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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 0-20148
CITIZENS FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Kentucky 61-1187135
(State of Incorporation) (I.R.S. Employer Identification No.)
12910 Shelbyville Road, Louisville, Kentucky 40243
(Address of principal executive offices)
(502) 244-2420
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 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
determined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes ~~~~~ No
~~X~~
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: Class A Stock - 1,671,628 as of
November 5, 2004.
The date of this Report is November 9, 2004.
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Part I - Financial Information; Item 1 - Financial Statements
Citizens Financial Corporation and Subsidiaries
Condensed Consolidated Statements of Operations
(Unaudited)
Nine Months Ended September 30 2004 2003
------------------------------------------------------------------------ -------------------- --------------------
Revenues:
Premiums and other considerations $ 22,262,399 $ 27,088,830
Premiums ceded (934,239) (826,587)
------------------------------------------------------------------------ -------------------- --------------------
Net premiums earned 21,328,160 26,262,243
Net investment income 5,091,174 4,332,680
Net realized investment gains 1,203,866 760,829
Other income 123,548 158,832
------------------------------------------------------------------------ -------------------- --------------------
Total Revenues 27,746,748 31,514,584
Policy Benefits and Expenses:
Policyholder benefits 17,440,821 15,965,187
Policyholder benefits ceded (810,063) (766,275)
------------------------------------------------------------------------ -------------------- --------------------
Net benefits 16,630,758 15,198,912
Increase in net benefit reserves 1,232,877 5,979,186
Interest credited on policyholder deposits 485,207 522,627
Commissions 3,677,250 4,999,926
General expenses 5,863,013 5,217,787
Interest expense 265,768 279,677
Policy acquisition costs deferred (936,598) (1,623,450)
Amortization of deferred policy acquisition costs
and value of insurance acquired 1,364,772 1,461,102
------------------------------------------------------------------------ -------------------- --------------------
Total Policy Benefits and Expenses 28,583,047 32,035,767
------------------------------------------------------------------------ -------------------- --------------------
Loss before income tax (836,299) (521,183)
Income tax (benefit) -- (121,000)
------------------------------------------------------------------------ -------------------- --------------------
Net Loss $ (836,299) $ (400,183)
------------------------------------------------------------------------ -------------------- --------------------
Net Loss per Common Share, basic and diluted $ (0.50) $ (0.24)
------------------------------------------------------------------------ -------------------- --------------------
See Notes to Condensed Consolidated Financial Statements.
Part I - Financial Information; Item 1 - Financial Statements
Citizens Financial Corporation and Subsidiaries
Condensed Consolidated Statements of Operations
(Unaudited)
Three Months Ended September 30 2004 2003
------------------------------------------------------------------------ -------------------- --------------------
Revenues:
Premiums and other considerations $ 7,361,683 $ 8,765,717
Premiums ceded (301,367) (293,985)
------------------------------------------------------------------------ -------------------- --------------------
Net premiums earned 7,060,316 8,471,732
Net investment income 1,751,197 1,580,841
Net realized investment gains 914,109 925,557
Other income 28,197 46,756
------------------------------------------------------------------------ -------------------- --------------------
Total Revenues 9,753,819 11,024,886
Policy Benefits and Expenses:
Policyholder benefits 6,142,749 5,283,059
Policyholder benefits ceded (269,057) (210,423)
------------------------------------------------------------------------ -------------------- --------------------
Net benefits 5,873,692 5,072,636
Increase (decrease) in net benefit reserves (4,561) 2,022,373
Interest credited on policyholder deposits 146,775 177,055
Commissions 1,136,614 1,611,689
General expenses 2,098,273 1,792,592
Interest expense 87,942 90,068
Policy acquisition costs deferred (302,143) (486,134)
Amortization of deferred policy acquisition costs
and value of insurance acquired 558,640 471,732
------------------------------------------------------------------------ -------------------- --------------------
Total Policy Benefits and Expenses 9,595,232 10,752,011
------------------------------------------------------------------------ -------------------- --------------------
Income before income tax 158,587 272,875
Income tax (benefit) 12,604 (20,000)
------------------------------------------------------------------------ -------------------- --------------------
Net Income $ 145,983 $ 252,875
------------------------------------------------------------------------ -------------------- --------------------
Net Income per Common Share, basic and diluted $ 0.09 $ 0.15
------------------------------------------------------------------------ -------------------- --------------------
See Notes to Condensed Consolidated Financial Statements.
Part I; Item 1 (continued)
Citizens Financial Corporation and Subsidiaries
Condensed Consolidated Statements of Financial Condition
September 30, December 31,
2004 2003
------------------------------------------------------------------------ -------------------- --------------------
ASSETS (Unaudited)
Investments:
Securities available for sale, at fair value:
Fixed maturities (amortized cost of $100,629,443
and $104,768,393 in 2004 and 2003, respectively) $ 103,668,849 $ 108,640,262
Equity securities (cost of $10,550,565 and
$8,061,783 in 2004 and 2003, respectively) 12,326,634 11,336,964
Investment real estate 3,091,654 3,162,223
Policy loans 4,520,744 4,409,301
Short-term investments 642,747 642,748
------------------------------------------------------------------------ -------------------- --------------------
Total Investments 124,250,628 128,191,498
Cash and cash equivalents 11,182,790 8,588,896
Accrued investment income 1,619,315 1,685,776
Reinsurance recoverable 2,562,003 2,834,222
Premiums receivable 445,172 256,140
Property and equipment 1,585,747 2,640,579
Deferred policy acquisition costs 10,241,786 10,325,660
Value of insurance acquired 2,805,013 3,119,609
Goodwill 755,782 755,782
Federal income tax receivable - 421,676
Other assets 361,118 60,494
------------------------------------------------------------------------ -------------------- --------------------
Total Assets $ 155,809,354 $ 158,880,332
------------------------------------------------------------------------ -------------------- --------------------
See Notes to Condensed Consolidated Financial Statements.
Part I; Item 1 (continued)
Citizens Financial Corporation and Subsidiaries
Condensed Consolidated Statements of Financial Condition
September 30, December 31,
2004 2003
------------------------------------------------------------------------ -------------------- --------------------
LIABILITIES AND SHAREHOLDERS' EQUITY (Unaudited)
Liabilities:
Policy Liabilities:
Future policy benefits $ 110,578,081 $ 109,383,695
Policyholder deposits 15,346,345 15,530,824
Policy and contract claims 1,645,649 1,663,249
Unearned premiums 240,584 249,572
Other 226,942 310,464
------------------------------------------------------------------------ -------------------- --------------------
Total Policy Liabilities 128,037,601 127,137,804
Note payable - bank 3,145,835 4,133,335
Note payable - related party 3,000,000 3,000,000
Accrued expenses and other liabilities 2,444,868 1,805,934
Deferred federal income tax 746,991 1,969,850
------------------------------------------------------------------------ -------------------- --------------------
Total Liabilities 137,375,295 138,046,923
Commitments and Contingencies
Shareholders' Equity:
Common stock, 6,000,000 shares authorized;
1,677,628 and 1,685,228 shares issued and outstanding
in 2004 and 2003, respectively 1,677,628 1,685,228
Additional paid-in capital 7,120,921 7,170,321
Accumulated other comprehensive income 3,089,428 4,595,473
Retained earnings 6,546,082 7,382,387
------------------------------------------------------------------------ -------------------- --------------------
Total Shareholders' Equity 18,434,059 20,833,409
------------------------------------------------------------------------ -------------------- --------------------
Total Liabilities and Shareholders' Equity $ 155,809,354 $ 158,880,332
------------------------------------------------------------------------ -------------------- --------------------
See Notes to Condensed Consolidated Financial Statements.
Part I; Item 1 (continued)
Citizens Financial Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended September 30 2004 2003
------------------------------------------------------------------------ -------------------- --------------------
Cash Flows from Operations:
Net loss $ (836,299) $ (400,183)
Adjustments to reconcile net loss to cash from operations:
Increase in benefit reserves 1,185,398 5,824,530
Decrease in claim liabilities (17,600) (219,469)
Decrease in reinsurance recoverable 272,219 280,730
Interest credited on policyholder deposits 415,676 522,627
Provision for amortization and depreciation, net of deferrals 608,594 59,851
Amortization of premium and accretion of discount on
securities purchased, net (22,802) 63,281
Net realized investment gains (1,203,866) (760,829)
(Increase) decrease in accrued investment income 66,461 (97,524)
Change in other assets and liabilities 290,939 66,404
Decrease (increase) in deferred federal income tax liability 1,541 (121,000)
Increase in federal income taxes receivable (154,749) (60,000)
------------------------------------------------------------------------ -------------------- --------------------
Net Cash provided by Operations 605,512 5,158,418
Cash Flows from Investment Activities:
Cost of securities acquired (35,273,943) (61,311,997)
Investments sold or matured 38,351,808 55,699,136
Investment management fees (355,241) (12,552)
Additions to real estate (74,522) (26,529)
(Additions) reductions to property and equipment, net 975,063 (12,195)
Other investing activities, net 9,872 (101,172)
------------------------------------------------------------------------ -------------------- --------------------
Net Cash provided by (used in) Investment Activities 3,633,037 (5,765,309)
Cash Flows from Financing Activities:
Policyholder deposits 464,466 417,888
Policyholder withdrawals (1,064,621) (1,178,146)
Payments on notes payable - bank (987,500) (1,316,666)
Repurchase of common stock (57,000) (7,759)
------------------------------------------------------------------------ -------------------- --------------------
Net Cash used in Financing Activities (1,644,655) (2,084,683)
------------------------------------------------------------------------ -------------------- --------------------
Net Increase (Decrease) in Cash and Cash Equivalents 2,593,894 (2,691,574)
Cash and Cash Equivalents at Beginning of Period 8,588,896 6,699,171
------------------------------------------------------------------------ -------------------- --------------------
------------------------------------------------------------------------ -------------------- --------------------
Cash and Cash Equivalents at End of Period $11,182,790 $ 4,007,597
------------------------------------------------------------------------ -------------------- --------------------
See Notes to Condensed Consolidated Financial Statements.
Part I; Item 1 (continued)
Citizens Financial Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
Note 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q in conformity with
accounting principles generally accepted in the United States. The accompanying
unaudited condensed financial statements reflect all adjustments that are, in
the opinion of management, necessary to a fair presentation of the results for
the interim periods. All such adjustments are of a normal recurring nature. For
further information, refer to the December 31, 2003 consolidated financial
statements and footnotes included in the Company's annual report on Form 10-K.
Note 2 - COMPREHENSIVE INCOME
The components of comprehensive income (loss), net of related tax, for the three
and nine month periods ended September 30, 2004 and 2003 are as follows:
---------------------------------- ----------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
----------------- ---------------- ----------------- ----------------
COMPREHENSIVE INCOME: 2004 2003 2004 2003
------------------------------------------- ----------------- ---------------- ----------------- ----------------
Net Income (Loss) $ 145,983 $ 252,875 $ (836,299) $ (400,183)
Net unrealized gains (losses) on
securities 1,313,490 (526,373) (1,506,044) 2,312,710
------------------------------------------- ----------------- ---------------- ----------------- ----------------
Comprehensive Income (Loss) $ 1,459,473 $ (273,498) $(2,342,343) $1,912,527
------------------------------------------- ----------------- ---------------- ----------------- ----------------
Note 3 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company's derivatives outstanding at September 30, 2004 include
approximately $237,000 of embedded options on convertible bonds and $43,000 of
other open option positions. Hedge accounting is not used for these securities
and changes in market value are reported currently as realized gains or losses.
Note 4 - NET REALIZED INVESTMENT GAINS, NET OF EXPENSES
The Company recorded pretax reductions to the carrying value of available for
sale securities totaling $754,000 and $135,000 for the nine months ended
September 30, 2004 and 2003, respectively, relating to declines in value which
were considered by management to be other than temporary. These amounts are
included along with other net realized gains. Until the Company terminated its
investment management agreements on January 31, 2004, the Company also netted
certain direct, incremental investment management fees against net realized
investment gains presented in the Condensed Consolidated Statements of
Operations. Such costs are based directly on or, are primarily associated with
capital gains. Costs netted against realized investment gains total $46,000 and
$236,000 for the nine months ended September 30, 2004 and 2003, respectively.
Note 5 - INCOME TAXES
Current taxes are provided based on estimates of the projected effective annual
tax rate. Deferred taxes reflect the net effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The effective tax rate
differs from the statutory tax rate of 34% primarily due to the small life
insurance company tax deduction and dividends-received tax deductions.
Part I; Item 1 (continued)
The Company has recorded no tax benefit for the nine months ended September 30,
2004 due to the inability to carry back any additional net operating losses for
tax purposes and management's judgment that it is not likely the full tax
benefit will be realized in the foreseeable future.
Note 6 - SEGMENT INFORMATION
The Company's operations are managed along five principal insurance product
lines: Home Service Life, Broker Life, Preneed Life, Dental, and Other Health.
Products in all five lines are sold through independent agency operations. Home
Service Life consists primarily of traditional life insurance coverage sold in
amounts of $10,000 and under to middle and lower income individuals. This
distribution channel is characterized by a significant amount of agent contact
with customers throughout the year. Broker Life product sales consist primarily
of simplified issue and graded-benefit policies in amounts of $10,000 and under.
Other products in this segment, which are not aggressively marketed, include:
group life, universal life, annuities and participating life policies. Preneed
Life products are sold to individuals in connection with prearrangement of their
funeral and include single premium and multi-pay policies with face values
generally in amounts of $10,000 and less. These policies are generally sold to
older individuals at increased premium rates. Dental products are term policies
generally sold to small and intermediate size employer groups. Other Health
products include various accident and health policies sold to individuals and
employer groups. Segment information as of September 30, 2004 and 2003, and for
the periods then ended is as follows:
---------------------------------- ----------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
------------------ --------------- ---------------- -----------------
REVENUE: 2004 2003 2004 2003
------------------------------------------- ------------------ --------------- ---------------- -----------------
Home Service Life $ 2,258,087 $ 2,267,969 $ 6,843,235 $ 6,815,681
Broker Life 1,438,001 1,485,946 4,432,764 4,317,588
Preneed Life 2,425,517 3,953,455 7,442,557 12,288,540
Dental 2,460,382 2,052,254 6,967,390 6,290,470
Other Health 257,723 339,705 856,937 1,041,476
------------------------------------------- ------------------ --------------- ---------------- -----------------
Segment Totals 8,839,710 10,099,329 26,542,882 30,753,755
Net realized investment gains (losses) 914,109 925,557 1,203,866 760,829
------------------------------------------- ------------------ --------------- ---------------- -----------------
Total Revenue $9,753,819 $ 11,024,886 $ 27,746,748 $ 31,514,584
------------------------------------------- ------------------ --------------- ---------------- -----------------
Below are the net investment income amounts which are included in the revenue
totals above.
---------------------------------- ----------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
----------------- ---------------- ----------------- ----------------
NET INVESTMENT INCOME: 2004 2003 2004 2003
------------------------------------------- ----------------- ---------------- ----------------- ----------------
Home Service Life $ 482,579 $ 434,121 $ 1,376,742 $ 1,208,152
Broker Life 606,476 580,429 1,813,459 1,633,080
Preneed Life 630,611 537,241 1,811,312 1,413,597
Dental 10,347 7,047 28,045 18,780
Other Health 21,184 22,003 61,616 59,071
------------------------------------------- ----------------- ---------------- ------------------ ---------------
Segment Totals $ 1,751,197 $1,580,841 $ 5,091,174 $4,332,680
------------------------------------------- ----------------- ---------------- ------------------ ---------------
Part I; Item 1 (continued)
The Company evaluates performance based on several factors, of which the primary
financial measure is segment profit. Segment profit represents pretax earnings,
except net realized investment gains and interest expense are excluded. A
significant portion of the Company's realized investment gains are generated
from investments in equity securities. The equities portfolio averaged (on a
cost basis) approximately $12,011,000 and $9,941,000 during the nine months
ended September 30, 2004 and 2003, respectively.
---------------------------------- ---------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
----------------- ---------------- ---------------- ----------------
SEGMENT PROFIT (LOSS): 2004 2003 2004 2003
-------------------------------------------- ----------------- ---------------- ---------------- ----------------
Home Service Life $ 69,150 $ (122,951) $ 7,653 $ (36,241)
Broker Life (40,954) (312,089) (507,584) (487,753)
Preneed Life (442,352) (59,469) (732,577) (438,880)
Dental (103,444) (10,726) (275,837) 195,170
Other Health (149,980) (57,379) (266,052) (234,631)
-------------------------------------------- ----------------- ---------------- ---------------- ----------------
Segment Totals (667,580) (562,614) (1,774,397) (1,002,335)
Net realized investment gains 914,109 925,557 1,203,866 760,829
Interest expense 87,942 90,068 265,768 279,677
-------------------------------------------- ----------------- ---------------- ---------------- ----------------
Profit (Loss) before Federal Income Tax $ 158,587 $ 272,875 $ (836,299) $ (521,183)
-------------------------------------------- ----------------- ---------------- ---------------- ----------------
Depreciation and amortization amounts below consist of depreciation expense
along with amortization of the value of insurance acquired and deferred policy
acquisition costs.
------------------------------- -------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------- --------------- --------------- ---------------
DEPRECIATION AND AMORTIZATION: 2004 2003 2004 2003
------------------------------------------------- --------------- --------------- --------------- ---------------
Home Service Life $ 262,179 $ 196,679 $ 496,256 $ 548,657
Broker Life 105,418 182,691 303,600 468,398
Preneed Life 226,266 147,511 652,624 597,884
Dental 9,723 15,759 37,694 44,284
Other Health 11,152 7,918 58,259 24,080
------------------------------------------------- --------------- --------------- --------------- ---------------
Segment Totals $ 614,738 $ 550,558 $1,548,433 $1,683,303
------------------------------------------------- --------------- --------------- --------------- ---------------
Segment asset totals are determined based on policy liabilities outstanding in
each segment.
----------------- ----------------
September 30, December 31,
ASSETS: 2004 2003
--------------------------------------------- ----------------- ----------------
Home Service Life $ 41,088,897 $41,312,914
Broker Life 53,477,111 54,585,019
Preneed Life 58,553,630 60,100,723
Dental 906,899 930,279
Other Health 1,782,817 1,951,397
--------------------------------------------- ----------------- ----------------
Segment Totals $155,809,354 $158,880,332
--------------------------------------------- ----------------- ----------------
Part I; Item 1 (continued)
Note 7 - LITIGATION
United Liberty Life Insurance Company, which the Company acquired in 1998, is
defending an action in an Ohio state court brought by two policyholders in 2000.
The Complaint referred to a class of life insurance policies, including related
certificates of participation, that United Liberty issued over a period of years
ending around 1971 (known as "Five Star Policies"). It alleged that United
Liberty's dividend payments on these policies from 1993 through 1999 were less
than the amounts required by the certificates of participation. It did not
specify the amount of the alleged underpayment but implied a maximum of about
$850,000. The plaintiffs also alleged that United Liberty is liable to pay
punitive damages, also in an unspecified amount, for breach of an implied
covenant of good faith and fair dealing to the plaintiffs in relation to the
dividends. The action has been certified as a class action on behalf of all
policyholders who were Ohio residents and whose policies were still in force in
1993. United Liberty denied the material allegations of the Complaint and has
defended the action vigorously.
As a result of a provisional settlement agreement dated October 8, 2004 that
would apply to all holders of the Five Star policies wherever they reside, the
Company has recognized as of September 30, 2004 an obligation for future
payments to the policyholders and their attorneys totaling $825,000. The terms
of the settlement agreement are subject to the approval of the court in which
the action is pending. The court has scheduled a hearing on the issue of
approval for January 24, 2005, following notice to members of the class, who
will be afforded the opportunity to argue in support of or opposition to the
settlement agreement. Accordingly, this description is subject to change
depending upon the outcome of the January hearing.
The $825,000 obligation for future payments consist of [i] up to $500,000
payable to all persons who owned Five Star Policies that were still in force in
1993, [ii] $315,000 in attorneys' fees payable to counsel for the class and
[iii] a $10,000 incentive award payable to the lead plaintiffs for the class.
The $500,000 portion is payable in respect of dividend obligations on the Five
Star Policies from 1993 through 2000 and is to be paid in three annual
installments beginning within 60 days after the time within which any appeal may
be taken from the trial court's approval of the settlement agreement has
expired. The Company currently projects the first payment date to be around
April 30, 2005 (the "Initial Payment Date"). The attorneys' fees and incentive
award are also payable by the Initial Payment Date.
The Company has reflected in the Condensed Consolidated Statements of Operations
for the three and nine months ended September 30, 2004 the $500,000 portion of
the amount payable for dividends in "Policy Benefits and Expenses", and the
$325,000 for attorneys' fees and incentive award in "General expenses". The
total amount payable of $825,000 is reflected in the Condensed Consolidated
Statement of Financial Position as of September 30, 2004 in "Accrued expenses
and other liabilities". The Settlement Agreement also provides that the Company
will have no further obligation to pay dividends on the Five Star Policies of
the kind that gave rise to the litigation. This change permitted the Company to
reduce the reserves it will be required to maintain for the Five Star Policies
to the extent they remain in force by the $500,000 settlement amount for
dividends. This reduction in reserves is reflected in the Condensed Consolidated
Statements of Operations for the three and nine months ended September 30, 2004
in "Policyholder benefits", and in the Condensed Consolidated Statement of
Financial Position as of September 30, 2004 in "Future policy benefits".
In 2001, Citizens Security was named a co-defendant in an action in an Alabama
state court brought by an alleged policyholder in which a former independent
agent was also named a defendant. The action was described in or referred to in
Part I, Item 1, of the Company's Form 10-Qs for the quarterly periods ended
March 31 and June 30, 2004. This action was dismissed by agreement of the
parties on August 12, 2004 and the Company paid an amount in complete settlement
of all claims. This amount is included in "Policyholder benefits" in the
Condensed Consolidated Statements of Operations for the nine months ended
September 30, 2004.
In addition, the Company is party to other lawsuits in the normal course of
business. Management believes that recorded claims liabilities are adequate to
ensure that these other suits will be resolved without material financial impact
to the Company.
Part I; Item 1 (continued)
Note 8 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2004, the Company adopted Statement of Position 03-1,
"Accounting and Reporting by Insurance Enterprises for certain Nontraditional
Long-Duration Contracts and for Separate Accounts (SOP 03-1)." The provisions of
SOP 03-1 did not have a material impact on the Company's financial statements.
Part I; Item 2 - Management's Discussion and Analysis
EXECUTIVE SUMMARY
The Company's management continuously monitors the performance and outlook of
the Company by analyzing several indicators that they judge to be critical.
Some, but not necessarily all, of the indicators of particular interest to
management are:
o The general economic environment
o Trend of premium volume
o Lapse rates
o Mortality and morbidity rates
o Trend of general expense levels
o Asset and Shareholders' Equity growth
o General interest rate movements
o Investment yields
o Diversity (e.g. by industry) and mix (e.g. between fixed income
securities and equity securities) of our portfolios
o Segment performance and trends
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's discussion and analysis of its financial condition and results of
operations are based on its consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. Preparation of these financial statements requires the Company to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, the Company evaluates its estimates,
including those related to investments, agent receivables, intangible assets,
policy liabilities, income taxes, regulatory requirements, contingencies and
litigation. The Company bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. The Company believes the following accounting
policies, judgments and estimates, which have been discussed with the Audit
Committee of the Board of Directors, critically impact preparation of its
consolidated financial statements.
Investment in Debt and Equity Securities. The Company holds debt and equity
interests in a variety of companies, many of which are seeking to exploit recent
technology advancements. The majority of these are publicly traded and many have
experienced volatile market prices. We periodically evaluate whether the
declines in fair value of our investments are other-than-temporary. These
evaluations involve significant judgment. Our evaluation consists of a review of
qualitative and quantitative factors, including analysis of the Company's
competitive position in its markets, deterioration in the financial condition of
the issuer, downgrades of the security by a rating agency, and other publicly
available issuer-specific news or general market conditions. Declines in fair
values of securities deemed to be temporary and which the Company has the
ability and intent to hold until recovery are included as an unrealized loss in
shareholders' equity. Declines in fair values of securities deemed to be
other-than-temporary are included in net income as realized investment losses.
Future adverse changes in market conditions or poor operating results of
underlying investments could result in losses or an inability to recover the
current carrying value of the investments, thereby possibly requiring an
impairment charge in the future.
Deferred Acquisition Costs ("DAC"). The Company is required to defer certain
policy acquisition costs and amortize them over future periods. These costs
include commissions and certain other expenses that vary with and are primarily
associated with acquiring new business. The deferred costs are recorded as an
asset commonly referred to as deferred policy acquisition costs. The DAC asset
balance is subsequently charged to income over the lives of the underlying
contracts in relation to the anticipated emergence of revenue or profits. Actual
revenue or profits can vary from Company estimates resulting in increases or
decreases in the rate of amortization. The Company regularly evaluates its DAC
balances to determine if actual experience or other evidence suggests that
earlier estimates should be revised. Assumptions considered significant include
surrender and lapse rates, mortality, expense levels, investment performance,
and estimated interest spread. Should actual experience dictate that the Company
change its assumptions regarding the emergence of future revenues or profits
(commonly referred to as "unlocking"), the Company would record a charge or
credit to bring its DAC balance to the level it would have been if using the new
assumptions from the inception date of each policy.
DAC is also subject to periodic recoverability and loss recognition testing.
These tests ensure that the present value of future contract-related cash flows
will support the capitalized DAC balance to be amortized in the future. The
present value of these cash flows, less the benefit reserve, is compared with
the unamortized DAC balance and if the DAC balance is greater, the deficiency is
charged to expense as a component of amortization and the asset balance is
reduced to the recoverable amount. For more information about accounting for DAC
see Note 1, Summary of Significant Accounting Policies, in the Notes to
Consolidated Financial Statements included in the Company's Form 10-Q/A for
December 31, 2003.
Goodwill and Intangible Impairment. The balance of our goodwill and value of
insurance acquired (VIF) was $3.6 million at September 30, 2004. The recovery of
these assets is dependent on the fair value of the business to which they
relate. Effective in 2002, pursuant to SFAS No. 142, "Goodwill and Other
Intangible Assets", ("SFAS No. 142"), goodwill is no longer amortized but is
subject to annual impairment tests based on the estimated fair value of the
respective assets. There are numerous assumptions and estimates underlying the
determination of the estimated fair value of these assets. Different valuation
methods and assumptions can produce significantly different results that could
affect the amount of any potential impairment charge that might be required to
be recognized. During both 2004 and 2003, the Company concluded that no
impairment adjustment was necessary for its goodwill or VIF.
Policy Liabilities and Policy Intangible Assets. Establishing policy liabilities
for the Company's long-duration insurance contracts requires making many
assumptions, including policyholder persistency, mortality rates, investment
yields, discretionary benefit increases, new business pricing, and operating
expense levels. The Company evaluates historical experience for these factors
when assessing the need for changing current assumptions. However, since many of
these factors are interdependent and subject to short-term volatility during the
long-duration contract period, substantial estimates and judgment are required.
Accordingly, if actual experience emerges differently from that assumed, any
such difference would be recognized in the current year's Consolidated Statement
of Operations.
Deferred Taxes. The Company records a valuation allowance to reduce its deferred
tax assets to the amount that it believes is more likely than not to be
realized. In assessing the need for the valuation allowance, the Company has not
assumed future taxable income. In the event the Company were to determine that
it would be able to realize its deferred tax assets in the future in excess of
its net recorded amount, an adjustment to deferred tax assets would increase
income in the period such determination was made. Likewise, should the Company
determine that it would not be able to realize all or part of its net deferred
tax assets in the future, an adjustment to deferred tax assets would be charged
to income in the period such determination was made.
Litigation. As further described in Note 7 of the Notes to Consolidated
Financial Statements, United Liberty has been a party to an outstanding lawsuit
concerning payment of policyholder dividends. The parties have reached a
provisional settlement agreement dated October 8, 2004. As described in Note 7,
the Company has recorded the financial impact of the agreement as of September
30, 2004.
OPERATIONS. Net premiums and other considerations decreased approximately
$1,411,000, or 16.7% during the three months ended September 30, 2004 compared
to the three months ended September 30, 2003 and decreased approximately
$4,934,000 for the first nine months of 2004 compared to the first nine months
of 2003. Below is a summary of net premiums earned by segment, for the three and
nine month periods ended September 30, 2004, along with the change from the same
periods of 2003.
--------------------------------- -------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
----------------- --------------- --------------- ---------------
NET PREMIUMS EARNED Total Change Total Change
---------------------------------- ----------------- --------------- --------------- ---------------
Home Service Life $ 1,765,959 $ (55,121) $ 5,433,083 $ (130,154)
Broker Life 798,906 (89,616) 2,577,497 (47,144)
Preneed Life 1,809,504 (1,590,581) 5,585,090 (5,238,031)
Dental 2,449,825 404,828 6,938,664 667,662
Other Health 236,122 (80,926) 793,826 (186,415)
---------------------------------- ----------------- --------------- --------------- ---------------
Segment Totals $ 7,060,316 $ (1,411,416) $21,328,160 $(4,934,082)
---------------------------------- ----------------- --------------- --------------- ---------------
Preneed Life premiums declined during the three quarters of 2004 compared to the
same period in 2003 as the result of the Company lowering crediting rates
related to face amount growth, lowering commission rates and changing the focus
of our marketing efforts in the second half of 2003 and further reducing
crediting rates as of September 1, 2004. The Company is in the process of
redirecting the focus of our marketing efforts to the Home Service, Broker and
Dental segments in an effort to improve profitability in those segments. During
2004, Dental premiums were favorably impacted by additional broker
relationships, increasing participation of certain groups and normal
inflationary premium increases. The Other Health segment products are not being
actively marketed. All other segments experienced only modest changes in premium
from the first three quarters of 2003.
The increase in net benefit reserves decreased $4,700,000 or 79% during the
first three quarters of 2004 compared to the same period in 2003 primarily due
to the decrease in Preneed policies issued and in force during the period. The
decrease in net benefit reserves in the third quarter was $2,027,000 or 100%
compared to the third quarter of 2003.
Pretax loss increased approximately $315,000 to $836,000 for the nine months
ended September 30, 2004, primarily due to unfavorable mortality and Dental
morbidity rates, settlement of two separate lawsuits and increased general
expenses, partially offset by an increase in realized investment gains of
$443,000 and an increase in net investment income of $758,000. Net investment
income increased 17.5% for the first three quarters of 2004 compared to the same
period of 2003, in spite of a decline in invested assets, due to an increased
yield on the Company's fixed maturities portfolio resulting from investing in
longer term fixed maturity securities. Net realized investment gains increased
to $1,204,000 for the first nine months of 2004 from net investment gains of
$761,000 for the same period in 2003. Net benefits increased $1,432,000 or 9%
during the first nine months of 2004 from the same period in 2003 due primarily
to adverse mortality rates in the Broker and the Preneed segments along with
adverse morbidity in the Dental and Other Health segments, partially offset by
an increase in Net realized investment gains of $443,000. Commissions decreased
$1,323,000 or 26% for the nine months ended September 30, 2004 compared to the
same period in 2003 due to a lowering in commission rates in the second half of
2003 on the Preneed premium and the decrease in that premium. General expenses
increased $645,000, or 12.4% for the first nine months of 2004 due to the
Company continuing to incur costs associated with outside consultants who were
employed to review profitability of the Company's life products and perform
other actuarial calculations and analysis, the cost of a severance agreement
settlement, legal costs associated with two separate litigation cases, and the
costs of a market conduct examination conducted by the Office of Insurance of
the Company's domiciliary state. Policy acquisition costs deferred decreased
$687,000 or 42% for the nine months ended September 30, 2004 compared to the
same period in 2003 principally due to the substantial decline in first year
Preneed premiums during the same period. Pretax Segment loss (excluding realized
investment gains (losses) and interest expense) for the first nine months of
2004 was approximately $1,774,000 compared to $1,002,000 for the first nine
months of 2003. This is primarily attributable to the factors described above
relative to revenue changes, mortality and morbidity rates, increased general
expenses and the settlement of two separate lawsuits discussed in Note 7 to the
Condensed Consolidated Financial Statements. Below are the approximate,
annualized pretax investment income and total return yields for the nine months
ended September 30, 2004 and 2003.
----------------- -----------------
Nine Months Ended September 30 2004 2003
-------------------------------------------- ----------------- -----------------
Investment Income $ 5,091,174 $ 4,332,680
Realized and Unrealized Gains (Losses) (1,127,711) 4,357,479
-------------------------------------------- ----------------- -----------------
Total Return $ 3,963,463 $ 8,690,159
-------------------------------------------- ----------------- -----------------
Average Cash and Investments $135,697,066 $130,248,047
Investment Income Yield - Annualized 4.99% 4.44%
Total Return - Annualized 3.88% 8.90%
The Company has recorded no income tax benefit due to not having any ability to
carry back any additional net operating losses for tax purposes and management's
judgment that it is not likely the full tax benefit will be realized in the
foreseeable future.
FINANCIAL POSITION. Shareholders' equity totaled approximately $18,434,000 and
$20,833,000 at September 30, 2004 and December 31, 2003, respectively. These
balances reflect an approximate 11.5% decrease for the nine months ended
September 30, 2004. As described above, the comprehensive income (loss) totaled
approximately $(2,472,000) and $1,913,000 for the nine months ended September
30, 2004 and 2003, respectively. A significant portion of the comprehensive
income (loss) is attributable to changes in the value of the Company's fixed
maturity and equity portfolios. Equity securities comprised approximately 7.9%
and 7.1% of the Company's total assets as of September 30, 2004 and December 31,
2003, respectively. Accordingly, as also described below, the Company's
financial position can be significantly affected by movements in the equities
markets. Equity portfolio positions increased $2,489,000 on a cost basis and
$990,000 on a market value basis, during the first nine months of 2004. Fixed
maturity portfolio positions decreased $4,139,000 on an amortized cost basis and
$4,971,000 on a market value basis during the same period. This difference
resulted primarily from disposals and maturities during the period. Cash and
cash equivalent positions increased approximately $7,441,000 during the quarter
ended September 30, 2004 primarily due to recent reductions in the Company's
fixed income and equities portfolios to take advantage of favorable market
conditions.
Equity markets continue to be highly volatile and were slightly unfavorable in
the third quarter of 2004. Interest yields on fixed maturity investments held in
our portfolio are continuing to slowly increase. Low short-term rates continue
to adversely impact the Company's investment portfolio yield and operating
earnings. The 2004 environment described continues to generate a relatively high
level of qualitative investment risk. However, measures of quantitative risk per
unit of investment are not believed to have changed significantly from those
previously disclosed in the Company's 2003 Form 10-K/A.
OFF-BALANCE SHEET ARRANGEMENTS
The Company does not participate in any off-balance sheet arrangements.
CASH FLOW AND LIQUIDITY. Cash flow from operations totaled $606,000 for the nine
months ended September 30, 2004 compared to $5,158,000 for the same period in
the prior year. The decrease in the positive cash flow is primarily attributable
to the decline in Preneed Life business which was growing during the second
quarter of 2003 and adverse mortality and morbidity rates. The $3,633,000 of
cash provided from investing activities for the nine months ended September 30,
2004 resulted primarily from sales and maturities of investments late in the
third quarter and by proceeds from the sale of the Company's interest in an
aircraft. The $1,645,000 of cash used in financing activities during the first
nine months of 2004 is primarily attributable to bank loan principal repayments
along with annuity and Universal Life account withdrawals. The Company also
purchased 7,600 shares of its common stock at a price of $7.50 per share as part
of a buy back plan. Due to continued earnings pressure from low yields on
investments and cash equivalents and the declining Preneed premiums, the Company
is completing a strategic review of its products and operations. A key element
of this initiative is improving profitability of the Preneed, Home Service, and
Broker Life segments by increasing premiums in the Home Service and Broker
segments, strengthening underwriting practices, modifying commissions, and where
possible, lowering interest crediting or policy growth rates. Regarding the
currently scheduled debt repayments, the Company believes its available funds
will be adequate to service 2004 debt obligations and, with other available
assets, management believes it will be adequate to service debt obligations
through 2005. The Company sold its interest in an aircraft to SMC Advisors Inc.,
an entity owned by the Company's Chairman, in April 2004, generating $971,000 in
additional cash. In addition, the Company's Chairman has expressed potential
willingness to loan the Company an additional $2,000,000 if necessary, which
could service debt obligations through the majority of 2007. For the quarter
ended September 30, 2004, the Company did not meet one of its bank debt
covenants (debt to earnings ratio), however the lender has waived this violation
for the quarter and for several previous quarters. In return for the waiver the
Company's Chairman has personally guaranteed the outstanding bank debt.
FORWARD-LOOKING INFORMATION.
All statements, trend analyses and other information contained in this report
relative to markets for the Company's products and trends in the Company's
operations or financial results, as well as other statements including words
such as "anticipate", "believe", "plan", "estimate", "expect", "intend", and
other similar expressions, constitute forward-looking statements under the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements are subject to known and unknown risks, uncertainties and other
factors which may cause actual results to be materially different from those
contemplated by the forward-looking statements. Such factors include, among
other things:
|X| the market value of the Company's investments, including stock market
performance and prevailing interest rate levels;
|X| customer and agent response to new products, distribution channels and
marketing initiatives, including exposure to unrecoverable advanced
commissions;
|X| mortality, morbidity, lapse rates, and other factors which may affect
the profitability of the Company's insurance products;
|X| regulatory changes or actions, including those relating to regulation of
insurance products and insurance companies;
|X| ratings assigned to the Company's insurance subsidiaries by independent
rating organizations which the Company believes are important to the
sale of its products;
|X| general economic conditions and increasing competition which may affect
the Company's ability to sell its products;
|X| the Company's ability to achieve anticipated levels of operating
efficiencies and meet cash requirements based upon projected
liquidity sources;
|X| unanticipated adverse litigation outcomes; and
|X| changes in the Federal income tax laws and regulations that may affect
the relative tax advantages of some of the Company's products.
There can be no assurance that other factors not currently anticipated by
management will not also materially and adversely affect the Company's results
of operations.
Part I; Item 3 - Quantitative and Qualitative Disclosures about Market Risk
Quantitative and Qualitative Risk. The primary changes in quantitative market
risks during the nine months ended September 30, 2004 are discussed in Part I,
Item 2 above.
Part I; Item 4 - Controls and Procedures
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Within the past 90 days, the
Company conducted an evaluation of its disclosure controls and procedures, with
the supervision and participation of its Chief Executive Officer and Principal
Financial Officer. The Company does not expect that its disclosure controls and
procedures will prevent all error and fraud. Such a control system, no matter
how well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further, the design
of a control system must balance the constraint of prudent resource expenditure
with a judgmental evaluation of risks and benefits. Based on this evaluation of
disclosure controls and procedures, the Company's Chief Executive Officer and
Principal Financial Officer have concluded that such controls and procedures
provide reasonable assurance that material information required to be included
in the Company's periodic SEC reports is made known on a timely basis to the
Company's principal executive and financial officers.
CHANGES IN INTERNAL CONTROLS. There have been no significant changes in the
Company's internal controls or changes in other factors that could significantly
affect these controls subsequent to their evaluation, nor has the Company
implemented any corrective actions regarding significant deficiencies or
material weaknesses in internal controls.
Part II - Other Information
Item 1. Legal Proceedings.
In 2001, Citizens Security Life Insurance Company was named a co-defendant in an
action in an Alabama state court brought by an alleged policyholder in which a
former independent agent was also named a defendant. The action was described in
Part II, Item 1, of the Company's Form 10-Q for the quarterly period ended March
31, 2004 and described or referred to in Part I, Item 1, of the Company's Form
10-Qs for the periods ended March 31 and June 30, 2004 and herein. This action
was dismissed by agreement of the parties on August 12, 2004 and the Company
paid an amount in complete settlement of all claims. This amount is included in
"Polcyholder benefits" in the Condensed Consolidated Statement of Operations for
the nine months ended September 30, 2004.
Item 6. Exhibits.
Exhibit 11 Statement re: computation of per share earnings
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification --Principal
Executive Officer
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification --Principal
Financial Officer
Exhibit 32.1 Section 1350 Certification --Principal Executive
Officer
Exhibit 32.2 Section 1350 Certification --Principal Financial
Officer
SIGNATURES
In accordance with the requirements of the Securities and Exchange Act of 1934,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
CITIZENS FINANCIAL CORPORATION
BY: /s/ Darrell R. Wells
-----------------------------------------
Darrell R. Wells
President and Chief Executive Officer
BY: /s/ Len E. Schweitzer
-----------------------------------------
Len E. Schweitzer
Treasurer and Principal Financial Officer
Date: November 9, 2004