The following discussion and analysis should be read in conjunction with our audited financial statements and related notes included herein.
Certain statements contained in this document, including Management’s Discussion and Analysis of Financial Condition and Results of Operations that are not historical facts, constitute forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results or performance of Regan and its businesses to be materially different from that expressed or implied by such forward-looking statements. These risks, uncertainties and factors include, among other things, the following: general market conditions and the changing interest rate environment; the interruption, deterioration, or termination of our relationships with the insurance carriers who provide our products or the agents who market and sell them; the ability to develop and market new products to keep up with the evolving industry in which we operate; increased governmental regulation, especially regulations affecting insurance, reinsurance, and holding companies; the ability to attract and retain talented and productive personnel; the ability to effectively fund our working capital requirements; and the risk of substantial litigation or insurance claims.
Under the terms of the Merger Agreement, any shareholder who is the record holder of less than 4,500 shares of Regan Series A Common Stock and/or Regan Series B Common Stock (together, “Regan Common Stock”) will receive $0.10 in cash in exchange for each share of Regan Common Stock that he or she owns, and any shareholder who is the record holder of 4,500 or more shares of Regan Common Stock will receive one share of Legacy Alliance common stock (“Legacy Alliance Common Stock”) for each block of 4,500 shares of Regan Common Stock that he or she owns and $0.10 in cash per share for any remaining shares of Regan Common Stock in lieu of any fractional shares of Legacy Alliance Common Stock. All stock options or other rights to acquire shares of Regan Common Stock held by Regan shareholders prior to the effective time of the Reorganization, including any that are unvested, will be vested pursuant to the terms of the Merger Agreement and if unexercised prior to the effective time of the Reorganization, will terminate.
Legacy Marketing also had administrative agreements with each of the insurance carriers listed above. Effective October 17, 2007, Legacy Marketing entered into an agreement with a subsidiary of Perot Systems, whereby Legacy Marketing agreed to transfer its third party administration services function and certain employees who provide these services to Perot Systems in exchange for Perot Systems’ assumption of such administrative service functions. As a result of this transaction, Legacy Marketing recognized a non-cash internal use software impairment charge of approximately $1.2 million in the fourth quarter of 2007.
Based on the structure of the transaction and contractual language, the Company accounted for the transaction as a sale according with the guidance of SFAS No. 140, Accounting for Transfers of Financial Assets and Extinguishments of Liabilities - a replacement of FASB Statement No. 125,which was primarily codified in ASC860 - Transfers and Servicing, EITF 88-18, Sales of Future Revenues, which was primarily codified in ASC470 - Debt, and FASB Statement No. 77, Reporting by Transferors for Transfers of Receivables with Recourse, which was primarily codified in ASC860 - Transfers and Servicing.
The annuity products, as defined in the Sale of a Partnership Interest & Assignment of Asset Based Trail Commissions agreement, were certain fixed annuity products sold by LMG on behalf of American National Insurance Company, OM Financial Life Insurance Company/Americom Life, Transamerica Life Insurance Company, IL Annuity and Insurance Company, and Investors Insurance Corporation where LMG, in accordance with each carrier’s marketing agreement, would earn monthly a specified number of basis points on each annuity’s cash value for as long as each annuity remained in-force. At the time of closing, we valued over 65,000 fixed annuity products that were in-force as of that date and had a trail commission due to LMG. The rights to the trail commissions with respect to policies that were terminated prior to the closing date were not transferred to the partnership as there would have been no continuing value.
In determining the $6.5 million value for the Class B interest, we contracted an outside consultant to perform financial projections based on policies placed in-force as of December 31, 2007 for those carriers listed above and applied certain key assumptions such as lapse rates, growth rates for accumulation values, rates of partial withdrawal, mortality rates, discount rates, and age of policies. This resulted in the seller and the purchaser agreeing upon $6.5 million as a fair price for the sale of the Class B interest.
A special committee of the Board of Directors of the Company comprising the independent directors, Ute Scott-Smith, J. Daniel Speight, Jr. and Donald Ratajczak, approved the amount of consideration. In connection with the committee’s deliberations the Company obtained a fairness opinion from an independent third party stating that the total value of the transaction to the Company was within an acceptable range of estimated fair values of the future trail commission cash flows. A portion of the proceeds was used to pay the $6 million note payable, to Washington National Insurance Company and interest accrued thereon. The remainder of the proceeds was available for general corporate purposes.
Legacy Financial was registered as a broker-dealer with, and was subject to regulation by the SEC, FINRA, the Municipal Securities Rulemaking Board, and various state agencies. As a result of federal and state broker-dealer registration and self-regulatory organization memberships, Legacy Financial was subject to regulation that covers many aspects of its securities business. 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. Also, these regulations included supervisory and organizational procedures intended to ensure compliance with securities laws and prevent improper trading on material nonpublic information. Rules of the self-regulatory organizations are designed to promote high standards of commercial honor and just and equitable principles of trade. A particular focus of the applicable regulations concerns the relationship between broker-dealers and their customers. As a result, many aspects of the broker-dealer customer relationship are subject to regulation, including “suitability” determinations as to customer transactions, limitations in the amounts that may be charged to customers, and correspondence with customers. As of September 29, 2008 Legacy Financial withdrew as a broker-dealer registered with FINRA, and FINRA approval of such withdrawal followed in January 2009.
Lynda Pitts, Chief Executive Officer, and R. Preston Pitts, President, Chief Operating Officer, Chief Financial Officer and Secretary of Regan, are the primary owners of PD Holdings. In connection with the sale, we also entered into a service agreement with PD Holdings whereby subsidiaries of Regan will provide certain administrative services to PD Holdings for a fee equal to the cost of the services provided.
On July 20, 2006, Legacy Marketing entered into a credit agreement (the “Credit Agreement”) with Washington National Insurance Company (the “Lender”). Pursuant to the terms of the Agreement, the Lender made a non-revolving multiple advance term loan (the “Term Loan”) to Legacy Marketing totaling $6.0 million. On April 12, 2007, Legacy Marketing amended certain terms of the Agreement through the execution of Amendment No. 1 to the Credit Agreement (the Credit Agreement as so amended, the “Amended Agreement”) and (1) extended the final maturity of the loan under the Credit Agreement from April 1, 2012, to December 31, 2012; (2) changed certain of the requirements for mandatory prepayments under the Credit Agreement; (3) changed certain terms of the financial covenants specified in the Credit Agreement; and (4) revised certain definitions contained in the Credit Agreement. On March 28, 2008, the balance due of $6.0 million, plus accrued interest, on the Credit Agreement was repaid.
On November 18, 2005, Regan sold its office buildings in Petaluma, California for $12.8 million. Proceeds from the sale of the buildings were used to repay the mortgage on the properties, the outstanding balance of which was $6,962,518.04, and the remainder of the proceeds was allocated to working capital. Regan and the third party buyer (the “Buyer”) further agreed to enter into a ten year lease agreement, concurrently with the sale of the buildings, whereby it leased back 71,612 square feet through March 14, 2007, and will continue to lease back 47,612 square feet for the remainder of the lease term. The monthly base rent was $1.37 per square foot in 2009 and $1.33 per square foot in 2008 and will increase annually by three percent during the term of the lease, in addition to monthly taxes and operating expenses.
On December 18, 2008, the Securities and Exchange Commission (“SEC”) adopted Rule 151A which, if it becomes effective in its current form, would require certain fixed indexed annuity sales to be registered with the SEC. In addition, under the rule registered fixed indexed annuities would only be able to be sold by Financial Industry Regulatory Authority (“FINRA”) registered broker-dealers and representatives. As a result, fixed indexed annuity sales would be subject to regulation and oversight by both the SEC and FINRA. In response to the rule's adoption, a coalition of insurance companies and insurance marketing organizations have filed suit to block the implementation of the rule. In addition, on February 17, 2009 the National Association of Insurance Commissioners (“NAIC”) and NCOIL (the association of state insurance regulators and a group representing state legislators) filed a petition with the U.S. Court of Appeals for the District of Columbia Circuit to block implementation of the rule. On July 21, 2009 the U.S. Court of Appeals ruled that the SEC has the authority to classify indexed annuities as securities but that the SEC failed to properly consider the effect of the rule upon efficiency, competition, and capital formation. If the SEC can satisfy the court’s order and Rule 151A becomes effective in the form originally adopted, we could be adversely impacted as we would have to expand our distribution capabilities into broker dealers. In a filing with the U.S. Court of Appeals on December 8, 2009, the SEC stated that Rule 151A would not become effective before two years after the completion of the proceedings.
Also, in recent years, the existing U.S. insurance and financial regulatory frameworks have come under scrutiny. Some state legislatures have considered laws that may alter or increase state regulation of insurance, reinsurance, and holding companies. Moreover, the NAIC and state insurance regulators regularly re-examine existing laws and regulations, often focusing on modifications to holding company regulations, interpretations of existing laws and the development of new laws pertaining to fixed annuities. Further, new accounting and actuarial proposals, including principles-based reserving, may be proposed and adopted. Changes in these laws and regulations or their interpretation could have a material adverse effect on our financial condition and results of operations.
New tax regulations have also been adopted recently that affect the treatment of tax-sheltered annuity contracts. In addition, new accounting and actuarial proposals, including principles-based reserving, may be adopted. These developments also could have a material adverse effect on our financial condition and results of operations.
Legacy Marketing has marketing agreements with certain insurance carriers. Under the terms of the marketing agreements, Legacy Marketing is responsible for recruiting Producers, who have contracted with Legacy Marketing to sell fixed annuity products, and are licensed with various states’ departments of insurance and appointed with the applicable insurance carriers. For these services, the insurance carriers pay Legacy Marketing commissions and marketing allowances.
There are no significant management judgments associated with reporting our revenues. When a policyholder remits a premium payment to that insurance carrier 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 cancel the insurance contract ten to thirty days after receiving such contract. 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.
Trailing commissions decreased $1.2 million (84%) in 2009 compared to 2008 primarily due to the exchange of trail commission rights for limited partnership interests. The limited partnership interest representing the Class B shares was sold for $6.5 million in March 2008.
During the year ended December 31, 2009, Legacy Marketing marketed and sold products primarily on behalf of four unaffiliated insurance carriers: Investors Insurance, Washington National, American National, and OM Financial (Americom). As indicated below, the agreements with these carriers generated a significant portion of our total consolidated revenue of $18.4 million:
On September 8, 2009, the parent company of Washington National, Conseco Marketing L.L.C., and Legacy Marketing Group entered into a mutual agreement to terminate the Marketing Agreement between Washington National and Legacy Marketing Group. As a result, after November 1, 2009, Washington National’s products were no longer sold through the Legacy Marketing Group sales network.
Other revenue decreased $655,000 (18%) in 2009 compared to 2008 primarily due to a reduction of expense reimbursements under a contractual arrangement with Perot Systems.
Depreciation expense decreased $2.5 million (64%) in 2009 compared to 2008, as there were a greater amount of assets that were fully depreciated in 2009.
Other expense decreased $236,000 (30%), primarily due to a reduction of equipment leases and maintenance expense.
Administrative fees decreased $5.3 million (100%) in 2008 compared to 2007 primarily due to the termination of administrative agreements with Washington National, American National, Investors Insurance, and OM Financial (Americom) effective October 17, 2007, as the result of an agreement with a subsidiary of Perot Systems, whereby we agreed to transfer our third party administration services function and certain employees who provide these services to Perot Systems in exchange for Perot Systems assumption of such administrative service functions. As a result of this transaction, Legacy Marketing recognized a non-cash internal use software impairment charge of approximately $1.2 million in the fourth quarter of 2007.
Trailing commissions decreased $1.7 million (56%) primarily due to the result of a decline in inforce policies and the exchange of trail commission rights for limited partnership interests. The limited partnership interest representing the Class B shares was subsequently sold for $6.5 million in March 2008.
Legacy Marketing’s operating expenses decreased $10.4 million (36%) in 2008 compared to 2007 primarily due to decreased selling, general and administrative expenses, other miscellaneous expenses, and deferred compensation, partially offset by an increase in depreciation and amortization expenses as a result of the acceleration of the estimated useful life of internal use software. Selling, general and administrative expenses decreased $9.4 million (41%) primarily due to reduced compensation and benefits, occupancy expense, and professional fees. Compensation and benefits decreased primarily due to decreased employee headcount resulting from the transfer of administrative services to the Perot subsidiary. Occupancy expenses decreased primarily due to a reduction in mortgage expense as a result of the sale of our Rome, Georgia facility in May 2008. Professional fees decreased primarily due to lower consulting and legal services.
Income tax provision increased $106,000 in 2008 primarily due to California’s suspension of using net operating loss carryforwards for tax year 2008.
On May 31, 2007, Regan and two of its subsidiaries, Legacy Financial and Legacy Advisory Services Inc., entered into an agreement with Multi-Financial Securities Corporation whereby Legacy Financial Services transferred its registered representatives and customer accounts to Multi-Financial Securities Corporation. Under the agreement, on September 28, 2007, Multi-Financial Securities Corporation paid Legacy Financial Services $1 million (11.5%) of the aggregate gross dealer concessions earned at Legacy Financial Services between May 1, 2006, and April 30, 2007, by those transferred representatives who were, as of the measurement date (as defined in the agreement), registered with Multi-Financial Securities Corporation and in good standing with the FINRA. In addition, on each of the first four anniversary dates of the measurement date, subject to certain conditions, Multi-Financial Securities Corporation is obligated to pay Legacy Financial Services an amount representing up to four and a half percent (4.5%) of each transferred representative’s aggregate gross dealer concessions earned with Multi-Financial Securities Corporation during the one year period prior to such anniversary date. As of December 31, 2008, Legacy Financial did not meet the specified terms in order to receive a second payment from Multi-Financial Securities Corporation and did not receive any payments related to this agreement as of December 31, 2009.
On January 25, 2007, prospectdigital LLC (“prospectdigital”), an indirect wholly owned subsidiary of Regan, sold certain of its assets, which primarily included fixed assets and other miscellaneous operating assets, to PD Holdings LLC (“PD Holdings”). In addition, PD Holdings agreed to assume certain liabilities of prospectdigital. The action was taken in a continuing effort to reduce our operating expenses, as prospectdigital continued to sustain losses through the date of sale.
Prospectdigital is being reported as a discontinued operation for the twelve months ended December 31, 2009 and 2008. On our consolidated balance sheet, prospectdigital’s assets consist of $29,000 in accounts receivable as of December 31, 2009 and $28,000 in accounts receivable as of December 31, 2008. Prospectdigital’s liabilities consist of $23,000 in accrued liabilities as of December 31, 2009 and $32,000 in accrued liabilities as of December 31, 2008. We incurred an $189,000 loss on the sale of prospectdigital’s assets in 2007.
Our net cash provided by operating activities generally follows the trend in our revenue and operating results. Our net cash provided by operating activities for the year ended December 31, 2009 was $849,000 which was consistent with our operating revenues offset by cash transferred to our investment account and the reduction of our current liabilities. Net cash provided by operations during the same period of 2008 was $8.8 million and was primarily due to the $6.5 million gain on the sale of the Limited Partnership Class B shares in Legacy TM, LP, offset in part by a decline in cash-based operating results.
Net cash used in investing activities in 2009 of $194,000 consisted of purchases of fixed assets and the issuance of notes receivable for debt owed, offset in part by payments received. Additions to fixed assets during the period included cash purchases of $93,000 related to internal use software capitalizations and of $40,000 related to computer hardware.
Net cash used in financing activities in 2009 of $550,000 consisted of repayments on capital equipment lease obligations and short-term borrowings.
Our operating activities in 2009 enabled us to generate $105,000 in cash, net of the $2.1 million in cash used to purchase investments, both of which has significantly increased our liquidity and capital resources compared to the same period of 2008. In the event that a cash shortfall occurs, we believe that adequate financing could be obtained to meet our cash flow needs. However, there can be no assurances that such financing would be available on favorable terms.
Net cash provided by investing activities during the same period of 2008 was $3.8 million and was primarily due to the $3.5 million sale of our Rome, Georgia building in May 2008 and the use of temporarily restricted cash to fund various arbitration settlements associated with our discontinued broker dealer operation, offset in part by repayment towards notes receivable.
Net cash used in financing activities of $12.2 million in 2008 consisted primarily of the repayment of the Washington National loan and the mortgage loan of our Rome, Georgia facility, partially offset by proceeds from a line of credit loan.
We lease office and warehouse premises and certain office equipment under non-cancelable operating and capital leases. As of December 31, 2009, our total contractual cash obligations were as follows:
$849,000 of cash was provided by operations in 2009 and $8.8 million in 2008. We used $6.2 million of cash in operations in 2007. Though, we generated net income of $2.2 million in 2009, we incurred consolidated net losses of $110,000 and $9.1 million in 2008 and 2007, respectively. To mitigate possible cash shortfalls, we are currently in the process of seeking shareholder approval to merge the Company into The Legacy Alliance, Inc. in order to reduce the number of shareholders below 300 and enable the Company to terminate its status as a public company. This is expected to reduce costs associated with reporting obligations under the Securities and Exchange Act of 1934. The estimated direct and indirect cost savings would be approximately $453,000 per year, plus an additional $257,000 in annual costs relating to compliance with Section 404 of the Sarbanes-Oxley Act. In 2008, we lowered our cost structure by reducing our employee headcount, by repayment of debt, and by reducing the amount of office equipment leases. In March 2008, we repaid the Washington National loan using the proceeds from the sale of partnership interests in Legacy TM, LP. In May 2008, we sold our facility in Rome, Georgia and used a portion of the proceeds to repay the mortgage loan. In October 2008, we liquidated a portion of our investment portfolio to repay the margin loans obtained from our investment broker. All of these actions eliminated approximately $1.6 million of annual cash used for interest and principal payments in 2008.
As a limited partner, LMG has no liability for the debits of the Partnership. The contractual language also clarifies the Pitts’ role as general partners:
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, which was primarily codified into ASC 820 - Fair Value Measurements and Disclosures, defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. ASC 820 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The effective date of ASC 820 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (that is, at least annually) is for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The Company adopted ASC 820 on January 1, 2008 and it did not have a material effect on our results of operations or financial condition.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, which was primarily codified into ASC 810 - Consolidation. This Statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Adoption of ASC 810 is not expected to have a material effect on our results of operations and financial condition.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles, which was primarily codified into ASC 105 - Generally Accepted Accounting Principles. The statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States. This Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board (PCAOB) amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. Adoption of ASC 105 did not have a material effect on our results of operations and financial condition.
In April 2008, the FASB Staff Position (FSP) issued FAS No. 142-3, Determination of the Useful Life of Intangible Assets, which was primarily codified into ASC 350- Intangibles - Goodwill and Other, to amend the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets. The intent of ASC 944 is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset under ASC 805 - Business Combinations, and other U.S. generally accepted accounting principles. ASC 944 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years with early adoption prohibited. Adoption of ASC 350 did not have a material effect on our results of operations and financial condition.
Transfers in and out of Levels 1 and 2. A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers.
The glossary of Topic 855 is amended to include the definition of SEC filer. An SEC filer is an entity that is required to file or furnish its financial statements with either the SEC or, with respect to an entity subject to Section 12(i) of the Securities Exchange Act of 1934, as amended, the appropriate agency under that Section. It does not include an entity that is not otherwise an SEC filer whose financial statements are included in a submission by another SEC filer.
We have audited the accompanying consolidated balance sheets of Regan Holding Corp. and its subsidiaries (the “Company”) as of December 31, 2009 and 2008, and the consolidated statements of operations, shareholders’ deficit, and cash flows for each of the three years in the period ended December 31, 2009. Our audits also included the financial statement Schedule II - Valuation and Qualifying Accounts as of and for the years ended December 31, 2009 and 2008. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates.
Interest income is recognized when earned. Realized gains and losses on sales of investments are recognized in the period sold using the specific identification method for determining cost.
In accordance with Statement of Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which was primarily codified into ASC360 - Property, Plant, and Equipment, 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 and product models/enhancements to determine if the carrying value is fully recoverable. If there are future cash flows directly related to the software or product models/enhancements 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, or product models/enhancements 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.
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements, which was primarily codified into ASC 820 - Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. ASC 820 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Effective January 1, 2008, the Company adopted the provisions of ASC 820, for our financial assets and liabilities. The adoption of this portion of ASC 820 did not have any effect on our financial position or results of operations and we do not expect the adoption of the provisions of ASC 820 related to non-financial assets and liabilities to have an effect on our financial position or results of operations
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, which was primarily codified into ASC 810 - Consolidation. This statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. Adoption of ASC 810 is not expected to have a material effect on our results of operations and financial condition.
In April 2008, the FASB Staff Position (FSP) issued FAS No. 142-3 Determination of the Useful Life of Intangible Assets, which was primarily codified into ASC 350 - Intangibles - Goodwill and Other, to amend the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset under ASC 805 - Business Combinations, and other U.S. generally accepted accounting principles. This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years with early adoption prohibited. Adoption of ASC 350 did not have a material effect on our results of operations and financial condition.
In June 2009, the FASB issued SFAS No. 168, FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles a replacement of FASB SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles, which was primarily codified into Topic 105 - Generally Accepted Accounting Standards in the Accounting Standards Codification (“ASC”). ASC 105 identifies the sources of and framework for accounting principles used in preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP). The ASC will become the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. This Statement is to modify the GAAP hierarchy to include only two levels of GAAP: authoritative and nonauthoritative. On the effective date of this statement, the Codification will supersede all then-existing non-SEC accounting and reporting standards. This statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009. Adoption of ASC 105 did not have a material effect on our results of operations and financial condition.
The quoted price of the identical liability when traded as an asset
Quoted prices for similar liabilities or similar liabilities when traded as assets.
Activity in Level 3 fair value measurements. In the reconciliation for fair value measurements using significant unobservable inputs (Level 3), a sales, issuances, and settlements (that is, on a gross basis rather than as one net number).
Throughout 2009, the Company retired $109,000 in unused hardware and purchased $40,000 in new computer hardware. Other changes in our fixed assets resulted in the addition of $37,000 in computer hardware and $35,000 in equipment that we acquired at the end of a lease, both of which have been fully recognized in accumulated depreciation, and the addition of $84,000 in equipment captured as capital leases, of which $15,000 has been depreciated as of December 31, 2009 and recognized in depreciation expense for 2009. Total accumulated depreciation for all capital lease assets as of December 31, 2009 and 2008 was $50,000 and $15,000, respectively.
On March 26, 2008, the Company’s subsidiary, Legacy Marketing Group (“LMG”), entered into a sale and assignment agreement to sell and assign all rights, title and interest in certain asset based trail commissions to Legacy TM, a limited partnership (the “Partnership”), for a Class A limited partnership interest in the Partnership and $6.5 million. LMG’s Class A limited partnership interest is unencumbered. The transaction closed on March 26, 2008. Through the Class A limited partnership interest, LMG received for a one-year period a 33.33% beneficial interest in the proceeds from the trail commissions on the policies existing on the closing date, and in perpetuity a 100% interest in the proceeds from trail commissions earned on new policies placed in force after the closing date. The trail commission revenue is recorded into income when it has been received. Simultaneously with the sale of the Class A limited partnership interest, the Partnership sold to Lynda L. Pitts and R. Preston Pitts the Class B limited partnership interest in exchange for the guarantee of $6.5 million in debt that the Partnership incurred to acquire the trail commissions. The holders of the Class B limited partnership interest received for a one-year period a 66.66% interest in the proceeds of the trail commissions on existing policies as of the closing date, and thereafter became entitled to receive a 100% interest in the proceeds from such assigned trail commissions. Lynda L. Pitts, Chief Executive Officer, and R. Preston Pitts, President, Chief Operating Officer and Chief Financial Officer of the Company, each of whom is also a director of the Company, are the general partners of the Partnership and together own all of the Class B interests in the Partnership. As a part of the agreement, LMG was not obligated to repurchase or require the Partnership to return the asset under any conditions.
Based on the structure of the transaction and contractual language, the Company accounted for the transaction as a sale according with the guidance of SFAS No. 140, Accounting for Transfers of Financial Assets and Extinguishments of Liabilities - a replacement of FASB Statement No. 125,which was primarily codified in ASC860 - Transfers and Servicing, EITF 88-18, Sales of Future Revenues, which was primarily codified in ASC605 - Revenue Recognition, and FASB Statement No. 77, Reporting by Transferors for Transfers of Receivables with Recourse, which was primarily codified in ASC860 - Transfers and Servicing.
In 2007, the Company obtained margin loans from its investment broker for general corporate purposes. The loans bear interest at the lender’s base lending rate plus a surcharge based on the amount of the loans (8.5% at December 31, 2007), and are collateralized by the Company’s investment portfolio. As there was no stated maturity date the Company had included the entire balance of $3.9 million as of December 31, 2007, in the current portion of notes payable and other borrowings. On October 9, 2008, the Company liquidated its investment portfolio for $5.4 million. The proceeds were used to repay the loans from its investment broker, the outstanding balance of which was $4.3 million.
Notes and other borrowings at December 31, 2009 and 2008 are as follows:
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. Each year, Legacy evaluates the interest in Deferred Compensation Plan and the cost benefit of holding an open enrollment. In the last few years, participation in the plan has been low. As of November 1, 2008, the Company decided not to hold an open enrollment for participation in 2009. The Company did not make any matching contributions for the years ended December 31, 2009, 2008, and 2007. As of December 31, 2009, cumulative investment gains (losses), including distributions, resulted in an ending balance of $404,000. As of December 31, 2008, employee contributions, including cumulative investment gains (losses) and distributions, resulted in an ending balance of $361,000.
Both of the Company’s non-qualified deferred compensation plans follow the guidelines of the Internal Revenue Code 409A (“IRC 409A”). In 2008, the IRS mandated that all companies offering such plans be in compliance with IRC 409A by December 31, 2008. The Company has successfully complied with these requirements within the IRS’ established time frame.
The Company’s future minimum annual lease commitments under all non-cancelable operating and capital leases as of December 31, 2009 are as follows:
Pursuant to the terms of our Amended and Restated Shareholder’s Agreement with Lynda L. Pitts, Chief Executive Officer of the Company and Chairman of the Company’s Board of Directors, upon the death of Mrs. Pitts, the Company would have the option (but not the obligation) to purchase from Mrs. Pitts’ estate all shares of common stock that were owned by Mrs. Pitts 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 Mrs. Pitts, 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, 2009, the Company believes that 125% of the fair market value of the shares owned by Mrs. Pitts was equal to $562,000. The Company has purchased life insurance coverage for the purpose of funding this potential obligation upon Mrs. Pitts’ death.
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.
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 did not grant any stock options in 2009, 2008 or 2007. There were no shares of Series A common stock awarded to non-employees during 2009, 2008 and 2007.
The Company estimates the fair value of each stock option award on the date of grant using the Black-Scholes stock option valuation model. The estimated fair value of employee stock option awards is amortized over the award’s vesting period on a straight-line basis. There were no stock options awarded in 2009, 2008 or 2007.
The provision for (benefit from) federal and state income taxes from continuing operations consist of amounts currently payable (receivable) and amounts deferred, which for the periods indicated, are shown below:
As of December 31, 2009, the Company had federal and primary state net operating loss carryforwards of $19.6 million and $40.1 million, respectively. On December 31, 2025, 2026 and 2027, $1.2 million, $12.1 million and $6.3 million, respectively, of the federal net operating losses will expire. On December 31, 2014, $4.9 million of the state net operating losses will begin to expire. The Company also has federal and state alternative minimum tax credit carryforwards of $246,000 and $268,000, respectively. These credits do not have an expiration date. Federal and state tax valuation allowances have been established for all of the federal and state net operating loss carryforwards and the federal and state tax credit carryforwards.
Federal income tax expense (benefit) at statutory rate (34%)- Discontinued Operations
Increase (decrease) in valuation allowance for federal net operating loss carryforward and other temporary differences
Under the intraperiod tax allocation requirements, the income tax provisions for the periods presented were allocated first to continuing operations with the remainder to discontinued operations. The consolidated income tax provision (benefit) is computed separately for each member of the consolidated group on a separate company return basis. Accordingly, all net operating loss carryforwards, temporary differences and valuation allowances in deferred taxes are accounted for on a separate company return basis. The intercompany adjustments (netting to zero) represent primarily the facility fees charged to Legacy Financial Services, Inc., a discontinued operation, by continuing operation members but eliminated in consolidation. For income tax purposes, the facility fees are not eliminated and are properly reflected by each respective member of the consolidated group. In 2009 and 2008, federal tax benefits of $823,000 and $245,000, respectively, relate to decreases in the federal valuation allowances for continuing operations. These decreases in the federal valuation allowances were due primarily to the utilization of prior year net operating loss carryforwards from continuing operations. 2009 and 2008 federal tax expense of $52,000 and $278,000, respectively, represents increases in the federal valuation allowances for discontinued operations. The increases in the federal valuation allowances were due primarily to the increases in the net operating loss carryforwards caused by the generation of additional 2009 and 2008 net operating losses by discontinued operations that were not utilized.
On November 18, 2005, the Company sold its office buildings in Petaluma, California for $12.8 million. Proceeds from the sale of the buildings were used to repay the mortgage on the properties, the outstanding balance of which was $7.0 million, and the remainder of the proceeds was allocated to working capital. The Company and the third party buyer (the “Buyer”) further agreed to enter into a ten year lease agreement, concurrently with the sale of the buildings, whereby the Company leased back 71,612 square feet through March 14, 2007, and will continue to lease back 47,612 square feet for the remainder of the lease term. The monthly base rent was $1.37 per square foot in 2009 and $1.33 per square foot in 2008 and will increase annually by three percent during the term of the lease, in addition to monthly taxes and operating expenses. Pursuant to the terms of the lease, the Company paid the Buyer a security deposit of $1.0 million and advance rent of $980,000. The advance rent was utilized to pay the monthly base rent, monthly taxes and operating expenses during the first nine months of the lease term. The security deposit will be reduced if the Company meets certain profitability criteria as specified in the lease agreement.
On March 30, 2010, the Company mailed out a notice of special meeting of shareholders to be held on April 20, 2010 along with a proxy statement for solicitation of shareholder approval of the Reorganization.