The ability of the Company to utilize NOLs and tax credit carryforwards to reduce future federal income taxes of the Company is also 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 which result in an aggregate change of more than 50% in the beneficial ownership of the stock of the Company. The Company is not aware of any pending or contemplated transactions that would result in an Ownership Change under Section 382. 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.
Associate Services The Company derives revenues from services provided to its marketing sales force, principally from a one-time enrollment fee of approximately $65 ($49 prior to February 1, 1996 and $55 prior to July 1996) from each new sales associate and the sale of marketing supplies and promotional materials to associates on an ongoing basis. Effective January 4, 1997, the Company implemented a training program which 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 69,789 new sales associates during 1996 compared to 50,464 during 1995 and 14,129 during 1994, 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.
Comparison of 1995 to 1994 The Company reported net income applicable to common shares of $7.2 million, or $.35 per common share, for 1995 up 35% from net income applicable to common shares of $3.3 million, or $.26 per common share, for 1994. This 35% increase in net income applicable to common shares was achieved despite a 67% increase in the weighted average number of shares used in computing earnings per share from 12.5 million shares in 1994 to 20.8 million shares for 1995. The increase in the net income applicable to common shares for 1995 is primarily the result of increases in every revenue category for 1995 as compared to 1994.
Primarily as a result of the increase in Contract premiums, total revenues increased to $37.1 million for 1995 from $24.6 million during 1994, an increase of 51%.
In our opinion, 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, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, 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.
PRE-PAID LEGAL SERVICES, INC. CONSOLIDATED BALANCE SHEETS (Amounts in 000's, except par values)
December 31, ------------------- 1996 1995 --------- -------- Current assets: Cash.................................................. $14,831 $14,489 Held-to-maturity investments - current portion........ 500 500 Accrued Contract income................................ 1,710 1,038 Commission advances - current portion.................. 9,108 3,923 ------- ------- Total current assets................................ 26,149 19,950 Held-to-maturity investments............................. 1,757 500 Investments pledged..................................... 2,772 2,766 Commission advances, net............................... 21,744 8,548 Property and equipment, net............................. 2,955 2,202 Other................................................... 2,155 1,663 ------- ------- Total assets........................................ $57,532 $35,629 ======= =======
Income before income taxes............... 19,185 11,244 3,396 Provision (benefit) for income taxes..... 6,715 3,932 (319) -------- -------- -------- Net income............................... 12,470 7,312 3,715 Less dividends on preferred shares....... 15 125 465 -------- -------- -------- Net income applicable to common shares... $ 12,455 $ 7,187 $ 3,250 ======== ======== ========
Stock-Based Compensation Compensation expense is recorded with respect to stock option grants and restricted stock awards to employees using the intrinsic value method prescribed by Accounting Principles ("APB") Opinion No. 25. This method calculates compensation expense on the measurement date as the excess of the current market price of the underlying Company stock over the amount the employee is required to pay for the shares, if any. The expense is recognized over the vesting period of the grant or award. The Company has elected not to adopt the fair value method of accounting for stock-based compensation which is encouraged, but not required, by Statement of Financial Accounting Standards No 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). The Company has adopted the disclosure requirements of SFAS 123 in preparing its 1996 financial statement disclosures (see Note 9).
The Company's investment securities are included in the accompanying consolidated balance sheets at December 31, 1996 and 1995 as follows. Remaining amounts included in these balance sheet captions represent certificates of deposit. December 31, ---------------- 1996 1995 ------- -------
The Company has an unsecured revolving credit agreement with Bank One, Texas under which the Company may borrow up to $5 million, as determined by the borrowing base defined by the agreement, through July, 1997. The borrowing base is determined by a formula based on 80% of the net cash flow from certain of the Company's Contracts that have been in existence for 18 months or more. At December 31, 1996, the borrowing base was approximately $5 million. Under the agreement, the interest rate, at the option of the Company is at the bank's base lending rate or an adjusted London interbank rate and is determined at the time of borrowing. Interest is to be paid monthly and any outstanding principal, unless converted to an 18 month term loan upon the occurrence of certain events, comes due in its entirety on July 1, 1997. The agreement contains restrictions which, among other things, require maintenance of certain financial ratios, restrict encumbrance of assets and creation of indebtedness, and limit the payment of dividends. To date, the Company has not borrowed under the bank credit agreement.
A summary of the status of the Company's Plan as of December 31, 1996, 1995 and 1994 and changes during the years ending on those dates is presented below: