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Pre-Paid Legal's Earnings Jump

But the increase comes the same quarter as it reports slowing customer growth.

Slowing customer growth at

Pre-Paid Legal Services

(PPD)

has yet to take a toll on the company's bottom line.

The Oklahoma-based company reported a 25% jump in fourth-quarter profits and an even higher 42% surge in fourth-quarter earnings per share. But that profit growth came during the first quarter in 10 years when Pre-Paid failed to report a corresponding growth in new customers and sales associates. The company saw new customer additions dip by 5.6% and new sales associates -- who employ Amway-like marketing techniques to sell Pre-Paid's product and its business opportunity -- plunge by 24% from a year ago.

Ironically, Pre-Paid would have reported lower earnings if its business had actually grown. The company's biggest expense -- commissions paid to sales associates -- naturally declines when fewer new policies are written. Fourth-quarter and full-year earnings also benefited from Pre-Paid's aggressive stock buybacks, which sharply reduced the company's total share count.

For the fourth quarter, Pre-Paid reported net income of $9.7 million on revenue of $90.5 million. That compares with net income of $7.8 million on revenue of $80 million a year earlier. EPS came in at 51 cents, up from 36 cents during the fourth quarter of 2001, due in part to a 10% reduction in the company's outstanding shares.

Full-year profits climbed 33% from $27.1 million to $36 million. And full-year EPS soared 44%, from $1.26 to $1.82, following the repurchase of 2.3 million shares of company stock -- at an average price of $21.67 a share -- during the year.

Pre-Paid's stock closed well below that average price on Tuesday, even after a 7.9% jump to $18 ahead of the company's earnings release. The stock is down roughly 40% from a peak it hit in December, shortly after New York hedge fund Gotham Partners issued a bullish report on the stock. In recent weeks, regulators have begun investigating both Pre-Paid and Gotham for involvement in a possible "pump-and-dump" scheme. During the run-up following Gotham's report, Pre-Paid COO Randy Harp cashed in more than $1.3 million worth of company stock to pay off an insider loan. Meanwhile, Gotham quietly began selling off some of its Pre-Paid stake even as it continued to feature the bullish stock report on its Web site.

Gotham announced last month that it would liquidate all its investments entirely as it shuts down its two hedge funds and returns money to unhappy investors. By the end of December, regulatory filings show, Gotham had already cut its 1-million-share position in Pre-Paid by roughly half.

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Gotham wasn't the only fund to cut its stake in Pre-Paid last quarter. Regulatory filings also show significant reductions by at least five other major institutional holders.

That selling took place during the first quarter in 39 in which Pre-Paid reported a shrinking customer base. After a major hit to the company's stock last month, Pre-Paid blamed the recent slowdown on an intentional plan to improve customer retention -- and foster future growth -- by eliminating sales associates whose business rapidly falls off the books.

"We put some policies into effect in the fourth quarter and just simply said to our sales associates ... 'If your business is not up to the company level, then we're not going to accept business from you from this point forward,'" Pre-Paid CEO Harland Stonecipher told

CNNfn

last month. "We made that change ... knowing it would probably cause some blip."

The company specifically singled out two of its top producers, Buck Reed and Sheri Sharman, for termination last quarter. Both Reed and Sharman first gained notoriety as top producers at Equinox, a company that was shut down by federal regulators in 2000 for violating anti-pyramid-scheme laws. By then, the pair had moved on to successful careers at Pre-Paid, which is itself being called an illegal pyramid scheme by former associates who've filed a class-action lawsuit against the company.

Pre-Paid has vehemently denied operating such a scheme. Still, many of the company's top performers have a history of profiting from scams in the past.

This month, Pre-Paid's front-runner in the Player's Club -- an internal contest for selling and recruiting -- is a former peddler of dental plans who's been slapped by regulators in at least three states. Before rising to prominence in Pre-Paid, Dean Tucci operated a company called Argus Dental that was sued by attorneys general in both Illinois and Pennsylvania for allegedly touting a bogus "free trial" period for legal coverage and defrauding customers who signed up for the service. Before then, Tucci was hit with a cease-and-desist order from the Washington insurance commissioner for selling the dental coverage without any license to do so.

Tucci is simply the latest in a string of Pre-Paid stars -- including another Player's Club leader -- whose past problems have been exposed by

TheStreet.com

. Tucci could not be located Tuesday for comment.