10-Q 1 p18981_10q.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q |X| Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2004 or |_| 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 |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| As of November 5, 2004, there were 23,034,000 shares of Common Stock-Series A outstanding and 553,000 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, 2004 2003 ----------- ----------- (Unaudited) Assets Cash and cash equivalents $ 3,309,000 $ 9,908,000 Trading investments 6,978,000 6,308,000 Available-for-sale investments 2,504,000 5,939,000 Accounts receivable, net of allowance of $617,000 and $866,000 at September 30, 2004 and December 31, 2003 2,291,000 4,225,000 Prepaid expenses and deposits 818,000 803,000 Deferred taxes 707,000 1,356,000 ----------- ----------- Total current assets 16,607,000 28,539,000 ----------- ----------- Net fixed assets 27,644,000 24,278,000 Deferred taxes 1,746,000 1,170,000 Goodwill -- 679,000 Intangible assets, net 140,000 196,000 Option to purchase Investors Insurance Company 2,975,000 1,200,000 Other assets 939,000 1,053,000 ----------- ----------- Total non current assets 33,444,000 28,576,000 ----------- ----------- Total assets $50,051,000 $57,115,000 =========== =========== Liabilities, redeemable common stock, and shareholders' equity Liabilities Accounts payable and accrued liabilities $ 5,658,000 $10,790,000 Income taxes payable 3,000 1,990,000 Current portion of notes payable 195,000 307,000 ----------- ----------- Total current liabilities 5,856,000 13,087,000 ----------- ----------- Deferred compensation payable 6,895,000 6,257,000 Other liabilities 1,060,000 196,000 Notes payable, less current portion 9,759,000 7,083,000 ----------- ----------- Total non current liabilities 17,714,000 13,536,000 ----------- ----------- Total liabilities 23,570,000 26,623,000 ----------- ----------- Redeemable common stock, Series A and B 8,084,000 8,964,000 ----------- ----------- Shareholders' equity 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: 20,167,000 shares and 20,252,000 shares at September 30, 2004 and December 31, 2003 3,068,000 3,158,000 Common stock committed 25,000 25,000 Paid-in capital 6,523,000 6,510,000 Retained earnings 8,781,000 11,779,000 Accumulated other comprehensive income, net -- 56,000 ----------- ----------- Total shareholders' equity 18,397,000 21,528,000 ----------- ----------- Total liabilities, redeemable common stock, and shareholders' equity $50,051,000 $57,115,000 =========== ===========
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, ------------------------------ ------------------------------ 2004 2003 2004 2003 ------------ ------------ ------------ ------------ Revenue Marketing allowances and commission overrides $ 3,838,000 $ 10,984,000 $ 16,788,000 $ 37,419,000 Trailing commissions 1,165,000 1,755,000 3,655,000 5,169,000 Administrative fees 2,460,000 3,542,000 7,999,000 10,678,000 Other revenue 418,000 512,000 1,510,000 3,052,000 ------------ ------------ ------------ ------------ Total revenue 7,881,000 16,793,000 29,952,000 56,318,000 ------------ ------------ ------------ ------------ Expenses Selling, general and administrative 8,637,000 13,676,000 29,475,000 41,550,000 Depreciation and amortization 1,050,000 1,009,000 3,255,000 3,129,000 Goodwill impairment losses -- 491,000 679,000 491,000 Other 603,000 1,134,000 1,775,000 2,819,000 ------------ ------------ ------------ ------------ Total expenses 10,290,000 16,310,000 35,184,000 47,989,000 ------------ ------------ ------------ ------------ Operating income (loss) (2,409,000) 483,000 (5,232,000) 8,329,000 ------------ ------------ ------------ ------------ Other income Investment income, net 158,000 102,000 411,000 257,000 Interest expense (2,000) (6,000) (7,000) (26,000) ------------ ------------ ------------ ------------ Total other income, net 156,000 96,000 404,000 231,000 ------------ ------------ ------------ ------------ Income (loss) before income taxes (2,253,000) 579,000 (4,828,000) 8,560,000 Provision for (benefit from) income taxes (850,000) 213,000 (1,856,000) 3,431,000 ------------ ------------ ------------ ------------ Net income (loss) before accretion of redeemable common stock (1,403,000) 366,000 (2,972,000) 5,129,000 Accretion of redeemable common stock -- -- 29,000 (70,000) ------------ ------------ ------------ ------------ Net income (loss) available for common shareholders $ (1,403,000) $ 366,000 $ (2,943,000) $ 5,059,000 ============ ============ ============ ============ Basic earnings (loss) per share: Earnings (loss) available for common shareholders $ (0.06) $ 0.02 $ (0.12) $ 0.21 Weighted average shares outstanding 23,672,000 24,292,000 23,865,000 24,519,000 Diluted earnings (loss) per share: Earnings (loss) available for common shareholders $ (0.06) $ 0.01 $ (0.12) $ 0.18 Weighted average shares outstanding 23,672,000 27,185,000 23,865,000 27,348,000
See notes to financial statements. 3 REGAN HOLDING CORP. AND SUBSIDIARIES Consolidated Statement of Shareholders' Equity (Unaudited)
Accumulated Series A Common Stock Common Other ------------------------ Stock Paid-in Retained Comprehensive Shares Amount Committed Capital Earnings Income Total ----------- ----------- ----------- ----------- ------------ ------------- ------------ Balance December 31, 2003 20,252,000 $ 3,158,000 $ 25,000 $ 6,510,000 $ 11,779,000 $ 56,000 $ 21,528,000 Comprehensive loss, net of tax: Net loss (2,972,000) (2,972,000) Net unrealized losses on investments (56,000) (56,000) ------------ Total comprehensive loss (3,028,000) Retirement of common stock upon voluntary repurchases (85,000) (90,000) (55,000) (145,000) Accretion to redemption value of redeemable common stock 29,000 29,000 Producer stock option expense 13,000 13,000 ----------- ----------- ----------- ----------- ------------ ------------- ------------ Balance September 30, 2004 (unaudited) 20,167,000 $ 3,068,000 $ 25,000 $ 6,523,000 $ 8,781,000 $ -- $ 18,397,000 =========== =========== =========== =========== ============ ============= ============
See notes to financial statements. 4 REGAN HOLDING CORP. AND SUBSIDIARIES Consolidated Statement of Cash Flows (Unaudited)
For the Nine Months Ended September 30, ---------------------------- 2004 2003 ------------ ------------ Cash flows from operating activities: Net income (loss) $ (2,972,000) $ 5,129,000 Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities: Depreciation and amortization 3,255,000 3,129,000 Write-off of fixed assets 64,000 648,000 Impairment of goodwill and intangible assets 679,000 538,000 Unrealized gains on trading securities, net (181,000) (986,000) Other (102,000) 336,000 Changes in operating assets and liabilities: Purchases of trading securities, net (485,000) (108,000) Accounts receivable 1,952,000 (1,269,000) Prepaid expenses and deposits (15,000) 1,414,000 Income taxes receivable and payable (1,987,000) (1,182,000) Deferred tax assets 110,000 (317,000) Accounts payable and accrued liabilities (5,132,000) 2,734,000 Deferred compensation payable 638,000 1,113,000 Other operating assets and liabilities (797,000) (487,000) ------------ ------------ Net cash provided by (used in) operating activities (4,973,000) 10,692,000 ------------ ------------ Cash flows from investing activities: Purchases of available-for-sale securities (2,101,000) (5,876,000) Proceeds from sales and maturities of available-for-sale securities 5,536,000 3,931,000 Purchases of fixed assets (6,629,000) (2,699,000) ------------ ------------ Net cash used in investing activities (3,194,000) (4,644,000) ------------ ------------ Cash flows from financing activities: Proceeds from note payable 5,025,000 -- Payments toward note payable (2,461,000) (82,000) Repurchases of redeemable common stock (851,000) (1,033,000) Voluntary repurchases of common stock (145,000) (396,000) ------------ ------------ Net cash provided by (used in) financing activities: 1,568,000 (1,511,000) ------------ ------------ Net increase (decrease) in cash and cash equivalents (6,599,000) 4,537,000 Cash and cash equivalents, beginning of period 9,908,000 4,793,000 ------------ ------------ Cash and cash equivalents, end of period $ 3,309,000 $ 9,330,000 ============ ============
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, 2004 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, 2003, which was filed by the Company with the Securities and Exchange Commission on March 30, 2004. 2. Stock Options The Company has a stock-based employee compensation plan and accounts for this plan under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation cost is reflected in net income (loss), as all options granted under the plan had an exercise price equal to the fair market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation:
For the Three Months Ended For the Nine Months Ended September 30, September 30, ---------------- ----------- ------------------------------ 2004 2003 2004 2003 ------------- ----------- ------------- ------------- Net income (loss) available for common shareholders, as reported $ (1,403,000) $ 366,000 $ (2,943,000) $ 5,059,000 Deduct: Total stock-based employee compensation expense determined under the fair value method for all awards, net of related tax effects (75,000) (115,000) (212,000) (312,000) ------------- ----------- ------------- ------------- Pro forma net income (loss) available for common shareholders $ (1,478,000) $ 251,000 $ (3,155,000) $ 4,747,000 ============= =========== ============= ============= Earnings (loss) per share: Basic - as reported $ (0.06) $ 0.02 $ (0.12) $ 0.21 Basic - pro forma $ (0.06) $ 0.01 $ (0.13) $ 0.19 Diluted - as reported $ (0.06) $ 0.01 $ (0.12) $ 0.18 Diluted - pro forma $ (0.06) $ 0.01 $ (0.13) $ 0.17
6 3. Earnings (Loss) per Share
For the Three Months Ended For the Nine Months Ended September 30, September 30, --------------------------- ---------------------------- 2004 2003 2004 2003 ----------- ---------- ----------- ----------- Net income (loss) available for common shareholders, as reported $(1,403,000) $ 366,000 $(2,943,000) $ 5,059,000 =========== ========== =========== =========== Reconciliation of shares used in basic and diluted earnings per share calculations: Basic: Weighted average common shares outstanding 23,672,000 24,292,000 23,865,000 24,519,000 =========== ========== =========== =========== Basic net income (loss) per share $ (0.06) $ 0.02 $ (0.12) $ 0.21 =========== ========== =========== =========== Diluted: Weighted average common shares outstanding 23,672,000 24,292,000 23,865,000 24,519,000 Dilutive effect of stock options -- 2,893,000 -- 2,829,000 ----------- ---------- ----------- ----------- Shares used in diluted net income (loss) per share calculation 23,672,000 27,185,000 23,865,000 27,348,000 =========== ========== =========== =========== Diluted net income (loss) per share $ (0.06) $ 0.01 $ (0.12) $ 0.18 =========== ========== =========== ===========
As the Company incurred net losses in the three and nine months ended September 30, 2004, options to purchase 15.5 million shares of the Company's common stock were excluded from the computation of diluted net loss per share for those periods, as the effect would have been antidilutive. Options to purchase 15,000 shares and 639,000 shares of the Company's common stock were excluded from the computation of diluted net income per share for the three and nine months ended September 30, 2003, as the options' exercise price was greater than the average market price of the common stock and, therefore, the effect would have been antidilutive. 4. Comprehensive Income (Loss) Total comprehensive loss for the three and nine months ended September 30, 2004 was $1,434,000 and $3,028,000. For the three and nine months ended September 30, 2003, total comprehensive income was $350,000 and $5,159,000. 5. Option to Purchase Investors Insurance Corporation On July 1, 2002, the Company entered into a Purchase Option Agreement with SCOR Life U.S. Re Insurance Company ("SCOR"), a 100% owner of the outstanding capital stock of Investors Insurance Corporation ("IIC"). Pursuant to the terms of the agreement, SCOR has granted the Company the right to purchase the outstanding capital stock of IIC in exchange for annual option fees. The Company has paid annual option fees totaling approximately $3.0 million as of September 30, 2004. The Company has the right to exercise the option at any time prior to the expiration date on June 30, 2005. If the Company elects to exercise the option, it must complete the purchase transaction within two years of exercising the option. Upon completion of a purchase transaction, the option fees will be included in the purchase price. If the option expires unused, the fees paid will be expensed. 6. Notes Payable The Company has a mortgage of $7.1 million on the office building which houses its headquarters. Payment in full of this note is due on August 1, 2012. Payments are due on the note based on a 25-year amortization schedule. On August 1, 2012, the Company must pay the remaining principal due on the note which will be approximately $5.9 million. Prior to August 1, 2006 the interest rate on the note is 6.95%. Thereafter, the interest rate will be 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 September 30, 2004, the balance due on the note was $7.1 million. During 2003, the Company began construction of a new building in Rome, Georgia and established a $2.7 million loan facility to finance construction costs. The balance due under this loan facility on December 31, 2003 was $191,000. During April 2004, the Company refinanced its construction loan replacing it with a $2.9 million variable interest rate note indexed to LIBOR plus 1.9%. The note is payable over ten years in monthly installments of principal, amortized on the basis of a 20-year term, and interest. At the end of the ten years, the Company must pay the balance of the principal due on the note. The outstanding balance of the 7 note as of September 30, 2004 was $2.8 million. To manage interest expense, the Company entered into an interest rate swap agreement with a notional amount equal to the principal balance of the note which modifies its interest expense from a variable rate to a fixed rate. The April 2004 swap agreement involves the exchange of interest obligations from April 2004 through April 2014 whereby the Company pays a fixed rate of 6.8% in exchange for LIBOR plus 1.9%. 7. Derivative Financial Instruments The Company accounts for derivative financial instruments in accordance with the provisions of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 requires the Company to measure all derivatives at fair value and to recognize them in the balance sheet as an asset or liability. For derivatives designated as cash flow hedges, changes in fair value of the derivative are reported as other comprehensive income and are subsequently reclassified into earnings when the hedged transaction affects earnings. Changes in fair value of derivative instruments not considered hedging instruments and ineffective portions of hedges are recognized in earnings in the current period. In April 2004 the Company entered into an interest rate swap agreement with a current notional amount of $2.8 million to hedge the interest expense associated with its LIBOR-based borrowings. The Company designates the interest rate swap as a qualifying cash flow hedge under SFAS 133. 8. Values Financial Network, Inc. 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 establishes fair value by preparing a forecast of the discounted value of future cash flows expected to be derived from VFN. During 2002, the Company revised the business model for VFN to focus on corporate and individual producer sales. The VFN projections of future cash flows supported the balance of goodwill at that time. In early 2003, the Company further refined its business model for VFN, including identifying a new market and committing additional resources to develop the business. During 2003, due to the failure of VFN to produce revenues as projected, the Company updated its annual measurement of fair value of VFN. The fair value measurement based on a revised cash flow forecast was predicated on VFN realizing a lower level of sales. This forecast of cash flows did not support the balance of goodwill, and the Company recorded a goodwill impairment loss of $491,000 during 2003. Projections of future cash flows supported the remaining balance of goodwill at that time. During the second quarter of 2004, due to the failure of VFN to produce revenues as projected, particularly in the corporate arena, management decided to cease actively marketing to the corporate market. As a result, management lowered its expectations for future sales. This event met the criteria of a "triggering event" for testing the recoverability of long-lived assets as required by Statement of Financial Accounting Standards No. 144 ("SFAS 144") "Accounting for the Impairment or Disposal of Long-Lived Assets". Accordingly, the Company compared the carrying amount of VFN's long-lived assets to the projected sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset group. Based on the fact that the sum of the undiscounted cash flows exceeded VFN's assets, the Company concluded no impairment had occurred to the long-lived assets. As a result of performing the impairment tests required under SFAS 144, the Company was then required under the provisions of SFAS 142 to perform a goodwill impairment test using the revised cash flows forecast discounted at an appropriate cost of capital. The results of this test indicated that the Company's goodwill was not recoverable. Accordingly, the Company recorded a goodwill impairment loss of $679,000 during the second quarter of 2004. 8 9. Segment Information
Total Revenue Net Income (Loss) ------------------------------------------------------ -------------------------------------------------- Three Months Ended Nine Months Ended Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, -------------------------- -------------------------- ------------------------ ------------------------ 2004 2003 2004 2003 2004 2003 2004 2003 ------------ ------------ ------------ ------------ ----------- ----------- ----------- ----------- Legacy Marketing Group $ 7,116,000 $ 15,983,000 $ 27,523,000 $ 54,378,000 $(1,162,000) $ 1,255,000 $(1,747,000) $ 7,027,000 Legacy Financial Services, Inc. 725,000 821,000 2,313,000 2,057,000 (114,000) (118,000) (320,000) (605,000) Imagent Online, LLC 83,000 98,000 217,000 186,000 (77,000) (137,000) (353,000) (437,000) Values Financial Network, Inc. 10,000 9,000 30,000 20,000 (79,000) (656,000) (677,000) (941,000) Other 111,000 37,000 338,000 149,000 29,000 22,000 125,000 85,000 Intercompany Eliminations (164,000) (155,000) (469,000) (472,000) -- -- -- -- ------------ ------------ ------------ ------------ ----------- ----------- ----------- ----------- Total $ 7,881,000 $ 16,793,000 $ 29,952,000 $ 56,318,000 $(1,403,000) $ 366,000 $(2,972,000) $ 5,129,000 ============ ============ ============ ============ =========== =========== =========== ===========
Total Assets ---------------------------- September 30, December 31, 2004 2003 ------------ ------------ Legacy Marketing Group $ 47,747,000 $ 54,698,000 Legacy Financial Services, Inc. 1,344,000 2,034,000 Imagent Online, LLC 493,000 622,000 Values Financial Network, Inc. 1,407,000 2,019,000 Other 593,000 403,000 Intercompany Eliminations (1,533,000) (2,661,000) ------------ ------------ Total $ 50,051,000 $ 57,115,000 ============ ============ 9 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 that expressed or implied by such forward-looking statements. These risks, uncertainties and factors include, among other things, the following: general economic and business conditions; political and social conditions; government regulations, especially regulations affecting the insurance industry; regulatory initiatives and compliance with governmental regulations; the effects upon insurance markets and upon insurance industry business practices and relationships due to investigations and regulatory activities by the California Attorney General's Office, the New York Attorney General's Office, the California Department of Insurance, and other authorities concerning, among other things, insurance broker practices, contingent commission arrangements and bid solicitation activities; demographic changes; the ability to adapt to changes resulting from acquisitions or new ventures; and various other factors referred to in Management's Discussion and Analysis of Financial Condition and Results of Operations. 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 On October 29, 2004, the California Attorney General's Office announced the launch of a formal investigation into possible anti-trust violations and fraud by insurance companies and brokers, including bid rigging and other anti-competitive conduct in the insurance industry. Other state authorities have announced similar investigations. In addition, California Insurance Commissioner John Garamendi has released for public review a proposed new set of regulations addressing broker conduct. As currently drafted, the proposed regulations would, among other things, impose penalties on brokers who fail to disclose all material facts surrounding their receipt or potential receipt of income from a third party flowing from a transaction on behalf of a client. Also, the National Association of Insurance Commissioners ("NAIC") recently announced that it has formed the NAIC Executive Task Force on Broker Activities to gather facts and coordinate activities to address alleged criminal misconduct and violations of existing insurance laws involving insurance companies and insurance brokers. The Task Force is comprised of 13 member states, including California, and will pursue a three-pronged action plan designed to coordinate multi-state interest and inquiries, leverage state expertise and resources, engage consumers and develop a model act for brokers' disclosure of compensation. The Company's core business consists of selling fixed annuity products, on behalf of insurance carriers, through a network of approximately 27,000 independent insurance brokers that the Company refers to as "Producers." If the proposed California regulations were to be adopted in their current form, or similar regulations were to be adopted in other jurisdictions, the Producers would have to disclose to potential purchasers of fixed annuity products, compensation they may receive from the Company or the insurance carriers, as a result of such sales. The Company is unable to predict whether these proposed regulations will become law or the final form in which the proposed regulations will be enacted and whether other new initiatives may affect the Company's business and the demand for the fixed annuity products that the Company markets. It is possible, however, that enactment of the proposed California regulations, or similar regulations in other jurisdictions, or the consequences of the announced investigations or other similar investigations, could have a material adverse effect on the insurance industry in general or on the Company's financial condition and results of operations. 10 Overview On July 1, 2002, the Company entered into a Purchase Option Agreement with SCOR Life U.S. Re Insurance Company ("SCOR"), a 100% owner of the outstanding capital stock of Investors Insurance Corporation ("IIC"). Pursuant to the terms of the agreement, SCOR has granted the Company the right to purchase the outstanding capital stock of IIC in exchange for annual option fees. The Company has paid annual option fees totaling approximately $3.0 million as of September 30, 2004. The Company has the right to exercise the option at any time prior to the expiration date on June 30, 2005. If the Company elects to exercise the option, it must complete the purchase transaction within two years of exercising the option. The Company is exploring various methods to finance the acquisition of IIC, including the issuance of debt or equity securities by the Company or a subsidiary of the Company. As a result, it is possible that the Company will issue a significant amount of debt or equity securities to one or more new investors. Any such issuance of equity securities would likely reduce the percentage ownership of the Company held by current shareholders. Regan Holding Corp. Consolidated We had a consolidated net loss of $1.4 million during the three months ended September 30, 2004, compared to consolidated net income of $366,000 during the same period in 2003. For the nine months ended September 30, 2004, we had a consolidated net loss of $3.0 million, compared to consolidated net income of $5.1 million during the nine months ended September 30, 2003. These unfavorable changes of $1.8 million and $8.1 million were primarily due to a net loss incurred by Legacy Marketing Group ("Legacy Marketing") in each period presented in 2004, compared to net income in each period presented in 2003, which was partially offset by decreased net losses from Values Financial Network in both periods and lower losses from Legacy Financial Services ("Legacy Financial") for the nine month period. Legacy Marketing During the three months ended September 30, 2004, Legacy Marketing had a net loss of $1.2 million, compared to net income of $1.3 million during the same period in 2003. For the nine months ended September 30, 2004, Legacy Marketing had a net loss of $1.7 million, compared to net income of $7.0 million during the same period in 2003. The decline in results was primarily due to decreased revenue, partially offset by decreased expenses. During the three months and nine months ended September 30, 2004, Legacy Marketing commissions and marketing allowances decreased $7.8 million (64%) and $22.6 million (55%), compared to the same periods in 2003. The decrease in each period was primarily due to decreased sales of fixed annuities issued by Legacy Marketing's carriers. The low interest rate environment continues to cause many carriers that issue declared rate annuities, such as American National Life Insurance Company ("American National"), to reduce the crediting rates and compensation paid to us and our network of Producers on certain products. As a result, sales of the affected products in the first nine months and third quarter of 2004 were lower than in the comparable periods of 2003. The affected products accounted for approximately 29% and 36% of our total consolidated revenue for the three and nine months ended September 30, 2003, and only 3% and 9% of our total consolidated revenue for the three and nine months ended September 30, 2004. Revenues from sales of American National products decreased $3.0 million and $15.0 million during the three and nine months ended September 30, 2004, compared to the corresponding periods in 2003. Legacy Marketing's annuity sales were also negatively affected by Transamerica Life Insurance Company ("Transamerica") and Legacy Marketing deciding to discontinue the marketing of Transamerica products that were marketed exclusively by Legacy Marketing, effective May 3, 2004. Legacy Marketing continues to offer other Transamerica products and is currently working with Transamerica to develop new products that Legacy Marketing will market exclusively. Legacy Marketing expects to begin marketing these Transamerica products in the near future. The discontinued products accounted for approximately 17% and 29% of our total consolidated revenue for the three months ended September 30, 2004 and 2003. For the nine months ended September 30, 2004 and 2003, the affected products accounted for approximately 25% and 22% of our total consolidated revenue. Revenues from sales of Transamerica products decreased $3.5 million and $6.1 million during the three and nine months ended September 30, 2004, compared to the same periods in 2003. Revenue from sales of Transamerica products accounted for 20% and 26% of our total consolidated revenue during the three and nine months ended September 30, 2004. We expect revenues from the sales of Transamerica products will continue to decrease during the remainder of 2004. We intend to continue providing administrative services in connection with Transamerica products. We also experienced a decrease in sales of fixed annuities issued by IIC during 2004. We believe the decrease was primarily attributable to a downgrade in the A.M. Best credit rating of IIC from an A- rating to a B++ rating in September 2003. Revenues from the sales of IIC products decreased $1.8 million and $2.9 million during the three and nine months ended September 30, 2004, compared to the same periods in 2003. Revenue from sales of IIC products accounted for 28% of our total consolidated revenue during the three and nine months ended September 30, 2004. Administrative fees decreased $1.1 million (31%) and $2.7 million (25%) during the three months and nine months ended September 30, 2004, compared to the same periods in 2003, primarily due to decreased issuing fees resulting from decreased fixed annuity sales. Other income increased $29,000 (16%) and decreased $1.6 million (64%) during the three months and nine months ended September 30, 2004, compared to the same periods in 2003. This decrease in the nine months ended September 30, 2004 was primarily due to a performance bonus earned during the first half of 2003 on sales of fixed annuity and life products 11 under the terms of one of the Company's insurance carrier partner contracts. The contract was amended to terminate the bonus program effective July 1, 2003. During the nine months ended September 30, 2004, Legacy Marketing sold and administered products on behalf of three unaffiliated insurance carriers: American National, Transamerica and Investors Insurance Corporation. As indicated below, the agreements with these carriers generated a significant portion of our total consolidated revenue: Three Months Ended Nine Months Ended September 30, September 30, --------------------------- ------------------------ 2004 2003 2004 2003 ------------- ------------ ----------- ----------- American National 26% 30% 24% 40% Transamerica 20% 30% 26% 24% Investors Insurance Corporation 28% 24% 28% 20% Legacy Marketing also performs administrative services for products issued by John Hancock Variable Life Insurance Company and IL Annuity and Insurance Company. Our consolidated revenues were derived primarily from sales and administration of the following annuity products:
Three Months Ended Nine Months Ended September 30, September 30, ------------------------ ------------------------ 2004 2003 2004 2003 ----------- ------------ ------------ ----------- BenchMark(SM) series (sold on behalf of American National) 24% 30% 23% 39% SelectMark(R) series (sold on behalf of Transamerica) 20% 30% 26% 24% MarkOne(SM) series (sold on behalf of Investors Insurance Corporation) 19% 24% 24% 20%
As mentioned above, sales of the SelectMark(R) series sold on behalf of Transamerica will continue to decrease during the remainder of 2004. Legacy Marketing expenses decreased $4.9 million (35%) and $12.2 million (28%) during the three months and nine months ended September 30, 2004, compared to the same periods in 2003, primarily due to decreases in selling, general and administrative expenses. Selling, general and administrative expenses decreased $4.8 million (38%) and $11.7 million (31%) primarily due to decreases in sales promotion and support expenses, employee compensation, and stationery and supplies. Sales promotion and support expenses decreased primarily due to decreased insurance Producer-related bonuses and incentive trip expense, and decreased sales support expenses resulting from decreased sales. Employee compensation decreased primarily due to decreased headcount, reduction in temporary help, reduced employee overtime and decreased incentive-based compensation based upon our consolidated year to date operating results. Decreased stationery and supplies were primarily due to reduced sales. Other expenses decreased $160,000 (25%) and $684,000 (33%) during the three and nine months ended September 30, 2004, compared to the same periods in 2003. The decrease was primarily due to decreased leased equipment costs and a decrease in losses on disposal of fixed assets. Legacy Financial During the third quarter of 2004, Legacy Financial had a net loss of $114,000, compared to a net loss of $118,000 during the same period in 2003. For the nine months ended September 30, 2004, Legacy Financial had a net loss of $320,000, compared to a net loss of $605,000 during the same period in 2003, due to increased revenues and decreased expenses. Legacy Financial revenue decreased $96,000 (12%) and increased $256,000 (12%) during the three months and nine months ended September 30, 2004, compared to the same periods in 2003. The decrease in the three months ended September 30, 2004, was primarily due to decreased reimbursable insurance premiums and sponsorship revenues, partially offset by an increase in commissions resulting from improved equity market conditions in 2004. There was also an increase in 12 commissions in the nine months ended September 30, 2004, compared to the same period in 2003, which was partially offset by a decrease in reimbursable insurance premiums and sponsorship revenues. Legacy Financial's expenses decreased $119,000 (12%) and $224,000 (7%) during the three months and nine months ended September 30, 2004, compared to the same periods in 2003. The decrease in the 2004 expenses was primarily due to a decrease in selling, general and administrative expenses. Selling, general and administrative expenses decreased $128,000 (14%) and $266,000 (10%) for the three and nine months ended September 30, 2004, compared to the corresponding 2003 periods. The decrease was primarily due to decreased employee compensation expense resulting from a reduced headcount. Imagent Online, LLC Imagent Online, LLC ("Imagent") had a net loss of $77,000 during the three months ended September 30, 2004, compared to a net loss of $137,000 during the same period in 2003. During the nine months ended September 30, 2004, Imagent had a net loss of $353,000, compared to a net loss of $437,000 during the same period in 2003. The reduced losses are primarily due to a reduction in expenses. Expenses decreased $113,000 (35%) and $110,000 (12%) during the three months and nine months ended September 30, 2004, compared to the corresponding 2003 periods, primarily due to decreased employee compensation resulting from a reduced headcount. In addition, there were decreases in professional fees and equipment costs in each of the periods. Values Financial Network, Inc. Values Financial Network, Inc. ("VFN") had a net loss of $79,000 during the three months ended September 30, 2004, compared to a net loss of $656,000 during the same period in 2003. During the nine months ended September 30, 2004, VFN had a net loss of $677,000, compared to a net loss of $941,000 during the same period in 2003. The decreased losses were primarily due to goodwill, intangibles, and long-lived asset impairment losses recorded during the third quarter of 2003, partially offset by goodwill impairment losses during the second quarter of 2004. Other VFN operating expenses decreased $62,000 (29%) and $213,000 (31%) during the three months and nine months ended September 30, 2004, compared to the same periods in 2003, primarily due to decreased depreciation expense resulting from the write-down in the value of long-term assets in the third quarter of 2003 mentioned above. When the Company purchased 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 establishes fair value by preparing a forecast of the discounted value of future cash flows expected to be derived from VFN. During 2002, the Company revised the business model for VFN to focus on corporate and individual producer sales. The VFN projections of future cash flows supported the balance of goodwill at that time. In early 2003, the Company further refined its business model for VFN, including identifying a new market and committing additional resources to develop the business. During 2003, due to the failure of VFN to produce revenues as projected, the Company updated its annual measurement of fair value of VFN. The fair value measurement based on a revised cash flow forecast was predicated on VFN realizing a lower level of sales. This forecast of cash flows did not support the balance of goodwill, and the Company recorded a goodwill impairment loss of $491,000 during 2003. Projections of future cash flows supported the remaining balance of goodwill at that time. During the second quarter of 2004, due to the failure of VFN to produce revenues as projected, particularly in the corporate arena, management decided to cease actively marketing to the corporate market. As a result, management lowered its expectations for future sales. This event met the criteria of a "triggering event" for testing the recoverability of long-lived assets as required by Statement of Financial Accounting Standards No. 144 ("SFAS 144") "Accounting for the Impairment or Disposal of Long-Lived Assets". Accordingly, the Company compared the carrying amount of VFN's long-lived assets to the projected sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset group. Based on the fact that the sum of the undiscounted cash flows exceeded VFN's assets, the Company concluded no impairment had occurred to the long-lived assets. 13 As a result of performing the impairment tests required under SFAS 144, the Company was then required under the provisions of SFAS 142 to perform a goodwill impairment test using the revised cash flows forecast discounted at an appropriate cost of capital. The results of this test indicated that the Company's goodwill was not recoverable. Accordingly, the Company recorded a goodwill impairment loss of $679,000 during the second quarter of 2004. Other Segment During the three months ended September 30, 2004, net income from Legacy Advisory Services was $29,000, compared to net income of $22,000 during the same period in 2003. For the nine months ended September 30, 2004, net income from Legacy Advisory Services was $125,000, compared to net income of $85,000 during the same period in 2003. These favorable changes were primarily due to increased advisory fee revenues, partially offset by increased professional fees. Liquidity and Capital Resources Net cash used by operating activities was $5.0 million for the nine months ended September 30, 2004, compared to net cash provided by operating activities of $10.7 million for the same period in 2003. The change was primarily due to decreased operating results, decreased accounts payable and accrued liabilities, primarily due to the payment of bonuses to wholesalers based on their achievement of predetermined 2003 sales targets, payments of employee 2003 incentive bonuses and payments associated with a Producer incentive trip, a smaller decrease in prepaid expenses and deposits compared to 2003, decreased income taxes payable due to a pre-tax loss in the first nine months of 2004 and a decrease in the write-off of fixed assets. These amounts were partially offset by decreased accounts receivable primarily due to decreased sales volume during the first nine months of 2004, compared to the same period in 2003 and decreased unrealized gains on trading securities. Net cash used in investing activities was $3.2 million for the nine months ended September 30, 2004, compared to $4.6 million for the nine months ended September 30, 2003. The decrease was due to reduced purchases and increased liquidation of available-for-sale investments to meet operating cash needs. The decrease was partially offset by increased purchases of fixed assets primarily due to construction costs related to the Company's new servicing facility building in Rome, Georgia and computer software costs. Net cash provided by financing activities was $1.6 million for the nine months ended September 30, 2004, compared to net cash used by financing activities of $1.5 million for the nine months ended September 30, 2003. The change was primarily due to proceeds from the Company's construction loan and mortgage loan for the new building in Rome, Georgia. During 2003, the Company began construction of a new building in Rome, Georgia and established a $2.7 million loan facility to finance construction costs. During April 2004, the Company refinanced its construction loan replacing it with a $2.9 million variable interest rate note indexed to LIBOR plus 1.9%. The note is payable over ten years in monthly installments of principal, amortized on the basis of a 20-year term, and interest. At the end of the ten years, the Company must pay the balance of the principal due on the note. The outstanding balance of the note as of September 30, 2004 was $2.8 million. To manage interest expense, the Company entered into an interest rate swap agreement for the notional amount of the note, to modify its interest characteristics from a variable rate to a fixed rate. The swap agreement involves the exchange of interest obligations from April 2004 through April 2014 whereby the Company pays a fixed rate of 6.8% in exchange for LIBOR plus 1.9%. The Company used $5.0 million of cash in its operations and incurred consolidated net losses of $3.0 during the nine months ended September 30, 2004. If the Company's consolidated net losses continue, or if requests to repurchase redeemable common stock increase significantly, a cash shortfall could ultimately occur. The Company believes that existing cash and investment balances, together with anticipated cash flow from operations, will provide sufficient funding for the foreseeable future. However, in the event that a cash shortfall occurred, the Company believes that adequate financing could be obtained to meet its cash flow needs. There can be no assurances that such financing would be available on favorable terms. 14 Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes in the Company's market risk, interest rate risk, credit risk, or equity price risk since December 31, 2003, except as described below. To manage interest expense, the Company entered into a hedging transaction whereby it purchased an interest rate swap with the same notional amount as the mortgage note on its new Rome, Georgia service facility. This swap is intended to have the effect of changing the interest rate characteristics of the note from a variable rate to a fixed rate. The April 2004 swap agreement involves the exchange of interest obligations from April 2004 through April 2014 whereby the Company pays a fixed rate of 6.8% in exchange for LIBOR plus 1.9%. Please see the Company's Annual Report on Form 10-K for the year ended December 31, 2003 for more information concerning Quantitative and Qualitative Disclosures About Market Risk. Item 4. Controls and Procedures The Company maintains 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, 2004, the Company's Chief Executive Officer and Chief Financial Officer evaluated, with the participation of the Company's management, the effectiveness of the Company's disclosure controls and procedures. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures were effective as of the end of the period covered by this report. The Company's management, including the Chief Executive Officer and the Chief Financial Officer, also evaluated the Company's 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, the Company's internal control over financial reporting. Based on that evaluation, there have been no such changes during the period covered by this report. 15 PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company is not involved in any material pending legal proceedings. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 31.1 Certification of Chief Executive Officer required by Rule 13a-14(a)/15d-14(a) under the Exchange Act. Exhibit 31.2 Certification of Chief Financial Officer required by Rule 13a-14(a)/15d-14(a) under the Exchange Act. Exhibit 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. Exhibit 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 (b) Reports on Form 8-K On September 16, 2004, the Company filed a Form 8-K for the purpose of filing a material contract. 16 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 12, 2004 Signature: /s/ R. Preston Pitts ---------------------------------- R. Preston Pitts President, Chief Operating Officer and Chief Financial Officer 17 INDEX TO EXHIBITS Number Description ------ ----------- Exhibit 31.1 Certification of Chief Executive Officer required by Rule 13a-14(a)/15d-14(a) under the Exchange Act. Exhibit 31.2 Certification of Chief Financial Officer required by Rule 13a-14(a)/15d-14(a) under the Exchange Act. Exhibit 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. Exhibit 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. 18