Through our wholly-owned broker-dealer subsidiary, Legacy Financial, we sell variable annuity and life insurance products, mutual funds, and debt and equity securities. Sales of investment products are conducted through Legacy Financial's network of independent registered representatives.
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 $2.20 per share and $1.82 per share for Series A and Series B redeemable common stock as of December 31, 2002. This valuation by management was derived from an independent appraisal of our stock value based on financial information provided by us.
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 attributable to net income at Legacy Marketing during 2001 compared to net losses during 2000, and reduced net losses at our Other segments, partially offset by increased losses by Values Financial Network, Inc., Legacy Financial, and Imagent Online, LLC.
2002 2001 ---- ---- Transamerica 52% 68% American National 17% 5% IL Annuity 12% 20% John Hancock 8% -
Legacy Marketing's expenses decreased $2.9 million (6%) primarily attributable to decreases in selling, general and administrative expenses. Selling, general and administrative expenses decreased $2.9 million (7%) primarily due to decreases in professional fees, commissions, compensation, and occupancy expenses. Professional fees decreased primarily due to lower consulting fees related to internal use software maintenance, and reduced legal expenses. The decrease in commissions was primarily related to lower sales. Compensation decreased primarily due to the effect of attrition, as Legacy Marketing's headcount decreased 4% in 2002. The decreased occupancy expense was primarily a result of our purchasing the building that houses our headquarters, which resulted in no rent expense after June 2001, partially offset by increased interest expense from financing the building purchase.
Legacy Marketing's expenses increased $2.8 million (6%) primarily attributable to increases in selling, general and administrative expenses, depreciation and amortization. The increase in selling, general and administrative expenses of $1.6 million (4%) is primarily due to increases in compensation, partially offset by decreases in professional fees, sales promotion and support expenses, and occupancy expenses. Compensation increased primarily due to the effect of salary increases effective December 2000, and the addition of employees at higher salary levels. Professional fees decreased primarily due to lower consulting fees related to internal use software maintenance. Sales promotion and support expenses decreased primarily due to our discontinuing a broad-based stock option sales related program in 2001. The decreased occupancy expense was primarily a result of our purchasing the building that houses our headquarters, which resulted in no rent expense after June 2001. Depreciation and amortization expense increased $670,000 (20%) primarily related to a higher internal use software balance. During 2001, Legacy Marketing determined that certain investment securities had other-than-temporary declines in fair value below cost. As a result, Legacy Marketing recorded impairment losses of $642,000, and the individual securities were written down to a new cost basis.
Legacy Financial incurred net losses of $595,000 during 2002, compared to net losses of $837,000 during 2001. The improved results are primarily due to increased revenues.
Legacy Financial's major source of revenue is commission income, which is generated through sales of variable life and annuity products, mutual funds, and debt and equity securities. Levels of commission income are directly related to the volume of sales of such products. Legacy Financial revenue increased $387,000 (18%) primarily due to increases in the volume of sales resulting from a more attractive product mix for Legacy Financial's distribution network of registered representatives.
During 2002, combined net income from other entities was $61,000, compared to combined net losses of $371,000 in 2001. This favorable change of $432,000 is primarily due to closing the operations of our LifeSurance Corporation subsidiary in late 2001.
We lease office and warehouse premises and certain office equipment under non-cancelable operating leases. As of December 31, 2002, our total contractual cash obligations, including the building financing discussed above, were as follows:
We generated $410,000 and $10.9 million of cash flow from operations in 2002 and 2001. However, 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 November 2002, we announced a strategic plan to consolidate the life and annuity product portfolio marketing business of Legacy Marketing. We believe this product consolidation will allow Legacy Marketing to focus its resources more efficiently.
In addition, Legacy Marketing discontinued the marketing of several annuity products issued by Transamerica during the first quarter of 2003. Legacy Marketing will continue to administer these annuity products and to accept additional premium payments, subject to applicable additional deposit rules for these products. The discontinued products accounted for approximately 31%, 59%, and 45% of our total consolidated revenue for the years ended December 31, 2002, 2001, and 2000.
R. Preston Pitts, President, Chief Operating Officer and Secretary, our business, operating results, and financial condition could be diminished because we rely on their contacts, insurance carrier and Producer relationships, and strategic direction to drive our revenues. However, we are not aware of any key personnel who are planning to retire or leave our company in the near future. Although we maintain and are the beneficiary of key person life insurance policies on the lives of Lynda L. Regan and R. Preston Pitts, we do not believe the proceeds would be adequate to compensate us for their loss.
o The failure of Legacy Marketing to comply with federal, state and other regulatory requirements applicable to the sale or administration of insurance products.
o Competition from other financial services companies in the sale and administration of insurance products.
We may be unable to effectively fund our working capital requirements, which could harm our operating results and earnings.
As of December 31, 2002, we are obligated to redeem 3,822,000 shares of Series A Common Stock at the option of the holders of these shares. Of the 560,000 shares of Series B Common Stock outstanding, we are obligated to redeem up to 10% of these shares at the option of the holders of these shares, limited to a specified twenty-day period each year. The price per share is based on the estimated fair market value of the stock on the redemption date. The redemption of all eligible shares during 2003 would require $8.5 million, which would materially decrease our cash position.
Under the Internal Revenue Code of 1986, as amended, income tax payable by policyholders on investment earnings is deferred during the accumulation period of most of the annuity products that we market. This favorable income tax treatment results in our policyholders paying no income tax on their earnings in the annuity products until they take a cash distribution. We believe that the tax deferral features contained within the annuity products that we market give our products a competitive advantage over other non-insurance investment products where income taxes may be due on current earnings. The President of the United States is currently advocating the
establishment of tax-deferred savings plans which would offer taxpayers the ability to contribute amounts substantially greater than IRA plans allow. If these plans are enacted, or if the tax code is revised to reduce the tax-deferred status of annuity products or to increase the tax-deferred status of competing products, our business could be adversely impacted because our competitive advantage could be weakened. In addition, some products that we sell receive favorable estate tax treatment under the tax code. If the tax code is revised to change existing estate tax laws, our business could be adversely affected. We cannot predict other future tax initiatives that the President or Congress may propose that may affect us.
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, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 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.
Regan Holding Corp. (the "Company") is a holding company, incorporated in California in 1990, whose primary operating subsidiaries are Legacy Marketing Group ("Legacy Marketing") and Legacy Financial Services, Inc. ("Legacy Financial").
Legacy Marketing has marketing agreements with Transamerica Life Insurance and Annuity Company ("Transamerica"), American National Insurance Company ("American National"), John Hancock Variable Life Insurance Company ("John Hancock"), and Investors Insurance Corporation (the "carriers"). During 2002, Legacy Marketing terminated its marketing agreement with IL Annuity and Insurance Company ("IL Annuity"). The marketing agreements grant Legacy Marketing the exclusive right to market certain fixed annuity products issued by the carriers (the "policies"). In addition, Legacy Marketing is responsible for appointing independent insurance producers who contract with Legacy Marketing to sell policies. The highest producers are referred to as wholesalers. For providing these services, the carriers pay Legacy Marketing commissions and marketing allowances.
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. 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.
Goodwill and Other Intangible assets were acquired in the Company's purchase of Values Financial Network, Inc. in 2000 and prospectdigital, LLC in 2002. Prior to January 1, 2002, goodwill was amortized on a straight-line basis over 10 years, which is its estimated useful life. Pursuant to Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," the Company ceased amortizing goodwill beginning January 1, 2002 (see Note 4). As required by SFAS 142, the Company performed a transitional and annual goodwill impairment test during 2002, and determined that goodwill was not impaired. Intangible assets are amortized on a straight-line basis over their estimated useful lives of 5 years.
At December 31, 2002, the Company has a stock-based employee compensation plan (see Note 12) and accounts for this plan under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. No stock-based employee compensation cost is reflected in net loss, as all options granted under the plan had an exercise price equal to the fair market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation:
The fair value of the employee option grants for pro forma disclosure purposes was estimated using the minimum value method, with the following assumptions:
l. Accounting Pronouncement to be Adopted Subsequent to December 31, 2002
In June 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146 nullifies Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3"), "Liability Recognition for Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)." SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost was recognized at the date of an entity's commitment to an exit plan. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The Company's management anticipates that the implementation of SFAS 146 will not have a material effect on its consolidated results of operations or financial position.
The following table provides comparative net loss and loss per share had the non-amortization provision of SFAS 142 been adopted for all periods presented:
The aggregate amortization expense for the year ended December 31, 2002 was $91,000. The estimated amortization expense for each of the next three years ended December 31, 2005 is $95,000, and the estimated amortization expense for the years ended December 31, 2006 and 2007 are $45,000 and $2,000.
In 2000, the Company purchased a 33.3% ownership interest in a development stage company named prospectdigital, LLC ("prospectdigital") 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 has used its capital to develop software to support its business. 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, which bears interest at 8.0%. As of December 31, 2001, prospectdigital had drawn $358,000 from the line of credit.
The Company did not have control over prospectdigital, therefore, the investment in prospectdigital was accounted for under the equity method. In applying the equity method, the Company recorded its proportionate share of the operations (losses) of prospectdigital using a hypothetical liquidation at book value at each balance sheet date, net of the Company's estimate of any other-than-temporary impairment. The Company's recorded loss on its investment, loans payable and advances to prospectdigital was $896,000 and $721,000 during 2001 and 2000, and is included in other expenses. The amounts invested and advanced, net of the Company's share of cumulative losses, have been included in other assets at December 31, 2001.
In January 2002, the Company purchased all of the remaining outstanding stock of prospectdigital for $225,000 in cash, a non-recourse note payable in the amount of $75,000 and payable out of the future profits of prospectdigital, and $100,000 of contingent consideration based on future income. Under the terms of the purchase agreement, prospectdigital remained liable for payment of the $1.5 million indebtedness, plus accrued interest, due to the Company.
December 31, ----------------------------- 2002 2001 ------------ ----------- Accrued compensation $ 2,346,000 $ 2,871,000 Accrued sales convention costs 1,664,000 1,039,000 Commissions payable 1,110,000 1,366,000 Payable to insurance carrier 1,097,000 581,000 Accounts payable 728,000 845,000 Accrued production premium deficiency 637,000 485,000 Miscellaneous accrued expenses 1,230,000 1,115,000 ------------ ----------- Total $ 8,812,000 $ 8,302,000 ============ ===========
semi-annual 1.00% increase/decrease in the interest rate. The maximum interest rate is 10.50%. As of December 31, 2002, the Company made payments of $42,000 toward the principal balance of the note. The required principal payments over the next five years are as follows: $109,000, $116,000, $125,000, $135,000, and $144,000.
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 15% of their annual compensation as contributions to the 401(k) plan, subject to a maximum of $11,000. The Company matches 50% of each employee's contributions, up to 6% of their annual compensation, subject to a maximum of $5,500. The Company's matching contributions were $434,000, $439,000, and $409,000 for the years ended December 31, 2002, 2001, and 2000.
The Company also sponsors a non-qualified tax 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 this 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. The Company made matching contributions of $59,000, $55,000, and $48,000 during the years ended December 31, 2002, 2001, and 2000. As of December 31, 2002 and 2001, employee contributions and Company matching contributions, net of accumulated investment losses, totaled $650,000 and $575,000.
The Company leases office and warehouse premises and certain office equipment under non-cancelable operating leases. Related rent expense of $585,000, $1.6 million, and $1.5 million is included in occupancy costs for the years ended December 31, 2002, 2001, and 2000. Total rentals for leases of equipment included in equipment expense were $1.1 million, $922,000, and $802,000 for the years ended December 31, 2002, 2001, and 2000.
discussions with legal counsel, that the ultimate disposition of these claims will not have a material adverse effect on our financial condition, cash flows or results of operations.
Between 1990 and 1992, the Company issued Series A and Series B redeemable common stock to certain shareholders. The Company is obligated to repurchase the redeemable common stock at the current fair market value. Because there is no active trading market for the Company's stock that would establish market value, the Company's Board of Directors approved a redemption value for Series A redeemable common stock of $2.20 per share and $2.19 per share, and a redemption value for Series B redeemable common stock of $1.82 and $2.19 per share, as of December 31, 2002 and 2001, based on an independent appraisal of the stock value obtained by management.
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. Total stock options granted to Producers for 2002, 2001, and 2000 were 10,000, 265,000, and 1.7 million. Total expenses recorded for Producer stock option grants were $4,000, $96,000, and $1.1 million
during 2002, 2001 and 2000. The Producer stock options granted for each of the three years ended December 31, 2002 vested immediately upon the grant date. The fair value of the Producer options were estimated using the Black-Scholes option-pricing model with the following assumptions:
2002 2001 2000 --------- ----------- ----------- Risk-free interest rates 4.78% 5.13%-6.80% 5.04%-6.52% Volatility 27% 27%-31% 28%-34% Dividend yield None None None Expected life 6 years 6-10 years 6-10 years
There were no shares of Series A common stock awarded to non-employees during 2002. 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, 2002.
The following table summarizes information about stock options outstanding at December 31, 2002 under both plans:
The benefit from income taxes differs from the benefit computed by applying the statutory federal income tax rate (34%) to income before taxes, as follows:
As of December 31, 2002, the Company has state net operating loss carryforwards of $8.6 million that are expected to be utilized in the future. $4.9 million of these state net operating losses begin to expire on December 31, 2012. The Company also has, for state income tax purposes, $304,000 in alternative minimum tax credits which can be used to reduce income taxes in subsequent years to the extent regular tax exceeds tentative minimum tax. The credits have no expiration date.
The diluted loss per share calculation for the years ended December 31, 2002, 2001 and 2000 excludes antidilutive stock options of 4.1 million, 3.3 million and 6.8 million.
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, Imagent Online, Values Financial Network, and Other. Intersegment transactions are generally accounted for at amounts comparable to transactions with unaffiliated customers, and are eliminated in consolidation. The Legacy Marketing business segment includes the results of selling and administering fixed annuity products and general corporate expenses not allocated to the Company's other segments. Previously, general corporate expenses were reported as a separate business segment. The segment disclosures for the years ended December 31, 2001 and 2000 have been restated to reflect the change in the composition of reportable segments.
2002 2001 2000 ---- ---- ---- SelectMark(SM) series (sold on behalf of Transamerica) 51% 67% 49% BenchMark(SM) series (sold on behalf of American National) 16% 4% 6% VisionMark(SM) series (sold on behalf of IL Annuity) 11% 19% 28% AssureMark(SM) series (sold on behalf of John Hancock) 8% - -
During the first quarter of 2003, Legacy Marketing discontinued marketing life insurance products issued by American National. Certain Legacy Marketing employees who were supporting the life insurance product operations were either terminated or reassigned to other positions in Legacy Marketing. In addition, Legacy Marketing discontinued marketing certain fixed annuity products issued by Transamerica.