The executive and administrative offices of the Company and its subsidiaries are located at 321 East Main Street, Ada, Oklahoma. These offices, containing approximately 40,000 square feet of office space, are owned by the Company. Additionally, during 1998, the Company completed construction of its Customer Care facility next to the Company's material distribution center. Both buildings are located approximately five miles from the Company's administrative offices. This new Customer Care structure contains approximately 10,000 square feet of office and call center space and is adjacent to the material distribution center constructed during 1997 containing 8,600 square feet of inventory, package assembly and shipping space. While the Company currently fully utilizes these existing facilities, management believes that it will have no difficulty in securing additional facilities in close proximity to its office building if necessary for future expansion.
Acquisitions The consolidated financial statements and related discussions thereof give retroactive effect to the merger with TPN, Inc. d.b.a. The People's Network ("TPN"), which has been 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. The consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows for the years ended December 31, 1998, 1997 and 1996 include the results of operations and cash flows for TPN. The period from inception through December 31, 1995 is included in TPN's 1995 financial statements. The consolidated balance sheets as of December 31, 1998 and 1997 include the financial position of TPN on such dates. 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. (See Notes to Consolidated Financial Statements-Note 2 for additional information regarding these acquisitions).
Commissions Beginning with new Memberships written after March 1, 1995, the Company implemented a level commission schedule which results in the Company incurring commission expense related to the sale of its legal expense plans on a basis more consistent with the collection of the premiums generated by the sale of such Memberships. Prior to March 1, 1995, the Company had incurred much higher commissions (approximately 70%) during the first year of the Membership with substantially lower commissions (approximately 16%) in all subsequent years. The level commission structure results in the Company incurring commissions at the rate of approximately 25% per year for all Membership years.
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, 1998 and 1997, was $4.0 million and $3.7 million, respectively.
Associates also receive compensation when associates sponsored by them or other associates that they have sponsored in their organization successfully complete the new training program implemented by the Company on January 4, 1997. In order to successfully qualify, the new associate going through the training program must produce 3 new Memberships and recruit 1 new associate within 15 days of receiving the training.
Cash Flow Considerations Relating to Sales of Memberships The Company generally advances significant commissions at the time a Membership is sold. Since approximately 92% of Membership premiums are collected on a monthly basis, a significant cash flow deficit is created at the time a Membership is sold. This deficit is reduced as monthly premiums are remitted and no additional commissions are paid on the Membership until all previous commission advances have been fully recovered. Since the cash advanced at the time of sale of a new Membership may be recovered over a multi-year period, cash flow from operations may be adversely affected depending on the number of new Memberships written in relation to the existing active base of Memberships and the composition of new or existing sales associates producing such Memberships.
The ability of the Company to utilize NOLs and tax credit carryforwards to reduce future federal income taxes of the Company is subject to various limitations under the Internal Revenue Code of 1986, as amended (the "Code"). One such limitation is contained in Section 382 of the Code which imposes an annual limitation on the amount of a corporation's taxable income that can be offset by those carryforwards in the event of a substantial change in ownership as defined in Section 382 ("Ownership Change"). In general, an Ownership Change occurs if during a specified three-year period there are capital stock transactions that result in an aggregate change of more than 50% in the beneficial ownership of the stock of the Company. However, the Company does not have control over all possible variables which can affect the Ownership Change calculation and, accordingly, it is possible that an Ownership Change could occur in the future. The effect of any such Ownership Change on the Company's financial condition or results of operations cannot be determined because it is dependent upon unknown future facts and circumstances at the time of any such change, including, among others, the amount of the Company's NOLs, the fair market value of the Company's stock and the Company's other tax attributes. The acquisition of TPN by the Company constituted an Ownership Change of TPN. As a result, the ability of the Company to utilize TPN's $5.7 million in NOLs is limited to $978,500 per year.
Disclosures About Market Risk The Company's consolidated balance sheets include a certain amount of assets and liabilities whose fair values are subject to market risk. Due to the Company's significant investment in fixed-maturity investments, interest rate risk represents the largest market risk factor affecting the Company's consolidated financial position. Increases and decreases in prevailing interest rates generally translate into decreases and increases in fair values of those instruments. Additionally, fair values of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, prepayment options, relative values of alternative investments, liquidity of the instrument and other general market conditions.
The Company is 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 is 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. Should these entities fail in their efforts to become Year 2000 compliant, the Company would immediately convert to monthly invoices until such time as all necessary entities become Year 2000 compliant. Although such actions would be inconvenient and more costly to process, it is not expected to materially affect the Company's long term business outlook. 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 has 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. To date these efforts have not revealed any vendor or service provider Year 2000 issue that the Company believes would have a material adverse impact on the Company's operations. However, the Company has no means of ensuring that its vendors or service providers will be Year 2000 ready, and the inability of vendors or service providers to complete their Year 2000 resolution process in a timely fashion could have an adverse impact on the Company's financial position or results of operations.
The Company presently believes based on its knowledge and representations of third parties that, with modifications to existing software and conversion to new software, the Year 2000 issue will not pose significant operational problems for the Company's computer systems as so modified and converted. However, if such modifications and conversions are not completed in a timely fashion, the Year 2000 issue may have a material adverse impact on the operations of the Company.
Accounting Standard to be Adopted Statement of Financial Accounting Standards 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 the Company recognize all derivatives as either assets or liabilities in the balance sheet 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. The Company will adopt SFAS 133 on January 1, 2000 as required. This Statement applies to all entities and is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company believes that it holds no derivative instruments at December 31, 1998.
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 combination classroom and field training program, titled Fast Start to Success ("Fast Start"), is aimed at increasing the level of new Membership sales per associate. The positive impact of the program is reflected in the increase in new Memberships written and new sales associates recruited per Fast Start 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, the new associate must 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.
Primarily as a result of the increase in Membership premiums, total revenues increased to $160.5 million for 1998 from $133.4 million during 1997, an increase of 20%.
Membership benefits totaled $36.1 million for 1998 compared to $25.1 million for 1997, and represented 33% of Membership premiums for both 1998 and 1997. This loss ratio (Membership benefits as a percentage of Membership premiums) should remain near 35% as the portion of active Memberships that provide for a capitated benefit continues to increase.
Product costs declined more than $9.0 million, or 33%, during 1998 to $18.0 million from $27.0 million for 1997 in conjunction with the 32% decline in product sales. Product costs as a percentage of product sales were 65% for 1998 compared to 66% during 1997. Product costs are expected to decline proportionately as product sales decline as more emphasis is placed on Membership sales rather than the sale of goods and services.
Commission expense was $24.3 million for 1998 compared to $16.7 million for 1997, and represented 22% of Membership premiums for 1998 and 1997. Commission expense, as a percentage of Membership premiums, should remain at or near 25% of Membership premiums in future years.
Dividends paid on outstanding preferred stock decreased to $9,800 for 1998 from $13,000 during 1997 and is attributable to the conversion of shares of $3.00 Cumulative Convertible Preferred Stock into common stock.
Comparison of 1997 to 1996 The Company reported net income applicable to common shares of $17.5 million, or $.74 per diluted common share, for 1997, up 71% from net income applicable to common shares of $10.2 million, or $.44 per diluted common share, for 1996. The increase in the net income applicable to common shares for 1997 is primarily the result of increases in all revenue categories for 1997 as compared to 1996.
Product sales increased 55% during 1997 to $41.1 million from $26.4 million in 1996 as the number of sales associates selling goods and services increased and the number of products available for sale increased. The sale of new satellite television subscriptions also increased.
Interest income for 1997 increased 30% to $1.7 million from $1.3 million for 1996. Interest income increased as a result of increases in the average investments outstanding. At December 31, 1997 the Company reported $35.4 million in cash and investments compared to $21.1 million at December 31, 1996.
Membership benefits totaled $25.1 million for 1997 compared to $16.9 million for 1996, and represented 33% of Membership premiums for both 1997 and 1996. This loss ratio (Membership benefits as a percentage of Membership premiums) should remain near 35% as the portion of active Memberships that provide for a capitated benefit continues to increase.
Commission expense was $16.7 million for 1997 compared to $11.5 million for 1996, and represented 22% and 23% of Membership premiums for 1997 and 1996, respectively. Commission expense, as a percentage of Membership premiums, should remain at or near 25% of Membership premiums in future years.
The Company's expense ratio, which represents commissions, general and administrative expenses and premium taxes as a percentage of Membership premiums and product sales, was 32% for 1997 compared to 35% for 1996. The product cost ratio, which represents product costs as a percentage of product sales, was 66% during 1997 compared to 78% for 1996. 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.
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 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.
Independent Auditors' Report of Deloitte & Touche LLP Report of Independent Public Accountants of Arthur Andersen LLP Report of Independent Auditors of Ernst & Young LLP
To the Board of Directors and Stockholders of Pre-Paid Legal Services, Inc.:
As discussed in Note 1, the financial statements for the year ended December 31, 1996 have been restated to record compensation expense in connection with the transfer of common stock from the majority shareholder of the Company to an employee of the Company.
Dallas, Texas September 10, 1997, except for Note 1, as to which the date is March 12, 1999
Income before income taxes................... 41,332 29,904 16,120 Provision for income taxes................... 11,122 12,381 5,857 -------- -------- -------- Net income................................... 30,210 17,523 10,263 Less dividends on preferred shares........... 10 13 15 -------- -------- -------- Net income applicable to common stockholders. $ 30,200 $ 17,510 $ 10,248 ======== ======== ========
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 8 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.
Investment Securities The Company accounts for its investments in debt and equity securities in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115"). Investments classified as trading are accounted for at fair value, available-for-sale investments are accounted for at fair value with unrealized gains and losses, net of taxes, excluded from earnings and reported as a separate component of stockholders' equity, and held-to-maturity investments are accounted for at amortized cost.
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. Due to the UFL acquisition and the requirement for $20.6 million as cash consideration paid, the Company liquidated a substantial portion of its investments previously classified as held-to-maturity. Although the Company previously had demonstrated its intent and capability to hold such investments until their scheduled maturities, the conversion of such investments to cash as part of the UFL transaction prior to their scheduled maturities resulted in all remaining investments of the Company, including the $25 million investment portfolio of UFL, being classified as available-for-sale investments. 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.
Goodwill Goodwill represents the excess of acquisition costs over the value assigned to the net assets acquired in business combinations 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. Since the UFL acquisition was effective December 30, 1998, no amortization expense was charged to earnings during 1998.
Life Insurance Reserves Incurred but not reported claim estimates are actuarially estimated based on life insurance in-force and estimated claims occurrences.
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 and compensates the selling associates with a commission. Revenues from these transactions are included in product sales in the consolidated statements of income.
Deferred Revenue Until January 1999, the Company sold merchandise certificates to certain of its sales associates. These certificates can be used to purchase products from the Company and expire one year from the date of issuance. Deferred revenue represents the anticipated value of certificates to be redeemed for products based on expected redemption rates of certificates issued.
Long-Lived Assets The Company periodically reviews long-lived assets to be held and used in operations when events or changes in circumstances indicate that the assets might be impaired. The carrying value of long-lived assets is considered impaired when the identifiable undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset. Fair value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of are determined in a similar manner, except that fair values are reduced by disposal costs.
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. Net revenues and net income applicable to common stockholders reported by the individual companies prior to the merger were as follows:
Assets and liabilities remaining in UFL at December 31, 1998 include $28.0 million in cash and investments, $835,000 relating to real estate, computer systems and furniture and fixtures (occupied and utilized by UFL) and $15.0 million of receivables generated in the ordinary course of business including a coinsurance receivable of $12.5 million. December 31, 1998 liabilities of UFL remaining after the transaction include life insurance reserves of $8.7 million, accident and health reserves of $12.5 million and other ordinary course of business accrued liabilities of $2.3 million and deferred income taxes of $467,000. The transaction is not expected to have a material effect on the Company's operating results in the near term. This acquisition was accounted for by the purchase method of accounting for business combinations. The assets acquired and the liabilities assumed were recorded at fair value, which approximated their historical carrying amounts, and excess cost representing the consideration paid in excess of identifiable net assets of $770,000 was recorded as goodwill. The accompanying consolidated statements of income do not include any revenues or expenses related to this acquisition prior to the closing date. Following are the Company's pro forma results for 1998 and 1997 including UFL's life insurance business assuming the acquisition occurred on January 1, 1997:
Net income applicable to common stockholders: As reported................................ $ 30,200 $ 17,510 Pro forma.................................. 31,026 18,132
Basic earnings per common share: As reported................................ $ 1.29 $ .76 Pro forma.................................. 1.32 .78
Diluted earnings per common share: As reported................................ $ 1.26 $ .74 Pro forma.................................. 1.30 .77
Amortized Cost Fair Value One year or less......................... $ 6,198 $ 6,195 Two years through five years............. 22,961 22,940 Five years through ten years............. 6,001 6,001 More than ten years...................... 3,022 3,022 --------- --------- Total.................................... $ 38,182 $ 38,158 ========= =========
December 31, ---------------------- 1998 1997 --------- --------- Held-to-maturity investments-current portion....... $ - $ 1,875 Available-for-sale investments-current portion..... 801 - Held-to-maturity investments....................... - 650 Available-for-sale investments..................... 36,207 - Investments pledged................................ 1,150 975 -------- -------- Total.............................................. $ 38,158 $ 3,500 ======== ========
Inventory consists of the following: December 31, ---------------------- 1998 1997 --------- --------- Personal and home care, and personal development inventory........................ $ 958 $ 937 Jewelry inventory............................... 952 662 Sales and promotional materials................. 678 677 Less: Inventory reserve......................... - (160) -------- -------- Total inventory $ 2,588 $ 2,116 ======== ========
Property and equipment is comprised of the following: Estimated December 31, ---------------- Useful Life 1998 1997 ------------ ------- ------ Equipment, furniture and fixtures........ 3-10 years $11,442 $ 7,874 Computer software........................ 5 years 3,258 2,809 Building and improvements................ 20 years 4,026 1,918 Automotive............................... 3 years 231 231 Land..................................... 110 110 ------- ------- 19,067 12,942 Accumulated depreciation................. (11,389) (7,716) ------- ------- Property and equipment, net.............. $ 7,678 $ 5,226 ======= =======
The net carrying value of capitalized leased assets was $1.0 million and $531,000, at December 31, 1998 and 1997, respectively.
Year Ended December 31, ------------------------------- 1998 1997 1996 -------- -------- -------- Current.................................. $ - $ 88 $ - Deferred................................. 11,122 12,293 5,857 -------- -------- -------- Total provision for income taxes......... $ 11,122 $ 12,381 $ 5,857 ======== ======== ========
December 31, --------------------- 1998 1997 --------- --------- Deferred tax liabilities: Commissions advanced......................... $ 28,650 $ 18,784 Unrealized investment gains (net)............ 467 - Depreciation................................. 224 - -------- -------- Total deferred tax liabilities............ 29,341 18,784 -------- --------
Deferred tax assets: Expenses not yet deducted for tax purposes... 449 445 Depreciation................................. - 14 Net operating loss carryforward.............. 1,053 5,099 Pre-merger net operating loss carryforward... 1,980 - General Business Credit carryforward......... 325 325 AMT Credit carryforward...................... 366 366 -------- -------- Total deferred tax assets................. 4,173 6,249 Valuation allowance for deferred tax assets.. (1,980) (3,936) -------- -------- Total net deferred tax assets............. 2,193 2,313 -------- -------- Net deferred liability....................... $(27,148) $(16,471) ======== ========
At December 31, 1998, the Company had net operating loss carryforwards ("NOLs") for Federal regular and alternative minimum tax purposes of approximately $3.0 million and $2.6 million, respectively, expiring in 2011 and 2012. In addition, the Company had general business and rehabilitation tax credit carryforwards of approximately $307,000 expiring primarily in 1999 to 2001, and an alternative minimum tax ("AMT") credit carryforward of $366,000 that does not expire. No valuation allowance has been established for these deferred tax assets as the Company believes it is more likely than not that the tax benefits of such deferred tax assets will be realized. The Company generated taxable income for the year ended December 31, 1998 of $11.5 million and utilized NOLs originally generated in 1986 through 1995 in their entirety and $2.3 million of the $2.8 million NOL originally generated in 1996. Tax expense for 1998 was reduced during the fourth quarter of 1998 through a reduction in a previously established valuation allowance to reflect this utilization of NOLs, not including those attributable to pre-merger activity of TPN. The Company has NOLs in the amount of $5.7 million representing the NOLs of TPN as of the merger date. A valuation allowance has been established for these NOLs as the Company does not believe it is more likely than not that the tax benefits of these carryforwards will be realized due to utilization restrictions imposed by the Internal Revenue Code.
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 $55,000 at December 31, 1998. During 1997 and 1996, $3.00 Cumulative Convertible Preferred Stock consisting of 1,714 and 40 shares was converted into 4,385 shares of Common Stock. No shares were converted during 1998.
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 $240,227 at December 31, 1998. During 1998, 1997 and 1996, Special Preferred Stock consisting of 4,766, 9,767 and 12,812 shares, respectively, were converted into 95,708 shares of Common Stock.
The following table summarizes information about stock options outstanding at December 31, 1998 issued pursuant to the Plan:
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 1998 and 1997 would have been reduced to the pro forma amounts indicated below:
In accordance with SFAS 123, the Company recorded compensation expense related to the issuance of stock options to non-employee marketing associates of $100,000 and $318,000 during 1997 and 1996, respectively. The weighted average fair value of options granted that met the minimum exercise criteria during 1997 was $1.07 per share. The fair value of each stock option grant to marketing associates was measured on the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions used: no dividend yield; risk-free interest rate of 5.00% and 6.00% for 1997 and 1996, respectively; expected life of 1 year; and expected volatility ranging from 30% to 49%.
During 1988, the Company adopted an employee stock ownership plan. Under the plan, employees may elect to defer a portion of their compensation by making contributions to the plan. Up to seventy-five percent of the contributions made by employees may be used to purchase Company common stock. The Company, at its option, may make matching contributions to the plan, and recorded expense during 1998, 1997 and 1996 of $58,027, $55,785 and $46,176 based on contributions of Company stock of 1,900 shares, 3,000 shares and 5,100 shares, respectively.
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 1998 but would be anti-dilutive, and therefore not considered in 1997 or 1996. 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.