Pre-Paid's 8-K released 1/26/01 provides detail on their commission practices. I think it is a good move by the company to publicize this information, but I'm not sure how much good it will do. Did everyone sell on the earnings good news, or did the announcement of the litigation settlement upset investors?
A portion of the 8-K is shown below. The rest can be viewed at www.freedgar.com, among other places.
ITEM 9. REGULATION FD DISCLOSURE.
Pre-Paid Legal Services, Inc. (the "Company") has included the following information pursuant to Regulation FD:
INTRODUCTION
The Company is in the business of providing prepaid legal expense plans, which are sold primarily through a multi-level marketing structure. The Company advances commissions to its sales associates. The Company initially records the commission advances on its balance sheet and then charges the advances to commission expense in proportion to premium revenue recognized. The commission advances are the result of our paying up to a 3-year commission advance when a sales associate sells a membership. The accounting treatment of these commission advances has been appropriately and accurately disclosed in the Company's previous Forms 10-K.
However, over the past 2 months, the accounting treatment of these commission advances has become a subject of public discussion by others. The primary purpose of the information presented herein is to provide details regarding the accounting treatment of these commission advances and expenses in response to the public discussion. We have over 20 years of actual membership sales, renewal and cancellation experience, which indicates the commission advances currently on our balance sheet are recoverable given our actual membership retention rates. And, while we focus on retention rates as opposed to an average life calculation, an independent actuary calculates the expected lifetime value of our memberships to be more than 6 years of revenue as summarized at the end of this filing. A "short" report also stated that our membership growth requires high growth rates in the recruitment of new sales associates. In fact, over the last 5 years, our compound annual growth rate in new memberships has been three times the compound annual growth of our new sales associates because we have improved our sales force productivity.
We have been in business for nearly 30 years. Over that time we have developed a business model we believe is economically sound. Over the past 6 years, that model has allowed us to generate membership fees of over $600 million, from which we have paid our sales associates nearly $300 million in commissions and our provider law firms more than $200 million. In the last 2 years, we have spent more than $49 million to repurchase shares of our common stock and still have more than $40 million in cash and investments at December 31, 2000. We have no debt and have not raised equity since 1994. We currently have more than 1 million active memberships, which will generate significant future cash flow. We reported net income of $38.9 million, $30.2 million and $17.5 million for 1999, 1998 and 1997, respectively, and cash flows from operating activities of $17.6 million, $9.9 million and $14.5 million for the same periods.
We believe the information contained in the Company's prior reports and in this filing demonstrates that our accounting policies are appropriate and that our
financial statements have been and continue to be prepared in accordance with generally accepted accounting principles ("GAAP"). Our independent certified public accountants, Deloitte & Touche LLP, audit our financial statements annually, and have done so since 1994.
COMMISSION ADVANCES AS AN ASSET
We believe that our accounting for commission expense and commission advances is in accordance with GAAP for the following reasons:
FASB Concept Statement No. 6, "Elements of Financial Statements," says, "assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events." The Company's commission advances, which are triggered by the sale of a membership in one of the Company's legal service plans, conform to that definition. The commission advances relate directly to memberships that represent a future economic benefit (a stream of future cash payments) to be received by the Company as a result of a past transaction (the original membership sale).
FASB Concept Statement No. 6, paragraph 80 further states that an expense is "a using up of assets ... from rendering services or carrying out other activities
that constitute the entity's ongoing major or central operations." For the Company, providing legal services to its legal plan members in exchange for monthly membership fees "constitutes our ongoing major or central operations".
The Company's historical accounting policy appropriately recognizes the recovery of commission advances and the expensing of commission costs as we are "rendering services" in exchange for monthly membership fees.
FASB Concept Statement No. 6, paragraph 145, states "accrual accounting uses accrual, deferral, and allocation procedures whose goal is to relate revenues,
expenses, gains and losses to periods to reflect an entity's performance during a period instead of merely listing its cash receipts and outlays." The Company's
policy of recognizing commission expense in proportion to the revenue recognized attempts to relate revenues and expenses "to reflect" our "performance during a period instead of merely listing" our "cash receipts and outlays."
Finally, FASB Statement 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" states "In performing the review for recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized. Otherwise, an impairment loss is not recognized." In this filing, we clearly
show that the "expected future cash flows (undiscounted and without interest charges)" associated with the commission advances currently on our balance sheet
is more than 150% of the carrying amount of those commission advances.
Since the key issue with respect to commission advances is recoverability, the remainder of this document addresses our membership retention rate, our actual commission advances, the recoverability of our commission advances and our unit economic model. It also addresses membership growth and the expected lifetime value of a membership. |
