Regan Holding Corp. is a holding company, whose primary operating subsidiaries are Legacy Marketing Group ("Legacy Marketing") and Legacy Financial Services, Inc. ("Legacy Financial").
Legacy Marketing designs, markets and administers fixed annuity and life insurance products on behalf of four unaffiliated insurance carriers in each of the United States, except Alabama and New York, and in the District of Columbia. Legacy Marketing has entered into marketing agreements with American National Insurance Company, IL Annuity and Insurance Company, Transamerica Life Insurance and Annuity Company, and John Hancock Variable Life Insurance Company. The marketing agreements grant Legacy Marketing the exclusive right to market certain fixed annuity and life insurance products issued by these insurance carriers. Legacy Marketing is responsible for appointing independent insurance producers who have contracted with Legacy Marketing to sell these products. For these services, the insurance carriers pay Legacy Marketing commissions and marketing allowances.
Legacy Marketing has also entered into administrative agreements with each of the four insurance carriers. Under the terms of the administrative agreements, Legacy Marketing provides clerical, administrative and accounting services with respect to the insurance policies. For providing these services, the insurance carriers pay Legacy Marketing administrative fees.
Under the terms of the administrative agreements, Legacy Marketing provides clerical, administrative and accounting services with respect to the insurance policies. For providing these services, the insurance carriers pay Legacy Marketing issuing, maintenance, and termination fees on a per transaction basis, with the amount of the fee depending on the type of policy and type of service. These fees are generally paid by carriers monthly in arrears and are booked as revenue during the month in which the services are performed.
We capitalize external consulting fees, and salaries and benefits for employees who are directly associated with the development of software for internal use. When the new software is placed in production, we begin amortizing the asset over its estimated useful life. Training and maintenance costs are accounted for as expenses as they occur. Modifications or enhancements made to an existing software product that result in additional functionality are capitalized and amortized over the modified product's estimated useful life.
We have issued Series A and Series B redeemable common stock to certain shareholders. We are obligated to repurchase the redeemable common stock at the current fair market value. Because there is no active trading market for our stock that would establish market value, our Board of Directors approved a redemption value of $2.19 per share as of December 31, 2001, based on an independent appraisal of the stock value obtained by our management.
All investments are periodically reviewed to determine if declines in fair value below cost are other-than-temporary. Significant and sustained decreases in quoted market prices, a series of historical and projected operating losses by the investee or other factors are considered as part of the review. If the decline in fair value has been determined to be other-than-temporary, an impairment loss is recorded in investment income and the individual security is written down to a new cost basis. During 2001, we determined that certain investment securities had other-than-temporary declines in fair value below cost. As a result, we recorded impairment losses of $642,000, and the individual securities were written down to a new cost basis.
We experienced consolidated net losses of $348,000 in 2001, compared to consolidated net losses of $3.6 million in 2000. The reduced losses are primarily due to net income at Legacy Marketing during 2001 compared to net losses during 2000, partially offset by recognition of losses at Regan Holding Corp. (stand-alone) in 2001 compared to income in 2000, and losses by Values Financial Network, Inc., Legacy Financial, and Imagent Online, LLC.
During 2001, Legacy Marketing's net income totaled $3.6 million, compared to losses of $2.2 million during 2000, an increase of $5.8 million (percentage not meaningful), primarily due to increased revenues partially offset by increased expenses.
Legacy Marketing's revenue increased $14.4 million (38%) primarily due to increased marketing allowances, commission income, and administrative fees. Marketing allowances and commission revenue, combined, increased $12.3 million (43%) due to a 49% increase in sales of fixed annuity and life policies. Commission revenue and marketing allowances did not increase at rates comparable to the increase in premium placed inforce primarily due to shifts between products that yield differing commissions. Administrative fees increased $1.9 million (21%) primarily due to increases in the number of policies administered.
Year ended December 31, 2001 2000 - ----------------------- ---- ---- Transamerica 69% 51% IL Annuity 21% 29%
In 2000, Legacy Marketing incurred a net loss of $2.2 million, compared to net income of $8.3 million in 1999, a decrease of $10.5 million (percentage not meaningful). The decrease was primarily due to lower marketing allowances and commission income, and increased operating expenses.
Legacy Marketing's revenue decreased $10.2 million (21%) primarily attributable to decreases in sales of annuities and life insurance policies and changes in product mix. Legacy Marketing's marketing allowances and commission revenue, combined, decreased $10.5 million (27%) due to a 36% decrease in fixed annuity and life sales, partially offset by a shift to fixed annuity and life insurance products that yield higher commissions. Administrative fees increased $402,000 (5%) primarily due to increases in the number of policies administered and to a shift in policies administered to those which generated higher administrative fees.
Legacy Marketing expenses increased $6.5 million (18%) primarily due to increases in selling, general and administrative expenses, and depreciation and amortization. Selling, general and administrative expenses increased $5.2 million (15%) primarily due to increases in professional fees, compensation, and occupancy, partially offset by decreases in certain promotion programs tied to premium levels. Depreciation and amortization expense increased $1 million (297%) primarily related to the amortization of internal use software and to acquisitions of fixed assets, which were necessary to improve newly leased office space.
Legacy Financial incurred net losses of $837,000 during 2001, compared to net losses of $143,000 during 2000, primarily due to decreased revenues and increased expenses.
Legacy Financial's expenses increased $241,000 (8%) primarily due to increases in selling, general and administrative expenses. Selling, general and administrative expenses increased $202,000 (7%) primarily attributable to increases in rent, compensation due to a higher number of employees, and professional fees, partially offset by decreases in sales promotion and support.
During 2000, Legacy Financial incurred net losses of $143,000, compared to net losses of $131,000 during 1999. The increased losses are primarily due to increases in expenses, partially offset by increases in revenues.
Legacy Financial expenses increased $1.1 million (57%) primarily due to increases in selling, general and administrative expenses. The increase in selling, general and administrative expenses is primarily attributable to increases in compensation, sales promotion and support, and occupancy expenses.
During 2000, we sold an office building and two parcels of land, and recognized a non-operating gain of $3.6 million. There were no asset sales in 2001, and Regan Holding Corp. recorded non-operating losses of $42,000.
Revenue decreased $105,000 (5%) primarily due to $551,000 of rental revenue received for 2000 from unaffiliated tenants of an office building. We sold the building in 2000. As a result, no rental income was recorded in 2001. Partially offsetting the absence of third-party rental income in 2001 was an increase in intercompany rental income of $446,000 (26%).
Expenses decreased $879,000 (19%) primarily due to decreased selling, general and administrative expenses. The decreases in selling, general and administrative expenses are primarily attributable to lower costs associated with a broad-based stock option sales incentive program for producers and representatives which was discontinued in 2001.
Regan Holding Corp. recorded net income of $613,000 in 2000, compared to net losses of $3.7 million during 1999, due to increases in non-operating income and decreased expenses, and increased revenues.
Expenses decreased $2.9 million (39%) primarily due to a decrease in non-employee stock option expenses.
Revenue increased $629,000 (38%) primarily due to rental revenue from an office building that we purchased in mid-1999. We sold the building in 2000.
Net cash provided from operating activities was $10.9 million for the year ended December 31, 2001, primarily due to improved operating results, and a federal income tax refund of $3.6 million resulting from applied overpayments and net operating loss carrybacks from 2000.
Net cash used in investing activities was $13.2 million, primarily related to acquisitions of fixed assets, as discussed above, and net purchases of short-term investment-grade securities. In connection with a real estate sale during 2000, in order to defer the taxes for the gain on sale we assigned the rights to cash consideration of $5.8 million to a qualified exchange intermediary in exchange for a note. During 2001, we purchased the office building which houses our headquarters for $10.6 million. In conjunction with the acquisition, we paid a portion of the purchase price by applying the proceeds from the note receivable from the qualified exchange intermediary and entered into a loan agreement for $4.8 million. The loan bears interest at a rate equal to LIBOR plus 3.50%, adjusted monthly. During 2001, the weighted average interest rate on the loan was 7.35%. Interest is due and payable monthly. The unpaid principal balance was due and payable in December 2001, however we extended the maturity date of the loan to June 19, 2002. As of December 31, 2001, no payments have been made toward the principal balance of the loan. Management is in the process of obtaining long-term financing to replace the current loan. However, there can be no assurances that the refinancing will occur, or that the terms will be more favorable than those currently existing.
Net cash provided by financing activities was $1.7 million. This was primarily due to proceeds from a loan obtained to finance the purchase of the office building discussed above, partially offset by payments towards a loan outstanding at the end of 2000, and repurchases of our common stock. Regan Holding Corp. is obligated to repurchase certain shares of its common stock. At December 31, 2001 and December 31, 2000, the total redemption value of all redeemable common stock outstanding was $11.1 million and $11.2 million. Cash paid to repurchase some of these shares totaled $500,000 during 2001, and $821,000 during 2000. As the value of our common stock rises, our monetary obligation with respect to the redeemable common stock also increases.
We lease office and warehouse premises and certain office equipment under non-cancelable operating leases. Our future minimum annual lease commitments under all operating leases are $2.2 million, with $1.1 million due during 2002 and the remaining $1.1 million due ratably between 2003 and 2006.
Regan Holding Corp. generated $10.9 million and $248,000 of cash flow from operations in 2001 and 2000. However, we incurred consolidated net losses of $348,000 and $3.6 million during 2001 and 2000. If our consolidated net losses continue, or if requests to repurchase redeemable common stock increase significantly, a cash shortfall could ultimately occur. Management believes that existing cash and investment balances, together with anticipated cash flow from operations, will provide sufficient funding for the foreseeable future. However, in the event that a cash shortfall were to occur, management believes that adequate financing could be obtained to meet our cash flow needs. There can be no assurances that such financing would be available on favorable terms.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Intangible Assets, which supercedes Accounting Principles Board ("APB") Opinion No. 17, Intangible Assets. SFAS 142 eliminates the current requirement to amortize goodwill and indefinite-lived intangible assets, addresses the amortization of intangible assets with a defined life and addresses the impairment testing and recognition for goodwill and intangible assets. The provisions of SFAS 142 are applicable on January 1, 2002. However, goodwill and intangible assets acquired after June 30, 2001 are subject immediately to SFAS 142. Management anticipates that the implementation of SFAS 142 will not have a material effect on our consolidated results of operations or financial position.
In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which supercedes SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and amends APB Opinion No. 30, Reporting Results of Operations - Reporting the Effects of Disposal of a Segment of a Business. SFAS 144 revises the accounting for the measurement of long-lived assets to be disposed of by sale and clarifies implementation issues for discontinued operations. SFAS 144 will be effective for fiscal years beginning after December 15, 2001. Management anticipates that the implementation of SFAS 144 will not have a material effect on our consolidated results of operations or financial position.
To the Board of Directors and Shareholders of Regan Holding Corp.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, shareholders' equity and cash flows present fairly, in all material respects, the financial position of Regan Holding Corp. and its subsidiaries (the "Company") at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1, during the year ended December 31, 2000, the Company changed its method of recognizing revenue for contracts with sales obligation provisions.
Through its wholly-owned broker-dealer subsidiary, Legacy Financial, the Company sells variable annuity and life insurance products, mutual funds and debt and equity securities. Legacy Financial has entered into agreements primarily with insurance companies and mutual funds that give Legacy Financial the non-exclusive right to sell investment products on behalf of those insurance companies and mutual funds. Sales of investment products are conducted through Legacy Financial's network of independent registered representatives. Legacy Financial is compensated based upon predetermined percentages of broker sales.
Cash and cash equivalents include marketable securities with an original maturity of ninety days or less at the date of purchase.
Depreciation and amortization expense recorded by the Company totaled approximately $3.5 million during 2000. Effective January 1, 2000, the Company changed its estimate of the useful life of certain computer hardware and software from five years to three years. Had this change in estimate not occurred, the Company would have recorded approximately $3.3 million in depreciation expense during 2000.
The Company reviews long-lived assets and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Measurement of the impairment of long-lived assets is based upon management's estimate of discounted future cash flows. The carrying amount of all long-lived assets is evaluated periodically to determine if adjustment to the useful life is warranted.
In 2000, the Company purchased a 33.3% ownership interest in a development stage company named prospectdigital, LLC for $403,000. Prospectdigital provides an on-line marketing service to brokers selling annuities and life insurance. To date prospectdigital has had nominal revenue and used its capital to develop software to support its business and incur operating expenses. The Company's investment in prospectdigital is accounted for under the equity method. The Company is recording 98.8% of the losses of prospectdigital to reflect a hypothetical liquidation at book value at each balance sheet date. The Company's share of prospectdigital's losses was $896,000 and $721,000 during 2001 and 2000 and is included in other expenses. In addition, the Company loaned $1.1 million to prospectdigital in 2000. The loan bears interest equal to the Prime Rate. In 2001, the Company extended a $400,000 line of credit to prospectdigital. The line of credit bears interest at 8.0%. As of December 31, 2001, prospectdigital had drawn $358,000 from the line of credit. The amounts invested and advanced, net of the Company's share of cumulative losses, have been included in other assets at December 31, 2001 and 2000.
6. Purchase of Values Financial Network, Inc. and Related Intangible Assets
December 31, --------------------------- 2001 2000 ---------- ---------- Accrued compensation $2,871,000 $2,767,000 Accrued sales convention costs 1,039,000 1,180,000 Commissions payable 1,366,000 906,000 Accrued website consulting services 94,000 802,000 Accounts payable 845,000 65,000 Miscellaneous accrued expenses 1,854,000 2,413,000 ---------- ---------- Total $8,069,000 $8,133,000 ========== ==========
During 2001, the Company purchased the office building which houses its headquarters for $10.6 million. In conjunction with the acquisition, the Company entered into a loan agreement for approximately $4.8 million. The property collateralizes the loan, which bears interest at a rate equal to LIBOR plus 3.50%, adjusted monthly. During 2001, the weighted average interest rate on the loan was 7.35%. Interest is due and payable monthly. The unpaid principal balance was due and payable in December 2001, however the Company extended the maturity date of the loan to June 19, 2002. As of December 31, 2001, no payments have been made toward the principal balance of the loan.
The Company sponsors a qualified defined contribution 401(k) plan, which is available to all employees. The 401(k) plan allows employees to defer, on a pre-tax basis, a portion of their compensation as contributions to the 401(k) plan. Employees may elect to contribute up to 15% of their annual compensation to the 401(k) plan. The Company matches 50% of each employee's contributions, up to a maximum of 6% of annual compensation. The Company's matching contributions were $439,000, $409,000, and $348,000, for the years ended December 31, 2001, 2000, and 1999.
Year Ended December 31, 2002 $1,067,000 2003 394,000 2004 334,000 2005 294,000 2006 150,000 ---------- Total minimum lease payments $2,239,000 ==========
Holders of Series A redeemable common stock may redeem their holdings without limitation. Holders of Series B redeemable common stock may only redeem up to 10% of their holdings once per year, limited to a specified twenty-day period during November of each year.
Producer Option Plan -- Under the Regan Holding Corp. Producer Stock Option and Award plan (the "Producer Option Plan"), the Company may grant to Legacy Marketing producers and Legacy Financial registered representatives shares of the Company's common stock and non-qualified stock options (the "Producer Options") to purchase the Company's common stock. A total of 12.5 million shares have been reserved for grant under the Producer Option Plan. The Producer Options granted through June 1999 vested ratably over five years following the grant. During the second quarter of 1999, however, the Company waived the Producer Options' vesting provisions, thereby converting the Producer Options from "variable" to "fixed" options. As a result, the Company recorded $2.9 million of expense representing management's estimate of the fair value of the Producer Options at the date that the vesting provisions were modified. Total expenses recorded for Producer stock option grants were $96,000, $1.1 million and $4.3 million during 2001, 2000 and 1999. The fair value of the Producer options were estimated using the Black-Scholes option-pricing model with the following assumptions:
The share grant for 2001 listed above includes 15,000 shares of Series A common stock that the Company was obligated to award to a service provider, but had not been issued as of December 31, 2001.
Employee Option Plan -- Under the Regan Holding Corp. 1998 Stock Option Plan (the "Employee Option Plan"), the Company may grant to employees and directors incentive stock options and non-qualified options to purchase the Company's common stock (collectively referred to herein as "Employee Options"). A total of 8.5 million shares have been reserved for grant under the Employee Option Plan. The Employee Options generally vest over four or five years and expire in ten years, except for incentive stock options granted to 10% shareholders, which expire in five years. The Company uses the intrinsic value method of accounting for stock-based awards granted to employees and, accordingly, does not recognize compensation expense for its stock-based awards to employees. The following table reflects pro forma net income (loss) and earnings (loss) per share had the Company elected to adopt the fair value method of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation.
Total Weighted average Shares Exercise Price ------ -------------- Outstanding at January 1, 1999 2,476,000 $ 0.75 Granted 6,473,000 $ 1.27 Exercised (72,000) $ 0.99 Forfeited (67,000) $ 1.09
Outstanding at December 31, 1999 8,810,000 $ 1.13 Granted 5,118,000 $ 1.52 Exercised (27,000) $ 0.95 Forfeited (525,000) $ 1.08
The provisions for federal and state income taxes consist of amounts currently (receivable) payable and amounts deferred which, for the periods indicated, are shown below:
The basic and diluted earnings per share calculations are based on the weighted average number of common shares outstanding including shares of redeemable common stock. The diluted earnings per share calculation includes the effect of stock options to the extent that the options have a dilutive effect on earnings per share.
The Company has identified its reportable segments based on its method of internal reporting and segregates its business into six primary reportable segments: Legacy Marketing, Legacy Financial, Regan Holding Corp. (stand-alone), Imagent Online, LLC, Values Financial Network, and Other. Intersegment transactions are generally accounted for at amounts comparable to transactions with unaffiliated customers, and are eliminated in consolidation. Certain items are maintained on the records of Regan Holding Corp. (stand-alone) and are not allocated to the segments. They primarily relate to certain stock option and stock award expenses.
2001 2000 1999 ---- ---- ---- American National 6% 10% 11% IL Annuity 21% 29% 74% Transamerica 69% 51% 11%