressed certainly with the improvements and changes that they’ve made since their initial launch.
They’ve brought on some other well known partners. One of them that have also launched so certainly haven’t given up on that initiative but would agree that we’re disappointed as well and again, had put a lot of effort into it but not a lot of money.
Second question, why does PPD continue to buy back stock? As a shareholder I would much rather have a dividend payment or invest this capital back into the business. I know that a reduced share count is supposed to be good, but it’s clearly having no effect on the stock price. Please elaborate on this and what is the end game of this buy back?
Let me first speak to the invested capital back into the business. I think Steve and I have always been very clear that the best use of our cash is to invest in the form of commission payment and the future of the business. That is, just to pay our associates commissions to go out and get quality business because that generates better after tax returns than we can generate by buying back stock or investing etc.
So our first priorities will always be to invest the capital back into the business in the form of commission payments. But we’ve been in a situation for a number of years now where the existing membership base throws off more cash and we have needed to pay commissions with and so the second best use of our cash that we’ve been able to identify, again I think is clearly a number two choice, but again will never be number one, is to buy back stock.
I think we said back in 1999 that we were going to start buying back significant amount of stock and we’ve done that for 10 going on 11 years now. I don’t thing there’s been very many companies if any that have been as consistent over a long period of time dedicated as much of their cash flow towards continuing to buy back stock as we have. So I do think it’s a good use of funds.
I might add that for this particular person that may not have followed us for a long period of time, we have in the past paid a few dividends, relatively small dividends that had been very disciplined, very focused on how we use our excess cash. Again, commissions are the best use.
We evaluate a lot of factors when we decide what we’re going to do. We can retire debt. We can buy back stock. We can pay dividends or any combination of those three items, or just accumulate cash I guess would be another option.
And some of the factors that we kind of look at is kind of overall economy, the actual share price, prospects for our growth, the actual retention rates. So we’re looking at a lot of things and it’s a very fluid changing environment each time and we just at the end of the day, what we’re trying to do is make the best long term decision for our shareholders.
A lot of things are debatable but we do try to go through a pretty disciplined evaluation of everything, and even as it relates to any new debt offerings. Over the years we’ve used debt to purchase additional shares to be more aggressive to effectively have the ability to buy those shares more quickly.
And again, we’ll evaluate that in the same way we do everything else, offer that new debt or the underlying covenants restrictions that we’re stepping into whenever we enter into any sort of new debt offering.
We’ve looked at a couple of those opportunities and are continuing to evaluate those. It does make sense to be more aggressive, and again, there is a lot of moving parts that we have been and will continue to be very disciplined in our approach in evaluating all the moving parts and will continue to attempt to make the best decision for the long term benefit of our shareholders.
As Steve said, we did pay $0.50 per share dividend and then the following year we slipped that up to $0.60 per share and concluded that the better use, the more accretive use of our cash was to continue to dedicate all that cash towards buying back shares. So the end game is we’ve been doing this for 11 years. We’ve bought a number of shares from 24 million roughly to 10 million, so a little over half and at the rate we’ve been buying, we still have six or seven or eight years left before we get near the end game.
I don’t know that there is an end game. I’m not sure what he’s referring to, what is the end game. Again, to me we look at it not on a quarterly basis. Randy and I talk about buying back shares and what we’re doing with our excess cash flow pretty much on a daily basis and we don’t know what the end game is.
If I knew what the future was, I probably wouldn’t be on this call today. I’d own my own island in Tahiti, but we don’t. So we’ll just try to evolve with the marketplace and with all the moving parts and try to make good decisions with any excess cash that we have.
Next question, what’s the status of the current FTC and SEC investigation? I find it discouraging that this company can’t just settle these issues and move on. I’m aware of the slow moving nature of these agencies but why can’t PPD just supply the requested information and resolve these issues? Also, why were the shareholders not notified of this matter when it happened? PPD received its initial inquiry from the SEC August 11, and didn’t issue the press release until October 6. Why were shareholders not informed sooner?
I’ll answer that in reverse order. Actually two SEC issues; one was a routine review of the 2008 10-K by the Division of Corporation Finance, a routine issue that every public company goes through. That is the letter that this shareholder is referring to that we received in August. Those are all, all those letters are available on Edgar.
And the Enforcement division of the SEC issued a subpoena to us on October 6, and we immediately the same day that we were notified of it, released or put out a press release announcing the Enforcement division subpoena. So two different issues; one very routine and non disclosable and just very routine. That matter has been, we worked with the staff of Cort Finn and resolved and amended our 10-K to reflect the discussions that we had with the commission and their staff.
As to the first part of the question about discouraging, how long it takes. Boy we couldn’t agree more. As Steve mentioned earlier in his analysis, these inquiries will cost our shareholders hundreds of thousands if not million plus dollars in legal fees. We have supplied all the requested information.
We have been to the FTC twice to meet with the staff and to meet with the commissioners. I’m certainly not aware as we speak that the either entity is waiting on anything from us. As you may recall, on the FTC issue, this actually started in April of 2007, their initial request for documents.
We immediately sent those documents to the FTC and then we didn’t hear back from them for more than 18 months. So we can’t control the process. We can only be responsive to their questions. It is a time consuming process to we’re searching back in paper files and electronic files for ten years.
That’s a very labor intensive time consuming process, but we have certainly complied and produced all the documents that we’ve been able to locate. So I agree with the frustration and the discouragement. Wish we had a choice, but we don’t and so we will continue to cooperate with these two Federal agencies.
We have engaged council and as Steve said, we’ve already incurred significant fees and will expect to continue to incur those types of expenses until these issues are resolved. But the Court issue again, was resolved and a very routine staff review of our 10-K and we amended the statement to include some additional disclosures pursuant to the discussions with the staff.
Next question, on the income statement commissions were $35.7 million in the fourth quarter compared to $36.7 million in the third quarter despite your memberships sold in the fourth quarter. Of the $35.7 million in commissions in the fourth quarter, how much of that was really from memberships sold in the third quarter.
Steve, I think you had mentioned you wanted to expand on that.
That particular item that he’s referring to is the method of accounting for our commissions. We actually amortize those over the first month of the membership’s life and the way we effectively do that, or practically do that, is in the last month of any given quarter, we defer half of the commissions that we paid during that last month of the quarter.
So for September of 2009, we actually had a much higher deferral than we did at December 31, 2009 due to the fact that we had a very strong September and had more of a normalized December payment, so that effectively the deferral came down, so that moved about $3 million of commissions into the fourth quarter.
I would point out that normally what you can do is look at a full year analysis and it’s a little bit smoother analysis. When you go back and look at the individual quarters, maybe a little more information is needed, but if you look at third quarter of ’09, that number that I talked about which is commissions as a percentage of new premium written, that number was 64.4% for the third quarter of ’09, 80% for the fourth quarter of 2009.
Again, that’s primarily due to that deferral. You had about $3 million less in the third quarter, $3 million more in the fourth quarter, but then when you roll forward and look at ’08 compared to ’09 for the full year, there really wasn’t a bit change in the 12/31/08 deferral compared to the 12/31/09.
So it’s really closer to the cash commissions that went out the door and that represented again, as I stated earlier for the full year ’09 versus ’08, it was 71% of new premiums written were in the form of commissions that we expenses. So that’s the question that you asked.
And just to be crystal clear, we do expense the advance commissions that we pay within the first 30 days from the membership so there is a slight deferral because the month end obviously we write business every day of the month, and those memberships that are written after the paying for the last month in the quarter, a portion of those advances are going to be deferred to the following quarter.
Question: If 10-K is not out prior to the call can you talk about how much cash, restricted cash and investments you have.
Probably the easiest way is to take the reverse on that Steve.
On the balance sheet we always have about $4 million worth of pledged investments, but if you look at cash and investments that aren’t pledged, it’s about $56.4 million as I stated before, and again, $42 million worth of debt.
I’m not sure exactly, but maybe you also want to know how much do we have available to spend to buy back shares, and we pretty much went through that in the fourth quarter. We were real aggressive so don’t have a lot of availability going into this very short buying opportunity that we have after we get off this call here, but we’ll generate quite a bit of availability in our covenants during this first quarter of 2010.
Since February is almost over can you in general talk about production and recruiting so far in 2010?
Production is up about 2%. I went through the end of the last week. That’s January through the first three weeks of February. Recruiting is still pretty strong, up about 46% and then one other metric that we watch is the percentage or the number of associates that are in production. That’s actually looking at how many people sold at least one piece of business. That number is up about 19%.
What is the current price to become a new associate? What if any changes are being made to help paying associates to improve their production?
There is currently and has always been two prices. One is $49.00 to become an associate. We currently have another offering at $72.00 which allows the associate should they perform to advance through the marketing structure a little more quickly.
As far as training new associates, we’re constantly putting out additional information. Certainly looking at new tools both refreshing the content of existing tools as well as new delivery systems to get information. We believe certainly a key piece of the game here is exposure and we certainly want to expose this certainly the membership benefits as well as the opportunity to as many people as we possibly can and are always looking for new and better ways to do that.
Some of the things that we continue to do that some people on this call may not be aware of is each quarter we have an APT which is a very low cost new associate advanced product training, and that’s exactly what it is. I was actually at a meeting helping with that presentation in Atlanta. They had a couple hundred folks there that were just trying to learn more about the company, about the products, so they could be more effective.
The other thing that we’ve implemented or are working on during this first quarter is a focus towards trying to get more people into group school. Actually we know that if they get that additional training, those folks that go to APT’s, that go to group schools, will produce more memberships and recruit more associates. So we’ve lowered the price of entry for group school and try to encourage that.
We have put forth maybe not regarding training, but just ways we’re trying to improve production during the fourth quarter, we did have quite a bit of bonuses that we paid out to associates. You may remember in the third quarter we had the expansion bonus, and that was a very large dollars that went out to kind of enhance and kind of get that extra motivation for more production.
We ended the expansion bonus program during the third quarter to fourth quarter. We rolled into some bonuses that were pretty large on a per associate basis and we changed that particular program, modified it somewhat, and effectively what we did, and I really do like the changes, we really took those dollars and spread them if you will, over the life of an associate.
In other words, once they first sign up, they have the ability if they get to manager in the first 15 days of becoming an associate, to have $100 bonus. If they don’t get it in 15 days, it’s only $50. So you have that fear of loss or that incentive to get it done quickly.
Then if they move to director, there is a $500 bonus available and that jumps up to $1,000 if they get it done in the first 30 days. And then there is bonuses to the upline executive director is one of their people in their down line move to that director level of $250 if they do it not within 30 days, $500 if within 30 days, so incentivizing the person who’s helping them build to that level.
And then one of the things that we’ve seen and heard from the field is that there is a big jump when you go from a director all the way to executive director. That’s a pretty big leap as far as moving through the commission structure and growing as an associate.
So what we did was added two more opportunities for a bonus called Director 25 and Director 50. And for those of you who may not be aware, you become and ED if you have 75 pieces of business that we count in any given month, so we basically split that up in thirds and we have this Director 25 and 50 bonus that effectively they have another very attainable goal that’s reachable that at the end of the day, what we’re trying to do, the goal is to have these smaller steps to keep them focused so that they can get things done more quickly.
I.e., they have bigger bonuses if they do it faster, but also it’s an attainable goal that at the end of the day we hope to have more production out of the average associate than we did before. So that’s kind of the program that we have for the first quarter of 2010 coupled with if you will, the group school initiative and the ongoing APT initiatives.
Next question, on February 1 you put out a press release regarding real estate issues in 2009. You listed $2.9 million for legal service. Is this information included in your marketing programs to associates?
Again, we communicate with our associates on a daily basis. Any press releases, any information like that we certainly email to them directly. In fact, we send a lot of things that we don’t do press releases.
Actually we put together a piece, there has been quite a bit of good news of late and we have a new marketing piece that’s available to all of our associates that they can pull down and print. The other goal in life is to try to get things in their hands that one, is very effective, and one very inexpensive to utilize.
So we actually have a PDF document that summarizes this along with a host of other good things about the need for the product and the about third party company credibility pieces that give the associates the ability to use than and encourage them and tell them how they can use that just as a door opener.
Last question; I have a question on PPD’s latest stock repurchase authorization. Does Pre-Paid implement the Safe Harbor 10-B18 which they’re executing brokers and if so, who are they executing brokers that PPD uses to complete their buyback programs?
We have for 10 to 11 years now always taken a very conservative approach to black out periods. They’re certainly in conjunction with 10-B18 the ability to buy through those type of periods by setting parameters in advance and continuing to make those purchases through the black out periods.
We have always taken a more conservative approach and not done that. We currently our black out periods are two weeks before end of the quarter until we have the earnings conference call each quarter. So again, a very conservative approach and would expect to continue that way, just better safe than sorry.
I might add that the brokers, and we’ve used several over the years are very knowledgeable about the company rules. Whenever the company buys back even short of this 10-B18, there are some companies that may use this, but more used for named executive officers that are putting forth some sales that they’re going to make that may or not be within a quite period.
As Randy said, we’re pretty conservative there. And at the end of the day, what we do is there is the general rules where you can buy back 25% of the prior four weeks average trading volume in any given day. You can’t leave it open. You can’t be in the last 15 minutes of the close and a whole host of other requirements if you’re the company out there buying.
We typically are one, very conservative on when we’re executing these open market purchases and two, even within the given day, we’re very conservative when we’re telling the broker, we always say don’t chase the stock. We want to be at the market. We want to participate in the market not be the market.
So very conservative on buy back today, and just trying to be real efficient with the use of our cash. Also included in our buy backs as we’ve disclosed in our 10-K includes some small percentages of non market purchases that we make from time to time, but those are relatively small.
In closing, let me throw a couple of numbers. I’m still impressed by these. We still have people that after 38 years question the economic viability of this financial model and on the point that Steve was just talking about, between stock repurchases which account for the vast majority and dividends, we’ve returned $475 million to shareholders.
We’ve built the home office that we’re in speaking now at a cost of $32 million. As Steve said, we have more than $65 unpledged cash and investments at the end of the year. So if you add all those numbers up, well over a half million, about $563 million. That’s more than 131% of our net income for that same time period. More than 13 times our existing debt of $42 million.
I just think those numbers overwhelmingly are convincing and clearly demonstrate the soundness of our financial model and our ability to deliver a high quality, legal plan product and our identity theft product, and still produce significant free cash, I think is very important and hard to overstate.
So Steve and I appreciate your continued confidence. We never take it for granted. We think this company and this business model is very unique and strongly believe that we can continue to produce results that all of your as shareholders can be proud of.
We appreciate you being on the call today and look forward to next quarter’s earnings call and I guess it will be in late April. So appreciate it. You know how to get hold of us if you have any further questions and we look forward to the opportunity to respond the questions and announce first quarter earnings in April. So we’ll see you then.
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