UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2006
or
o
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from _____________ to ____________
Commission File Number: 0-19704
REGAN HOLDING CORP.
(Exact name of registrant as specified in its charter)
California
68-0211359
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
2090 Marina Avenue, Petaluma, CA
94954
(Address of principal executive offices)
(Zip Code)
707-778-8638
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
Accelerated filer o
Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
As of November 6, 2006, there were 23,525,000 shares of Common Stock-Series A outstanding and 550,000 shares of Common Stock-Series B outstanding.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
REGAN HOLDING CORP. AND SUBSIDIARIES
Consolidated Balance Sheet
September 30, | December 31, | ||||||||
2006 | 2005 | ||||||||
(Unaudited) | |||||||||
Assets | |||||||||
Cash and cash equivalents | $ | 2,762,000 | $ | 3,862,000 | |||||
Trading investments | 7,728,000 | 8,010,000 | |||||||
Accounts receivable, net of allowance of $192,000 and $227,000 | |||||||||
at September 30, 2006 and December 31, 2005 | 1,281,000 | 1,716,000 | |||||||
Prepaid expenses and deposits | 615,000 | 1,572,000 | |||||||
Income taxes receivable | 27,000 | - | |||||||
Total current assets | 12,413,000 | 15,160,000 | |||||||
Net fixed assets | 12,615,000 | 13,424,000 | |||||||
Notes receivable, net | 560,000 | 680,000 | |||||||
Other assets | 1,450,000 | 1,136,000 | |||||||
Total non current assets | 14,625,000 | 15,240,000 | |||||||
Total assets | $ | 27,038,000 | $ | 30,400,000 | |||||
Liabilities, redeemable common stock, and shareholders' equity | |||||||||
Liabilities | |||||||||
Accounts payable and accrued liabilities | $ | 6,435,000 | $ | 5,476,000 | |||||
Income taxes payable | - | 2,650,000 | |||||||
Current portion of notes payable | 232,000 | 78,000 | |||||||
Total current liabilities | 6,667,000 | 8,204,000 | |||||||
Deferred compensation payable | 7,596,000 | 8,044,000 | |||||||
Deferred gain on sale of building | 2,502,000 | 2,724,000 | |||||||
Other liabilities | 238,000 | 125,000 | |||||||
Notes payable, less current portion | 6,460,000 | 2,673,000 | |||||||
Total non current liabilities | 16,796,000 | 13,566,000 | |||||||
Total liabilities | 23,463,000 | 21,770,000 | |||||||
Redeemable common stock, Series A and B | 5,897,000 | 6,219,000 | |||||||
Shareholders' equity (deficit) | |||||||||
Preferred stock, no par value: Authorized: 100,000,000 shares; | |||||||||
No shares issued or outstanding | - | - | |||||||
Series A common stock, no par value: | |||||||||
Authorized: 45,000,000 shares; issued and outstanding: 20,959,000 | |||||||||
shares at September 30, 2006 and December 31, 2005 | 3,921,000 | 3,921,000 | |||||||
Paid-in capital | 6,650,000 | 6,561,000 | |||||||
Accumulated deficit | (12,893,000) | (8,071,000) | |||||||
Total shareholders' equity (deficit) | (2,322,000) | 2,411,000 | |||||||
Total liabilities, redeemable common stock, and shareholders' equity (deficit) | $ | 27,038,000 | $ | 30,400,000 | |||||
See notes to financial statements. |
2
REGAN HOLDING CORP. AND SUBSIDIARIES
Consolidated Statement of Operations
(Unaudited)
For the Three Months Ended | For the Nine Months Ended | ||||||||||||||||
September 30, | September 30, | ||||||||||||||||
2006 | 2005 | 2006 | 2005 | ||||||||||||||
Revenue | |||||||||||||||||
Marketing allowances and commission overrides | $ | 5,292,000 | $ | 3,180,000 | $ | 12,181,000 | $ | 10,394,000 | |||||||||
Trailing commissions | 858,000 | 1,004,000 | 2,703,000 | 3,133,000 | |||||||||||||
Administrative fees | 1,844,000 | 2,222,000 | 5,964,000 | 6,816,000 | |||||||||||||
Other revenue | 353,000 | 343,000 | 1,417,000 | 881,000 | |||||||||||||
Total revenue | 8,347,000 | 6,749,000 | 22,265,000 | 21,224,000 | |||||||||||||
Expenses | |||||||||||||||||
Selling, general and administrative | 8,469,000 | 7,567,000 | 25,579,000 | 25,411,000 | |||||||||||||
Depreciation and amortization | 916,000 | 946,000 | 2,616,000 | 3,028,000 | |||||||||||||
Internal use software impairment loss | - | - | - | 2,939,000 | |||||||||||||
Other | 635,000 | 550,000 | 1,830,000 | 1,808,000 | |||||||||||||
Total expenses | 10,020,000 | 9,063,000 | 30,025,000 | 33,186,000 | |||||||||||||
Operating loss | (1,673,000) | (2,314,000) | (7,760,000) | (11,962,000) | |||||||||||||
Other income | 53,000 | 60,000 | 174,000 | 474,000 | |||||||||||||
Interest expense | (67,000) | (32,000) | (83,000) | (45,000) | |||||||||||||
Total other income (expense), net | (14,000) | 28,000 | 91,000 | 429,000 | |||||||||||||
Loss from continuing operations before income taxes | (1,687,000) | (2,286,000) | (7,669,000) | (11,533,000) | |||||||||||||
Provision for (benefit from) income taxes | 3,000 | 181,000 | (2,691,000) | (274,000) | |||||||||||||
Loss from continuing operations | (1,690,000) | (2,467,000) | (4,978,000) | (11,259,000) | |||||||||||||
Loss from discontinued operation, net of tax | (2,000) | (92,000) | (9,000) | (288,000) | |||||||||||||
Net loss | (1,692,000) | (2,559,000) | (4,987,000) | (11,547,000) | |||||||||||||
Reduction of redeemable common stock | - | - | 165,000 | 871,000 | |||||||||||||
Net loss to common shareholders | $ | (1,692,000) | $ | (2,559,000) | $ | (4,822,000) | $ | (10,676,000) | |||||||||
Basic and diluted net loss per share: | |||||||||||||||||
Loss from continuing operations | $ | (0.07) | $ | (0.10) | $ | (0.21) | $ | (0.46) | |||||||||
Net loss | $ | (0.07) | $ | (0.11) | $ | (0.21) | $ | (0.48) | |||||||||
Net loss to common shareholders | $ | (0.07) | $ | (0.11) | $ | (0.20) | $ | (0.44) | |||||||||
Weighted average shares outstanding used to | |||||||||||||||||
compute basic and diluted net loss per share amounts | 24,076,000 | 24,220,000 | 24,101,000 | 24,285,000 | |||||||||||||
See notes to financial statements. |
3
REGAN HOLDING CORP. AND SUBSIDIARIES
Consolidated Statement of Shareholders’ Equity (Deficit)
(Unaudited)
Series A Common Stock | Paid-in | Accumulated | ||||||||||
Shares | Amount | Capital | Deficit | Total | ||||||||
Balance December 31, 2005 | 20,959,000 | $ 3,921,000 | $ 6,561,000 | $ (8,071,000) | $ 2,411,000 | |||||||
Net loss | (4,987,000) | (4,987,000) | ||||||||||
Repurchases of redeemable common stock | ||||||||||||
79,000 | 79,000 | |||||||||||
Reduction to redemption value of redeemable common stock | ||||||||||||
165,000 | 165,000 | |||||||||||
Stock option compensation | 10,000 | 10,000 | ||||||||||
Balance September 30, 2006 (unaudited) | 20,959,000 | $ 3,921,000 | $ 6,650,000 | $ (12,893,000) | $ (2,322,000) | |||||||
See notes to financial statements. |
4
REGAN HOLDING CORP. AND SUBSIDIARIES
Consolidated Statement of Cash Flows
(Unaudited)
For the Nine Months Ended | ||||||||||
September 30, | ||||||||||
2006 | 2005 | |||||||||
Cash flows from operating activities: | ||||||||||
Net loss | $ | (4,987,000) | $ | (11,547,000) | ||||||
Adjustments to reconcile net loss to net cash used in | ||||||||||
operating activities: | ||||||||||
Depreciation and amortization | 2,616,000 | 3,210,000 | ||||||||
Amortization of deferred gain on sale of building | (222,000) | - | ||||||||
Losses on write-off of fixed assets | 7,000 | 3,051,000 | ||||||||
Reduction of allowance for doubtful accounts | (35,000) | (330,000) | ||||||||
Gains on trading securities, net | (569,000) | (211,000) | ||||||||
Stock option compensation expense | 10,000 | 8,000 | ||||||||
Sales of trading securities, net | 851,000 | 196,000 | ||||||||
Accounts receivable | 470,000 | 69,000 | ||||||||
Prepaid expenses and deposits | 957,000 | 83,000 | ||||||||
Income taxes receivable (payable), net | (2,677,000) | 175,000 | ||||||||
Deferred taxes | - | (470,000) | ||||||||
Accounts payable and accrued liabilities | 959,000 | 154,000 | ||||||||
Deferred compensation payable | (448,000) | 209,000 | ||||||||
Other operating assets and liabilities | (245,000) | (703,000) | ||||||||
Net cash used in operating activities: | (3,313,000) | (6,106,000) | ||||||||
Cash flows from investing activities: | ||||||||||
Purchases of fixed assets | (1,770,000) | (2,245,000) | ||||||||
Repayments (issuance) of notes receivable, net | 120,000 | (216,000) | ||||||||
Option to purchase Investors Insurance Company | - | 2,975,000 | ||||||||
Net cash provided by (used in) investing activities: | (1,650,000) | 514,000 | ||||||||
Cash flows from financing activities: | ||||||||||
Proceeds from notes payable | 4,000,000 | 2,680,000 | ||||||||
Payments of notes payable | (59,000) | (163,000) | ||||||||
Repurchases of redeemable common stock | (78,000) | (321,000) | ||||||||
Stock option exercises | - | 69,000 | ||||||||
Net cash provided by financing activities: | 3,863,000 | 2,265,000 | ||||||||
Net decrease in cash and cash equivalents | (1,100,000) | (3,327,000) | ||||||||
Cash and cash equivalents, beginning of period | 3,862,000 | 4,348,000 | ||||||||
Cash and cash equivalents, end of period | $ | 2,762,000 | $ | (1,021,000) | ||||||
See notes to financial statements. |
5
REGAN HOLDING CORP. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
1.
Basis of Presentation
The accompanying Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States of America and include the accounts of Regan Holding Corp. (the “Company”) and its wholly owned subsidiaries. All intercompany transactions have been eliminated.
The Consolidated Financial Statements are unaudited but reflect all adjustments, consisting only of normal recurring adjustments which are, in the opinion of management, necessary for a fair statement of the Company’s consolidated financial position and results of operations. The results for the three months and nine months ended September 30, 2006 are not necessarily indicative of the results to be expected for the entire year. These unaudited Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, which was filed by the Company with the Securities and Exchange Commission on March 31, 2006.
2.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157,Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating the effect, if any, that implementation of SFAS No. 157 will have on its results of operations and financial condition.
3.
Stock-Based Compensation
On January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment,” using the prospective application method prescribed by SFAS No. 123R. Prior to the adoption of SFAS No. 123R, the Company accounted for stock option awards to employees in accordance with APB Opinion No. 25, “Accounting for Stock Issued to Employees” (the intrinsic value method) and, accordingly, recognized no compensation expense for stock option awards to employees. Stock option awards to non-employees are accounted for using the fair value method in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation.”
Under the prospective application method, the Company is required to record compensation expense prospectively for all employee stock options awarded during the reporting period based upon the fair-value-based method prescribed by SFAS No. 123R. 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. Compensation expense related to stock options awarded in the nine months ended September 30, 2006 was immaterial.
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4.
Loss per Share
For the Three Months Ended | For the Nine Months Ended | ||||||||||
September 30, | September 30, | ||||||||||
2006 | 2005 | 2006 | 2005 | ||||||||
Loss from continuing operations | $ (1,690,000) | $ (2,467,000) | $ (4,978,000) | $ (11,259,000) | |||||||
Loss from discontinued operation | (2,000) | (92,000) | (9,000) | (288,000) | |||||||
Net loss | (1,692,000) | (2,559,000) | (4,987,000) | (11,547,000) | |||||||
Reduction of redeemable common stock | - | - | 165,000 | 871,000 | |||||||
Net loss to common shareholders | $ (1,692,000) | $ (2,559,000) | $ (4,822,000) | $ (10,676,000) | |||||||
Weighted average shares used to compute basic and | |||||||||||
diluted net loss per share amounts | 24,076,000 | 24,220,000 | 24,101,000 | 24,285,000 | |||||||
Basic and diluted net loss per share: | |||||||||||
Loss from continuing operations | $ (0.07) | $ (0.10) | $ (0.21) | $ (0.46) | |||||||
Net loss | $ (0.07) | $ (0.11) | $ (0.21) | $ (0.48) | |||||||
Net loss to common shareholders | $ (0.07) | $ (0.11) | $ (0.20) | $ (0.44) | |||||||
As the Company incurred net losses in the periods presented, options to purchase 6.0 million and 7.9 million shares of the Company’s common stock as of September 30, 2006 and 2005 were excluded from the computation of diluted net loss per share, as the effect would have been antidilutive.
5.
Discontinued Operation
In January 2006, management of the Company decided to discontinue the operation of Values Financial Network, Inc. (“VFN”). Accordingly, VFN is reported as a discontinued operation for the three months and nine months ended September 30, 2006 and 2005.
6.
Income Taxes
The rate of benefit from income taxes differed from the federal and state statutory rate for each of the periods presented, which was primarily due to the following: in the nine months ended September 30, 2006, the Company had a benefit from income taxes of approximately $2.7 million resulting from a settlement of prior years’ tax matters. In addition, there was an increase in the valuation allowance against existing deferred tax assets in the amount of $697,000 and $3.0 million for the three and nine months ended September 30, 2006, and $1.1 million and $4.3 million for the three and nine months ended September 30, 2005.
7.
Impairment of Internal Use Software
In 1998, the Company began a project intending to replace its existing policy administration system with new licensed software after the vendor of the existing policy administration system required the Company to migrate from the existing system to an alternative platform. In late 2002, the Company learned from its vendor that it might be able to retain its existing system. Modification and customization of the licensed software was suspended in December of 2002. As a result of an evaluation of the Company-wide technological needs, which included an assessment of the viability of the existing system, it was concluded that the Company would use both systems. In the fourth quarter of 2003 the Company recorded a write-off of $1.1 million associated with the abandoned components of the software costs.
In 2004, the Company began the process of creating a new technology architecture, the intent of which was to implement a multi-tiered structure that would allow the Company to continue to use its existing administration system to administer its current business while using the new administration system for new products and carriers.
7
In 2005, the Company conducted further independent research, including consultation with industry experts about software solutions currently available in the marketplace and the benefits that companies, which are employing these systems, are receiving. In the second quarter of 2005, the Company concluded that the advances in technology and functionality that these new designs have delivered, along with the associated financial benefits, are greater than the Company would realize by completing its plans to implement its new administration system. In addition, the vendor of the Company’s new administration system announced that it will no longer be providing the appropriate updates for the system to the licensed users for all future regulatory changes, and that it will be the responsibility of each company that uses the system to modify the system for such changes. As a result, management determined that the inter nal use software project associated with the new administration system had been impaired, and in the second quarter of 2005, the Company recorded a write-off of $2.9 million associated with abandoned components of the internal use software project.
8.
Term Loan
On July 20, 2006, Legacy Marketing Group (the “Borrower”), the primary operating subsidiary of the Company, entered into a credit agreement (the “Agreement”) with Washington National Insurance Company (the “Lender”). Pursuant to the terms of the Agreement, the Lender will make a non-revolving multiple advance term loan (the “Term Loan”) to the Borrower totaling $6.0 million. As of September 30, 2006, the balance due under this Agreement was $4.0million.
Pursuant to the terms of the Agreement, beginning July 1, 2007, the Borrower will be required to make quarterly principal payments on the Term Loan equal to a percentage of the outstanding principal balance of the Term Loan as of June 30, 2007, as follows: 3.75% of the balance for the first four payments, 5.0% of the balance for the next twelve payments and 6.25% of the balance for the final four payments. The quarterly principal payments will be reduced, in order of maturity, by any optional prepayments by the Borrower or prepayments resulting from prepayment events specified in the Agreement. Additionally, beginning March 31, 2008, the Borrower will be required to semi-annually prepay the Term Loan on March 31 and September 30 in an amount equal to fifty percent of the Company’s excess cash flow (as defined in the Agreement) for the immediately preceding six month periods ended December 31 and June 30, s ubject to certain conditions specified in the Agreement. Interest on the unpaid principal balance of the Term Loan is currently payable on a monthly basis and accrues at the LIBOR-based rate (as defined in the Agreement) plus 3.5%, which was 8.83% as of September 30, 2006. The principal balance and accrued interest on the Term Loan is payable in full by April 1, 2012.
The Term Loan is primarily secured by Regan Holding Corp.’s bank and securities accounts, equipment and investment property, and the Borrower’s obligations are currently guaranteed by Regan Holding Corp., Legacy Advisory Services, Inc., Imagent Online LLC and certain shareholders of Regan Holding Corp. In addition, the Borrower is required to comply with other financial and non-financial covenants specified in the Agreement. In the event of default under the Agreement, the entire balance of the Term Loan would become immediately payable unless the Borrower obtains a waiver from the Lender.
8
9.
Segment Information
Total Revenue | Loss from Continuing Operations | ||||||||||||||
Three Months Ended | Nine Months Ended | Three Months Ended | Nine Months Ended | ||||||||||||
September 30, | September 30, | September 30, | September 30, | ||||||||||||
2006 | 2005 | 2006 | 2005 | 2006 | 2005 | 2006 | 2005 | ||||||||
Legacy Marketing Group | |||||||||||||||
$ 7,461,000 | $ 5,989,000 | $ 19,797,000 | $ 18,923,000 | $(1,189,000) | $ (2,015,000) | $ (3,280,000) | $ (9,773,000) | ||||||||
Legacy Financial Services, Inc. | |||||||||||||||
922,000 | 804,000 | 2,581,000 | 2,524,000 | (180,000) | (18,000) | (649,000) | (145,000) | ||||||||
Imagent Online, LLC | 54,000 | 52,000 | 154,000 | 150,000 | (321,000) | (434,000) | (1,049,000) | (1,341,000) | |||||||
Intercompany Eliminations | |||||||||||||||
(90,000) | (96,000) | (267,000) | (373,000) | - | - | - | - | ||||||||
Total | $ 8,347,000 | $ 6,749,000 | $ 22,265,000 | $ 21,224,000 | $(1,690,000) | $ (2,467,000) | $ (4,978,000) | $ (11,259,000) | |||||||
Total Assets | |||||
September 30, | December 31, | ||||
2006 | 2005 | ||||
Legacy Marketing Group | $ 31,442,000 | $ 33,532,000 | |||
Legacy Financial Services, Inc. | 1,516,000 | 1,751,000 | |||
Imagent Online, LLC | 3,003,000 | 2,995,000 | |||
Intercompany Eliminations | (8,923,000) | (7,878,000) | |||
Total | $ 27,038,000 | $ 30,400,000 | |||
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Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
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” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results or performance of Regan Holding Corp. and its businesses to be materially different from those 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 ma rket 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; the risk of substantial litigation or insurance claims; and other factors referred to in Management’s Discussion and Analysis of Financial Condition and Results of Operations located in our Annual Report on Form 10-K for the year ended December 31, 2005.
Regan Holding Corp. assumes no obligation to update forward-looking statements to reflect actual results or changes in or additions to the factors affecting such forward-looking statements.
Recent Industry Developments
In 2005, the Securities and Exchange Commission (“SEC”) informed certain issuers of equity-indexed annuities that it is examining whether such annuities need to be registered under the Securities Act of 1933. On August 8, 2005, the National Association of Securities Dealers (“NASD”) issued guidance to its members indicating that broker-dealers regulated by the NASD have certain responsibilities with respect to the offer and sale of equity-indexed annuities, including an obligation to determine the suitability of such products for their customers, regardless of whether equity-indexed annuities are deemed to be securities. Finally, some state insurance regulators are considering whether additional suitability regulations should be implemented with respect to all sales of fixed annuities, particularly with respect to senior citizens. In California, Commissioner Garamendi issued a letter on October 7, 2005, to Californi a life insurance companies urging them to develop suitability standards for the sale of annuity products to seniors, and the California Department of Insurance sponsored a legislative measure that would have required the industry to establish such insurer suitability standards. The bill was considered by the California legislature but did not pass in June 2006. The bill cannot be taken up again this year unless a rule waiver is obtained. There can be no assurance that this or similar bills will not be introduced in future years.
Our core business consists of selling fixed annuity products, on behalf of insurance carriers, through a network of independent insurance producers (“Producers”). If the initiatives undertaken by California and other states, the Securities and Exchange Commission or the NASD with respect to equity-indexed and other annuities result in new regulation or legislation, our operations and those of our Producers could be adversely affected. We are unable to predict whether, or which, of these initiatives will result in new laws or regulations, or whether other initiatives may affect our business and the demand for fixed annuity products marketed by Legacy Marketing Group (“Legacy Marketing”). If such initiatives result in new regulation or laws, they could have a material adverse effect on the insurance industry in general or on our financial condition and results of operations.
In recent years, the U.S. insurance regulatory framework has come under increased scrutiny. Some state legislatures have considered laws that may alter or increase state regulation of insurance, reinsurance, and holding companies. Moreover, the National Association of Insurance Commissioners 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. Changes in these laws and regulations or their interpretation could have a material adverse effect on our financial condition or results of operations. In addition, the U.S. Congress has considered statutes that would impose certain national uniform standards and repeal the McCarran-Ferguson antitrust exemption for the business of insurance. While no legislation is currently pending, the U.S. Congress c ould adopt laws or regulations that could have a material adverse effect on our financial condition or results of operations.
Legacy Financial Services, Inc. (“Legacy Financial”) is registered as a broker-dealer with, and is subject to regulation by, the SEC, NASD, Municipal Securities Rulemaking Board, and various state agencies. This regulation
10
covers matters such as capital requirements, recordkeeping and reporting requirements, and employee-related matters, including qualification and licensing of supervisory and sales personnel. Any proceeding alleging violation of, or noncompliance with, laws and regulations applicable to Legacy Financial could harm its business, financial condition, results of operations, and business prospects. In addition, changes in federal legislation, state legislation, court decisions and administrative policies could significantly and adversely affect the securities industry in general and Legacy Financial’s business in particular.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157,Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the impact, if any, that implementation of SFAS No. 157 will have on our results of operations and financial condition.
Results of Operations
Total revenue increased $1.6 million (24%) and $1.0 million (5%) in the three months and nine months ended September 30, 2006, compared to the same periods in 2005, primarily due to an increase in marketing allowances and commission overrides of $2.1 million and $1.8 million, partially offset by a decrease in administrative fees revenue of $378,000 and $852,000.
The increase in marketing allowances and commission overrides during the three months and nine months ended September 30, 2006 was primarily attributable to sales of new products issued by Washington National Insurance Company (“Washington National”), an unaffiliated insurance carrier. We began marketing Washington National products in March 2006.
The increase in marketing allowances and commission overrides generated primarily by sales of Washington National products was largely offset by a decrease in revenue derived from sales of products issued by Investors Insurance Corporation (“Investors Insurance”). This decrease occurred primarily because we discontinued selling fixed annuity products issued by Investors Insurance in certain states during the third quarter of 2005 due to changes in regulatory requirements related to minimum guaranteed rates.
The decrease in administrative fees revenue was primarily due to the transition of the administration of certain IL Annuity and Insurance Company (‘IL Annuity”) insurance contracts to AmerUs Annuity Group Co. (“Amerus”) upon expiration of the administrative agreement with IL Annuity, effective April 30, 2006. The expiration of the administrative agreement does not affect the commissions earned by Legacy Marketing on additional premium received or assets under management with respect to the underlying IL Annuity insurance contracts.
During the three months and nine months ended September 30, 2006 and 2005, Legacy Marketing sold and administered products primarily on behalf of five unaffiliated insurance carriers: American National, Transamerica, Americom, Washington National and Investors Insurance. As indicated below, the agreements with certain of these carriers generated a significant portion of our total consolidated revenue:
Three Months Ended | Nine Months Ended | ||||||||
September 30, | September 30, | ||||||||
2006 | 2005 | 2006 | 2005 | ||||||
Washington National | 42% | 0% | 23% | 0% | |||||
American National | 16% | 21% | 19% | 24% | |||||
Transamerica | 12% | 18% | 15% | 19% | |||||
Investors Insurance | 5% | 19% | 7% | 21% | |||||
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Our consolidated revenues were derived primarily from sales and administration of the following fixed annuity products:
Three Months Ended | Nine Months Ended | |||||||||
September 30, | September 30, | |||||||||
2006 | 2005 | 2006 | 2005 | |||||||
RewardMark(SM) series (sold on behalf of Washington National) | 42% | 0% | 23% | 0% | ||||||
BenchMark(SM) series (sold on behalf of American National) | 15% | 20% | 18% | 22% | ||||||
SelectMark® series (sold on behalf of Transamerica) | 12% | 18% | 15% | 19% |
Selling, general and administrative expenses increased $902,000 (12%) during the three months ended September 30, 2006, compared to the same period in 2005, mainly due to an increase in sales incentive program costs. We incurred an impairment charge of $2.9 million for internal use software in the second quarter of 2005. Excluding this charge, our operating expenses decreased $222,000 (1%) in the nine months ended September 30, 2006, compared to the same period in 2005. Although selling, general and administrative expenses remained relatively unchanged during the nine months ended September 30, 2006, compared to the same period in 2005, we experienced a decrease in compensation and benefits expense as a result of reduced headcount, which was offset primarily by an increase in sales incentive programs, occupancy costs and legal fees.
We had a benefit from income taxes of approximately $2.7 million in the nine months ended September 30, 2006 resulting from a settlement of prior years’ tax matters. In addition, we have established a valuation allowance related primarily to our federal and state deferred tax assets, which increased$697,000 and $3.0million for the three months and nine months ended September 30, 2006 and $1.1 million and $4.3 millionfor the three months and nine months ended September 30, 2005.
Liquidity and Capital Resources
Our cash provided by or used in operating activities generally follows the trend in our revenue and operating results. Our cash used in operating activities in the nine months ended September 30, 2006 and 2005 of $3.3 million and $6.1 million was primarily the result of our net loss, partially offset by non-cash charges such as depreciation and amortization and losses on write-off of fixed assets.
In the nine months ended September 30, 2006, a non-cash decrease in income taxes payable resulting from a settlement of prior years’ tax matters and gains on trading securities contributed to a decrease in cash used in operating activities. These decreases were partially offset by an increase in cash from proceeds from sales of trading securities, an increase in accounts payable and accrued liabilities and a decrease in prepaid expenses.
Net cash used in investing activities of $1.7 million for the nine months ended September 30, 2006, primarily consisted of purchases of fixed assets. Net cash provided by investing activities of $514,000 for the nine months ended September 30, 2005, primarily consisted of a refund of option fees pursuant to the terms of the Purchase Option Agreement with SCOR totaling $3.0 million, excluding interest, partially offset by purchases of fixed assets totaling $2.2 million.
Net cash provided by financing activities of $3.9 million for the nine months ended September 30, 2006, primarily consisted of loan proceeds of $4.0 million resulting from our credit agreement with Washington National. Net cash provided by financing activities of $2.3 million for the nine months ended September 30, 2005, primarily consisted of loan proceeds of $2.7 million from our investment broker, partially offset by repurchases of our redeemable common stock of $321,000 and payments against our mortgage loan of $163,000.
On July 20, 2006, Legacy Marketing Group (the “Borrower”), our primary operating subsidiary, entered into a credit agreement (the “Agreement”) with Washington National Insurance Company (the “Lender”). Pursuant to the terms of the Agreement, the Lender will make a non-revolving multiple advance term loan (the “Term Loan”) to the Borrower totaling $6.0 million. As of September 30, 2006, the balance due under this Agreement was $4.0million.
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Pursuant to the terms of the Agreement, beginning July 1, 2007, the Borrower will be required to make quarterly principal payments on the Term Loan equal to a percentage of the outstanding principal balance of the Term Loan as of June 30, 2007, as follows: 3.75% of the balance for the first four payments, 5.0% of the balance for the next twelve payments and 6.25% of the balance for the final four payments. The quarterly principal payments will be reduced, in order of maturity, by any optional prepayments by the Borrower or prepayments resulting from prepayment events specified in the Agreement. Additionally, beginning March 31, 2008, the Borrower will be required to semi-annually prepay the Term Loan on March 31 and September 30 in an amount equal to fifty percent of the Company’s excess cash flow (as defined in the Agreement) for the immediately preceding six month periods ended D ecember 31 and June 30, subject to certain conditions specified in the Agreement. Interest on the unpaid principal balance of the Term Loan is currently payable on a monthly basis and accrues at the LIBOR-based rate (as defined in the Agreement) plus 3.5%, which was 8.83% as of September 30, 2006. The principal balance and accrued interest on the Term Loan is payable in full by April 1, 2012.
The Term Loan is primarily secured by our bank and securities accounts, equipment and investment property, and the Borrower’s obligations are currently guaranteed by Regan Holding Corp., Legacy Advisory Services, Inc., Imagent Online LLC and certain shareholders of Regan Holding Corp. In addition, the Borrower is required to comply with other financial and non-financial covenants specified in the Agreement. In the event of default under the Agreement, the entire balance of the Term Loan would become immediately payable unless the Borrower obtains a waiver from the Lender.
We used $3.3 million of cash in our operations and incurred consolidated net losses of $5.0 million during the nine months ended September 30, 2006. If our consolidated net losses continue, a cash shortfall could ultimately occur. We believe that existing cash and investment balances, together with proceeds from the term loan and cash flow from operations, will provide sufficient funding for the foreseeable future. Furthermore, we have lowered our cost structure by reducing our employee headcount and eliminating consulting costs on several corporate initiatives. However, in the event that a cash shortfall does occur, we believe that adequate financing could be obtained to meet our cash flow needs. There can be no assurances that such financing would be available on favorable terms.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in our market risk, interest rate risk, credit risk, or equity price risk since December 31, 2005. Please see our Annual Report on Form 10-K for the year ended December 31, 2005 for more information concerning Quantitative and Qualitative Disclosures About Market Risk.
Item 4.
Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended) designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the specified time periods. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and executed, can provide only reasonable assurance of achieving the desired control objectives. As of September 30, 2006, our Chief Executive Officer and Chief Financial Officer evaluated, with the participation of our management, the effectiveness of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures wer e effective as of the end of the period covered by this report. Our management, including the Chief Executive Officer and the Chief Financial Officer, also evaluated our internal control over financial reporting to determine whether any changes occurred during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, there have been no such changes during the period covered by this report.
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PART II - OTHER INFORMATION
Item 1.
Legal Proceedings
From time to time, we are involved in various claims and legal proceedings arising in the ordinary course of business. There have been no material changes to any legal matters from those reported in our Annual Report on Form 10-K for the year ended December 31, 2005.
Item 1A. Risk Factors
There have been no material changes to our risk factors from those reported in our Annual Report on Form 10-K for the year ended December 31, 2005.
Item 6.
Exhibits
10.1
Credit Agreement between Legacy Marketing Group and Washington National Insurance Company dated July 20, 2006.
31.1
Certification of Chief Executive Officer required by Rule 13a-14(a)/15d-14(a) under the Exchange Act.
31.2
Certification of Chief Financial Officer required by Rule 13a-14(a)/15d-14(a) under the Exchange Act.
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Items 2, 3, 4 and 5 are not applicable and have been omitted.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
REGAN HOLDING CORP. | |
Date: November 14, 2006 | Signature: /s/ R. Preston Pitts |
R. Preston Pitts | |
President, Chief Operating Officer and Chief | |
Financial Officer | |
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