(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.
We capitalize external consulting fees, and salaries and benefits for employees who are directly associated with the development of software for internal use when both of the following occur:
When the Company purchased Values Financial Network, Inc. ("VFN") in 2000, part of the purchase price was for goodwill. Before January 1, 2002, the Company amortized the goodwill on a straight-line basis over 10 years, which was its estimated useful life. Pursuant to Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," the Company ceased amortizing goodwill on January 1, 2002. As required by SFAS 142, the Company performs an annual goodwill impairment test. The impairment test of SFAS 142 requires the Company to measure fair value of the reporting unit. The Company established fair value by preparing a forecast of the discounted value of future cash flows expected to be derived from VFN.
investment securities had other-than-temporary declines in fair value below cost. As a result, in 2001 we recorded impairment losses of $642,000, and the individual securities were written down to a new cost basis.
We had consolidated net losses of $60,000 in 2002, compared to consolidated net losses of $348,000 in 2001. The improved results are primarily due to reduced losses at Values Financial Network, Inc. and Legacy Financial, and the recognition of net income at our Other segments in 2002 compared to net losses in 2001, partially offset by lower net income at Legacy Marketing.
During 2003, Legacy Marketing's revenue increased $20.2 million (42%) primarily due to increased commissions and marketing allowances. Marketing allowances and commissions increased $16.3 million (46%). Legacy Marketing's sales increase was driven by sales of declared rate and equity index annuities, reflecting a shift in the marketplace toward more traditional fixed income-based annuities. The overall increase in commissions and marketing allowances during 2003 was offset in part by the effect of discontinuing several annuity products issued by Transamerica. Legacy Marketing will continue to administer these annuity products and to accept additional premium payments, subject to applicable additional deposit limitations for these products. The discontinued products accounted for approximately 3% and 31% of our total consolidated revenue during 2003 and 2002. Sales of recently introduced Transamerica products have partially offset the effect of the discontinued Transamerica products. However, effective in May 2004 Legacy Marketing will discontinue marketing Transamerica products. We intend to continue providing administrative services. In addition, during the second quarter of 2003, American National reduced the crediting rates of several annuity products marketed by Legacy Marketing and lowered the commission rates that they pay to Legacy Marketing for sales of these products. As a result, sales of annuity products on behalf of American National began to decrease during the second quarter of 2003. This trend continued throughout the remainder of 2003. It is possible that overall consolidated revenues may also decline due to this event. Legacy Marketing has developed new annuity products with American National that may result in increased sales for Legacy Marketing in the long term. Furthermore, during the third quarter of 2003, Legacy Marketing began discontinuing the marketing of the AssureMark (SM) fixed annuity product issued by John Hancock. As a result, sales of annuity products on behalf of John Hancock decreased during 2003. Legacy Marketing plans to develop new annuity products with John Hancock that may result in increased sales in the long term.
As of December 31, 2003, Legacy Marketing sold products on behalf of four unaffiliated insurance carriers: Transamerica, American National, John Hancock and Investors Insurance Corporation. Legacy Marketing also performs administrative services for products of IL Annuity. The agreements with the following carriers generated a significant portion of the Company's total consolidated revenue (sales on behalf of Investors Insurance Corporation began in the second quarter of 2002):
2003 2002 ---- ---- BenchMark(SM) series (sold on behalf of American National) 37% 16% SelectMark(SM) series (sold on behalf of Transamerica) 25% 51% MarkOne(SM) series (sold on behalf of Investors Insurance Corporation) 23% 6% VisionMark(SM) series (sold on behalf of IL Annuity) 4% 11% AssureMark(SM) series (sold on behalf of John Hancock) 3% 8%
As indicated above, American National reduced the crediting rates on several annuity products and we will cease marketing Transamerica products effective in May 2004. As a result of these events our sales of Transamerica and American National products will likely decrease.
Legacy Financial has incurred cumulative losses since its inception in 1995. We have committed to make sufficient contributions to support Legacy Financial's operations through February 2005.
Legacy Financial incurred net losses of $595,000 during 2002, compared to net losses of $837,000 during 2001. The improved results were primarily due to increased revenues.
Legacy Financial's total expenses were unchanged during 2002 compared to 2001.
When the Company purchased the assets of Values Financial Network, Inc. ("VFN") in 2000, part of the purchase price was for goodwill. Before January 1, 2002, the Company amortized the goodwill on a straight-line basis over 10 years, which was its estimated useful life. Pursuant to Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," the Company ceased amortizing goodwill on January 1, 2002. As required by SFAS 142, the Company performed a transitional and annual goodwill impairment test during 2002. The impairment test of SFAS 142 required the Company to measure fair value of the reporting unit. The Company established fair value by preparing a forecast of the discounted value of future cash flows expected to be derived from VFN.
In 2000, we purchased, through Imagent Online, a 33.3% ownership interest in a development stage company named prospectdigital, LLC ("prospectdigital") for $403,000.
Imagent Online had net losses of $606,000 during 2003, compared to net losses of $648,000 during 2002. This favorable change of $39,000 was primarily due to increased revenues at prospectdigital in 2003.
Year ended December 31, 2002 compared with year ended December 31, 2001
Imagent Online had net losses of $648,000 during 2002, compared to net losses of $660,000 during 2001. This favorable change of $12,000 was primarily due to increased revenues at prospectdigital in 2002. As discussed above, prospectdigital's results of operations are included in the Consolidated Financial Statements since our acquisition of it in January 2002. Prior to the acquisition, we accounted for our investment in prospectdigital under the equity method of accounting. Accordingly, our share of prospectdigital's losses during 2001 were included in other expenses. Imagent Online had no revenue in 2001, and its expenses primarily consisted of its share of prospectdigital's losses.
During 2002, combined net income from Legacy Advisory Services, Legacy Re and Concept Strategies, Inc. was $61,000, compared to combined net losses of $371,000 in 2001. This favorable change of $432,000 is primarily due to closing the operations of our LifeSurance Corporation subsidiary in late 2001.
We require cash for the following purposes: (i) to fund operating expenses, which consist primarily of selling, general and administrative expenses; (ii) to purchase and develop fixed assets, primarily internal use software and computer hardware, in order to increase operational efficiency; (iii) to fund continued product development; and (iv) as a reserve to cover possible redemptions of certain shares of our common stock, which are redeemable at the option of the shareholders. Our primary source of cash is from operating activities.
During 2003, we began construction of a new building in Rome, Georgia and established a $2.7 million loan facility to be drawn against to finance construction costs. The interest rate is equal to LIBOR plus 2.10%. The interest rate as of December 31, 2003 was 3.24%. The loan matures on October 27, 2004. As of December 31, 2003, $2.5 million was available under the construction loan.
We had net losses of $60,000 and $348,000 for the years ended December 31, 2002 and 2001. We had net income of $5.0 million during 2003. We intend to continue to invest in marketing, operations, technology, and product development. We will need to generate adequate revenues and reduce our operating costs to maintain profitability. If we fail to maintain profitability, our financial condition and prospects could be weakened.
We depend on a limited number of sources for our products, and any interruption, deterioration, or termination of the relationship with any of our insurance carriers could be disruptive to our business and harm our results of operations and financial condition.
Legacy Marketing has marketing agreements with Transamerica Life Insurance and Annuity Company, American National Insurance Company, John Hancock Variable Life Insurance Company, and Investors Insurance Corporation. Legacy Marketing has also entered into administrative agreements with each of the four insurance carriers, and IL Annuity and Insurance Company, whose marketing agreement terminated during the first quarter of 2002. During 2003, 37%, 25%, 23%, 6%, and 3% of our total consolidated revenue resulted from agreements with American National, Transamerica, Investors Insurance Corporation, IL Annuity, and John Hancock.
In addition, Legacy Marketing discontinued marketing life insurance products issued by American National effective during the first quarter of 2003. These products accounted for a nominal amount of revenue during each of the years ending December 31, 2003, 2002, and 2001. Legacy Marketing will continue to administer American National life insurance products, including acceptance of renewal premium. Two Legacy Marketing employees who were supporting the life insurance product operations were terminated and nine were reassigned to other positions in Legacy Marketing.
During the third quarter of 2003, Legacy Marketing began discontinuing the marketing of the AssureMark (SM) fixed annuity product issued by John Hancock. As a result, sales of annuity products on behalf of John Hancock decreased during the third quarter and will continue to decrease for the remainder of 2003. Legacy Marketing is developing new annuity products with John Hancock that may result in increased sales in the long term.
Our performance will depend on the continued growth of Legacy Marketing. If Legacy Marketing fails to grow, our financial performance could suffer.
State legislators, state insurance regulators and the National Association of Insurance Commissioners continually reexamine existing laws and regulations, and may impose changes in the future that materially adversely affect our business, results of operations and financial condition. In particular, rate rollback legislation and legislation to control premiums, policy terminations and other policy terms may affect the marketability of policies or the amount of premiums that can be charged for such policies, and thus the commissions we can earn. Recently a committee of the U.S. House of Representatives has been considering the advisability of enacting federal statutes that would impose certain national uniform insurance regulatory standards to be applied by state insurance regulators. No such legislation has yet been introduced. A bill entitled "The Federal Insurance Consumer Protection Act of 2003" (S. 1373), has been introduced in the U.S. Senate which, if enacted, would establish comprehensive and exclusive federal regulation over all "interstate insurers," including all property and casualty insurers selling in more than one state, with no option for such insurers to remain regulated by the states. This legislation would repeal the McCarran-Ferguson antitrust exemption for the business of insurance. It would also establish a Federal Insurance Regulatory Commission within the Department of Commerce that would have exclusive regulatory jurisdiction over property and casualty and life insurers that do business in more than one U.S. jurisdiction. The legislation would establish comprehensive federal regulatory oversight over such insurers, including licensing, solvency supervision, accounting and auditing practices, form and rate approval, and market conduct examination. The legislation also would establish a National Insurance Guaranty Fund, which may be empowered to collect pre-funded assessments that are different from, and potentially greater than, current state guaranty fund assessment levels. We cannot predict whether these or other proposals will be adopted, or what impact, if any, such proposals may have on our business, financial condition or results of operation.
We operate in an industry in which there is significant risk of litigation. Substantial claims against us could diminish our financial condition or results of operation.
In accordance with Statement of Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," the Company reviews long-lived assets and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Measurement of the impairment of long-lived assets is based upon management's estimate of undiscounted future cash flows. We periodically review capitalized internal use software to determine if the carrying value is 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.
2003 2002 2001 --------- --------- --------- Gross realized gains $ 6,000 $ 281,000 $ 92,000 Gross realized losses $ (18,000) $ (62,000) $(230,000)
December 31, ----------------------------- 2003 2002 ------------ ------------ Computer hardware and purchased software $ 8,075,000 $ 7,796,000 Internal use software development costs 15,742,000 16,345,000 Leasehold improvements 1,361,000 1,324,000 Furniture and equipment 3,108,000 3,169,000 Building 9,446,000 7,798,000 Land 2,718,000 2,703,000 ------------ ------------ 40,450,000 39,135,000 Accumulated depreciation and amortization (16,172,000) (13,294,000) ------------ ------------ Total $ 24,278,000 $ 25,841,000 ============ ============
During 2003, we completed our evaluation of an internal use software project that we initially licensed in 1998 with the intent to modify and customize the licensed software prior to deployment. We began this project intending to replace our administration system after the vendor of our existing administration system required us to migrate from the existing system to an alternative platform. In late 2002, we learned from our vendor that we might be able to retain our existing system. Modification and customization of the licensed software was suspended in December of 2002. A financial analysis completed in the first quarter of 2003 indicated that remaining on the existing system may provide greater benefit than converting to a new system. In the third quarter of 2003, our vendor concluded that we could continue to use our existing system for an extended period. We have completed a rigorous evaluation of our Company-wide technological needs, which included an assessment of the viability of the existing system. As a result of this assessment we concluded that we would use both systems and in the fourth quarter of 2003 we recorded a write-off of $1.1 million associated with the abandoned components of the software costs. Our assessment supports the remaining $3.3 million balance.
The carrying amount of goodwill was $679,000 and $1.2 million as of December 31, 2003 and December 31, 2002.
December 31, ----------------------------- 2003 2002 ----------- ----------- Accrued compensation $ 3,351,000 $ 2,346,000 Accrued sales bonus 2,022,000 -- Accrued sales convention costs 1,381,000 1,664,000 Commissions payable 832,000 1,204,000 Payable to insurance carrier 345,000 1,097,000 Accounts payable 548,000 728,000 Accrued production premium deficiency 206,000 637,000 Miscellaneous accrued expenses 2,105,000 1,230,000 ----------- -----------
During 2001, the Company purchased the office building which houses its headquarters for $10.6 million. In conjunction with the acquisition, the Company entered into a bridge loan agreement for $4.8 million. In July 2002, the Company replaced the bridge loan with permanent financing in the amount of $7.4 million. This note is payable over ten years in monthly installments of principal and interest based on a 25-year term. At the end of ten years, the Company must pay the balance of principal due on the note. For the first five years, the interest rate is 6.95%. Thereafter, the interest rate is equal to LIBOR plus 2.55%, adjusted semi-annually, subject to a maximum semi-annual 1.00% increase/decrease in the interest rate. The maximum interest rate is 10.50%. As of December 31, 2003, the Company made payments of $151,000 toward the principal balance of the note. The required principal payments over the next five years are: $116,000, $125,000, $135,000, $144,000, and $154,000.
During 2003, Legacy Marketing Group initiated a sales incentive program for its top independent insurance producers ("Wholesalers"). This program offers bonuses to Wholesalers based primarily on their achievement of predetermined annual sales targets. Bonuses will be 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 leases office and warehouse premises and certain office equipment under non-cancelable operating leases. Related rent expense of $531,000, $585,000, and $1.6 million is included in occupancy costs for the years ended December 31, 2003, 2002, and 2001. Total rentals for leases of equipment included in equipment expense were $1.0 million, $1.1 million, and $922,000 for the years ended December 31, 2003, 2002, and 2001.
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, 2003, the Company believes that 125% of the fair market value of the shares owned by Ms. Regan was equal to $28.3 million. The Company has purchased two life insurance policies with a combined face amount of $29 million for the purpose of funding this potential obligation upon Ms. Regan's death.
Between 1990 and 1992, the Company issued Series A and Series B redeemable common stock to certain shareholders. The Company is obligated to repurchase the redeemable common stock at the current fair market value. Because there is no active trading market for the Company's stock that would establish market value, the Company's Board of Directors approved a redemption value for Series A redeemable common stock of $2.21 per share and $2.20 per share, and a redemption value for Series B redeemable common stock of $1.82 and $1.82 per share, as of December 31, 2003 and 2002, based on an independent appraisal of the stock value obtained by management. The appraisal also determined that non-redeemable stock had a value of $1.69 per share at December 31, 2003.
Holders of Series A redeemable common stock may redeem their holdings without limitation. Holders of Series B redeemable common stock may only redeem up to 10% of their holdings once per year, limited to a specified twenty-day period during November.
---- Share grants 48,000 Fair value per share $1.53-$1.65 Expense recorded $ 75,000
There were no shares of Series A common stock awarded to non-employees during 2003 and 2002. The share grant for 2001 listed above includes 15,000 shares of Series A common stock that the Company was obligated to award to a service provider, but had not been issued as of December 31, 2003.
Outstanding at December 31, 2001 15,564,000 $ 1.35 Granted 1,153,000 $ 1.68 Exercised -- $ -- Forfeited (768,000) $ 1.22
The following table summarizes information about stock options outstanding at December 31, 2003 under both plans:
The benefits from income taxes differ from the benefits computed by applying the statutory federal income tax rate (34%) to income before taxes, as follows:
As of December 31, 2003, the Company has state net operating loss carryforwards of $8.6 million that are expected to be utilized in the future. $4.9 million of these state net operating losses begin to expire on December 31, 2012. The Company also has, for state income tax purposes, $263,000 in alternative minimum tax credits which can be used to reduce income taxes in subsequent years to the extent regular tax exceeds tentative minimum tax. The credits have no expiration date.
The diluted loss per share calculation for the years ended December 31, 2002 and 2001 excludes antidilutive stock options of 4.1 million and 3.3 million.
The Company has identified its reportable segments based on its method of internal reporting and segregates its business into six primary reportable segments: Legacy Marketing, Legacy Financial, Imagent Online, Values Financial Network, and Other. Intersegment transactions are eliminated in consolidation. The Legacy Marketing business segment includes the results of selling and administering fixed annuity and life insurance products and general corporate expenses not allocated to the Company's other segments.
As of December 31, 2003, Legacy Marketing sold its products on behalf of four unaffiliated insurance carriers: American National, Transamerica, John Hancock and Investors Insurance Corporation. Effective during the first quarter of 2002, Legacy Marketing and IL Annuity terminated their marketing agreement. The agreements with the following carriers generated a significant portion of the Company's total consolidated revenue (sales on behalf of Investors Insurance Corporation began in the second quarter of 2002):
2003 2002 2001 ---- ---- ---- American National 37% 17% 5% Transamerica 25% 52% 68% Investors Insurance Corporation 23% 6% -- IL Annuity 6% 12% 20% John Hancock 3% 8% --
Our audits of the consolidated financial statements referred to in our report dated March 30, 2004 also included an audit of the financial schedules listed in Item 15(a)(2) of this Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.