- ---------------------- (1) When a policyholder remits a premium payment with an accurate and completed application for an insurance policy, the policy is placed inforce. Inforce premium and policies are statistics of our carriers but are factors that directly affect our revenue.
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, 2005, Legacy Marketing had marketing agreements with American National, Investors Insurance, Transamerica, Americom 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.
Legacy Marketing also has administrative agreements with each of the insurance carriers listed above, and with IL Annuity. 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 administrative fees.
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 the fourth quarter of 2003 we recorded a write-off of $1.1 million associated with the abandoned components of the software costs.
In 2004, we began the process of creating a new technology architecture, the intent of which was to implement a multi-tiered structure that would allow us to continue to use the existing administration system to administer our current business while using the new administration system for new products and carriers.
In 2005, we conducted further 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, we concluded that the advances in technology and functionality that these new designs have delivered, along with the associated financial benefits, are greater than we would realize by completing our plans to implement the 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 has been impaired, and in the second quarter of 2005, we recorded a write-off of $2.9 million associated with abandoned components of the internal use software project.
In early 2005, the California Department of Insurance had proposed regulations that would have statutorily imposed fiduciary duties and certain mandatory disclosure obligations on insurance agents and brokers. In November 2005, the Department announced that it would suspend efforts to adopt such regulation, due to self-regulatory initiatives taken by certain industry groups establishing voluntary compensation disclosure guidelines for agents and brokers similar to those required by the Model Act.
Also in 2005, the Securities and Exchange Commission informed certain issuers of equity-indexed annuities that it is examining whether such annuities need to be registered under the Securities Act of 1933. On August 8, 2005, the 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 on October 7, 2005 to California life insurance companies urging them to develop suitability standards for the sale of annuity products to seniors, and the California Department of Insurance has sponsored a legislative measure that would require the industry to establish such insurer suitability standards. The bill may be considered by the California legislature in 2006.
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.
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.
o The preliminary project stage is completed and the project is therefore in the application development stage; and
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, Values Financial Network and Imagent Online. Excluding the $2.9 million impairment charge for internal use software, our consolidated net loss was $10.8 million in 2005.
Legacy Marketing experienced a decrease in sales of fixed annuity products issued by Investors Insurance in 2005 compared to 2004. We believe the decrease was primarily attributable to a downgrade in the A.M. Best credit rating of Investors Insurance from an A- rating to a B++ rating in September 2003. As a
Legacy Marketing's product sales were also negatively affected by Transamerica and Legacy Marketing deciding to discontinue the marketing of Transamerica products that were marketed exclusively by Legacy Marketing, effective May 3, 2004. Revenue derived from sales and administration of Transamerica products decreased $8.5 million in 2004 compared to 2003 and accounted for approximately 24% and 25% of our total consolidated revenue for the years ended December 31, 2004 and 2003. Legacy Marketing continues to administer the discontinued products and to accept additional premium payments, subject to applicable additional deposit rules for these products.
Administrative fees decreased $3.6 million (26%) compared to 2003 primarily due to decreased issuing fees, appointment fees and operating expense reimbursements from insurance carriers contracted with Legacy Marketing resulting from decreased fixed annuity product sales.
Legacy Financial revenue decreased $115,000 (3%) in 2005 compared to 2004 primarily due to decreased commission income and advisory fees as a result of decreased sales volume and a decrease in other income.
Legacy Financial operating expenses decreased $329,000 (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.
Legacy Financial revenue increased $436,000 (13%) in 2004 compared to 2003 primarily due to increased commission income and advisory fee revenue as a result of increased sales volume.
Legacy Financial expenses decreased $115,000 (3%) in 2004 compared to 2003. The decrease was primarily due to a decrease in selling, general and administrative expenses of $136,000 (4%), which was mainly attributable to a decrease in compensation and benefits resulting from decreased headcount, reduction in temporary help and decreased employee incentive-based compensation, partially offset by an increase in professional fees due to higher legal and consulting costs.
In January 2006, we decided to discontinue the operations of VFN. We will incur insignificant costs in connection with exiting the operations.
In connection with the updated measurement of the fair value of VFN as discussed above, we also recorded a long-lived asset impairment loss of $394,000 during 2003, included in Other expenses.
Imagent Online had a net loss of $515,000 in 2004 compared to a net loss of $606,000 in 2003. The reduction in net loss was primarily due to decreased compensation expense resulting from reduced headcount.
Our cash provided by operating activities generally follows the trend in our revenue and operating results. Our cash used in operating activities was $5.6 million and $4.4 million in 2005 and 2004. Our cash provided by operating activities was $12.7 million in 2003. Our cash used in operating activities during 2005 was primarily the result of our net loss and an increase in deposits and other assets resulting from the prepayment of rent and a lease deposit in connection with the sale/leaseback of our Petaluma office buildings. These amounts were partially offset by non-cash charges, including depreciation and amortization and losses on write-off of fixed assets. In addition, our income tax receivable declined due to an income tax refund received in 2005.
Our cash provided by operating activities of $12.7 million in 2003 was primarily the result of our net income, significant non-cash charges, a decrease in prepaid expenses and deposits and an increase in accounts payable and accrued liabilities and deferred compensation payable. These amounts were partially offset by unrealized gains on trading securities and a decrease in accounts receivable.
We are obligated to repurchase certain shares of our common stock. Cash paid to repurchase some of these shares totaled $365,000 in 2005 and $966,000 in 2004. Based upon the estimated fair market values of the Series A Redeemable Common Stock as of December 31, 2005, the redemption of all eligible shares during 2006 would require $1.8 million.
In May 2005, the Financial Accounting Standards Board ("FASB") issued Statement No. 154, "Accounting Changes and Error Corrections, a replacement of Accounting Principles Board ("APB") Opinion No. 20 and FASB Statement No. 3 ("FAS 154"). FAS 154 provides guidance on the accounting for, and reporting of, a change in accounting principle, in the absence of explicit transition requirements specific to a newly adopted accounting principle. Previously, most voluntary changes in accounting principles were required to be recognized by way of a cumulative effect adjustment within net income during the period of the change. FAS 154 requires retrospective application to prior periods' financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. FAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. We do not believe that the adoption of FAS 154 will have a material effect on its consolidated financial position, results of operations or cash flows.
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R, "Share-Based Payment" ("SFAS 123R"), which establishes standards for transactions in which an entity exchanges its equity instruments for goods or services. This standard requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the date of grant. This
eliminates the exception to account for such awards using the intrinsic method previously allowable under APB Opinion No. 25. In April 2005, the Securities and Exchange Commission adopted a rule that delayed the compliance dates for adoption of SFAS 123R, which we had previously been required to adopt no later than July 1, 2005. The SEC's rule allows companies to implement SFAS 123R at the beginning of their next fiscal year. As a result, we adopted SFAS 123R effective January 1, 2006. We do not believe that adoption of SFAS 123R will have a material impact on our financial position, results of operations or statement of cash flows.
We have audited the accompanying consolidated balance sheet of Regan Holding Corp. and its subsidiaries (the "Company") as of December 31, 2005, and the consolidated statements of operations, shareholders' equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our audit also included the financial statement schedule for the year ended December 31, 2005 listed in the Index at Item 15(a)(2). Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audit.
As of December 31, 2005, Legacy Marketing had marketing agreements with American National Insurance Company ("American National"), Investors Insurance Corporation ("Investors Insurance"), Transamerica Life Insurance and Annuity Company ("Transamerica"), Americom Life & Annuity Insurance Company ("Americom") and John Hancock Variable Life Insurance Company ("John Hancock") (collectively, 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 and life insurance 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, with the applicable carrier. For providing these services, the carriers pay Legacy Marketing commissions and marketing allowances.
The carrying values of the Company's financial instruments, including cash equivalents, trading investments, accounts receivable, accounts payable, accrued liabilities and notes payable approximate their market values based on their
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.
voluntary changes in accounting principles were required to be recognized by way of a cumulative effect adjustment within net income during the period of the change. FAS 154 requires retrospective application to prior periods' financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. FAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The Company does not believe that the adoption of FAS 154 will have a material effect on its consolidated financial position, results of operations or cash flows.
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R, "Share-Based Payment" ("SFAS 123R"), which establishes standards for transactions in which an entity exchanges its equity instruments for goods or services. This standard requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the date of grant. This eliminates the exception to account for such awards using the intrinsic method previously allowable under APB Opinion No. 25. In April 2005, the Securities and Exchange Commission adopted a rule that delayed the compliance dates for adoption of SFAS 123R, which the Company had previously been required to adopt no later than July 1, 2005. The SEC's rule allows companies to implement SFAS 123R at the beginning of their next fiscal year. As a result, the Company adopted SFAS 123R effective January 1, 2006. The Company does not believe that the adoption of SFAS 123R will have a material effect on its financial position, results of operations or statement of cash flows.
The Company had no available for sale investments at December 31, 2005 and 2004. The Company's recorded realized gains (losses) from available-for-sale investments as follows:
2005 2004 2003 ---- ---- ---- Gross realized gains $ -- $ 162,000 $ 6,000 Gross realized losses $ -- $ (33,000) $ (18,000)
In 2004, the Company began the process of creating a new technology architecture, the intent of which was to implement a multi-tiered structure that would allow the Company to continue to use the existing administration system to administer the Company's current business while using the new administration system for new products and carriers.
In 2005, the Company conducted further 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 the 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 has 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.
Accumulated Cost Depreciation ----------- -------- Buildings $ 7,776,000 $(843,000) Land and land improvements 2,754,000 -- Leasehold improvements 86,000 (31,000) ----------- -------- $10,616,000 $(874,000) =========== ========
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 has repaid the option fees paid by the Company pursuant to the Option Agreement, including interest, totaling approximately $3.3 million.
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 $14,000. The Company typically matches 50% of each employee's contributions up to 6% of their annual compensation, subject to a maximum of $7,000. The Company's matching contributions were $115,000, $311,000, and $405,000 for the years ended December 31, 2005, 2004, and 2003.
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 typically 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 $0, $23,000, and $32,000 during the years ended December 31, 2005, 2004, and 2003. As of December 31, 2005 and 2004, employee contributions and Company matching contributions, including cumulative investment gains, totaled $548,000 and $788,000.
During 2003, Legacy Marketing initiated a sales incentive program for its Wholesalers. This program offered bonuses to Wholesalers based primarily on their achievement of predetermined annual sales targets. Bonuses were paid to qualifying Wholesalers during the first quarter of 2004. The Company recorded expense of $2.0 million during the year ended December 31, 2003 related to the sales incentive program. These amounts 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, 2005 are as follows:
Year Ended December 31, 2006 $ 999,000 2007 1,503,000 2008 1,017,000 2009 986,000 2010 918,000 Thereafter 4,658,000 ----------- Total minimum lease payments $l0,081,000 ===========
During 2003, the Company amended its Shareholder Agreement with Lynda L. Regan, Chief Executive Officer of the Company and Chairman of the Company's Board of Directors. Under the terms of the amended agreement, 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, 2005, the Company believes that 125% of the fair market value of the shares owned by Ms. Regan was equal to $8.8 million. The Company has purchased life insurance coverage for the purpose of funding this potential obligation upon Ms. Regan's death.
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 Producers in each of the years ended December 31, 2005, 2004 and 2003. Total expenses recorded for Producer stock option grants were $8,000, $12,000 and $10,000 during 2005, 2004 and 2003. The Producer stock options granted for each of the three years ended December 31, 2005 vested immediately upon the grant date and expire six years from the date of grant. The fair value of the Producer options were estimated using the Black-Scholes option-pricing model with the following assumptions:
There were no shares of Series A common stock awarded to non-employees during 2005, 2004 and 2003.
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. The Company uses the intrinsic value method of accounting for stock-based awards granted to employees and, accordingly, does not recognize compensation expense for its stock-based awards to employees.
The following table summarizes information about stock options outstanding at December 31, 2005 under both plans:
The provision for (benefit from) federal and state income taxes consist of amounts currently (receivable) payable and amounts deferred, which for the periods indicated, are shown below:
Deferred income taxes: Federal (738,000) 2,172,000 (696,000) State 268,000 862,000 (168,000) ----------- ----------- ----------- Total deferred (470,000) 3,034,000 (864,000) ----------- ----------- ----------- Income tax (benefit) expense $ (269,000) $ (343,000) $ 3,391,000 =========== =========== ===========
The income tax provision (benefit) in 2005, 2004 and 2003 differed from the amounts computed by applying the statutory federal income tax rate of 34% to pretax income (loss) as a result of the following:
2005 2004 2003 ---- ---- ---- BenchMark(SM) series (American National) 22% 24% 37% SelectMark(R) series (Transamerica) 18% 24% 25% MarkOne(SM) series (Investors Insurance) 13% 23% 23%