Pre-Paid Struggling to Keep Customers

"Obviously, that number is now approaching 100%," said one hedge fund manager with a large short position in Pre-Paid's stock. "In a quarter or two, they could be losing more members than they are adding" on an annual basis.

While its customer base declined sequentially, Pre-Paid did manage to grow its business by 3% last year overall. But the same company indicated a year ago that its 2002 growth rate, at 11%, was already disappointing.

The company's recruiting, which is crucial to future growth, has also slowed down. Last year, Pre-Paid recruited 108,557 new associates -- customers who double as Pre-Paid sales agents -- or 30% fewer than it did a year earlier. Even fourth-quarter recruiting, which inched up 12% from last year's tough final period, struck short-sellers as "irrelevant."

Instead, they focused on the slump in "independent," nonassociate customers. After stripping away new sales associates -- and a few thousand identity theft protection customers -- Pre-Paid actually saw its independent customer base shrink by nearly 40,000 in the latest period, critics said.

One short-seller, pointing to Pre-Paid's growing reliance on sales associates for business, shook his head at that "record" number.

"Not only do these numbers show the obvious deterioration in their real business -- recurring membership sales -- but they highlight the pyramid nature of the company," he said. "This suggests the revenue mix is shifting from product sales to recruiting fees ... (and this) should concern both the (attorneys general) out there as well as the next associates recruited."

Instead, attorneys general -- particularly in Pre-Paid's home state of Oklahoma -- have lent support to the controversial company after pocketing generous campaign contributions from its employees and its sales force. But the company has attracted scrutiny closer to Wall Street. Both the Securities and Exchange Commission and the U.S. attorney's office in Manhattan are investigating Pre-Paid about questionable trading in the company's shares ahead of last year's devastating production report.