In addition to the property described above that is owned by the Company, the Company opened an additional Customer Care facility in Antlers, Oklahoma during March 2000, in building space provided at no cost to the Company. This facility will contain approximately 50 additional Customer Care representatives initially with the option of adding another 50 to 100 representatives in the next two years.
Prior Year Acquisitions The consolidated financial statements and related discussions thereof give retroactive effect to the 1998 merger with TPN, Inc. d.b.a. The People's Network ("TPN") which was accounted for as a pooling of interests. TPN was merged into the Company in a tax-free exchange of 999,992 shares (after adjustment for fractional shares) of the Company's common stock effective October 2, 1998. Additionally, the 1998 consolidated balance sheet data reflects the December 30, 1998 acquisition of Universal Fidelity Life Insurance Company ("UFL") that was accounted for as a purchase transaction and accordingly, none of the operating results of UFL are included in any periods prior to 1999. (See Notes to Consolidated Financial Statements-Note 2 for additional information regarding these 1998 acquisitions).
Membership benefit costs relating to open panel Memberships, which constituted approximately 3% of Memberships in force at December 31, 1999, are based on the usual, reasonable and customary fee for providing the required services. Such costs are generally paid on a current basis, as most costs are certain in amount and require only limited investigation. The Company maintains a reserve for estimated incurred but not reported open panel Membership benefit costs as well as costs which are in the payment process. These reserves are reviewed annually by an independent actuary as necessary in conjunction with the preparation and filing of financial statements and other reports with various state insurance regulatory authorities. Underwriting risks associated with the open panel Memberships are managed primarily through contractual benefit limitations and, as a result, underwriting decisions are not necessarily based on individual Membership purchases.
Product costs consist primarily of the actual cost paid to acquire such goods and services. Costs to purchase products and deliver services are included in Product costs in the Statement of Income
Prior to January 1997 the Company advanced commissions at the time of sale of all new Memberships. In January 1997, the Company implemented a policy whereby the associate receives only earned commissions on the first three sales unless the associate has successfully completed the new training program that was implemented at the same time. For all sales beginning with the fourth Membership or all sales made by an associate successfully completing the new training program, the Company currently advances commissions at the time of sale of a new Membership. The amount of cash potentially advanced upon the sale of a new Membership, prior to the recoupment of any charge-backs (described below), represents an amount equal to up to three years commission earnings. Although the average number of marketing associates receiving an advance commission payment on a new Membership is 12, the overall initial advance may be paid to more than twenty different individuals, each at a different level within the overall commission structure. This commission advance immediately increases an associate's account with the Company and represents prepaid commissions on active Memberships.
Should a Membership lapse before the advances have been recovered for each commission level, the Company immediately generates an immediate "charge-back" to the applicable sales associate to recapture 50% of any unearned advance. This charge-back is deducted from any future advances that would otherwise be payable to the associate for additional new Memberships. The Company historically has been able to immediately recover the majority of such charge-backs. Any remaining unrecovered advance on a Membership that has lapsed represents a receivable from the associate and is reflected as commission advances and is categorized as current or non-current based on the expected recovery period. Additionally, even though a commission advance may have been fully recovered on a particular Membership, no additional commission earnings from any Membership will be paid to an associate until all previous advances on all Memberships, both active and lapsed, have been recovered. During 1999, 21% of all associates submitting new Memberships accounted for 75% of all such new Memberships produced thereby further enhancing the recovery of commission advances.
The Company's commission advance policy exposes the Company to the risk of uncollectible commission advances, particularly for associates who do not receive commissions on a large number of Memberships or who experience below average Membership persistency. The Company closely monitors such commission advances to ensure maximum recoverability and maintains a recoverability reserve which at December 31, 1999 and 1998, was $4.5 million and $4.0 million, respectively.
Operating Ratios Three principal operating measures monitored by the Company in addition to Membership persistency are the loss ratio, product cost ratio and the expense ratio. The loss ratio represents Membership benefit costs as a percentage of Membership fees. The product cost ratio represents product costs as a percentage of product sales. The expense ratio represents the total of commissions, general and administrative expenses and premium taxes as a percentage of Membership fees and product sales. The Company strives to maintain these ratios as low as possible. These ratios do not measure total profitability because they do not take into account all revenues and expenses.
Associate Services The Company derives revenues from services provided to its marketing sales force, principally from a one-time enrollment fee of approximately $65 from each new sales associate and the sale of marketing supplies and promotional materials to associates on an ongoing basis. In January 1997, the Company implemented a training program ("Fast Start") that allows an associate who successfully completes the program to advance through the various commission levels at a faster rate. Associates participating in this program pay a one-time fee of $249 instead of the $65 fee. The increased fee covers the additional training and materials used in the training program. The Company enrolled 92,644 new sales associates during 1999 compared to 75,737 during 1998 and 58,121 during 1997, resulting in significant increases in associate services revenues and costs. The Company's direct costs of providing materials and services to associates are reflected as costs of associate services and direct marketing. Amounts collected from sales associates are intended primarily to offset the Company's direct and indirect costs incurred in recruiting, monitoring and providing materials to sales associates and are not intended to generate material profits from such activities.
The table above illustrates, for example, that an instantaneous 200 basis point increase in market interest rates at December 31, 1999 would reduce the estimated fair value of the Company's fixed-maturity investments by approximately $2.3 million at that date. At December 31, 1998, and based on the fair value of fixed-maturity investments of $35.8 million, an instantaneous 200 basis point increase in market interest rates would have reduced the estimated fair value of the Company's fixed-maturity investments by approximately $1.8 million at that date. The Company's increased sensitivity to rising interest rates is due to an overall increase in interest rates at December 31, 1999 as compared to December 31, 1998 and the additional investments with maturities over ten years. The definitive extent of the interest rate risk is not quantifiable or predictable due to the variability of future interest rates, but the Company does not believe such risk is material.
Year 2000 Issues The Company did not experience any significant malfunctions or errors in its operating or business systems when the date changed from 1999 to 2000. Based on operations since January 1, 2000, the Company does not expect any significant impact to its ongoing business as a result of the "Year 2000 issue." However, it is possible that the full impact of the date change, which was of concern due to computer programs that use two digits instead of four digits to define years, has not been fully recognized. For example, it is possible that Year 2000 or similar issues may occur with billing, payroll, financial closings at month end, quarterly, or year-end. The Company believes that any such problems are likely to be minor and correctable. In addition, the Company could still be negatively affected if its customers or suppliers are adversely affected by the Year 2000 or similar issues. The Company currently is not aware of any significant Year 2000 or similar problems that have arisen for its customers and suppliers.
Testing and conversion of system applications commenced during 1993 and was completed during 1999. Testing of the Company's information technology systems (as modified for Year 2000 issues) with system dates set beyond January 1, 2000 successfully occurred in February 1999. The Company was also exposed to the risk that one or more of its vendors or service providers could experience Year 2000 problems that impact the ability of such vendor or service provider to provide goods and services. Though this was not considered as significant a risk with respect to the suppliers of goods, due to the availability of alternative suppliers, the disruption of certain services, such as utilities, could, depending upon the extent of the disruption, have a material adverse impact on the Company's operations. Further, the Company must rely on other entities such as the Federal Reserve and its member banks whose Year 2000 readiness efforts it does not control. The Company relies on such entities for the timely processing of its monthly Automated Clearing House transactions and credit card transactions. The Company has initiated a comprehensive program to assess the Year 2000 compliance of its key vendors and service providers in order to determine the extent to which the Company is vulnerable to such third parties that fail to remedy their own Year 2000 issues. In this regard, the Company initiated formal communications with its significant vendors and financial institutions to assess their Year 2000 readiness. No material costs related to Year 2000 compliance efforts by the Company regarding such third parties have been incurred to date. These efforts did not reveal any vendor or service provider Year 2000 issue that the Company believed would have a material adverse impact on the Company's operations.
Membership fees totaled $157.2 million during 1999 compared to $110.0 million for 1998, an increase of 43%. Membership fees and their impact on total revenues in any period are determined directly by the number of active Memberships in force during any such period. The active Memberships in force are determined by both the number of new Memberships sold in any period together with the persistency, or renewal rate, of existing Memberships. New Membership sales increased 34% during 1999 to 525,352 from 391,827 during 1998. At December 31, 1999, there were 827,979 active Memberships in force compared to 603,017 at December 31, 1998, an increase of 37%. Additionally, the average annual fee per Membership has increased from $229 for all Memberships in force at December 31, 1998 to $238 for all Memberships in force at December 31, 1999, a 4% increase, as a result of a higher portion of active Memberships containing the additional pre-trial hours benefit at an additional cost to the member together with increased sales of the Business Owners' Legal Solutions plan.
Primarily as a result of the increase in Membership fees, total revenues increased to $196.2 million for 1999 from $160.5 million during 1998, an increase of 22%.
Commission expense was $37.4 million for 1999 compared to $24.3 million for 1998, and represented 24% and 22% of Membership fees for such years. Commission expense, as a percentage of Membership fees, should remain at or near 25% of Membership fees in future years based on the existing commission structure.
Depreciation and amortization increased from $2.9 million for 1998 to $3.1 million for 1999. This increase was primarily due in part to increased amortization of production costs by $425,000.
The Company's expense ratio, which represents commissions, general and administrative expenses and premium taxes as a percentage of Membership fees and product sales, was 36% for 1999 compared to 34% for 1998. The loss ratio, product cost ratio and the expense ratio do not measure total profitability because they do not take into account all revenues and expenses.
Associate services revenue increased 42% from $12.1 million for 1997 to $17.3 million during 1998 as a result of more new associates recruited and as a result of Fast Start which resulted in the Company receiving training fees of approximately $9.3 million during 1998 compared to $5.7 million during 1997. The field training program, titled Fast Start to Success ("Fast Start"), is aimed at increasing the level of new Membership sales per associate. Fast Start requires a training fee of $184 per new associate and upon successful completion of the program provides for the payment of certain training bonuses. In order to be deemed successful for Fast Start purposes during 1998, the new associate was required to write three new Memberships and recruit one new sales associate within 15 days of the associate's Fast Start training. The $9.3 million and $5.7 million for 1998 and 1997, respectively, in training fees was comprised of $184 from each of approximately 50,622 new sales associates who elected to participate in Fast Start in 1998 compared to 28,900 that paid the $184 and 14,500 existing associates that paid $25 during 1997. New associates enrolled during 1998 were 75,737 compared to 58,121 for 1997, an increase of 30%. While the number of new associates increased during 1998, the number of new Memberships sold, at least partially as a result of the Fast Start program, increased even more significantly. Future revenues from associate services will depend primarily on the number of new associates enrolled and the number who choose to participate in the Company's training program, but the Company expects that such revenues will continue to be largely offset by the direct and indirect cost to the Company of training bonuses paid, providing associate services and other direct marketing expenses.
Membership benefits totaled $36.1 million for 1998 compared to $25.1 million for 1997, and represented 33% of Membership fees for both 1998 and 1997. This loss ratio (Membership benefits as a percentage of Membership fees) should remain near 35% as the portion of active Memberships that provide for a capitated benefit continues to increase.
Commission expense was $24.3 million for 1998 compared to $16.7 million for 1997, and represented 22% of Membership fees for 1998 and 1997. Commission expense, as a percentage of Membership fees, should remain at or near 25% of Membership fees in future years.
Due to continuing annual property and equipment additions, depreciation increased from $2.0 million for 1997 to $2.9 million for 1998.
The Company's expense ratio, which represents commissions, general and administrative expenses and premium taxes as a percentage of Membership fees and product sales, was 34% for 1998 compared to 32% for 1997. The product cost ratio, which represents product costs as a percentage of product sales, was 65% during 1998 compared to 66% for 1997. The loss ratio, product cost ratio and the expense ratio do not measure total profitability because they do not take into account all revenues and expenses.
Provision for income taxes decreased during 1998 to $11.1 million compared to $12.4 million for 1997, representing 26.9% and 41.4% of income before income taxes for 1998 and 1997, respectively. The 1998 provision for income taxes reflects a $3.5 million benefit attributable to a reduction of a previously established valuation allowance due to the utilization of certain of the Company's deferred tax benefits. Tax expense for 1997 exceeded established statutory rates due to TPN's establishment of a $1.9 million valuation allowance pertaining to previously recorded deferred tax assets.
Dividends paid on outstanding preferred stock decreased to $9,800 for 1998 from $13,000 during 1997 and is attributable to the conversion of additional shares of $3.00 Cumulative Convertible Preferred Stock into common stock.
Parent Company Funding and Dividends Although the Company is the operating entity in many jurisdictions, the Company's subsidiaries serve as operating companies in various states which regulate Memberships as insurance or specialized legal expense products. The most significant of these wholly owned subsidiaries are PPLCI, UFL and PPLSIF. The ability of PPLCI, UFL and PPLSIF to provide funds to the Company is subject to a number of restrictions under various insurance laws in the jurisdictions in which PPLCI, UFL and PPLSIF conduct business, including limitations on the amount of dividends and management fees that may be paid and requirements to maintain specified levels of capital and reserves. In addition PPLCI and UFL will be required to maintain its stockholders' equity at levels sufficient to satisfy various state or provincial regulatory requirements, the most restrictive of which is currently $3 million for PPLCI. Additional capital requirements of PPLCI, UFL or PPLSIF will be funded by the Company in the form of capital contributions or surplus debentures. At December 31, 1999, neither PPLCI, UFL nor PPLSIF had funds available for payment of substantial dividends without the prior approval of the respective insurance commissioners.
Independent Auditors' Report of Deloitte & Touche LLP Report of Independent Public Accountants of Arthur Andersen LLP
In our opinion, based on our audits and the report of the other auditors, such consolidated financial statements present fairly, in all material respects, the financial position of Pre-Paid Legal Services, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, based on our audits and (as to the amounts included for TPN) the report of other auditors, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of TPN, Inc. d.b.a. The Peoples Network for the year ended December 31, 1997, in conformity with generally accepted accounting principles.
Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, as well as those of PPL Agency, Inc. (See Note 9 for additional information regarding PPL Agency, Inc.) The primary subsidiaries of the Company include Pre-Paid Legal Casualty, Inc. ("PPLCI"), Pre-Paid Legal Services, Inc. of Florida ("PPLSIF") and UFL. All significant intercompany accounts and transactions have been eliminated.
All investment securities are adjusted for amortization of premiums and accretion of discounts. Amortization of premiums and accretion of discounts are recorded to income over the contractual maturity or estimated life of the individual investment on the level yield method. Gain or loss on sale of investments is based upon the specific identification method. Income earned on the Company's investments in state and political subdivisions is not taxable.
Property and Equipment Property and equipment is stated at cost less accumulated depreciation and amortization. Depreciation of property and equipment is computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the estimated useful lives of the related assets or the period of the lease, whichever is shorter. Maintenance and repairs are expensed as incurred and renewals and betterments are capitalized.
Revenue Recognition Membership fees are recognized in income when due in accordance with Membership terms, which generally requires the holder of the Membership to remit fees on a monthly basis. Memberships are canceled for nonpayment of fees after a period of not more than ninety days. Fees due but not collected at the end of an accounting period are recorded as accrued Membership income; a provision for uncollectible fees, if any, is recorded currently. Revenues from Associates' training program fees and sales of marketing supplies are recognized as income when earned. Revenues for product sales are recognized when products are shipped or services provided.
Goodwill Goodwill, included in Other Assets, primarily represents the excess of acquisition costs over the value assigned to the net assets acquired in the 1998 UFL business combination and is amortized on the straight-line method over a period of ten years. The carrying amount of goodwill is reviewed using estimated undiscounted cash flows for the business acquired over the remaining amortization periods. Goodwill amortization for 1999 was $83,000. Since the UFL acquisition was effective December 30, 1998, no amortization expense was charged to earnings during 1998. The unamortized goodwill balance at December 31, 1999 is $747,000.
Life Insurance Reserves Life insurance reserves are actuarially determined based on life insurance in-force and estimated claims occurrences. The aggregate reserve for life insurance policies is an amount which is considered adequate to provide future guaranteed benefits as they become payable under the provisions of the insurance policies issued by UFL and remaining in force. The policy reserve is the aggregate result of an actuarial computation on each policy or group of policies.
Product Sales and Product Costs Product sales consist primarily of the sale of personal and home care products, jewelry, books, audiocassettes and videotapes focusing on personal achievement. Other products and services include digital satellite television subscriptions, Internet access and web sites, long distance and travel services provided by business partners. The Company has certain alliances with business partners, whereby sales associates buy or sell products or services provided by such business partners and in return the Company receives commissions on the sales of such goods and services. Revenues from these transactions are included in product sales in the consolidated statements of income.
Product costs consist primarily of the actual cost paid to acquire such goods and services. Costs to purchase products and deliver services are included in product costs in the consolidated statements of income.
Income Taxes The Company accounts for income taxes using the asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that are recognized in different periods in the Company's financial statements and tax returns. In estimating future tax consequences, the Company generally considers all future events other than the enactment of changes in the tax law or rates.
Segment Information The Company has applied the requirements of Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131") in its 1999 financial statements, the first year the Company has operated in more than one segment. That statement establishes standards for the reporting of information about operating segments in annual and interim financial statements and requires restatement of prior year information. Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker(s) in deciding how to allocate resources and in assessing performance. SFAS No. 131 also requires disclosures about products and services, geographic areas and major customers. The application of SFAS No. 131 did not affect results of operations or financial position of the Company but does govern the disclosure of segment information, as presented in Note 15.
Accounting Standard to be Adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS 133") was issued in June 1998. This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. In June 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 137 that deferred the effective date of SFAS 133 for one year. SFAS 133 applies to all entities and is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company will adopt SFAS 133 on January 1, 2001 as required. The Company believes that it holds no derivative instruments at December 31, 1999.
Effective October 2, 1998, the Company issued 999,992 shares of its common stock in exchange for all of the outstanding common stock of TPN based on a conversion ratio of 345 shares of the Company's common stock for each share of TPN common stock. The merger qualified as a tax-free reorganization and has been accounted for as a pooling of interests.
The Company completed its acquisition of UFL on December 30, 1998. UFL, based in Duncan, Oklahoma, was a subsidiary of Pioneer Financial Services, Inc. ("Pioneer"), which is a subsidiary of the Conseco group of companies. The Company paid $20.7 million in cash to Pioneer in exchange for all of the outstanding capital stock of UFL, which had assets and liabilities at December 31, 1998 with carrying values of $43.9 million and $24.0 million, respectively, which approximated their fair values. This acquisition was accounted for by the purchase method of accounting for business combinations. The accompanying consolidated statements of income do not include any revenues or expenses related to this acquisition prior to the closing date. The transaction has not had a material effect on the Company's operating results. As a part of the transaction, Pioneer Life Insurance Company, a wholly-owned subsidiary of Pioneer, entered into a 100% coinsurance agreement with UFL assuming all of the assets and liabilities relating to Medicare supplement and health care business written by UFL. UFL retained its existing life insurance business (1999 premiums were approximately $1.0 million) and continues to provide claims processing for the coinsured Medicare supplement and health care policies and receives full cost reimbursement for such services. During 1999, premium income and benefits expense for this coinsurance business (each of which were fully ceded to the coinsuring party) were $33.1 million and $24.1 million, respectively.
A summary of the amortized cost, unrealized gains and losses and fair values of the Company's investments at December 31, 1999 and 1998 follows:
December 31, 1998 ----------------------------------------- Amortized Gross Unrealized Fair Available-for-Sale Cost Gains Losses Value - ------------------ --------- ------- -------- -------- U.S. Government obligations........ $6,183 $ 23 $ (105) $ 6,101 Corporate obligations.............. 27,025 92 (25) 7,092 Equity securities.................. 3,178 - - 3,178 Obligations of state and political 2,226 12 (34) 2,204 subdivisions..................... Certificates of deposit............ 3,339 - - 3,339 Total.............................. -------- -------- --------- -------- $ 41,951 $ 127 $ (164) $ 41,914 ======== ======== ========= ========
The contractual maturities of the Company's available-for-sale investments in debt securities and certificates of deposit at December 31, 1999 by maturity date follows:
Amortized Cost Fair Value --------- --------- One year or less................... $ 4,568 $ 4,537 Two years through five years....... 8,887 8,228 Five years through ten years....... 5,180 4,575 More than ten years................ 9,590 8,823 -------- --------- Total $ 28,225 $ 26,163 ========= =========
Proceeds from sales of investment securities available-for-sale were $18,150,000 in 1999 resulting in gross realized gains of $700,000 and gross realized losses of $155,000. Proceeds from sales of investment securities held-to-maturity were $23,718,000 in 1998, resulting in gross realized gains of $17,500 and gross realized losses of $81,500. Sales of investments during 1997 were not significant.
Inventories consist of the following: December 31, ------------------- 1999 1998 --------- --------- Personal and home care, and personal development inventory................................. $ 618 $ 958 Jewelry inventory............................... 763 952 Sales and promotional materials................. 873 678 Less: Inventory reserve......................... (812) - --------- --------- Total $ 1,442 $ 2,588 ========= =========
Estimated Useful December 31, Life 1999 1998 ---------- -------- -------- Equipment, furniture and fixtures........ 3-10 years $ 11,896 $ 11,442 Computer software ....................... 5 years 4,537 3,258 Building and improvements ............... 20 years 2,835 4,026 Automotive .............................. 3 years 250 231 Land .................................... 110 110 -------- -------- 19,628 19,067 Accumulated depreciation ................ (11,267) (11,389) -------- -------- Property and equipment, net ............. $ 8,361 $ 7,678 ======== ========
Year Ended December 31, ----------------------- 1999 1998 1997 ------- ------- ------- Current income taxes: Federal ............................... $ 5,339 $ - $ 88 State ................................. 1,067 - - ------ ------- ------- 6,406 - 88 Deferred ................................ 14,568 11,122 12,293 ------ ------ ------- Total provision for income taxes..... $20,974 $11,122 $12,381 ======= ======= =======
Year Ended December 31, ------------------------------- 1999 1998 1997 ------- ------- ------- Statutory Federal income tax rate......... 35.0% 35.0% 35.0% Change in valuation allowance .............. - (8.2) 6.4 Tax exempt interest ........................ - (.1) (.2) State income taxes ......................... 1.5 1.0 1.0 Other ...................................... (1.5) (.8) (.8) ------- ------- ------- Effective income tax rate .................. 35.0% 26.9% 41.4% ======= ======= =======
Deferred tax liabilities and assets at December 31, 1999 and 1998 are comprised of the following:
Deferred tax assets: Expenses not yet deducted for tax purposes ..... 728 449 Unrealized loss on investments .................. 516 - Net operating loss carryforward.................. - 1,053 Pre-merger net operating loss .................. 1,637 1,980 General Business Credit carryforward............. 261 325 AMT Credit carryforward ......................... 586 366 -------- -------- Total deferred tax assets ...................... 3,728 4,173 Valuation allowance for deferred tax assets...... (1,898) (1,980) -------- -------- Total net deferred tax assets ................ 1,830 2,193 --------- -------- Net deferred liability .......................... $(41,199) $(27,148) ======== ========
Each share of $3.00 Cumulative Convertible Preferred Stock is entitled to receive cumulative cash dividends at the annual rate of $3 per share, payable quarterly, is convertible into 2.5 shares of Common Stock and is redeemable at the option of the Company at $25 per share. The $3.00 Cumulative Convertible Preferred Stock had a liquidation value of $53,000 at December 31, 1999. During 1999 and 1997, $3.00 Cumulative Convertible Preferred Stock consisting of 111 shares and 1,714 shares, respectively, were converted into 4,563 shares of Common Stock.
Each share of the Special Preferred Stock is entitled to a non-cumulative annual dividend of $1.00 per share, is convertible into 3.5 shares of Common Stock and is redeemable at the option of the Company at $13.34 per share, plus all accumulated and unpaid dividends. The Special Preferred Stock had a liquidation value of $235,011 at December 31, 1999. During 1999, 1998 and 1997, Special Preferred Stock consisting of 391 shares, 4,766 shares and 9,767 shares, respectively, were converted into 52,234 shares of Common Stock.
Agency's financial position and results of operations are included in the Company's financial statements on a combined basis. Agency earned commissions, net of amounts paid directly to its agents by the underwriter, during 1999, 1998 and 1997 of $121,000, $119,000 and $110,000, respectively, through its sales of insurance products of an unaffiliated company. Agency had a net loss for the years ended December 31, 1999, 1998 and 1997 of $18,148, $10,694 and $12,500, respectively, after incurring commissions earned by the Chairman of $49,000, $47,000 and $50,000, respectively, and annual management fees paid to the Company of $36,000 for 1999 and 1998 and $72,000 for 1997.
The Chairman and his wife own Stonecipher Aviation LLC ("SA"). The Company has agreed to reimburse SA for certain expenses pertaining to trips made by Company personnel for Company business purposes using aircraft owned by SA. Such reimbursement represents the pro rata portion of direct operating expenses, such as fuel, maintenance, pilot fees and landing fees, incurred in connection with such aircraft based on the relative number of flights taken for Company business purposes versus the number of other flights during the applicable period. No reimbursement is made for depreciation, capital expenditures or improvements relating to such aircraft. During 1999, 1998 and 1997, the Company paid $276,000, $279,000 and $192,000, respectively, to SA as reimbursement for such transportation expenses.
An executive officer (President) and director of the Company has loans from the Company made in December 1992, December 1996 and October 1998. The largest aggregate balance of these loans during the year ended December 31, 1999 was $511,000. The outstanding balance of these loans as of December 31, 1999 was $510,745. These loans bear annual interest at the rate of 3% in excess of the prime rate, adjusted on January 1 of each year, and are secured by commissions due from the Company. This individual also owns corporations or partnerships not affiliated with the Company but engaged in the marketing of the Company's Memberships and which earn commissions from sales of Memberships. These entities earned commissions, net of amounts passed through as commissions to their sales agents, during 1999, 1998 and 1997 of $14,000, $39,000 and $49,000, respectively.
The Company is a named defendant in certain other lawsuits arising in the ordinary course of the Company's business. While the outcome of these lawsuits cannot be predicted with certainty, the Company does not expect these matters to have a material adverse effect on the Company's financial condition, liquidity or results of operations.
The Plan provides for automatic grants of options to non-employee directors of the Company. Under the Plan, each incumbent non-employee director and any new non-employee director will receive options to purchase 10,000 shares of common stock on March 1 of each year commencing March 1, 1996. The options to be granted on March 1 of each year will be immediately exercisable as to 2,500 shares and will vest in additional increments of 2,500 shares on the following June 1st, September 1st, and December 1st in the year of grant, subject to continued service by the non-employee director during such periods. Options granted to non-employee directors under the Plan have an exercise price equal to the closing price of the common stock on the date of grant.
A summary of the status of the Company's Plan as of December 31, 1999, 1998 and 1997 and changes during the years ended on those dates is presented below:
Weighted Average Remaining Weighted Average Range of Exercise Prices Number Outstanding Contractual Life Exercise Price - ------------------------ ------------------ ---------------- ----------------- $8.13 - $16.00 229,500 1.94 $13.14 $25.50 - $35.88 424,000 3.61 30.38 $38.50 - $43.13 47,500 2.85 40.39 ------------------ ---------------- ----------------- 701,000 3.01 $25.41 ================== ================= =================
Weighted Average Remaining Weighted Average Range of Exercise Prices Number Outstanding Contractual Life Exercise Price - ------------------------ ------------------ ---------------- ----------------- $8.13 - $16.00 229,500 1.94 $13.14 $25.50 - $35.88 371,500 2.07 25.21 $38.50 - $43.13 47,500 2.85 40.39 ------------------ ---------------- ----------------- 648,500 2.08 $22.05 ================== ================= =================
The following table summarizes information about stock options other than those included in the Plan or issued to marketing associates outstanding at December 31, 1999:
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation," ("SFAS 123") establishes a fair value method and disclosure standards for stock-based employee compensation arrangements, such as stock purchase plans and stock options. It also applies to transactions in which an entity issues its equity instruments to acquire goods or services from nonemployees, requiring that such transactions be accounted for based on fair value. As allowed by SFAS 123, the Company will continue to follow the provisions of Accounting Principles Board Opinion No. 25 and related interpretations for its employee compensation arrangements, and disclose the pro forma effects of applying SFAS 123. Had compensation cost for the Company's employee related stock option plans, including options granted to RVPs, been determined based on the fair value at the grant dates for awards under the Plan consistent with the method of SFAS 123, the Company's net income and earnings per share for 1999, 1998 and 1997 would have been reduced to the pro forma amounts indicated below:
Diluted earnings per common share: As reported.................. $ 1.67 $ 1.26 $ .74 Pro forma.................... 1.54 .91 .70
Diluted earnings per common share are computed by dividing net income applicable to common stockholders by the weighted average number of shares of common stock and common stock equivalents outstanding during the year. The $3.00 Cumulative Convertible Preferred stock is considered to be a dilutive common stock equivalent in 1999 and 1998 but would be anti-dilutive, and therefore not considered in 1997. The Special Preferred stock is considered to be a dilutive common stock equivalent for all periods and the number of shares issuable on conversion of the $3.00 Cumulative Convertible Preferred stock and the Special Preferred Stock is added to the weighted average number of common shares. The weighted average number of common shares is also increased by the number of shares issuable on the exercise of options less the number of common shares assumed to have been purchased with the proceeds from the exercise of the options pursuant to the treasury stock method; those purchases are assumed to have been made at the average price of the common stock during the respective period.
Following is a summary of the unaudited interim results of operations for the years ended December 31, 1999 and 1998. As a result of the 1998 fourth quarter acquisition of TPN that was accounted for as a pooling of interests, the 1998 periods have been restated to include the operating results of TPN.
The Company derived approximately 98% of its revenues and net income from the sale of legal service plans and directly related activities during 1999. Revenues and net income from the Company's other operating segment (life insurance, through UFL) were approximately 2% each of the respective consolidated totals for 1999. UFL markets primarily to individuals, age 65 and over, in New Mexico, Oklahoma and Texas. The following table sets forth the composition of the segments and total Company revenues, net income and identifiable assets for the years ended December 31, 1999 and 1998. (For years prior to 1998, the Company operated in only one segment.):
Year Ended December 31, 1999 19988 --------- --------- Revenues: Legal service plans and directly related activities: Legal service plan membership fees................. $ 157,217 $ 110,003 Product sales...................................... 5,888 27,779 Associate Services................................. 22,816 17,255 Interest income.................................... 2,286 2,576 Other.............................................. 3,809 2,840 --------- --------- Total........................................... 192,016 160,453 ========= =========
Net Income: Legal service plans and directly related activities.. $ 38,127 $ 30,210 Life insurance segment (UFL)......................... 826 - --------- --------- Net Income................................... $ 38,953 $ 30,210 ========= =========
Assets: Legal service plans and directly related activities.. $ 163,755 $ 124,075 Life insurance segment (UFL)......................... 30,020 43,828 --------- --------- Total assets................................. $ 193,775 $ 167,903 ========= =========
The December 31, 1998 consolidated balance sheet data reflects the December 30, 1998 acquisition of Universal Fidelity Life Insurance Company ("UFL") that was accounted for as a purchase transaction and accordingly, none of the operating results of UFL for 1998 are included in the Company's consolidated financial statements.