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 $2.7 million at December 31, 2006. We currently lease two office buildings in Petaluma, California, which serve as the principal executive offices of Legacy Marketing and Legacy Financial.
Legacy Marketing designs, markets and administers fixed annuity products on behalf of certain unaffiliated insurance carriers in each of the United States, except Alabama and New York. As of December 31, 2006, Legacy Marketing had marketing agreements with American National, Investors Insurance, Transamerica, Americom, Washington National and John Hancock. The marketing agreements grant Legacy Marketing the exclusive right to market certain fixed annuity products issued by these insurance carriers. Legacy Marketing is responsible for appointing Producers, who have contracted with Legacy Marketing to sell these products, with the applicable insurance carrier. For these services, the insurance carriers pay Legacy Marketing commissions and marketing allowances.
Pursuant to the terms of the Agreement, beginning July 1, 2007, Legacy Marketing will be required to make quarterly principal payments on the Term Loan equal to a percentage of the outstanding principal balance of the Term Loan as of June 30, 2007, as follows: 3.75% of the balance for the first four payments, 5.0% of the balance for the next twelve payments and 6.25% of the balance for the final four payments. The quarterly principal payments will be reduced, in order of maturity, by any optional prepayments by Legacy Marketing or prepayments resulting from prepayment events specified in the Agreement. Additionally, beginning March 31, 2008, the Borrower will be required to semi-annually prepay the Term Loan on each March 31 and September 30 in an amount equal to fifty percent of the Company’s excess cash flow (as defined in the Agreement) for the immediately preceding six month periods ended December 31 and June 30, subject to certain conditions specified in the Agreement. Interest on the unpaid principal balance of the Term Loan is currently payable on a monthly basis and accrues at the LIBOR-based rate (as defined in the Agreement) plus 3.5%, which was 8.82% as of December 31, 2006. The principal balance and accrued interest on the Term Loan is payable in full by April 1, 2012.
On November 18, 2005, Regan Holding sold its office buildings in Petaluma, California for $12.8 million. Regan Holding and the third party buyer (the “Buyer”) further agreed to enter into a ten year lease agreement, concurrently with the sale of the buildings, whereby we leased back 71,612 square feet through March 14, 2007, and will continue to lease back 47,612 square feet for the remainder of the lease term. The monthly base rent is $1.29 per square foot and will increase annually by three percent during the term of the lease, in addition to monthly taxes and operating expenses.
In 2005, the Securities and Exchange Commission (“SEC”) informed certain issuers of equity-indexed annuities that it is examining whether such annuities need to be registered under the Securities Act of 1933. Also in 2005, the National Association of Securities Dealers (“NASD”) issued guidance to its members indicating that broker-dealers regulated by the NASD have certain responsibilities with respect to the offer and sale of equity-indexed annuities, including an obligation to determine the suitability of such products for their customers, regardless of whether equity-indexed annuities are deemed to be securities. Finally, some state insurance regulators are considering whether additional suitability regulations should be implemented with respect to all sales of fixed annuities, particularly with respect to senior citizens. In California, Commissioner Garamendi issued a letter in 2005, to California life insurance companies urging them to develop suitability standards for the sale of annuity products to seniors.
Our core business consists of selling fixed annuity products, on behalf of insurance carriers, through a network of independent insurance producers (“Producers”). If the initiatives undertaken by California and other states, the Securities and Exchange Commission or the NASD with respect to equity-indexed and other annuities, or similar initiative that may be undertaken in this or future years, result in new regulation or legislation, our operations and those of our Producers could be adversely affected. We are unable to predict whether, or which, of these initiatives will result in new laws or regulations, or whether other initiatives may affect our business and the demand for fixed annuity products marketed by Legacy Marketing. If such initiatives result in new regulation or laws, they could have a material adverse effect on the insurance industry in general or on our financial condition and results of operations.
Legacy Financial is registered as a broker-dealer with, and is subject to regulation by, the SEC, NASD, Municipal Securities Rulemaking Board, and various state agencies. This regulation covers matters such as capital requirements, recordkeeping and reporting requirements, and employee-related matters, including qualification and licensing of supervisory and sales personnel. Any proceeding alleging violation of, or noncompliance with, laws and regulations applicable to Legacy Financial could harm its business, financial condition, results of operations, and business prospects. In addition, changes in federal legislation, state legislation, court decisions and administrative policies could significantly and adversely affect the securities industry in general and Legacy Financial’s business in particular.
Legacy Marketing has marketing and administrative agreements with certain insurance carriers. Under the terms of the marketing agreements, Legacy Marketing is responsible for appointing Producers, who have contracted with Legacy Marketing to sell fixed annuity products, with various states’ departments of insurance and the applicable 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 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.
Year ended December 31, 2006 compared with year ended December 31, 2005
Year ended December 31, 2005 compared with year ended December 31, 2004
We had a consolidated net loss of $13.7 million in 2005, compared to a consolidated net loss of $7.5 million in 2004. The $6.2 million increase in losses was primarily due to higher net losses incurred by Legacy Marketing and Imagent Online, and higher losses from discontinued operations. Excluding the $2.9 million impairment charge for internal use software, our consolidated net loss was $10.8 million in 2005.
Other revenue increased $884,000 (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.
During the year ended December 31, 2006, 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:
Over the last two years, the low interest rate environment has caused many carriers that issue declared rate annuities, such as American National, to reduce crediting rates and compensation on certain products. Sales of these products accounted for approximately 3% and 9% of our total consolidated revenue for the years ended December 31, 2005 and 2004. In addition, the fixed annuity industry is experiencing a relative shift in sales from declared rate annuities to equity-indexed annuities. As a result, sales of the American National products in 2005 were lower compared to 2004. Revenue derived from sales and administration of American National products decreased $2.8 million in 2005 compared to 2004 and accounted for approximately 23% and 25% of our total consolidated revenue for the years ended December 31, 2005 and 2004.
Legacy Marketing’s operating expenses decreased $2.9 million (7%) in 2005 compared to 2004 primarily due to decreased selling, general and administrative expenses. Excluding the $2.9 million impairment charge for internal use software, Legacy Marketing’s expenses decreased $5.8 million (15%) in 2005 compared to 2004. Selling, general and administrative expenses decreased $5.6 million (16%) primarily due to decreased compensation and benefits and professional fees. Compensation and benefits decreased primarily due to decreased employee headcount and a reduction in temporary help. Professional fees decreased primarily due to decreased consulting fees.
Legacy Financial revenue increased $177,000 (5%) in 2006 compared to 2005 primarily due to increased commission income as a result of increased sales volume and an increase in other income.
Legacy Financial operating expenses increased $766,000 (21%) in 2006 compared to 2005, which was due to an increase in selling, general and administrative expenses of $434,000 (14%) and other expenses of $334,000 (57%). The increase in selling, general and administrative expenses was mainly attributable to an increase in professional fees and compensation and benefits as the result of increased headcount and temporary help. Professional fees increased mainly due to higher legal costs. Other expenses increased in 2006 compared to 2005 primarily due to higher arbitration costs during the year.
Legacy Financial operating expenses decreased $332,000 (8%) in 2005 compared to 2004, which was primarily due to a decrease in selling, general and administrative expenses of $346,000 (10%). This decrease was mainly attributable to a decrease in compensation and benefits and professional fees. Compensation and benefits decreased as the result of decreased headcount, a reduction in temporary help and decreased management fees paid to Legacy Marketing. In addition, professional fees decreased mainly due to lower legal costs and advisory expenses.
Our net loss in 2004 was significantly offset by non-cash charges, as well as a decrease in accounts receivable, which was primarily due to a decrease in sales volume, and an increase in deferred compensation payable. Significant uses of cash included an increase in income taxes receivable due to a pre-tax loss and a decrease in accounts payable and accrued liabilities. The decrease in accounts payable and accrued liabilities was primarily due to payment of bonuses during 2004 to Wholesalers based upon their achievement of predetermined 2003 sales targets, payments of 2003 employee incentive bonuses and payments associated with a Producer incentive trip.
Net cash provided by investing activities of $12.6 million in 2005 primarily consisted of the proceeds from the sale of our office buildings in Petaluma, California, and a refund of option fees pursuant to the terms of the Purchase Option Agreement with SCOR Life U.S. Re Insurance Company (“SCOR”) totaling $3.0 million, excluding interest, partially offset by purchases of fixed assets totaling $2.7 million.
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the effect, if any, that implementation of SFAS No. 157 will have on our results of operations and financial condition.
We have audited the accompanying consolidated balance sheets of Regan Holding Corp. and its subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the consolidated statements of operations, shareholders’ equity (deficit), and cash flows for the years then ended. Our audits also included the financial statement schedule listed in Item 15(a)(2) as of and for the years ended December 31, 2006 and 2005. 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.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Regan Holding Corp. and its subsidiaries as of December 31, 2006 and 2005 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule as of and for the years ended December 31, 2006 and 2005, when considered in relation to the consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We have also audited the adjustments to the 2004 consolidated financial statements to retroactively apply the change in accounting for discontinued operations, as described in Note 15. In our opinion, such adjustments are appropriate and have been properly applied. We were not engaged to audit, review, or apply any procedures to the 2004 consolidated financial statements of the Company other than with respect to the adjustments and, accordingly, we do not express an opinion or any form of assurance on the 2004 consolidated financial statements taken as a whole.
We were not engaged to audit, review, or apply any procedures to the adjustments to retrospectively reflect the discontinued operations described in Note 15 and accordingly, we do not express an opinion or any other form of assurance about whether such adjustments are appropriate and have properly applied. Those adjustments were audited by other auditors.
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 sales agreements with investment companies that give it the non-exclusive right to sell investment products on behalf of those companies. Sales of investment products are conducted through Legacy Financial’s network of independent registered representatives.
When a policyholder remits a premium payment with an accurate and completed application for an insurance policy, the policy is placed 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. Legacy Marketing recognizes administrative fees on a per transaction basis as services are performed, with the amount of the fee depending on the type of policy and type of service.
In accordance with Statement of Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” 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 undiscounted future cash flows. The Company periodically reviews capitalized internal use software to determine if the carrying value is fully recoverable. If there are future cash flows directly related to the software or the business unit of which it is a part, as applicable, 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.
On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123R, “Share-Based Payments” (“SFAS 123R”) which addresses the accounting for stock-based payment transactions whereby an entity receives employee services in exchange for equity instruments, including stock options. SFAS 123R eliminates the ability to account for stock-based compensation transactions using the intrinsic value method under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, and instead generally requires that such transactions be accounted for using a fair-value based method. Prior to January 1, 2006, the Company used the minimum value method in estimating the value of employee option grants as allowed by SFAS 123, amended by SFAS 148, “Accounting for Stock-Based Compensation - Transition and Disclosure”. Accordingly, the Company has elected the prospective transition method as permitted under SFAS 123R, and prior periods have not been restated to reflect the impact of SFAS 123R. The prospective transition method requires that stock-based compensation expense be recorded for all new stock options that are ultimately expected to vest as the requisite service is rendered beginning on January 1, 2006. The Company issues new shares of common stock upon the exercise of stock options.
The Company had no available for sale investments at December 31, 2006, 2005, and 2004. The Company’s recorded realized gains (losses) from available-for-sale investments as follows:
In 1998, the Company began a project intending to replace our existing policy administration system with new licensed software. In 2005, the Company conducted independent research, including consultation with industry experts about software solutions currently available in the marketplace and the benefits that companies, which are employing these systems, are receiving. In the second quarter of 2005, the Company concluded that the advances in technology and functionality that these new designs have delivered, along with the associated financial benefits, are greater than the Company would realize by completing its plans to implement a new administration system. In addition, the vendor of the new administration system announced that it will no longer be providing the appropriate updates for the system to the licensed users for all future regulatory changes, and that it will be the responsibility of each company that uses the system to modify the system for such changes. As a result, management determined that the internal use software project associated with the new administration system had been impaired, and in the second quarter of 2005, the Company recorded a write-off of $2.9 million associated with abandoned components of the internal use software project.
In 2004, due to the failure of VFN to produce revenues as projected, particularly in the corporate arena, management decided to cease actively marketing to the corporate market. As a result, management lowered its expectations for future sales. This event met the criteria of a “triggering event” for testing the recoverability of long-lived assets as required by Statement of Financial Accounting Standards No. 144 (“SFAS 144”) “Accounting for the Impairment or Disposal of Long-Lived Assets.” Accordingly, the Company compared the carrying amount of VFN’s long-lived assets to the projected sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset group. Based on the fact that the sum of the undiscounted cash flows exceeded VFN’s assets, the Company concluded no impairment had occurred to the long-lived assets.
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
Pursuant to the terms of the Agreement, beginning July 1, 2007, Legacy Marketing will be required to make quarterly principal payments on the Term Loan equal to a percentage of the outstanding principal balance of the Term Loan as of June 30, 2007, as follows: 3.75% of the balance for the first four payments, 5.0% of the balance for the next twelve payments and 6.25% of the balance for the final four payments. The quarterly principal payments will be reduced, in order of maturity, by any optional prepayments by Legacy Marketing or prepayments resulting from prepayment events specified in the Agreement. Additionally, beginning March 31, 2008, Legacy Marketing will be required to semi-annually prepay the Term Loan on each March 31 and September 30 in an amount equal to fifty percent of the Company’s excess cash flow (as defined in the Agreement) for the immediately preceding six month periods ended December 31 and June 30, subject to certain conditions specified in the Agreement. Interest on the unpaid principal balance of the Term Loan is currently payable on a monthly basis and accrues at the LIBOR-based rate (as defined in the Agreement) plus 3.5%, which was 8.82% as of December 31, 2006. The principal balance and accrued interest on the Term Loan is payable in full by April 1, 2012.
The Term Loan is primarily secured by the Company’s bank and securities accounts, equipment and investment property, and Legacy Marketing’s obligations are currently guaranteed by the Company, Legacy Advisory Services, Inc., Imagent Online LLC and certain shareholders of the Company. In addition, Legacy Marketing is required to comply with other financial and non-financial covenants specified in the Agreement. In the event of default under the Agreement, the entire balance of the Term Loan would become immediately payable unless Legacy Marketing obtains a waiver from the Lender.
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 $2.7 million as of December 31, 2006, and $2.8 million as of each of December 31, 2005 and 2004. 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, 2006, the Company made payments of $197,000 toward the principal balance of the note. The required principal payments over the next five years are: $84,000, $90,000, $96,000, $103,000 and $110,000.
The Company also sponsors a non-qualified tax deferred compensation plan under which producers who earn a minimum of $100,000 may defer, on a pre-tax basis, up to 50% of annual commissions. In addition, the Company will match producer contributions for those producers who earn over $250,000 in annual commissions at rates ranging from 2% to 5% of amounts deferred, depending on the level of annual commissions earned. During the years ended December 31, 2006, 2005, and 2004, matching contributions related to the producer commission deferral plan were $2,000, $8,000, and $18,000. Producer contributions and Company matching contributions, including cumulative investment gains, totaled $7.5 million as of December 31, 2006 and 2005. The liability to the employee or producer is credited or charged based on the performance of the investment option selected by the participant.
During 2006, 2005 and 2004, 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
The Company’s future minimum annual lease commitments under all non-cancelable operating leases as of December 31, 2006 are as follows:
Pursuant to the terms of our Amended and Restated Shareholder's Agreement with Lynda L. Regan, Chief Executive Officer of the Company and Chairman of the Company’s Board of Directors, upon the death of Ms. Regan, the Company would have the option (but not the obligation) to purchase 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. In addition, upon the death of Ms. Regan, her heirs would have the option (but not the obligation) to sell their inherited shares to the Company. The purchase price to be paid by the Company shall be equal to 125% of the fair market value of the shares. As of December 31, 2006, the Company believes that 125% of the fair market value of the shares owned by Ms. Regan was equal to $900,000. The Company has purchased life insurance coverage for the purpose of funding this potential obligation upon Ms. Regan’s death.
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, 2006, there were no outstanding commitments by the Company relating to such obligations.
The Company recorded redeemable common stock reduction of $165,000, $871,000 and $512,000 related to Series A redeemable common stock for the years ended December 31, 2006, 2005 and 2004.
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 granted a total of 15,000 stock options to a Producer in each of the years ended December 31, 2006, 2005 and 2004. Compensation expense related to stock options awarded during 2006, 2005 and 2004 was immaterial. There were no shares of Series A common stock awarded to non-employees during 2006, 2005 and 2004.
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 shareholders who own 10% or more of the outstanding shares of the Company’s stock, which expire in five years. On January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment,” using the prospective application method prescribed by SFAS No. 123R. Prior to the adoption of SFAS No. 123R, the Company accounted for stock option awards to employees in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees” (the intrinsic value method) and, accordingly, recognized no compensation expense for stock option awards to employees.
The income tax provision (benefit) in 2006, 2005 and 2004 differed from the amounts computed by applying the statutory federal income tax rate of 34% to pretax loss as a result of the following:
As the Company incurred net losses in the years ended December 31, 2006, 2005 and 2004, options to purchase 4.3 million, 6.0 million and 8.8 million shares of the Company’s common stock were excluded from the computation of diluted net loss per share for those periods, as the effect would have been antidilutive.
The Company has identified its reportable segments based on its method of internal reporting and segregates its business into three primary reportable segments: Legacy Marketing, Legacy Financial, and Imagent Online. Intersegment transactions are eliminated in consolidation. The Legacy Marketing business segment includes the results of selling and administering fixed annuity and life insurance products and general corporate expenses not allocated to the Company’s other segments.
In January 2006, the Company decided to discontinue the operations of Values Financial Network (“VFN”). We incurred insignificant costs in connection with exiting the operations.
As of December 31, 2006, Legacy Marketing sold and administered its products primarily on behalf of three unaffiliated insurance carriers: Washington National, American National, and Transamerica. The agreements with those carriers generated a significant portion of the Company’s total consolidated revenue: