We own an office building in Rome, Georgia, which is used to accommodate some of Legacy Marketing’s operating activities. We financed the property with a mortgage loan, which totaled $2.6 million at December 31, 2007. On October 17, 2007, we entered into a lease with Perot Systems whereby Perot Systems will lease our offices in Rome, Georgia, for a ten-year term at an initial rental price of $8.00 per square foot (a lease amount of approximately $300,000 per year). We currently lease an office building in Petaluma, California, which serves as the principal executive offices of Legacy Marketing.
Legacy Marketing also had administrative agreements with each of the insurance carriers listed above. Effective October 17, 2007, Legacy Marketing entered into an agreement with a subsidiary of Perot Systems, whereby Legacy Marketing agreed to transfer its third party administration services function and the employees who provide these services to Perot Systems in exchange for Perot Systems’ assumption of such administrative service functions. As a result of this transaction, Legacy Marketing recognized a non-cash internal use software impairment charge of approximately $1.2 million in the fourth quarter of 2007.
Prospectdigital received $116,000 in consideration of the sale, which was greater than the estimated fair value of the assets of prospectdigital being sold, as determined by a third-party independent valuation. The amount of consideration was approved by the Board of Directors of Regan Holding.
On July 20, 2006, Legacy Marketing entered into a credit agreement (the “Credit Agreement”) with Washington National Insurance Company (the “Lender”). Pursuant to the terms of the Agreement, the Lender made a non-revolving multiple advance term loan (the “Term Loan”) to Legacy Marketing totaling $6.0 million. On April 12, 2007, Legacy Marketing amended certain terms of the Agreement through the execution of Amendment No. 1 to the Credit Agreement (the Credit Agreement as so amended, the “Amended Agreement”) and (1) extended the final maturity of the loan under the Credit Agreement from April 1, 2012, to December 31, 2012; (2) changed certain of the requirements for mandatory prepayments under the Credit Agreement; (3) changed certain terms of the financial covenants specified in the Credit Agreement; and (4) revised certain definitions contained in the Credit Agreement. As of December 31, 2007, the balance due under the Credit Agreement was $6.0 million.
In 1998, we began a project intending to replace our existing policy administration system with new licensed software after the vendor of the existing policy administration system required us to migrate from the existing system to an alternative platform. In late 2002, we learned from the vendor that we might be able to retain the existing system. Modification and customization of the licensed software was suspended in December of 2002. As a result of an evaluation of the Company-wide technological needs, which included an assessment of the viability of the existing system, it was concluded that we would use both systems.
In addition, the U.S. Congress is again considering legislation that would impose certain national uniform standards on insurance companies, establish an optional federal charter system for insurance companies and repeal the McCarran-Ferguson antitrust exemption for the business of insurance, any of which could have a significant impact on our business. If such laws or regulations are adopted, they could have a material adverse effect on our financial condition and results of operations.
New tax regulations have also been adopted recently that affect the treatment of tax-sheltered annuity contracts. Also, new accounting and actuarial proposals, including principles-based reserving, may be proposed and adopted. These developments also could have a material adverse effect on our financial condition and results of operations.
There are no significant management judgments associated with reporting our revenues. When a policyholder remits a premium payment with an accurate and completed application for an insurance policy, the policy is considered inforce and Legacy Marketing recognizes marketing allowances and commission income. Legacy Marketing’s carriers grant policyholders a contractual right to terminate the insurance contract ten to thirty days after a policy is placed inforce. This return period varies depending on the carrier, the type of policy and the jurisdiction in which the policy is sold. Legacy Marketing gathers historical product return data that does not vary significantly from quarter to quarter, and has historically been predictive of future events. Returns are estimated using this data and have been reflected in the Consolidated Financial Statements.
Modifications or enhancements made to an existing software product that result in additional functionality are also capitalized. 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. We periodically review capitalized internal use software to determine if the carrying value is fully recoverable. If there are future cash flows directly related to the software we record an impairment loss when the present value of the future cash flows is less than the carrying value. If software, or components of software, in development are abandoned, the Company takes a charge to write off the capitalized amount in the period the decision is made to abandon it.
During the year ended December 31, 2007, Legacy Marketing sold and administered products primarily on behalf of three unaffiliated insurance carriers: Washington National, American National, and Transamerica. As indicated below, the agreements with these carriers generated a significant portion of our total consolidated revenue:
Legacy Marketing’s revenue increased $1.3 million (5%) in 2006 compared to 2005 primarily due to increased marketing allowances and commissions of $2.2 million and other revenue of $885,000, partially offset by a decline in administrative fees of $1.2 million. Marketing allowances and commissions increased $2.2 million (20%) primarily due to the sales of fixed annuity products issued by Washington National. We began marketing Washington National products in March 2006. The increase in sales due to the introduction of a new product with Washington National was partially offset by a decline in sales of fixed annuity products issued by Investors Insurance. This decrease occurred primarily because we discontinued selling fixed annuity products issued by Investors Insurance in certain states during the third quarter of 2005 due to changes in regulatory requirements of those jurisdictions related to minimum guaranteed rates.
Other revenue increased $885,000 (110%) primarily due to an increase in new product implementation and marketing program fees, and revenue resulting from amortization of deferred gain on the sale of our Petaluma, CA building.
Administrative fees decreased $1.2 million (14%) in 2006 compared to 2005 primarily due to the expiration of the administrative agreement with IL Annuity on April 30, 2006. The expiration of the administrative agreement does not affect the commissions earned by Legacy Marketing on additional premium received or assets under management with respect to the underlying IL Annuity insurance contracts.
On May 31, 2007, Regan Holding and two of its subsidiaries, Legacy Financial and Legacy Advisory Services Inc., entered into an agreement with Multi-Financial Securities Corporation whereby Legacy Financial Services transferred its registered representatives and customer accounts to Multi-Financial Securities Corporation. Under the agreement, on September 28, 2007, Multi-Financial Securities Corporation paid Legacy Financial Services $1 million (11.5%) of the aggregate gross dealer concessions earned at Legacy Financial Services between May 1, 2006, and April 30, 2007, by those transferred representatives who were, as of the measurement date (as defined in the agreement), registered with Multi-Financial Securities Corporation and in good standing with the FINRA . In addition, on each of the first four anniversary dates of the measurement date, subject to certain conditions, Multi-Financial Securities Corporation is obligated to pay Legacy Financial Services an amount representing up to four and a half percent (4.5%) of each transferred representative’s aggregate gross dealer concessions earned with Multi-Financial Securities Corporation during the one year period prior to such anniversary date.
We recognized a $1 million gain on the transfer of Legacy Financial’s registered representatives and customer accounts to Multi-Financial Securities Corporation in 2007, and as a result Legacy Financial had net income of $133,000 for the twelve months ended December 31, 2007. Legacy Financial incurred losses of $660,000 for the twelve months ended December 31, 2006. Legacy Financial’s results are being reported as discontinued operations. On our consolidated balance sheet, Legacy Financial’s assets of $380,000 as of December 31, 2007, and $592,000 as of December 31, 2006, are included in prepaid expenses and other current assets, and Legacy Financial’s liabilities of $210,000 as of December 31, 2007, and $748,000 as of December 31, 2006, are included in accounts payable and accrued liabilities.
In January 2006, we decided to discontinue the operations of Values Financial Network (“VFN”). We incurred insignificant costs in connection with exiting the operations of VFN.
Net cash provided by financing activities of $3.8 million in 2007 primarily consisted of proceeds from loans received from our investment broker.
We lease office and warehouse premises and certain office equipment under non-cancelable operating leases. As of December 31, 2007, our total contractual cash obligations, including the building financing and the loan with Washington National discussed above, were as follows:
On March 26, 2008, we entered into an agreement to sell certain of our asset based trail commissions (“trail commissions”) to Legacy TM, a limited partnership (the “Partnership”), for $6.5 million in cash and an interest in the limited partnership. The transaction closed on March 26, 2008. As a portion of the consideration for the trail commissions, the Partnership issued to us a Class A limited partnership interest in the Partnership that includes the beneficial interest in 33 1/3% of the trail commission revenue received on those policies in effect on or prior to the closing date for the one year period subsequent to the closing date and all revenue associated with policies that become effective after the closing date. Our limited partnership interest is unencumbered. Lynda Pitts, Chief Executive Officer, and Preston Pitts, President, Chief Operating Officer and Chief Financial Officer of the Company, each of whom is also a director of the Company, are the general partners of the Partnership and together own all of the Class B interests in the Partnership.
We are also in negotiations, which, if successful, will result in additional cash inflows. There can be no assurance that such negotiations will be successful, or will occur within any specific timeframe. In the event that a cash shortfall does occur, we believe that adequate financing could be obtained to meet our cash flow needs. However, there can be no assurances that such financing would be available on favorable terms.
We have audited the accompanying consolidated balance sheets of Regan Holding Corp. and its subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the consolidated statements of operations, shareholders’ (deficit), and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedule listed in Item 15(a)(2) as of and for the years ended December 31, 2007 and 2006. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor have we been engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Regan Holding Corp. (the “Company”) is a holding company, incorporated in California in 1990, whose primary operating subsidiary is Legacy Marketing Group (“Legacy Marketing”).
As required by the Financial Industry Regulatory Authority (“FINRA”), the cash balances of Legacy Financial Services are set aside to satisfy customer claims, settlements and other financial exposures.
Redeemable common stock is carried at the greater of the issuance value or the redemption value. Periodic adjustments to reflect increases or decreases in redemption value are recorded as accretion, with an offsetting adjustment to retained earnings. The Company is currently unable to redeem its redeemable common stock due to restrictions in California corporation law.
On January 25, 2007, prospectdigital LLC ("prospectdigital"), an indirect wholly owned subsidiary of the Company, sold certain of its assets, which primarily included fixed assets and other miscellaneous operating assets, to PD Holdings LLC ("PD Holdings"). In addition, PD Holdings agreed to assume certain liabilities of prospectdigital. The action was taken in a continuing effort to reduce our operating expenses, as prospectdigital continued to sustain losses through the date of sale.
Effective October 17, 2007, Legacy Marketing entered into an agreement with a subsidiary of Perot Systems Corporation, whereby Legacy Marketing agreed to transfer its third party administration services function and the employees who provide these services to Perot Systems in exchange for Perot Systems’ assumption of such administrative service functions. As a result of this transaction, Legacy Marketing recognized a non-cash internal use software impairment charge of approximately $1.2 million in the fourth quarter of 2007.
On July 1, 2002, the Company entered into a Purchase Option Agreement with SCOR Life U.S. Re Insurance Company (“SCOR”), a 100% owner of the outstanding capital stock of Investors Insurance Corporation. Pursuant to the terms of the agreement, SCOR granted the Company the right to purchase the outstanding capital stock of Investors Insurance in exchange for annual option fees. The Company had the right to exercise the option at any time on or prior to June 30, 2005, or terminate the Option Agreement in accordance with its terms before such date if the A.M. Best rating of Investors Insurance declined below a specified level. The A.M. Best rating of Investors Insurance fell below the specified level. On June 22, 2005, the Company terminated the Option Agreement. SCOR repaid the option fees paid by the Company pursuant to the Option Agreement, including interest, totaling approximately $3.3 million.
In 2007, the Company obtained loans from its investment broker for general corporate purposes. The loans bear interest at the lender's base lending rate plus a surcharge based on the amount of the loans (8.5% at December 31, 2007), and are collateralized by the Company's investment portfolio. As there is no stated maturity date the Company has included the entire balance of $3.9 million as of December 31, 2007, in the current portion of notes payable and other borrowings.
The Company has a mortgage on its office building in Rome, Georgia. The note has a variable interest rate indexed to 30-day LIBOR plus 1.9% and is payable over ten years in monthly installments of principal, amortized on the basis of a 20-year term, and interest. At the end of the ten years, the Company must pay the balance of the principal due on the note. The outstanding balance of the note was $2.6 million as of December 31, 2007, $2.7 million as of December 31, 2006, and $2.8 million as of December 31, 2005. To manage interest expense, the Company entered into an interest rate swap agreement with a notional amount equal to the principal balance of the note, which modifies its interest expense from a variable rate to a fixed rate. The April 2004 swap agreement involves the exchange of interest obligations from April 2004 through April 2014 whereby the Company pays a fixed rate of 6.8% in exchange for LIBOR plus 1.9%. As of December 31, 2007, the Company made payments of $281,000 toward the principal balance of the note. The required principal payments over the next five years are: $90,000, $96,000, $103,000, $110,000 and $118,000.
The Company’s combined aggregate future annual principal payments on the Term Loan and the mortgage are as follows:
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, up to 70% of their annual compensation as contributions to the 401(k) plan, subject to a maximum of $15,500. The Company typically matches 50% of each employee’s contributions up to 6% of their annual compensation, subject to a maximum of $7,750. The Company’s matching contributions were $223,000, $223,000, and $108,000 for the years ended December 31, 2007, 2006, and 2005.
During 2007, 2006 and 2005, Legacy Marketing initiated sales incentive programs for its independent insurance producers and its top producers (“Wholesalers”), which granted bonuses to the producers and Wholesalers based upon their achievement of predetermined monthly sales targets. The Company recorded expense of $1.0 million during the year ended December 31, 2007, related to these programs, of which $707,000 was paid as of December 31, 2007. The Company recorded expense of $1.9 million during the year ended December 31, 2006 related to these programs, of which $332,000 was paid as of December 31, 2006. The amount expensed in 2005 was $910,000, of which $425,000 was paid as of December 31, 2005. The amounts expensed are included in selling, general and administrative expenses.
The Company’s future minimum annual lease commitments under all non-cancelable operating leases as of December 31, 2007 are as follows:
As part of the Company’s agreements with certain of its insurance producers, the Company may, under certain circumstances, be obligated to offer to purchase the business of the producers. At December 31, 2007, there were no outstanding commitments by the Company relating to such obligations.
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. We did not grant any stock options in 2007 and granted a total of 15,000 stock options to a Producer in each of the years ended December 31, 2006 and 2005. Compensation expense related to stock options awarded during 2006 and 2005 was immaterial. There were no shares of Series A common stock awarded to non-employees during 2007, 2006 and 2005.
Under the prospective application method, the Company is required to record compensation expense prospectively for all employee stock options awarded during the reporting period based upon the fair-value-based method prescribed by SFAS No. 123R. The Company estimates the fair value of each stock option award on the date of grant using the Black-Scholes stock option valuation model. The estimated fair value of employee stock option awards is amortized over the award’s vesting period on a straight-line basis. There were no stock options awarded in 2007, and the compensation expense related to stock options awarded in 2006 was immaterial.
The following table summarizes information about stock options outstanding at December 31, 2007, under both plans:
As of December 31, 2007, the Company had federal and primary state net operating loss carryforwards of $23.4 million and $40.9 million. On December 31, 2024, 2025 and 2026, $251,000, $4.8 million and $12.1 million of the federal net operating losses will expire. On December 31, 2012, $4.9 million of the state net operating losses will begin to expire. The Company also has federal and state alternative minimum tax credit carryforwards of $192,000 and $275,000. These credits do not have an expiration date. Federal and state tax valuation allowances have been established for all of the federal and state net operating loss carryforwards and the federal and state tax credit carryforwards.
Effective January 1, 2007, the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). This interpretation creates a two step approach for evaluation of uncertain tax positions. Recognition (step one) occurs when an enterprise concludes that a tax position, based solely on its technical merits, is more likely than not to be sustained upon examination. Measurement (step two) determines the highest amount of benefit that more likely than not will be realized upon settlement. The Company does not currently have an unrecognized tax benefit balance and for federal income tax purposes, the statute of limitations are open for tax years 2004 through 2007. The adoption of FIN 48 did not have a significant impact on the Company’s financial condition or results of operations.
The basic and diluted loss per share calculations are based on the weighted average number of common shares outstanding including shares of redeemable common stock.
The Company is also in negotiations, which, if successful, will result in additional cash inflows. In the event that a cash shortfall does occur, the Company believes that adequate financing could be obtained to meet its cash flow needs. However, there can be no assurances that such financing would be available on favorable terms.
On March 26, 2008, Legacy Marketing entered into an agreement to sell certain of its asset based trail commissions (“trail commissions”) to Legacy TM, a limited partnership (the “Partnership”), for $6.5 million in cash and an interest in the limited partnership. The transaction closed on March 26, 2008. As a portion of the consideration for the trail commissions, the Partnership issued to Legacy Marketing a Class A limited partnership interest in the Partnership that includes the beneficial interest in 33 1/3% of the trail commission revenue received on those policies in effect on or prior to the closing date for the one year period subsequent to the closing date and all revenue associated with policies that become effective after the closing date. Legacy Marketing’s limited partnership interest is unencumbered. Lynda Pitts, Chief Executive Officer, and Preston Pitts, President, Chief Operating Officer and Chief Financial Officer of the Company, each of whom is also a director of the Company, are the general partners of the Partnership and together own all of the Class B interests in the Partnership.