The Company currently leases approximately 72,000 square feet of office space in Petaluma, California, at which the Company's headquarters are located. This lease expires in April 2009, subject to extension at the option of the Company for two additional terms of five years each.
Results of Operations--The Company's consolidated net income decreased approximately $5.3 million in 1999, compared to 1998, due primarily to increases in LMG expenses, as discussed below. Consolidated net income increased approximately $6.6 million in 1998, compared to 1997, and is primarily attributable to increases in LMG revenue, as discussed below.
Liquidity and Capital Resources--The Company's ability to mobilize its assets remained strong at December 31, 1999 and 1998, with cash and short-term investment grade securities representing 47.1% and 73.2% of the Company's total consolidated assets, respectively. At December 31, 1999, the Company's investment portfolio included a $12 million investment in Indianapolis Life Group of Companies ("Indianapolis Group"), an affiliate of IL Annuity, which represents 25.8% of the Company's total assets. In the first quarter of 2000, the Indianapolis Group repurchased the equity securities from the Company for approximately $12.5 million, pursuant to the terms of the investment agreement under which the securities were purchased.
During the second half of 1999, the Company obtained $3.5 million in margin loan advances from its investment broker. The margin loan was repaid in full during the first quarter of 2000, using proceeds from the repurchase of equity securities by the Indianapolis Group, as discussed above.
In May 1999, the Company purchased for $4.3 million the building in Petaluma, California, which previously housed the Company's headquarters. In conjunction with the building acquisition, the Company paid $2.2 million of the purchase price in cash and entered into a loan payable for the remaining $2.1 million. The loan has a ten-year term and is payable in monthly installments plus one balloon payment of approximately $1.8 million, due on May 10, 2009. In addition, the loan agreement contains certain covenants with which the Company must comply, including restrictions on indebtedness or investments outside the ordinary course of business and restrictions on dividends or other changes in the Company's capital structure. One of the covenants requires management to obtain lender approval prior to repurchasing non-redeemable common stock. The Lender has waived this covenant through June 30, 2000, provided that such voluntary repurchases do not exceed $125,000 per quarter. Management expects to obtain an extension of this waiver throughout the term of the loan. Pursuant to the loan agreement, the Company was also required to place approximately $560,000 in reserve to cover loan payments in the event of default and to provide for certain repair costs.
In order to fund LFS during the start-up phase, the Company has committed to make sufficient contributions to support LFS' operations to ensure LFS' compliance with financial requirements through December, 2000. Such contributions totaled $247,000 in 1999 and $475,000 in 1998. LFS operating results reached break-even on a monthly basis during the second half of 1999. As a result, future contributions are expected to decrease from prior levels.
Expenses--Total LMG expenses increased approximately $6.6 million, or 24.0%, during 1999 compared to 1998, and increased approximately $12.6 million, or 83.9%, during 1998 compared to 1997. These increases are due primarily to increases in compensation, sales promotion and support, and professional fees, as discussed below.
Sales promotion and support expense consists primarily of costs related to LMG's annual national sales conventions and to various sales and training events. Also included in sales and promotion support expense is the cost of designing and printing sales brochures for use by producers. It is expected that these expenses will continue to be a major element of LMG's cost structure, as attendance at the national sales conventions increases, as the number of producers marketing products for the Company increases and as new products are introduced. This expense increased approximately $1.2 million, or 22.2%, in 1999 from 1998 and increased approximately $2.9 million, or 120.3%, in 1998 from 1997. These increases are due primarily to increased incentives paid to producers to stimulate sales and increased printing costs related to the introduction of new products and enhancements to existing products.
Courier and postage, stationery and supplies, equipment, and miscellaneous expenses increased in 1999 from 1998 and in 1998 from 1997 due primarily to overall increases in the volume of business, increases in employment, and newly leased office space, all of which are discussed above.
Results of Operations--LFS net income increased approximately $177,470, or 196.3%, in 1999 from 1998, and net income of approximately $90,000 in 1998 represented an approximate $202,000 shift from net losses of approximately $112,000 in 1997. These fluctuations are due primarily to increases in revenue, offset by increases
Revenue--LFS' major source of revenue is commission overrides, which are generated through sales of life and annuity products, mutual funds, and certain equity securities. Levels of commission income are directly related to the volume of sales of such products. Total LFS revenue increased approximately $873,000, or 106.3%, in 1999 from 1998, and increased approximately $510,000, or 163.4%, in 1998 from 1997. These increases are attributable to increases in the volume of sales by LFS' distribution network of registered representatives in 1999 and 1998, respectively. Also contributing to increases in commission income were shifts to sales by representative networks from which LFS receives a higher net commission.
Expenses - Total LFS expenses increased approximately $624,000, or 72.4%, in 1999 from 1998 and increased approximately $208,000, or 31.7%, in 1998 from 1997 due primarily to increases in salaries and related benefits. As a service organization, LFS operating expenses consist primarily of salaries and related employee benefits. These expenses increased approximately $315,000, or 47.5%, in 1999 from 1998, and increased approximately $228,000, or 52.4%, in 1998 from 1997, due primarily to increases in the average number of employees to accommodate increases in sales volume, to the addition of personnel at higher pay levels, and to regular annual pay increases.
The increase in 1999 expenses is attributable primarily to: (i) $2.9 million in stock option expense recorded during 1999 by Regan Holding Corp. related to approximately 4.9 million stock options that were granted to LMG producers during 1999 and 1998; (ii) awards of the Company's common stock to producers, which resulted in recognition of approximately $420,000 in related expense; (iii) $1.6 million in expenses relating to the producer estate planning seminars conducted under the name of WTES, which were reported in LMG expenses in 1998 and 1997 and which are now reported as expenses of LifeSurance Corporation; and (iv) increases in legal and consulting fees related to various parent company strategic planning projects. During the first quarter of 2000, approximately 2.1 million additional producer stock options were granted. As a result, related stock option expense is expected to be recorded in the first quarter of 2000. This latter grant is expected to be the final "broad-scale" grant to producers. However, future grants to the highest performing producers are still expected to occur which will result in additional expense in future years.
The increase in 1998 expenses is due primarily to increases in depreciation and equipment expense attributable to overall increases in subsidiary sales volume and employment, as discussed above.
ITEM 7 - A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
In accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), all of the Company's short-term investments are treated as available-for-sale.
Investments in fixed income instruments carry a degree of market risk. Market risk represents the potential for loss due to adverse changes in the fair market value of financial investments. The market risks faced by the Company relate primarily to its investment portfolio, which exposes the Company to risks related to interest rates and, to a lesser extent, credit quality and equity prices.
Equity price risk is the potential loss arising from changes in the value of equity securities. In general, equity securities have more year-to-year price variability than intermediate term high grade bonds. However, returns over longer time frames have been consistently higher. The Company's equity securities consist primarily of preferred stocks, which provide consistent income. As a result of unfavorable market conditions related to preferred securities, the fair value of the Company's equity securities is below original cost at December 31, 1999 and 1998. The original cost and fair values of the Company's marketable equity securities are shown below:
As discussed Note 1, the Company changed its method of accounting for the cost of computer software developed or obtained for internal use in 1999.
Regan Holding Corp. (the "Company") was incorporated in the State of California on February 21, 1990.
Through LifeSurance Corporation, a wholly-owned subsidiary, the Company conducts estate planning seminars which provide continuing education credits for producers at various locations throughout the United States. Producers pay attendance fees to attend the seminars and may also purchase educational materials which can be used as tools in promoting life insurance and annuity policies and estate planning concepts. The seminars and educational materials are marketed under the business name Wealth Transfer Educational Systems.
Legacy Advisory Services, Inc. ("LAS") is a wholly-owned subsidiary of the Company, incorporated in the state of California for the purpose of operating as an "investment advisor," as defined by and regulated pursuant to the Investment Advisors Act of 1940. LAS is registered with the Securities and Exchange Commission (the "SEC") and has conducted limited operations to date.
Legacy Reinsurance Company ("LegacyRe") is a wholly-owned subsidiary of the Company, incorporated in the State of Arizona. The Company is in the process of obtaining approval from the Arizona Department of Insurance for LegacyRe to engage in the reinsurance business. Accordingly, LegacyRe has conducted no business to date. Upon receipt of approval from the Arizona Department of Insurance, LegacyRe may enter into one or more reinsurance agreements to reinsure annuity and life products.
Marketing allowances and commissions are recognized when policies become inforce. Administrative fees are recognized on a per transaction basis as services are performed.
Investments include mortgage-backed securities, corporate bonds and equity securities, and obligations backed by U.S. government agencies. The Company's investments are classified as available-for-sale and are carried at market value. Market values are determined using published quotes as of the close of business. Unrealized gains and losses, net of the related tax effect, are excluded from earnings and are reported as a separate component of shareholders' equity, within "accumulated other comprehensive income," until realized.
Basic and diluted earnings per share are presented in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share. Earnings per share is based on the weighted average number of common shares outstanding, including shares of redeemable common stock.
Included in operating results for the years ended December 31, 1999, 1998, and 1997, are $917,505, $824,164, and $494,033 of interest income earned on investments, respectively.
On May 7, 1999, the Company purchased for $4.3 million the building in Petaluma, California, which previously housed the Company's headquarters. In conjunction with the building acquisition, the Company paid $2.2 million of the purchase price in cash and entered into a loan payable for the remaining $2.1 million. The loan has a ten-year term and is payable in monthly installments plus one balloon payment of approximately $1.8 million, due on May 10, 2009. The loan bears interest at 0.5% per annum above the Prime Rate, as published in the West Coast Edition of the Wall Street Journal. The loan is fully guaranteed by each of the Company's subsidiaries. In addition, the loan agreement contains certain covenants with which the Company must comply, including restrictions on indebtedness or investments outside the ordinary course of business and restrictions on dividends or other changes in the Company's capital structure. One of the covenants requires management to obtain lender approval prior to repurchasing non-redeemable common stock. The Lender has waived this covenant through June 30, 2000, provided that such voluntary repurchases do not exceed $125,000 per quarter. Pursuant to the loan agreement, the Company was also required to place approximately $560,000 in reserve to cover loan payments in the event of default and to provide for certain repair costs. Such reserved amounts are classified as Other Assets in the accompanying consolidated balance sheet at December 31, 1999.
Under the Company's Officer Incentive Bonus Plan (the "Plan"), each officer of the Company is allocated from 0.75% to 1.25% of annual net income in a given year (the "Bonus Year"), before officer incentive bonuses, as an incentive bonus (the "Bonus"). The payment of the Bonus occurs in equal amounts over the three years following the Bonus Year. The first payment is automatically paid immediately following the end of the Bonus Year. The remaining two payments are paid in the second and third years following the Bonus Year and are contingent upon the Company achieving targeted growth in net income during the first and second years following the Bonus Year, respectively. The Bonus payment is forfeited for any year during which the specified growth is not achieved. At December 31, 1999 and 1998, $596,506 and $798,062 respectively, are reflected as incentive compensation payable in the accompanying consolidated balance sheets of which $469,720 and $488,671, respectively, are classified as non-current liabilities. Such amounts primarily represent the deferred portion of the 1999 and 1998 Bonuses.
The Company also sponsors a non-qualified deferred compensation plan (the "Key Employee Deferred Compensation Plan"), which is available to certain employees who, because of Internal Revenue Code limitations, are prohibited from contributing the maximum percentage of salary to the 401(k) Plan. Under
the Key Employee Deferred Compensation Plan certain employees may defer, on a pre-tax basis, a percentage of annual compensation, including bonuses. The Company matches 50% of each employee's contributions, up to a maximum of 6% of annual compensation, less amounts already matched under the 401(k) Plan. Deferrals under the Key Employee Deferred Compensation Plan began in the first quarter of 1999. Pursuant to the Key Employee Deferred Compensation Plan, the Company recorded $53,073 in matching expense during the year ended December 31, 1999. As of December 31, 1999, employee contributions and Company matching contributions, net of accumulated losses, totaled $213,045. Such amounts are reflected as a liability in the accompanying consolidated balance sheet.
The Company also sponsors a non-qualified deferred compensation plan under which producers may defer, on a pre-tax basis, up to 50% of annual commissions (the "Producer Commission Deferral Plan"). Producers who earn a minimum of $100,000 in annual commission are eligible to participate in the Producer Commission Deferral Plan. In addition, the Company will match producer contributions for those producers who earn over $250,000 in annual commissions at rates ranging from 1% to 5% of amounts deferred, depending on the level of annual commissions earned. Deferrals under the Producer Commission Deferral Plan began in the second quarter of 1999. During the year ended December 31, 1999, $55,710 in matching contributions were charged to operating expenses related to the Producer Commission Deferral Plan. As of December 31, 1999, producer contributions and Company matching contributions, net of accumulated losses, totaled $1,151,668. Such amounts are reflected as a liability in the accompanying consolidated balance sheet.
Assets held by the Company in the Key Employee Deferred Compensation Plan and the Producer Commission Deferral Plan are subject to the general creditors of the Company.
The Company leases office and warehouse premises and certain office equipment under non-cancelable operating leases. Related rent expense of $875,971, $369,231, and $335,973 are included in occupancy costs for the years ended December 31, 1999, 1998, and 1997, respectively. Total rentals for and leases of equipment included in equipment expense were $416,770, $255,078, and $146,874 for the years ended December 31, 1999, 1998, and 1997, respectively.
The Company also leases 18,200 square feet of office space in Des Moines, Iowa, at a monthly rate of $14,292, increasing to $26,179 per month in April 2000, and expiring in October 2004. In addition, the Company leases 30,500 square feet of office space in Rome, Georgia, at a rate of $11,438 per month, expiring December 2001.
In May 1998, the Company entered into a Shareholder's Agreement with Lynda Regan, Chief Executive Officer of the Company and Chairman of the Company's Board of Directors, and certain other individuals. Under the terms of this agreement, in the event of the death of Ms. Regan, the Company shall repurchase from Ms. Regan's estate all shares of common stock that were owned by Ms. Regan at the time of her death, or were transferred by her to one or more trusts prior to her death. The purchase price to be paid by the Company shall be equal to 125% of the fair market value of the shares. The Company has purchased a life insurance policy with a face amount of $14.0 million for the purpose of funding this obligation in the event of Ms. Regan's death.
Shares of Redeemable Common Stock are excluded from total shares issued and outstanding in the accompanying consolidated balance sheets.
Producer Option Plan--Under the Regan Holding Corp. Producer Stock Option and Award plan (the "Producer Option Plan"), the Company may grant to LMG producers and LFS registered representatives non-qualified stock options (the "Producer Options") to purchase the Company's common stock. 9,500,000 shares have been reserved for grant under the Producer Option Plan. The Producer Options granted through June 1999 vested ratably over the five years following 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 pursuant to guidance proscribed in Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, as interpreted by Emerging Issues Task Force Issue 96-18 Accounting for Equity Instruments That Are Issued to Other Than Employees For Acquiring or in Conjunction With Selling Goods and Services. As a result, the Company recorded $2,867,000 of expense during 1999 representing management's estimate of the fair value of the Producer Options at the date that the vesting provisions were waived. The fair value of the options was estimated using the Black-Scholes option-pricing model with the following assumptions: risk-free interest rates ranging from 5.3% to 6.0%, expected volatility ranging from 27.7% to 39.5%, and expected lives ranging from one to five years. A dividend yield assumption was not applicable, as the Company's stock is not publicly traded nor does the Company pay dividends. All Producer Options granted after June 1999 were immediately vested upon grant. Producer Options generally expire in six years.
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"). 5,500,000 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 applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for the Employee Option Plan. Accordingly, no compensation expense has been recognized for options granted under the Employee Option Plan. Had the Company elected to recognize compensation expense in accordance with SFAS No. 123, the Company's net income and earnings per share for the year ended December 31, 1999 would have been reduced for options granted under the Employee Option Plan to the pro-forma amounts indicated below:
seven years. Volatility and dividend yield assumptions were not applicable, as the Company's stock is not publicly traded nor does the Company pay dividends.
The following table summarizes information about stock options outstanding at December 31, 1999 under both plans:
The Company's reportable segments are those that are based on the Company's method of internal reporting, which desegregates its business into two primary reportable segments: Legacy Marketing Group, and Legacy Financial Services, Inc. The financial results of the Company's operating segments are presented on an accrual basis. There are no significant differences between the accounting policies of the segments as compared to the Company's consolidated financial statements. In addition to revenues and expenses recorded directly by each segment, the Company evaluates the performance of its segments and allocates resources to them based on estimates of salaries and other expenses attributed to each of the segments' operations. There are no material intersegment revenues.
The table below presents information about the Company's operating segments for the years ended December 31, 1999, 1998 and 1997:
At December 31, 1999, the Company's investment portfolio included a $12 million investment in Indianapolis Life Group of Companies ("Indianapolis Group"), an affiliate of IL Annuity, which represents 25.8% of the Company's total assets. In the first quarter of 2000, the Indianapolis Group repurchased the equity securities from the Company for $12,546,099, pursuant to the terms of the Investment Agreement.
REGAN HOLDING CORP. AND SUBSIDIARIES Consolidating Income Statement For the Year Ended December 31, 1999