The Securities and Exchange Commission (SEC) has twice forced Pre-Paid to restate its financials. In 1994, Pre-Paid wanted to do a public stock offering, however the SEC said no unless Pre-Paid expensed its customer acquisition costs instead of amortizing them. Pre-Paid fought the change but ultimately capitulated - devastating its balance sheet. Stockholders' equity fell 90% to $2.4 million; assets declined 69% to $11.1 million; and 1993 net income of $306,000 became a net loss of $613,000.
In 2001, the SEC again forced Pre-Paid to restate its results. Pre-Paid went from treating sales agents' commissions as an asset which it amortized, to expensing them immediately. Pre-Paid slashed its 2000 per-share earnings 42% to 81 cents and its 1999 results 66% to 57 cents.
Stonecipher said that Pre-Paid should treat the commissions as an asset the way life insurance companies do, however, the SEC did not agree.
Pre-Paid's disclosure of and protection against lawsuits are flimsy. Its recent quarterly report details numerous lawsuits filed against Pre-Paid. Stonecipher declined to estimate the suits' total damages. But Pre-Paid's SEC filing estimates that just two assess $415 million in damages. Yet Pre-Paid has reserved a mere $3.3 million against all these lawsuits.
Many believe Pre-Paid's stock is due to fall. Pre-Paid's short interest is higher than all but three NYSE stocks. With 8 million Pre-Paid shares sold short and a 186,000 share average daily trading volume, it would take 44 days to cover this short position.
But Pre-Paid is in a Mexican standoff with these short sellers. According to a hedge fund manager with a large Pre-Paid short position, "either you're a cult believer in Pre-Paid - because much of the stock is held by people who are associated with the company - or you're short. And there's very little in between. The sales associates are only buying - never selling - and the company has its big buyback program [Pre-Paid has spent $145 million since April 1999 buying 6.5 million shares]. Meanwhile, the shorts can't short the stock anymore. So the stock's just going to sit there until there's a major event."
Stonecipher's comment on why the short interest in Pre-Paid is so high: "Ask the shorts."
In 2002, Pre-Paid took on a $30 million credit line to finance a $30 million headquarters edifice and to buy back more stock. To avoid default, Pre-Paid must retain over 50% of its customers with policies in force for under a year. In 2002, that rate was a meager 51.8%. Pre-Paid must keep the ratio of Total Liabilities to Tangible Net Worth below 375 percent. But Pre-Paid's stock repurchase program lowered its net worth, so its bank loosened the ratio from the original 250 percent to avoid a default.
Stonecipher did not comment on the loosening of this covenant but claimed that Pre-Paid is in no danger of violating any of them and that the bank with which it has the credit line had visited Pre-Paid recently to lend it more money.