In June 2001, we purchased the building that houses our headquarters and most of Legacy Marketing's operations in Petaluma, California.
(1) When a policyholder remits a premium payment with an accurate and completed application for an insurance policy, the policy is considered inforce. Inforce premium and policies are statistics of our carriers but are factors that directly affect our revenue.
Regan Holding Corp. is a holding company, whose primary operating subsidiaries are 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, and the District of Columbia. Legacy Marketing has marketing agreements with Transamerica, American National, John Hancock, and Investors Insurance Corporation. 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 independent insurance producers who have contracted with Legacy Marketing to sell these products. For these services, the insurance carriers pay Legacy Marketing commissions and marketing allowances.
Legacy Marketing has marketing and administrative agreements with certain insurance carriers, listed above. 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 to the general public.
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 fairly stated. If our review determines that future cash flows related to the software are insufficient, or if new technology indicates that the value of replacement software is less than our carrying value, we record an impairment loss.
During 2002, we began an evaluation of an internal use software project that we initially licensed in 1998. We began this project intending to replace our administration system after the vendor required us to migrate from the existing system to an alternative platform. In late 2002, we learned from our vendor that we might be able to retain our existing system. A financial analysis completed in February 2003 indicated that staying on the existing system may provide greater benefit than converting to a new system even after considering the investment to date. Our evaluation of the new software project, while still ongoing, is nearing conclusion. Our final decision is dependent upon successful conclusion of negotiations with our software vendor, allowing us to continue to use our existing system for an extended period. If we are successful in favorably concluding our negotiations, we will probably abandon most of the work associated with the replacement system. To date, we have $4.4 million capitalized relating to this software. We estimate that approximately $1.2 million of this asset has continuing value and can be used to upgrade our existing system. If our final decision is to abandon the new software, we expect to write-off the remaining $3.2 million in the period we make our decision.
Investments classified as available-for-sale are periodically reviewed to determine if declines in fair value below cost are other-than-temporary. Significant and sustained decreases in quoted market prices, a series of historical and projected operating losses by the investee or other factors are considered as part of the review. If the decline in fair value has been determined to be other-than-temporary, an impairment loss is recorded in investment income and the individual security is written down to a new cost basis. During 2001, we determined that certain investment securities had other-than-temporary declines in fair value below cost. As a result, in 2001 we recorded impairment losses of $642,000, and the individual securities were written down to a new cost basis.
Legacy Marketing's revenue decreased $5.6 million (10%) primarily due to decreased marketing allowances and commission income. Marketing allowances and commission revenue, combined, decreased $5.9 million (14%) due to a decrease in sales of fixed annuity and life policies. The sales decrease is primarily due to a shift in the marketplace toward more traditional fixed income-based annuities. Administrative fees increased $307,000 (3%) primarily due to an increase in the number of policies administered year over year, partially offset by a lower number of policies issued in 2002.
In addition, during the first quarter of 2003, Legacy Marketing discontinued the marketing of several annuity products issued by Transamerica. 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. However, our sales of recently introduced Transamerica products have been strong. Furthermore, sales on behalf of our other carriers have increased during the two months ended February 28, 2003, and total sales of annuity products have increased by 26% during this period compared to the same period in 2002. Legacy Marketing is also developing new products that we expect to result in increased sales in 2003.
As of December 31, 2002, Legacy Marketing sold products on behalf of four unaffiliated insurance carriers: Transamerica, American National, John Hancock and Investors Insurance Corporation. During the first quarter of 2002, Legacy Marketing ceased selling products on behalf of IL Annuity, as both parties mutually agreed to terminate their marketing agreement. Legacy Marketing currently intends to continue to administer IL Annuity products. The agreements with the following carriers generated a significant portion of the Company's total consolidated revenue (sales on behalf of Investors Insurance Corporation began in the second quarter of 2002):
Although Legacy Marketing sells and administers several products on behalf of the insurance carriers, our consolidated revenues are derived primarily from sales and administration of the following annuity product series:
2002 2001 ---- ---- SelectMark(SM) series (sold on behalf of Transamerica) 51% 67% BenchMark(SM) series (sold on behalf of American National) 16% 4% VisionMark(SM) series (sold on behalf of IL Annuity) 11% 19% AssureMark(SM) series (sold on behalf of John Hancock) 8% -
Legacy Marketing recognized investment income of $638,000 in 2002 compared to investment losses of $239,000 in 2001. This shift was primarily because 2001 included impairment losses of $642,000 related to other-than-temporary declines in the value of certain investment securities.
During 2001, Legacy Marketing's net income totaled $2.8 million, compared to losses of $1.6 million during 2000, primarily due to increased revenues partially offset by increased expenses and the recognition of non-operating losses in 2001 compared to non-operating income in 2000.
Legacy Marketing's revenue increased $14 million (36%) primarily due to increased marketing allowances, commission income, and administrative fees. Marketing allowances and commission revenue, combined, increased $12.3 million (43%) due to an increase in sales of fixed annuity and life policies. The sales increase was primarily due to: i) favorable market conditions for fixed return investment products, ii) the implementation of marketing programs designed to strengthen relationships with existing producers and attract new producers, and, iii) the introduction of new products and enhancements of existing products. Administrative fees increased $2.2 million (23%) primarily due to increases in the number of policies issued and administered.
Legacy Financial revenue decreased $829,000 (28%) primarily due to decreases in the volume of sales resulting from adverse market conditions for variable investment products.
Legacy Financial's expenses increased $266,000 (8%) primarily due to increases in selling, general and administrative expenses. Selling, general and administrative expenses increased $316,000 (11%) primarily attributable to compensation due to a higher number of employees, and increases in rent and legal fees, partially offset by decreased sales promotion and support expenses. Increased rent expense resulted from our sale in December 2000 of the building that houses Legacy Financial's operations and the subsequent office lease payments made by Legacy Financial to the new building owner. Legal fees increased primarily due to higher legal fees associated with litigation in the normal course of business. Sales promotion and support expenses decreased primarily due to costs incurred in 2000 to purchase sales leads and the discontinuance of a broad-based stock option sales incentive program in 2001.
We purchased Values Financial Network, Inc. in December 2000. During 2001, Values Financial Network incurred net losses of $1.2 million, compared to net losses of $86,000 during 2000, primarily due to expenses incurred during the entity's start-up phase.
Imagent Online had net losses of $648,000 during 2002, compared to net losses of $660,000 during 2001. This favorable change of $12,000 is primarily due to increased revenues at prospectdigital in 2002. As discussed above, prospectdigital's results of operations are included in the Consolidated Financial Statements since our acquisition of it in January 2002. Prior to the acquisition, we accounted for our investment in prospectdigital under the equity method of accounting. Accordingly, our share of prospectdigital's losses during 2001 and 2000 were included in other expenses. Imagent Online had no revenue in 2001 and 2000, and its expenses primarily consisted of its share of prospectdigital's losses.
During 2001, combined net losses from other entities were $371,000, compared to combined net losses of $1.1 million in 2000. The reduced net losses are primarily due to the dissolution of our subsidiary LifeSurance Corporation, resulting from a plan announced during the first quarter of 2001. All employees were either terminated or transferred to Legacy Marketing. LifeSurance Corporation was dissolved in December 2001.
Net cash provided by operating activities, which includes a series of transactions where we purchased investment securities, was $410,000 for the year ended December 31, 2002. During 2002, we sold equity securities that were classified as available-for-sale. The proceeds from these sales are reflected as cash provided from investing activities. Subsequently, we purchased equity securities that we classified as trading securities. These purchases are reflected as cash used in operating activities. Operating cash flows were also affected by improved operating results.
In 1998, we entered into an agreement with Lynda L. Regan, Chief Executive Officer and Chairman of the Board of Directors. Under the terms of this agreement, in the event of the death of Ms. Regan, we are obligated to repurchase from Ms. Regan's estate all of the shares of our common stock that were owned by Ms. Regan at the time of her death or that were transferred by her to one or more trusts prior to her death. The purchase price to be paid by us shall be equal to 125% of the fair market value of the shares. The purchase price was equal to $28 million at December 31, 2002. We have purchased two life insurance policies with a combined face amount of $29 million for the purpose of funding this obligation in the event of Ms. Regan's death.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees and Indebtedness of Others". This interpretation requires the initial recognition and initial measurement, on a prospective basis only, to guarantees issued or modified after December 31, 2002. The Company anticipates that the implementation of this interpretation will not have a material effect on its 2003 consolidated results of operations or financial position.
We have experienced losses in recent years and if losses continue, our business could suffer.
We had a $60,000 net loss for the year ended December 31, 2002, and net losses of $348,000 and $3.6 million for the years ended December 31, 2001 and 2000. We intend to continue to invest in marketing, operations, technology, and product development. As a result, we will need to generate increases in revenue and reduce our operating costs to achieve profitability. If we fail to improve our operating results, our financial condition and prospects could be weakened.
Legacy Marketing has marketing agreements with Transamerica Life Insurance and Annuity Company, American National Insurance Company, John Hancock Variable Life Insurance Company, and Investors Insurance Corporation. Legacy Marketing has also entered into administrative agreements with each of the four insurance carriers, and IL Annuity and Insurance Company, whose marketing agreement terminated during the first quarter of 2002. During 2002, 52%, 17%, 12%, and 8% of our total consolidated revenue resulted from agreements with Transamerica, American National, IL Annuity, and John Hancock.
In June 2002, Legacy Marketing entered into marketing and administrative services agreements with Investors Insurance Corporation, an unaffiliated insurance carrier. Under these agreements, Legacy Marketing will sell and administer annuity products on behalf of Investors Insurance Corporation. Legacy Marketing has an option to buy Investors Insurance Corporation within the next five years. Sales on behalf of Investors Insurance Corporation began in June 2002.
Legacy Marketing discontinued marketing life insurance products issued by American National effective during the first quarter of 2003. These products accounted for a nominal amount of revenue during each of the years ending December 31, 2002, 2001, and 2000. Legacy Marketing will continue to administer American National life insurance products, including acceptance of renewal premium. Certain Legacy Marketing employees who were supporting the life insurance product operations were either terminated or reassigned to other positions in Legacy Marketing.
The marketing agreement with American National expires November 15, 2007, and the administrative agreement with American National expires on February 15, 2008. Both agreements may be renewed by mutual agreement for successive one-year terms. The agreements may be terminated by either party upon twelve months prior written notice without cause, and may be terminated by either party immediately for cause. The marketing and administrative agreements with Transamerica and John Hancock do not have fixed terms but may be terminated by either party upon twelve months prior written notice without cause, and may be terminated by either party immediately for cause.
Our success also depends on our continued ability to attract, retain, and motivate highly skilled employees. In the recent past, we have been successful attracting and retaining highly skilled personnel. Competition for employees in our industry is intense, particularly for personnel with training and experience. We may be unable to retain our highly skilled employees or to attract, assimilate, or retain other highly qualified employees in the future.
o The degree of market acceptance of the products marketed on behalf of our insurance carriers.
We may not be able to compete successfully with competitors that may have greater resources than we do.
The annuity business is rapidly evolving and intensely competitive. Legacy Marketing's primary market is fixed annuities sold through independent producers. In addition, Legacy Marketing administers the products sold by Producers on behalf of the issuing insurance carriers. Fixed annuity sales in the United States were approximately $94 billion in 2002. Some of Legacy Marketing's top competitors selling fixed annuities through independent sales channels are Allianz Life of North America, Midland National Life Insurance Company, American Equity Investment Life, the North American Company for Life and Health Insurance, the AmerUs Group, and Jackson National Life Insurance Company. These competitors may have greater financial resources than we do. However, our business model allows us greater flexibility, as we can adjust the mix of business sold if one or more of our carriers were to experience capital constraints or other events that affect their business models. Our competitors may respond more quickly than us to new or emerging products and changes in customer requirements. We are not aware of any significant new means of competition, products or services that our competitors provide or will soon provide. However, in the highly competitive fixed annuity marketplace, new distribution models, product innovations and technological advances may occur at any time and could present us with competitive challenges. There can be no assurance that we will be able to compete successfully. In addition, our business model relies on Producers to effectively market our products competitively. Maintaining relationships with these Producers requires introducing new products to the market in an efficient and timely manner, offering competitive commission schedules, and providing superior marketing, training, and support. In the recent past, we have been reasonably successful in attracting and retaining Producers. We are not aware of any top Producers who are planning to discontinue marketing our products. Due to competition among insurance companies and insurance marketing organizations for successful producers, there can be no assurance that we will be able to retain some or all of our top Producers.
State insurance regulators and the National Association of Insurance Commissioners continually reexamine existing laws and regulations, and may impose changes in the future that materially adversely affect our business, results of operations and financial condition. In particular, rate rollback legislation and legislation to control premiums, policy terminations and other policy terms may affect the marketability of policies or the amount of premiums that can be charged for such policies, and thus the commissions we can earn. Also, recently a committee of Congress has been considering, in general, the advisability of enacting federal statutes providing for the regulation of insurance. Although there is not yet a specific proposal, additional regulation at the federal level could affect our business, results of operations and financial condition.
Legacy Financial is registered as a broker-dealer with, and is subject to regulation by, the SEC, NASD, and Municipal Securities Rulemaking Board. 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 us or our subsidiaries could harm our 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 insurance industry generally and our business in particular.
Adverse changes in tax laws could diminish the marketability of most of our products, resulting in decreased revenue.
We operate in an industry in which there is significant risk of litigation. Substantial claims against us could diminish our financial condition or results of operations.
As a professional services firm primarily engaged in marketing and administration of annuity products, we encounter litigation in the normal course of business. Although it is difficult to predict the ultimate outcome of these cases, management believes, based on 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. In addition, companies in the life insurance industry have been subject to substantial claims involving sales practices, agent misconduct, failure to properly supervise agents, and other matters in connection with sales of life insurance, annuities, and other investment products. Increasingly, these lawsuits have resulted in the award of substantial judgments, including material amounts of punitive damages that are disproportionate to the actual damages. In some states juries have substantial discretion in awarding punitive damages that creates the potential for material adverse judgments in litigation. If any similar lawsuit or other litigation is brought against us, such proceedings may materially harm our business, financial condition, or results of operations.
As discussed in Note 1, the Company changed its method of recognizing revenue for contracts with sales obligation provisions in accordance with Staff Accounting Bulletin 101, Revenue Recognition in Financial Statements, during the year ended December 31, 2000, and changed its method of accounting for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, during the year ended December 31, 2002.
Effective January 1, 2000, the Company changed its revenue recognition policy in order to comply with SEC Staff Accounting Bulletin No. 101 with respect to a production premium deficiency requirement under one of its marketing agreements. This change is reflected in the statement of operations as a cumulative effect of accounting change of $226,000, net of taxes of $149,000, during the year ended December 31, 2000.
Cash and cash equivalents include marketable securities with an original maturity of ninety days or less.
Fixed assets are stated at cost, less accumulated depreciation and amortization. The Company capitalizes consulting fees, and salaries and benefits for employees who are directly associated with the development of software for internal use when both of the following occur:
o The preliminary project stage is completed and therefore the project is in the application development stage; and
o Management authorizes and commits to funding a software project and it is probable that the project will be completed and the software will be used to perform the function desired.
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.
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. We periodically review capitalized internal use software to determine if the carrying value is fairly stated. If our review determines that future cash flows directly related to the software or the business unit of which it is a part, as applicable, are insufficient, or if new technology indicates that the value of replacement software is less than our carrying value, we record an impairment loss. If software in development is abandoned, the Company takes a charge to write off the capitalized amount in the period the decision is made to abandon it.
2002 2001 2000 ------------ ------------ -------- Risk-free interest rates 4.08%-4.52% 4.50%-4.88% 5.92%-6.67% Expected life 4 years 3-5 years 3-5 years Dividend yield None None None
December 31, ------------------------- 2002 2001 ------------ ----------- Computer hardware and purchased software $ 7,796,000 $ 7,340,000 Internal use software development costs 16,345,000 10,996,000 Leasehold improvements 1,324,000 1,260,000 Furniture and equipment 3,169,000 3,174,000 Building 7,798,000 7,780,000 Land 2,703,000 2,689,000 ------------ ----------- 39,135,000 33,239,000 Accumulated depreciation and amortization (13,294,000) (9,192,000) ------------ ----------- Total $ 25,841,000 $24,047,000 ============ ===========
On January 1, 2002, the Company adopted SFAS 142, which eliminates the requirement to amortize goodwill and indefinite-lived intangible assets, addresses the amortization of intangible assets with a defined life and addresses the impairment testing and recognition for goodwill and intangible assets. As of December 31, 2002, the balance of intangible assets included $1.2 million of goodwill related to the Company's purchase of Values Financial Network, Inc. in December 2000 that was being amortized over ten years prior to January 1, 2002. As required by SFAS 142, the Company is no longer amortizing goodwill. The Company completed a transitional and annual goodwill impairment test during the six months ended June 30, 2002 and year ended December 31, 2002 and determined that goodwill was not impaired.
There was no amortization of goodwill for the year ended December 31, 2000, and the carrying amount of goodwill of $1.2 million did not change from December 31, 2001 to December 31, 2002.
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 1% to 5% of amounts deferred, depending on the level of annual commissions earned. During the years ended December 31, 2002, 2001, and 2000, matching contributions related to the producer commission deferral plan were $19,000, $36,000, and $32,000. As of December 31, 2002 and 2001, producer contributions and Company matching contributions, net of accumulated investment losses, totaled $3.6 million and $3.8 million.
The Company's future minimum annual lease commitments under all operating leases as of December 31, 2002 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, 2002, there were no outstanding commitments by the Company relating to such obligations.
The Company recorded redeemable common stock accretion of $26,000 and $397,000 and related to Series A redeemable common stock for the years ended December 31, 2002 and 2001. The carrying value of Series B redeemable common stock is greater than the redemption value, and has not been accreted.
The Company currently sponsors two stock-based compensation plans. Under both plans, the exercise price of each option equals the estimated fair value of the underlying common stock on the date of grant, as estimated by management, except for incentive stock options granted to shareholders who own 10% or more of the Company's outstanding stock, where the exercise price equals 110% of the estimated fair value. Both plans are administered by committees, which are appointed by the Company's Board of Directors.
The following table summarizes information with respect to shares of Series A common stock awarded to non-employees:
2001 2000 ----------- -------- Share grants 48,000 66,000 Fair value per share $1.53-$1.65 $ 1.53 Expense recorded $ 75,000 $100,000
Total Weighted average Shares Exercise Price ------ -------------- Outstanding at December 31, 1999 8,810,000 $1.13 Granted 5,118,000 $1.52 Exercised (27,000) $0.95 Forfeited (525,000) $1.08
Outstanding at December 31, 2000 13,376,000 $1.28 Granted 2,976,000 $1.62 Exercised -- $ -- Forfeited (788,000) $1.25
Outstanding at December 31, 2001 15,564,000 $1.35 Granted 1,153,000 $1.68 Exercised -- $ -- Forfeited (768,000) $1.22
Exercisable at December 31, 2000 8,984,000 $1.25 Exercisable at December 31, 2001 11,512,000 $1.31 Exercisable at December 31, 2002 12,407,000 $1.32
The benefit from federal and state income taxes consists of amounts currently (receivable) payable and amounts deferred which, for the periods indicated, are shown below:
December 31, ------------------------ 2002 2001 ----------- ----------- Producer stock option and stock awards $ 2,182,000 $ 2,180,000 Producer deferred compensation 1,696,000 1,735,000 Accrued sales convention costs 663,000 414,000 State net operating loss carryforward, less valuation allowance of $362,000 and $264,000, net of federal taxes 248,000 321,000 Alternative minimum tax credit carryforward 304,000 304,000 Investment impairment charge -- 256,000 Capital loss 353,000 70,000 Unrealized losses 427,000 -- Other 817,000 335,000 ----------- ----------- Subtotal deferred tax assets 6,690,000 5,615,000
Fixed asset depreciation (3,611,000) (2,658,000) Deferred gain on building sale (1,364,000) (1,364,000) Unrealized gains -- (37,000) Other -- (27,000) ----------- ----------- Subtotal deferred tax liabilities (4,975,000) (4,086,000) ----------- ----------- Deferred tax assets, net $ 1,715,000 $ 1,529,000 =========== ===========
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of deferred tax assets will, or will not, be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. Management believes it is more likely than not that the deferred tax assets will be realized.
As of December 31, 2002, Legacy Marketing sold its products on behalf of four unaffiliated insurance carriers: American National, Transamerica, John Hancock and Investors Insurance Corporation. Effective during the first quarter of 2002, Legacy Marketing and IL Annuity terminated their marketing agreement. The agreements with the following carriers generated a significant portion of the Company's total consolidated revenue (sales on behalf of Investors Insurance Corporation began in the second quarter of 2002):
2002 2001 2000 ---- ---- ---- Transamerica 52% 68% 50% American National 17% 5% 10% IL Annuity 12% 20% 29% John Hancock 8% - -
Although Legacy Marketing sells and administers several annuity and life insurance products on behalf of the insurance carriers, its revenues are derived primarily from sales and administration of certain annuity product series:
Our audits of the consolidated financial statements referred to in our report dated March 27, 2003 also included an audit of the financial statement schedules listed in Item 15(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.