What happens if the member quits
before 3 years are up?
•could account for as a write–off
commission expense (+) xx
commission advance (–) xx
•or could do nothing!
So what’s the big accounting
issue in the press release?
“Even though commission advances
increased $9.2 million as a result of
increasing membership sales during the
third quarter of 1999, cash flow from
operations was $5,199,000, a decrease of
$379,000, or 7 percent…”
An accounting alternative
ending balance
So, originating = expensed + change in balance.
19019 = 9819 + 9200
as reported restated
Revenues: — —
Membership premiums 39,748 39,748
Product sales 1,256 1,256
Associate services 5,832 5,832
Interest income 897 897
Other 1,292 1,292
$49,025 $49,025
Costs and expenses: — —
Membership benefits 13,764 13,764
Product costs 790 790
Commissions 9,819 19,019
General and administrative 4,428 4,428
Associate services and direct marketing 3,676 3,676
Depreciation and amortization 688 688
Premium taxes 389 389
Other 285 285
$33,839 $43,039
Income before income taxes 15,186 5,986
Provision for income taxes (ETR = 35%) 5,316 2,095
Net income $9,870 $3,891
Less dividends on preferred shares 2 2
Net income applicable to common stockholders 9,868 3,889
Basic earnings per common share (22949K equivalent shares) 0.43 0.17
profit margin .20 .08
Membership Persistency
……The Company’s Membership persistency rate measures
the number of Memberships in force at the end of a year as a percentage of the
total of (i) Memberships in force at the beginning of such year, plus (ii) new
Memberships sold during such year. From 1981 through the year ended December 31,
1998, the Company’s annual Membership persistency rates, using the foregoing
method, have averaged approximately 75%. The annual Membership persistency rates
were 73.8%, 73.6% and 73.9% for 1998, 1997 and 1996, respectively. The Company’s
overall Membership persistency rate varies based on, among other factors, the
relative age of total Memberships in force. The Company’s overall Membership
persistency rate could be lower when the Memberships in force include a higher
proportion of newer Memberships. During the last three years, the Company has
experienced significant increases in new Membership sales and, as a result, the
percentage of newer Memberships in its total Memberships in force has increased.
Unless offset by other factors, this increase could result in a decline in the
Company’s overall Membership persistency rate as determined by the formula
adversely affected if the persistency rates of existing and new Memberships are
materially lower than the Company’s historical experience.
(old + new –quit)/(old + new) = .75
expected participation of member = 1/(1-.75) = 4 years
membership persistency
Panel A Expense Advertising Costs Immediately
Year 0 1 2 3 4 5
Income Statement
Revenue 300 900 1200 900 300
Advertising Expense 100 200 200 100 0
Profit 200 700 1000 800 300
profit margin 66.7% 77.8% 83.3% 88.9% 100%
Panel B Capitalize Advertising Costs and Expense Equally over Two Years
Suppose every dollar of advertising generated $3 in current year and
Q3 1999 press
release in case 10b5 lawsuits announced
every day for weeks
SEC announces inquiry
news articles and research
reports questioning accounting
announce large new memberships,
release revised 2000 annual report,
shorts must cover
analyst upgrades
announce 30-50% NI growth
The Court denied the plantiffs’ motion yesterday, stating that the
Court found, and continues to find, that the Plaintiffs did not
sufficiently plead scienter as to the Pre-Paid Defendants.” The Court
went on to note: “A review of these documents … shows that even
with the estimated (now actual) restatement of net income, Pre-Paid
buy
sell
sell
sell
The Paton Center Money Pump