Ryan Brown

Colin Henry
Jen Kraus
Mirella Picchi
QUESTIONS
1. Identify and evaluate the key elements of PPDs business strategy. Make sure you understand
the product they are selling and how they go about selling it.
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Pre-paid Legal Services offer a subscription model for legal services. The premiums paid
by the companys clients provide said clients with the financial security to cover
certain legal expenses described in their contracts and up to predetermined financial
limits.

The company employs a multi-level marketing strategy with a salesforce that is only
compensated for actual sales. The multi-level marketing strategy allows for significant
recruitment to take place with low recruitment costs via contract workers, many of which
work part-time and all of which dont have benefits.

Compensation uses a commission structure that somewhat controls labor costs. However,
multiple associates may be compensated for any booked business, as commission flows
up to the associates who, through their recruiting efforts, may have indirectly influenced
the sale. The strategy is similar to that of insurance industry where critical mass means
success in capturing consistent future revenues, and having enough cash reserves to
cover claims.

The company targets middle income families and individuals with dependable disposable
income who need security in any of the five categories of potential litigation that the
company covers.

The company also leverages the salesforce of affiliate companies to further drive sales,
reduce training costs and grow the business. They track active associates in their
management metric to keep a gauge on how many of their contract salesforce are
actively seeking new clients (growth).

2. Identify the problem revealed by the third-quarter earnings announcement that resulted in
PPDs stock price drop. What was the cause of this problem?
The main problem identified by the third-quarter earnings announcement is the obvious
disconnect between PPDs treatment of commission payments and the relevant effect on
operating cash flow. PPD encourages new members to join their MLM-style business model by
advancing a representatives first three years worth of commissions; these commissions are
treated as assets on PPDs balance sheet and are then amortized (expensed) as the
representative meets certain business development obligations. However, the inherent risk in this
method is that PPD is paying out a significant amount of commissions without the guarantee
that the representative will be able to meet the obligations to qualify for those commissions in
the first place. An increase in commission advances coupled with a decrease in operating cash
flow, as seen in the third-quarter announcement, signifies that the firms core cash-generating
business model is weakening, despite a large influx of new representatives. Furthermore, due to

Ryan Brown
Colin Henry
Jen Kraus
Mirella Picchi
the firm experiencing bolt-on growth from recent acquisitions, the adverse effect on Net
Income is actually being hidden from shareholders.
3. Suggest an alternative method of accounting for the transactions that led to the problem
identified in Question 2 above and recompute PPDs earnings using this method.
An alternative method of accounting for commission advances would simply be to expense them
in the period incurred. Exhibit 1 shows the impact of treating commission advances as expenses
rather than assets: Q3 Net Income declines roughly -$6MM to $3.831MM, while Net Income
margin declines 12 points to only 8% of revenue.
4. Do you think that earnings computed using the method you identified in Question 3 above
provide a better or a worse indication of PPDs actual performance?
A more appropriate method of accounting for the commission advances would be to expense
them immediately in the period in which they were incurred. The amount of uncertainty around
whether or not a new representative will actually generate revenue to justify the commissions, let
alone if the method of estimating those commissions is even appropriate, generates an extreme
amount of financial risk. Despite having an allowance to offset losses on these commissions,
there is still too much ambiguity in the reporting process and can be seen as a convenient way to
manipulate earnings and deceive shareholders.
5. What actions would you advise PPDs management take in response to investors reaction to
the
third-quarter earnings announcement?
-Acknowledge investor concerns about future growth prospects and declining cash generation
-Adopt a more conservative approach to commissions by expensing instead of capitalizing
6. What information would you seek from PPDs subsequent press releases and SEC filings in
order
to determine whether the price reaction to the third quarter announcement was warranted?
One thing to consider would be a comparison of the sales associates and members. If the sales
associates grow at a faster rate than the members, then it would show the associates are not
keeping up with their targets, and are receiving commissions for work they are unable to
complete. This would show that the reaction was warranted given their current accounting
methods. I would also compare their previously projected growth with actual to determine verify
if they are over capitalizing on commissions or were actually making correct predictions.

Ryan Brown
Colin Henry
Jen Kraus
Mirella Picchi
Exhibit 1.