The Company also currently leases approximately 30,500 square feet of office space in Rome, Georgia. This lease expires in December, 2002, unless the Company exercises its option to extend the lease for a period of three years.
Management believes that existing and planned office space is and will continue to be adequate for the Company's operations for the foreseeable future.
Income--The Company's major sources of income are marketing allowances, commission income and administrative fees from sales and administration of annuity and life insurance products on behalf of the Carriers. Levels of marketing allowances and commission income are directly related to the sales volume of such products. Administrative fees are a function not only of product sales, but also of administration of policies inforce and producer appointments. Total income increased approximately $24.6 million, or 108.8%, in 1998 compared to 1997, and increased approximately $4.3 million, or 23.8%, in 1997 compared to 1996. These increases are attributable primarily to increases in premium placed inforce for the Carriers, as discussed below.
Administrative fees increased approximately $3.1 million, or 84.9%, in 1998 compared to 1997 and increased approximately $468,000, or 14.9%, in 1997 compared to 1996. These increases are due primarily to increases in the number of policies sold and administered during the respective periods and to a shift in policies administered to those which generate higher administrative fees.
Savings and investment income represents earnings primarily from investments in marketable securities. Such earnings increased approximately $523,000, or 75.0%, in 1998 from 1997 due primarily to an increase in the amount of assets invested.
Sales promotion and support expense consists primarily of costs related to the Company's annual national sales conventions and to various sales training activities. Also included in sales promotion and support expense is the cost of designing and printing sales brochures for use by producers. It is expected that these expenses will continue to be a major element of the Company's cost structure, as attendance at the national sales convention increases, as the number of producers marketing products for the Company increases, and as new products are introduced. This expense increased approximately $3.0 million, or 115.2%, in 1998 from 1997 and increased approximately $333,000, or 14.9%, in 1997 from 1996, due primarily to increased producer support costs associated with higher sales volume, as discussed above. The increase in 1998 from 1997 is also attributable to higher attendance at national sales conventions.
Professional fees increased approximately $1.9 million, or 267.5%, during 1998 compared to 1997 as a result of increased consulting fees related to various information systems products and expenses associated with the settlement of litigation described in Note eight to Part I, Item 8, "Financial Statements."
Depreciation and amortization expense increased approximately $682,000, or 106.5%, in 1998 from 1997 and increased approximately $171,000, or 36.5%, in 1997 from 1996. These increases are due primarily to acquisitions of fixed assets. Such acquisitions were necessary to improve newly leased office space and to accommodate increases in employment, as discussed above. In addition, as a result of the Company's plans to purchase the building which houses its current office space in Petaluma, California (see "Business of Company--Property"), increased depreciation expense of approximately $411,000 attributable to leasehold improvements was recognized during the fourth quarter of 1998 and approximately $300,000 was recognized during the first quarter of 1999.
Travel and entertainment increased approximately $265,000, or 80.3%, during 1998 from 1997 and $90,000, or 37.7%, from 1997 to 1996. These increases are due to increased travel by personnel in the Company's marketing department, to travel related to implementation of the carrier relationship with Transamerica, as discussed above, and to travel necessary for set-up and training for an east coast service center which became operational in July, 1998.
Equipment expense increased approximately $217,000, or 58.5%, during 1998 from 1997 and $77,000, or 26.3%, from 1997 to 1996. The increases are due to the increased volume of business and increased number of employees as described above.
The Company's ability to mobilize its assets remained strong at December 31, 1998 and 1997, with cash and short-term investment grade debt securities representing 73.2% and 66.8% of the Company's total assets, respectively. Generally, the Company's principal needs for cash are: (i) funding operating expenses; (ii) the purchase of computer hardware and software, leasehold improvements, and acquisitions of furniture and fixtures to accommodate new employees and support the growth in operations; (iii) funding continued product development and potential strategic acquisitions; and, (iv) as a reserve to cover possible redemptions of certain of the Company's common stock, which is redeemable at the option of shareholders under various agreements with the Company. It is contemplated that, during the first quarter of 1999, approximately $12.0 million will be invested in the equity securities of Indianapolis Life Insurance Group of Companies, Inc. (see discussion at "Recent Developments" below). In addition, during the second quarter of 1999, approximately $1.0 million will be paid as a down payment toward purchase of the building that the Company currently occupies and approximately $1.7 million is expected to be paid for furniture, fixtures and leasehold improvements for the leased building into which the Company intends to move.
As the year 2000 approaches, a critical business issue has emerged regarding how existing application software programs and operating systems can accommodate this date value. In brief, many existing application software products in the marketplace were designed to only accommodate a two digit date position which represents the year (e.g., '95 is stored on the system and represents the year 1995). As a result, the year 1999 (i.e., '99) could be the maximum date value these systems will be able to accurately process. Management has developed and is implementing a plan to ensure that the Company will be year 2000 compliant. This plan consists of the following four stages: (i) conducting an inventory of all hardware, software and support systems, (ii) assessing whether such hardware, software and support systems are year 2000 compliant, (iii) correcting or replacing any non-compliant hardware, software and support systems; and (iv) testing to ensure that all corrections to replacements made pursuant to the third phase of the plan are functioning properly. The first two stages of this plan have been completed and management anticipates that the last two stages will be completed by April 30, 1999. The Company is also working closely with the Carriers and significant customers and vendors to ensure that their systems will be fully year 2000 compliant. Based on information currently available, Management does not anticipate that the Company will incur significant operating expenses or be required to invest heavily in computer system improvements to be year 2000 compliant. However, as noted, the Company has not completed implementation of its compliance plan. Although the Company presently believes that, with the planned modifications to existing systems and the replacement or retirement of other systems, the year 2000 compliance issue will be resolved in a timely manner and will not pose significant operating problems for the Company, there can be no absolute assurance in this regard. The Company's business operations, as well as its ability to provide products and services to its customers without undue delay or interruption, could be at risk in the event unanticipated year 2000 issues arise. In addition, there can be no absolute assurances that unanticipated expenses related to the Company's ongoing year 2000 compliance efforts will not be incurred. As previously noted, the Company has communicated with its key suppliers and customers to determine their year 2000 readiness and the extent to which the Company is vulnerable to any third party year 2000 issues. There can be no guarantee that the systems of other companies on which the Company's systems rely will be converted in a timely manner or in a manner that is compatible with the Company's systems. A failure by such a company to convert their systems in a timely manner or a conversion that renders such systems incompatible with those of the Company could have a material adverse effect on the Company and there can be no assurance that the Company's contingency plans will adequately mitigate the effects of any third party noncompliance. In addition, it is unrealistic to assume that the Company could remain unaffected if the year 2000 issue results in a widespread economic downturn. Also, it is possible that the Company's insurance carriers could assert that its existing liability insurance programs do not cover liabilities arising out of any operational problems associated with the advent of the year 2000.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, shareholders' equity (deficit) and cash flows present fairly, in all material respects, the financial position of Regan Holding Corp. and its subsidiaries (the "Company") at December 31, 1998 and 1997, and results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. 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 generally accepted auditing standard 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 the opinion expressed above.
Regan Holding Corp. (the "Company") was incorporated in the State of California on February 21, 1990, for the primary purpose of owning and operating an insurance company. The Company conducted business through its primary subsidiary, Old Colony Life Insurance Company ("Old Colony"), until May 21, 1992. The Company conducted no operations and prepared no financial statements through August 1, 1993.
The Company, through its wholly-owned subsidiary Legacy Marketing Group ("LMG"), has entered into marketing agreements (the "Marketing Agreements") with American National Insurance Company ("American National"), IL Annuity and Insurance Company ("IL Annuity") and Transamerica Life Insurance and Annuity Company ("Transamerica"), collectively referred to herein as the "Carriers." American National is an unaffiliated company with over $1.4 billion in capital and surplus and is rated "A++" by A.M. Best. IL Annuity is an unaffiliated company, with over $13.0 million in capital and surplus and is rated "A" by A.M. Best. Transamerica is also an unaffiliated company, with over $560 million in capital and surplus and is rated "A+" by A.M. Best. The Marketing Agreements grant the Company the exclusive right to market certain annuity and life insurance products issued by the Carriers (the "Policies"). Under the terms of the Marketing Agreements, the Company is responsible for the recruiting, appointing, and training of producers in the sale of the Policies. For these services, the Carriers pay the Company marketing allowances and commissions based on the volume of Policies sold.
The Marketing and Administrative Agreements with American National and IL Annuity expire May 15, 1999, and December 31, 2005, respectively, but may be renewed by mutual agreement for successive one year terms. The Agreements may be terminated by either party upon 180 days notice without cause, and may be terminated by either party immediately for cause. In addition, the Marketing Agreements will terminate automatically at the end of any calendar quarter upon failure of the Company to meet certain quarterly minimum production requirements for two successive calendar quarters. The Company is currently negotiating with American National to renew the Marketing and Administrative Agreements. Management expects that new agreements will be signed during the second quarter of 1999. The Marketing and Administrative Agreements with Transamerica do not have a fixed term but may be terminated by either party upon twelve months notice without cause, and may be terminated by either party immediately for cause.
In August 1997, Legacy Advisory Services, Inc. ("LAS"), a wholly-owned subsidiary of the Company, was incorporated in the state of California for the purpose of operating as an "investment advisor," as defined by and regulated pursuant to the Investment Advisors Act of 1940. LAS is registered with the Securities and Exchange Commission (the "SEC") and is in the process of filing notices with several states to provide investment management services to clients of investment advisor representatives of LAS. LAS has conducted no operations to date.
In July 1998, Legacy Reinsurance Company ("LegacyRe"), a wholly-owned subsidiary of the Company, was incorporated in the State of Arizona. The Company is in the process of obtaining approval from the Arizona Department of Insurance for LegacyRe to engage in the reinsurance business. Accordingly, LegacyRe has conducted no business to date. Upon receipt of approval from the Arizona Department of Insurance, LegacyRe may enter into one or more reinsurance agreements to reinsure annuity and life products.
The accompanying consolidated financial statements are prepared in conformity with generally accepted accounting principles and include the accounts of Regan Holding Corp. and its wholly-owned subsidiaries, Legacy Marketing Group, Legacy Financial Services, Inc., Legacy Advisory Services, Inc., Legacy Reinsurance Company, and LifeSurance Corporation. All significant intercompany accounts and transactions have been eliminated.
Fixed assets are stated at cost, less accumulated depreciation and amortization. Depreciation is computed on the straight-line method over the estimated useful life of each type of asset. The Company uses an estimated useful life for computers and furniture and equipment of 5 years. Leasehold improvements are amortized over the term of the lease or the estimated useful life, whichever is shorter. Upon retirement or disposition of fixed assets, any gain or loss is included in income.
Basic and diluted earnings per share are presented in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." Earnings per share is based on the weighted average number of common shares outstanding, including shares of redeemable common stock.
In April 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 provides guidance on determining whether computer software is internal use software and on accounting for the proceeds from computer software originally developed or obtained for internal use and then subsequently sold to the public. It also provides guidance on capitalization of the costs incurred for computer software developed or obtained for internal use. The Company has not yet determined the impact, if any, of adopting SOP 98-1, which will be effective for the Company's year ending December 31, 1999.
December 31, 1998 Computers $ 3,406,540 $ 1,499,340 $ 1,907,200 Leasehold improvements 1,290,647 970,030 320,617 Furniture and equipment 1,202,577 578,659 623,918 Land 127,522 -- 127,522 Artwork 3,010 -- 3,010 ----------- ----------- ----------- Totals $ 6,030,296 $ 3,048,029 $ 2,982,267 =========== =========== ===========
1998 1997 Accrued compensation $ 2,595,760 $ 976,428 Commissions payable 714,926 234,836 Producer seminar expenses -- 39,498 Investment acquisition payable 500,000 -- Other 577,715 128,923 ----------- ----------- Totals $ 4,388,401 $ 1,379,685
The Company also sponsors a non-qualified deferred compensation plan, which is available to certain employees who, because of Internal Revenue Code limitations, do not receive Company matching contributions of up to 6% of annual compensation (the "Non-qualified Employee Plan"). Under the Non- qualified Employee 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. Deferrals under the Non-qualified Employee Plan did not begin until first quarter 1999.
The Company currently leases approximately 43,000 square feet of office space in Petaluma, California, at which the Company's headquarters are located. In March, 1999, the Company entered into an agreement to purchase the building which houses the office space currently leased for $4,300,000. Management is currently negotiating with financial institutions and expects to obtain financing for approximately $3,225,000 of the purchase price during the second quarter of 1999. The building consists of approximately 53,700 total square feet of useable office and warehouse space. In addition, as a result of the Company's plans to purchase the building which houses its current office space in Petaluma, California (see "Business of Company--Property"), increased depreciation expense of approximately $411,000 attributable to leasehold improvements was recognized during the fourth quarter of 1998 and approximately $300,000 was recognized during the first quarter of 1999. On October 27, 1998, the Company entered into a new lease for approximately 72,000 square feet of office space in Petaluma, California, into which the Company intends to move its headquarters upon vacating the space it currently leases. This lease expires in April, 2009, and includes an option to extend the term for two five-year periods. Pursuant to the lease, the Company, will pay monthly rent of $71,612, plus a pro-rata share of property taxes and operating expenses based on leased square footage.
As a professional services firm engaged in marketing and servicing life insurance and annuity products, the Company encounters litigation in the normal course of business, including the activities relating to its former business of operating an insurance company. In December 1996, LMG and American National Insurance Company ("American National") were named in a lawsuit filed in the Circuit Court of Jefferson County, Alabama, alleging misrepresentation and price discrimination in connection with the sale of certain annuity products issued by American National and marketed by LMG. American National and LMG have denied the allegations contained in the complaint as well as any wrongdoing with respect to the sale and issuance of annuities. However, on June 7, 1998, in order to avoid protracted litigation, American National and LMG entered into a settlement agreement with the plaintiffs and other class members. LMG's portion of the settlement, net of recovery under its errors and omissions insurance policy, was approximately $1.1 million, which was recorded as an expense during the second quarter of 1998. Management is not aware of any material asserted or unasserted litigation which existed at December 31, 1998.
Redeemable Common Stock has been recorded at the greater of the issuance value or the redemption value as of December 31, 1998 and 1997. The 701 Plan, the Subscription Agreement, and the Merger Agreement specify that the Redeemable Common Stock is to be redeemed at a rate per share based upon current fair market value. These Agreements specify factors to be considered in determining fair market value, including the net present value of inforce insurance policy cash flows. However, since the Company no longer operates an insurance business, this factor is not applicable. Further, there is no active trading market for the Company's stock which would establish market value. Accordingly, the Company's Board of Directors has approved a redemption value of $1.66 per share as of December 31, 1998, based on management's estimate of fair market value. The total redemption value for Series A and Series B Redeemable Common Stock was $8,584,602 and $994,552, respectively, at December 31, 1998, and $5,287,033 and $576,827, respectively, at December 31, 1997. Carrying value exceeded redemption value by $1,646,277 at December 31, 1998, and $5,978,791 at December 31, 1997. As the shares are redeemed, the excess of carrying value over redemption value is reflected as additional paid-in capital.
Changes to Redeemable Common Stock during the years ended December 31, 1998, 1997, and 1996 were as follows:
At December 31, 1998, the Company has two stock-based compensation plans, which are described below. Options were first granted under both plans during 1998. Under both plans, the exercise price of each option equals the estimated fair market value of the Company's stock on the date of grant, as estimated by management (see Note 9), except for options granted to 10% shareholders where the exercise price equals 110% of the estimated fair market value.
Effective January 1, 1998, 1,479,000 and 892,000 options were granted under the Employee Option Plan and the Producer Option Plan, respectively, at an exercise price of $0.73 per share. Effective July 1, 1998, 34,000 and 100,000 options were granted under the Employee Option Plan and the Producer Option Plan, respectively, at an exercise price of $1.03 per share. The employee options granted during 1998 expire in ten years and the producer options granted during 1998 expire in six years. In addition, during the first quarter of 1999, 1,477,300 and 4,913,000 options were granted under the Employee Option Plan and the Producer Option Plan, respectively, at an exercise price of $1.27 per share and at terms consistent with those described above. A summary of option activity during 1998 follows:
The Company accounts for the fair value of the Producer Option Plan in accordance with SFAS No. 123 "Accounting for Stock-based Compensation." Accordingly, the fair value of each option grant is estimated on the date of grant using the "minimum value" model prescribed by SFAS No. 123, using the following assumptions: (i) a risk free interest rate of 5.9% for both plans; and, (ii) an estimated life of six years and ten years for options granted under the Employee Option Plan and Producer Option Plan, respectively. Volatility and dividend yield assumptions are not applicable, as the Company's stock is not publicly traded nor does the Company pay dividends. $25,000 of compensation cost has been included in sales promotion and support expense in the accompanying financial statements for the year ended December 31, 1998. The Company applies APB Opinion 25 and related Interpretations in accounting for the Employee Option Plan. Accordingly, no compensation expense has been recognized for the Employee Option Plan. Had the Company elected to recognize compensation cost in accordance with SFAS No. 123, the Company's net income and earnings per share for the year ended December 31, 1998, would have been reduced for the Employee Option Plan to the pro forma amounts indicated below:
As reported Pro forma ----------- ----------- Net Income $ 9,770,208 $ 9,727,809 Basic earnings per share $ 0.37 $ 0.37 Diluted earnings per share $ 0.36 $ 0.36
The Employee Option Plan and the Producer Option Plan are administered by committees which are appointed by the Company's Board of Directors. 5,500,000 and 9,500,000 shares have been reserved for grant under the Employee Option Plan and the Producer Option Plan, respectively, subject to approval by shareholders at the Company's Annual Meeting to be held in May, 1999.
Pursuant to the Producer Option Plan, the Company may also award shares of common stock to Producers. During 1998, no stock awards were made. However, during the first quarter of 1999, 291,264 shares of Series A common stock were awarded to wholesalers.
The Company's deferred tax assets (liabilities) at December 31 consist of the following:
As of December 31, 1998, the Company also has, for income tax purposes, $373,620, 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 Company adopted SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information", on January 1, 1998. SFAS No. 131 supersedes SFAS No. 14 "Financial Reporting for Segments of a Business Enterprise" replacing the "industry segment" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. SFAS No. 131 also requires disclosure about products and services, geographic areas and major customers. The adoption of SFAS No. 131 did not affect the consolidated results of operations or consolidated financial position as previously reported.
The Company paid Ashley A. Penney, a director until August, 1997, $173,300, $133,113, and $140,100 for services provided as a human resource consultant during the years ended December 31, 1998, 1997, and 1996, respectively.
Prior to December, 1995, American National was the only insurance company with which the Company was contracted to market insurance products. This arrangement generated approximately 12.7%, 36.2% and 87.5% of total revenues to the Company during 1998, 1997 and 1996, respectively. In December 1995, the Company contracted to provide marketing and administrative services for IL Annuity. This arrangement generated approximately 79.9%, 57.0% and 5.9% of the Company's revenues during 1998, 1997 and 1996, respectively. In May 1998, the Company contracted to provide marketing and administrative services for Transamerica. These agreements generated approximately 1.7% of the company's revenue during 1998. However, neither the Marketing Agreements nor the Administrative Agreements prevent the Company from entering into similar arrangements with other insurance companies.
REGAN HOLDING CORP. AND SUBSIDIARIES Consolidating Balance Sheet December 31, 1998
REGAN HOLDING CORP. AND SUBSIDIARIES Consolidating Income Statement For the Year Ended December 31, 1998