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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 1998
TRANSITION REPORT UNDER 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
(Name of small business issuer 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
(Issuer's telephone number)
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act: Class A
Stock, No Par Value
Check whether the issuer (1) filed all reports required to be filed by
Sections 13 or 15(d) of the Exchange Act during the past 12 months, and (2)
has been subject to such filing requirements for the past 90 days.
Yes X No
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy
information or information statements incorporated by reference in Part III
of this Form 10-KSB or any amendment to this Form 10-KSB. [ X ]
State issuer's revenues for its most recent fiscal year: $27,277,005.
State the aggregate market value of the common equity held by
non-affiliates: $7,179,000 (based on a $9.50 per share quoted price on
March 26, 1999).
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: 1,800,315 shares of Class A
stock as of March 26, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the issuer's Board of Director's Proxy Statement for the Annual
Meeting of Shareholders now scheduled for May 20, 1999 are incorporated into
Part III of this Form 10-KSB.
Transitional Small Business Disclosure Format (Check one): Yes No X
This Report consists of 51 consecutively numbered pages. The date of this
Report is March 31, 1999.
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CONTENTS
PART I
Page
ITEM 1. DESCRIPTION OF BUSINESS........................... 3
ITEM 2. DESCRIPTION OF PROPERTY........................... 10
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS ................................... 10
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS ...................... 10
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR
PLAN OF OPERATIONS ............................... 12
ITEM 7. FINANCIAL STATEMENTS.............................. 24
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE ................ 46
PART III
ITEM 9 DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS,
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT ... 46
ITEM 10. EXECUTIVE COMPENSATION .............................. 46
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT ........................ 46
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS ................................. 46
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K .................... 47
SIGNATURES ................................................... 48
EXHIBIT INDEX ................................................ 49
EXHIBITS...................................................... 51
PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
Citizens Financial Corporation (herein, the "Company" or the "Registrant")
was incorporated in Kentucky in 1990 at the direction of the Board of
Directors of Citizens Security Life Insurance Company ("Citizens Security")
for the ultimate purpose of becoming an insurance holding company. Pursuant
to a merger completed in 1991, Citizens Security became a wholly-owned
subsidiary of the Company. The Company is now a holding company that engages
in the business of life insurance, annuities, and accident and health
insurance through Citizens Security and United Liberty Life Insurance Company
"United Liberty") (herein collectively, the "Insurance Subsidiaries").
Citizens Security was incorporated in Kentucky and commenced business in
1965. In 1971, Citizens Security acquired Central Investors Life Insurance
Company by merger. In 1987, it purchased the stock of Old South Life
Insurance Company ("Old South"). In 1992, Old South merged into Citizens
Security. In 1995, the Company and Citizens Security purchased substantially
all of the stock of Integrity National Life Insurance Company ("Integrity")
and merged it into Citizens Security. On May 12, 1998, Citizens Security
purchased all of the outstanding shares of United Liberty. See Item 6.
"Management's Discussion and Analysis or Plan of Operations" and Item 7, Note
2 of the Notes to Consolidated Financial Statements for a description of this
acquisition. The Insurance Subsidiaries are currently licensed to transact
the business of life insurance, annuities, and accident and health
insurance. Citizens Security is licensed in twenty states and the District
of Columbia while United Liberty is licensed in twenty-three states.
Insurance Operations
The Company, through its Insurance Subsidiaries, operates in five segments --
1) home service life insurance, 2) broker-sold life insurance and annuities,
3) preneed life insurance, 4) dental insurance, and 5) other health and
accident insurance. The home service and preneed life segments provide
individual coverages; the dental segment provides group coverages; while the
broker life and other health segments include individual and group
insurance. The following table presents each business segment's revenue;
pretax income or loss excluding realized investment gains and interest
expense; and ending assets for each of the last three fiscal years.
Additional segment information is contained in Item 6, "Management's
Discussion and Analysis or Plan of Operations" and in Item 7, Note 11 of the
Notes to Consolidated Financial Statements.
Segment Revenue, Profit or Loss, and Assets:
Segment Revenue, Profit or Loss, and Assets:
Year Ended December 31 1998 1997 1996
- -------------------------------------------------------------------------
Revenue:
Home Service Life $ 8,315,66 $ 8,322,33 $ 8,660,688
Broker Life 5,341,104 4,482,486 4,860,066
Preneed Life 2,099,584 --- ---
Dental 6,435,680 7,218,575 6,938,889
Other Health 1,409,483 1,485,301 1,675,480
- -------------------------------------------------------------------------
Segment Totals 23,601,516 21,508,695 22,135,123
Net realized investment gains, 3,675,489 2,193,148 915,062
net of expenses
- -------------------------------------------------------------------------
Total Revenue $ 27,277,00 $23,701,84 $23,050,185
- -------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- -------------------------------------------------------------------------
Segment Profit (Loss):
Home Service Life $ 211,71 $97,98 703,509
Broker Life 254,189 100,655 223,739
Preneed Life 15,325 --- ---
Dental 295,038 214,495 (105,254)
Other Health 90,174 206,591 382,895
- -------------------------------------------------------------------------
Segment Totals 866,439 618,839 1,204,889
Net realized investment gains, 3,675,489 2,193,148 915,062
net of expenses
Interest expense 468,268 341,275 784,325
- -------------------------------------------------------------------------
Income before Federal Income Tax $ 4,073,66 2,470,71 1,335,626
- -------------------------------------------------------------------------
December 31 1998 1997 1996
- -------------------------------------------------------------------------
Assets:
Home Service Life $ 43,299,03 42,944,97 39,484,726
Broker Life 52,783,159 39,165,663 38,063,665
Preneed Life 30,869,962 --- ---
Dental 674,728 699,382 747,463
Other Health 1,872,237 1,939,822 1,966,854
- -------------------------------------------------------------------------
Total Assets $129,499,123 84,749,84 80,262,708
- -------------------------------------------------------------------------
Home Service Life. The Home Service Life segment consist of traditional
whole life insurance, which provides policyholders with permanent life
insurance and fixed, guaranteed rates of return on the cash value element of
policy premiums. Agents for these products sell primarily small face value
policies (typically from $1,000 to $10,000). These policies are subject to
normal underwriting procedures with the extent of such procedures determined
by the amount of insurance, age of applicant and other pertinent factors.
Broker Life. The Broker Life segment offers traditional whole life
insurance; universal life insurance, which provides policyholders with
permanent life insurance and adjustable rates of return on the cash value
element of policy premiums, based upon current interest rates; annuities;
group life; accidental death and dismemberment; and dependent life insurance.
The majority of Broker Life sales consist of graded death benefit and
simplified issue (traditional, whole life) policies. The graded death
benefit policy returns premium plus interest compounded at an annual rate of
10% if the insured dies of natural causes during the first three years the
policy is in force. After three years, and during the first three years if
the insured dies of an accidental cause, the benefit payable is the face
amount of the policy. Prior to introduction of this product in the second
quarter of 1997, the Company issued graded death benefit policies with a two
year return-of-premium period. The simplified issue product provides full
face amount coverage from date of issue, is more extensively underwritten and
carries lower premium rates than the graded death benefit product. This
product was introduced in the third quarter of 1997. These products are
targeted towards the "final expense market".
Generally, traditional whole life insurance products are more profitable than
universal life policies, in part because investment margins are normally
greater for traditional whole life products than for universal life
policies. Overall profitability on universal life policies may decline as a
result of downward interest crediting rate adjustments to the extent that
policyholders withdraw funds to invest in higher-yielding financial
products. The profitability of traditional whole life products and universal
life policies is also dependent upon the ultimate underwriting experience and
the realization of anticipated unit administrative costs. The Company
believes that the historical claims experience for the traditional whole life
and universal life products issued by the Insurance Subsidiaries has been
within expected ranges, in relation to the mortality assumptions used to
price the products.
Substantially all annuity considerations are attributable to sales of
flexible premium deferred annuities, life policy annuity riders, and single
premium deferred annuities. Generally, a flexible premium deferred annuity
or a life policy annuity rider permits premium payments in such amounts as
the policyholder deems appropriate, while a single premium deferred annuity
requires a one-time lump sum payment.
Preneed Life. The Preneed Life segment products are traditional life
policies sold to individuals in connection with prearrangement of their
funeral and include single and multi-pay coverages, generally in amounts of
$10,000 and less. These policies are generally sold to older individuals at
increased premium rates.
The following table provides information concerning the Insurance
Subsidiaries' volume of life insurance coverage in force excluding
participation in group underwriting pools for federal employees (FEGLI) and
service personnel (SGLI) for each of the last three fiscal years.
Year Ended December 31
(Dollars in Thousands) 1998 1997 1996
- ----------------------------------- -------------- ------------- --------------
In force at beginning of period1 $680,664 $712,581 $769,471
Acquired business of United
Liberty $88,107 --- ---
New business issued during period:
Individual 65,860 61,519 51,477
Group 4,026 3,755 6,787
- ----------------------------------- -------------- ------------- --------------
Total $ 69,886 $ 65,274 $58,264
- ----------------------------------- -------------- ------------- --------------
Terminations during period $ 81,086 $ 97,191 $115,154
Termination rate2 10.80% 13.64% 14.97%
In force at end of period1:
Individual 590,467 507,381 515,163
Group 167,104 173,283 197,418
- ----------------------------------- -------------- ------------- --------------
Total $757,571 $680,664 $712,581
- ----------------------------------- -------------- ------------- --------------
Net reinsurance ceded at end of
period $122,993 $115,218 $129,287
1Before deduction of reinsurance ceded.
2Represents the percentage of individual policies terminated during the
indicated period by lapse, surrender, conversion,
maturity, or otherwise. For 1998, terminations of United Liberty
policies have been annualized.
Dental Insurance. Dental products are indemnity policies sold on a pure
group and voluntary group basis. Voluntary dental groups must meet
prescribed participation limits. All dental products have annual limits on
all covered procedures and lifetime limits on orthodontia procedures. In
addition, orthodontia and major restorative procedures are not covered for
the first six months to one year, depending upon the plan, unless a
no-loss-no-gain provision is attached to the policy.
Other Health Insurance. Other Health products include individual accident
and health insurance policies, which provide coverage for monthly income
during periods of hospitalization, scheduled reimbursement for specific
hospital and surgical expenses and cancer treatments, and lump sum payments
for accidental death or dismemberment. Group health plans are also marketed,
providing coverage for short and long-term disability, and income protection.
Marketing. The Insurance Subsidiaries are currently licensed to sell
products in 29 states and the District of Columbia. Citizens Security and
United Liberty are both licensed in the states designated below with a"b"
while only Citizens Security is licensed in the states designated "c" and
only United Liberty in the states designated "u".
b Alabama b Indiana u Nebraska u Oregon
u Arizona u Kansas u Nevada c Pennsylvania
b Arkansas b Kentucky c New Jersey b South
Carolina
u Colorado b Louisiana u New Mexico b Tennessee
c Delaware b Maryland c North b Texas
Carolina
c District of b Mississippi u Oklahoma u Utah
Columbia
b Florida b Missouri b Ohio c Virginia
c Georgia b West
Virginia
The Insurance Subsidiaries market products through the personal producing
general agent distribution system. Approximately 2,100 sales representatives
are licensed as independent agents for the Insurance Subsidiaries. The
majority of these agents also represent other insurers. Approximately 360 of
these agents specialize in the home service market. That market consists
primarily of middle and low-income families and individuals who desire whole
life policies with policy limits typically below $10,000. Agents usually
collect premiums directly at monthly intervals. The home service market has
higher than average policy lapse rates. Approximately 60 agents specialize
in the preneed market. Typically, these agents are funeral directors or
operate from facilities owned by funeral directors.
The Insurance Subsidiaries furnish rate material, brochures, applications,
and other pertinent sales material, at no expense to the agents. The agents
are responsible for complying with state licensing laws and any related
appointment fees. Agents are compensated by commissions. The Insurance
Subsidiaries have agent commission arrangements that are generally intended
to provide competitive incentives for agents to increase their production of
new insurance and to promote continued renewals of in-force insurance.
Historically, these incentives have frequently involved awards, overrides,
and compensation scales that escalate according to achievement levels for
newly-issued business and that provide additional payments for renewal
business.
Underwriting. The Insurance Subsidiaries follow underwriting procedures
designed to assess and quantify insurance risks before issuing life and
health insurance policies to individuals and members of groups. Such
procedures require medical examinations (including blood tests, where
permitted) of applicants for certain policies of health insurance and for
policies of life insurance in excess of certain policy limits. These
requirements are graduated according to the applicant's age and vary by
policy type. The Insurance Subsidiaries also rely upon medical records and
upon each applicant's written application for insurance, which is generally
prepared under the supervision of a trained agent. In issuing health
insurance, information from the application and, in some cases, inspection
reports, physician statements, or medical examinations are used to determine
whether a policy should be issued as applied for, issued with reduced
coverage under a health rider, or rejected.
Acquired Immunodeficiency Syndrome ("AIDS") claims identified to date, as a
percentage of total claims, have not been significant for the Insurance
Subsidiaries. Evaluating the impact of future AIDS claims under health and
life insurance policies issued is extremely difficult, in part due to the
insufficiency and conflicting data regarding the number of persons now
infected with the AIDS virus, uncertainty as to the speed at which the AIDS
virus has and may spread through the general population, and advancements in
medical treatment options. The Insurance Subsidiaries have implemented,
where legally permitted, underwriting procedures designed to assist in the
detection of the AIDS virus in applicants.
Investments. The Company derives a substantial portion of its income from
investments. The Insurance Subsidiaries maintain diversified investment
portfolios that are held primarily to fund future policyholder obligations.
State insurance laws impose certain restrictions on the nature and extent of
investments by insurance companies and, in some states, require divestiture
of assets contravening these restrictions. Within the framework of such
laws, the Insurance Subsidiaries follow a general strategy to maximize total
return (current income plus appreciation) without subjecting themselves to
undue risk. Where deemed appropriate, the Insurance Subsidiaries will hold
selected non-investment grade bonds that provide higher yields or are
convertible to common stock. The Company considers a bond non-investment
grade if it is unrated or rated less than BBB by Standard & Poor's Rating
Group ("S&P") or BAA by Moody's Investors Service ("Moody's"). The Insurance
Subsidiaries' non-investment grade bonds, based on reported fair values,
represented 7.9% of the Company's cash and invested assets as of December 31,
1998. Citizens Security has maintained substantial investments in equity
securities in order to achieve higher investment earnings than can usually be
achieved through portfolio bonds but at a greater comparative risk. The
Company also maintains an investment portfolio of equity securities separate
from those of the Insurance Subsidiaries. Mortgage loans, federally-insured
mortgage-backed securities, collateralized mortgage obligations and real
estate investments, apart from the investment in the office building
described in Item 2. "Description of Property," represented approximately
5.5% of cash and invested assets as of December 31, 1998. Neither the
Company nor its subsidiaries owned any collateralized mortgage-backed
securities as of December 31, 1998 that would be included in the high-risk
classification.
For additional information concerning investment results, see Item 6,
"Management's Discussion and Analysis or Plan of Operations."
Reinsurance. In keeping with industry practice, the Insurance Subsidiaries
reinsure, with unaffiliated insurance companies, portions of the life and
health insurance risks, which it underwrites. The Insurance Subsidiaries
retain no more than $40,000 of individual life insurance risk and $15,000 of
group life insurance risk for any single life. Graded death benefit coverages
above $4,000 are generally 50% reinsured, with the Insurance Subsidiaries
maintaining a maximum $10,000 risk on any one life. Individual and group
accidental death coverage is 100% reinsured. At December 31, 1998,
approximately $122,993,000 or 16% of life insurance in force was reinsured
under arrangements described in Note 12 to the Consolidated Financial
Statements. Under most reinsurance arrangements described above, new
insurance is reinsured automatically rather than on a basis that would
require the reinsurer's prior approval. Generally, the Insurance
Subsidiaries enter into indemnity reinsurance arrangements to assist in
diversifying their risks and to limit its maximum loss on large or unusually
hazardous risks. Indemnity reinsurance does not discharge the ceding
insurer's liability to meet policy claims on the reinsured business.
Accordingly, the Insurance Subsidiaries remain responsible for policy claims
on the reinsured business to the extent a reinsurer should fail to pay such
claims.
Competition. The insurance industry is highly competitive, with over 1,700
life and health insurance companies in the United States. Many insurers and
insurance holding company systems have substantially greater capital and
surplus, larger and more diversified portfolios of life and health insurance
policies, and larger agency sales operations than those of the Insurance
Subsidiaries. Financial and claims-paying ratings assigned to insurers by
A.M. Best Company ("Best") and by nationally-recognized statistical rating
organizations have become more important to policyholders. Citizens
Security's rating was last changed by Best in May, 1996, when it was moved to
B- (Good) in financial size Class IV from C++ (Fair) in the same size Class.
United Liberty's rating at the date of its acquisition was B- (Good) in
financial size Class IV. According to Best, a B- rating is assigned to
companies that, in its opinion, have achieved good overall performance when
compared to the standards established by Best. Also according to Best, B-
companies generally have an adequate ability to meet their policyholder and
other contractual obligations, but their financial strength may be
susceptible to unfavorable changes in underwriting or economic conditions.
There are seven Best rating categories above the B- category from B to A++.
The Insurance Subsidiaries will continue to pursue upward revisions in their
Best ratings.
S&P assigns claims-paying ability ratings to certain U.S. insurers.
Generally, such a rating is S&P's opinion of an insurer's financial capacity
to meet the obligations of its insurance policies in accordance with their
terms. In the case of companies like Citizens Security that have not
requested ratings, S&P's methodology uses statistical tests based on
statutory financial data as filed with the National Association of Insurance
Commissioners ("NAIC"). The rating process does not involve contact between
S&P analysts and the insurer's management. In 1998, S&P changed their rating
methodology and revised Citizens Security's rating from BBq to BBpi. (The
"q" subscript designated the quantitative method of rating while the "pi"
subscript designates the public information method). United Liberty has not
been rated by S&P. According to S&P, BB companies may have adequate
financial security but their capacity to meet policyholder obligations is
vulnerable to adverse economic and underwriting conditions. The BB rating is
the highest of five ratings in the vulnerable range of ratings. The Company
was not informed of particular reasons for the latest change in its rating.
A rating is not a recommendation to buy, sell or hold securities and is
subject to revision or withdrawal by the assigning rating organization. Each
rating should be evaluated independently of any other rating.
The Insurance Subsidiaries compete primarily on the basis of the experience,
size, accessibility and claims response of its customer service
representatives, product design, service and pricing. The Company believes
that the Insurance Subsidiaries are: generally competitive in the markets in
which they are engaged based upon premium rates and services; have good
relationships with their agents; and have an adequate variety of insurance
and annuity products approved for issuance.
State Insurance Regulation. The Insurance Subsidiaries, in common with other
insurers, are subject to comprehensive regulation in the states in which they
are authorized to conduct business. The laws of such states establish
supervisory agencies with broad administrative powers, among other things,
to: grant and revoke licenses for transacting business, regulate the form and
content of policies, establish reserve requirements, prescribe the type and
amount of allowable investments, and review premium rates for fairness and
adequacy. The Insurance Subsidiaries file detailed annual convention
statements with all states in which they are licensed to transact business.
The Kentucky Department of Insurance also periodically examines the business
and accounts of the Insurance Subsidiaries.
The Insurance Subsidiaries also can be required, under the solvency or
guaranty laws of most states in which they do business, to pay assessments
(up to prescribed limits) to fund policyholder losses or liabilities of other
insurance companies that become insolvent. These assessments may be deferred
or foregone under most guaranty laws if they would threaten an insurer's
financial strength and, in certain instances, may be offset against future
premium or intangible property taxes. Gross assessments for the Insurance
Subsidiaries, before offsets for future premium or intangible property taxes,
were $24,665, $15,325, and $20,308 in 1998, 1997 and 1996, respectively. The
amount of any future assessments under these laws cannot be reasonably
estimated.
Kentucky, in common with substantially all states, regulates transactions
between or affecting insurance holding companies and their insurance company
subsidiaries, including the Company and the Insurance Subsidiaries.
Generally, under Kentucky insurance holding company statutes, the Kentucky
Department of Insurance must approve in advance the direct or indirect
acquisition of 15% or more of the voting securities of an insurance company
organized under the laws of Kentucky. Such statutes also regulate certain
transactions among affiliates, including the payment of dividends by an
insurance company to its holding company parent. Under the Kentucky
statutes, the Insurance Subsidiaries may not during any year pay dividends on
their common and preferred stock to their parent company in excess of the
lesser of the net gain from operations for the preceding year or 10% of their
capital and surplus at the end of the preceding year, without the consent of
the Kentucky Commissioner of Insurance. For 1999, the maximum amount of
dividends that Citizens Security and United Liberty could pay, without the
Commissioner's approval, is $1,106,000 and $224,000, respectively. It is
presently anticipated that the Company will derive substantially all of its
liquidity from income and capital gains earned on its investment portfolio,
management service fees and dividends paid by the Insurance Subsidiaries, and
Citizens Security's repurchase of its preferred stock owed by the Company.
During recent years, the National Association of Insurance Commissioners
(NAIC) has taken several steps to address public concerns regarding insurer
solvency. These steps included implementing a state certification program
designed to promote uniformity among the insurance laws of the various states
and developing insurer reporting requirements that focus on asset quality,
capital adequacy, profitability, asset/liability matching, and liquidity.
These requirements include establishment of asset valuation reserves ("AVR")
and interest maintenance reserves ("IMR"); risk-based capital ("RBC") rules
to assess the capital adequacy of an insurer; and a revision to the Standard
Valuation Law ("SVL") that specifies minimum reserve levels and requires cash
flow testing in which projected cash inflows from assets are compared to
projected cash outflows for liabilities to determine reserve adequacy.
The Insurance Subsidiaries' AVR, as of December 31, 1998, 1997 and 1996, is
shown in Item 6. "Management's Discussion and Analysis or Plan of
Operations". Cash flow testing and the results of such testing as applied to
the Insurance Subsidiaries are also described and discussed in Item 6.
RBC provides a means of establishing the capital standards for insurance
companies to support their overall business operations in light of their size
and risk profile. The four categories of major risk involved in the formula
are [i] asset risk -- the risk with respect to the insurer's assets;
[ii] insurance risk -- the risk of adverse insurance experience with respect
to the insurer's liabilities and obligations; [iii] interest rate risk -- the
interest risk with respect to the insurer's business; and [iv] business risk
- -- all other business risks. A company's RBC is calculated by applying
factors to various asset, premium and reserve items, with higher factors for
those items with greater underlying risk and lower for less risky items. RBC
standards are used by regulators to set in motion appropriate regulatory
actions relating to insurers that show signs of weak or deteriorating
conditions. They also provide an additional standard for minimum capital,
below which companies would be placed in conservatorship. Based on RBC
computations as of December 31, 1998, Citizens Security and United Liberty
each have capital levels, which are at least 400% of the minimum requirements.
Action taken by the NAIC in these and other areas may have a significant
impact on the regulation of insurance companies during the next several
years. Given their comparatively small size, it may be expected that the
Insurance Subsidiaries would be affected by more stringent regulatory policy,
both under existing laws and any new regulatory initiatives. Such effects
could include curtailment or discontinuance of insurance underwriting in one
or more states, mandated increases in capital and surplus, and/or other
effects.
Federal Income Taxation. The Insurance Subsidiaries are taxed under the life
insurance company provisions of the Internal Revenue Code of 1986, as amended
(the "Code"). Under the Code, a life insurance company's taxable income
incorporates all income, including life and health premiums, investment
income, and certain decreases in reserves. The Code currently establishes a
maximum corporate tax rate of 35% and imposes a corporate alternative minimum
tax rate of 20%. See Item 6. "Management's Discussion and Analysis or Plan
of Operations" and Note 9 of the Notes to Consolidated Financial Statements.
The Code currently requires capitalization and amortization over a five to
ten year period of certain policy acquisition costs incurred in connection
with the sale of certain insurance products. Prior tax laws permitted these
costs to be deducted as incurred. These provisions apply to life, health,
and annuity business. Certain proposals to make additional changes in the
federal income tax laws, including increasing marginal tax rates, and
regulations affecting insurance companies or insurance products, continue to
be considered at various times in the United States Congress and by the
Internal Revenue Service. The Company currently cannot predict whether any
additional changes will be adopted in the foreseeable future or, if adopted,
whether such measures will have a material effect on its operations.
Reserves. In accordance with applicable insurance laws, the Insurance
Subsidiaries have established and carry as liabilities actuarial reserves to
meet their policy obligations. Life insurance reserves, when added to
interest thereon at certain assumed rates and premiums to be received on
outstanding policies, are required to be sufficient to meet policy
obligations. The actuarial factors used in determining reserves in the
statutory basis financial statements are based upon statutorily prescribed
mortality and interest rates. Reserves maintained for health insurance
include the unearned premiums under each policy, reserves for claims that
have been reported but not yet paid, and reserves for claims that have been
incurred but have not been reported. Furthermore, for all health policies
under which renewability is guaranteed, additional reserves are maintained in
recognition of the actuarially-calculated probability that the frequency and
amount of claims will increase as policies persist. The Insurance
Subsidiaries do not continue accumulating reserves on reinsured business
after it is ceded. The Insurance Subsidiaries are required to maintain
reserves on reinsured business assumed on a basis essentially comparable to
direct insurance reserves. Reinsurance business assumed is presently
insignificant in amount.
The reserves carried in the financial statements included elsewhere in this
Form 10-KSB are calculated on the basis of generally accepted accounting
principles and differ from the reserves specified by the laws of the various
statutes and carried in the financial statements of the Insurance
Subsidiaries prepared on the basis of statutory accounting principles. These
differences arise from the use of different mortality and morbidity tables
and interest assumptions, the introduction of lapse assumptions into the
reserve calculation, and the use of the level premium reserve method on all
insurance business. See Note 1 of the Notes to Consolidated Financial
Statements for certain additional information regarding reserve assumptions
under generally accepted accounting principles.
Employees. The total number of persons employed by the Company and its
subsidiaries on March 26, 1999, exclusive of agents, was 66 of whom 64 were
full time. As of that date, the Company had approximately 2,100 independent
agents licensed to sell its products.
ITEM 2. DESCRIPTION OF PROPERTY
The Company owns, through Citizens Security, a three-story, 63,000 square
foot office building in suburban Louisville, Kentucky completed in 1988. The
Company and its Insurance Subsidiaries occupy about 15,600 square feet in the
building for their headquarters and home offices. Another 47,400 square feet
of the remaining space are leased to unaffiliated tenants under leases of
various duration. Market conditions for this property are favorable and, in
management's opinion, the property is adequately covered by insurance.
Currently, the Company's policy is not to invest in additional real estate or
real estate mortgages, although a change in such policy would not require a
vote of security holders. In addition, the Company's current bank lending
agreement precludes investment in additional real estate and in mortgages
with a loan-to-appraised-value ratio of more than 75%.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings pending against the Company or its
subsidiaries or of which any of their property is the subject other than
routine litigation incidental to the business of the Company and its
subsidiaries. There are no material proceedings in which any director,
officer, affiliate or shareholder of the Company, or any of their associates,
is a party adverse to the Company or any of its subsidiaries or has a
material interest adverse to the Company or any of its subsidiaries.
ITEM 4. SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year covered
by this Form 10KSB to a vote of the Company's security holders, through the
solicitation of proxies or otherwise.
PART II
ITEM 5. MARKET FOR COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
As of March 26, 1999, there were approximately 2,820 holders of record of the
Company's Class A Stock, its only class of common equity.
The Class A Stock is currently eligible for quotation on the National
Association of Securities Dealers, Inc.'s Small-Cap Market ("NASDAQ") under
the trading symbol CNFL. Trading volume in 1998 was about 11% of the average
shares outstanding during the year and about 23% of the average shares owned
by non-affiliates during the year.
The following table summarizes quarterly high and low bid quotations for the
Class A Stock in 1998 and 1997 as reported by NASDAQ. Such quotations
reflect inter-dealer prices and do not include retail markup, markdown, or
commission, and may not represent actual transactions.
Bid Quotations for
Class A Stock
-----------------------------
Quarter High Low
Ended Bid Bid
-----------------------------
December 31, 1998 $ 10.25 $ 8
September 30, 1998 $ 12 $ 10.25
June 30, 1998 $ 15.13 $ 9
March 31, 1998 $ 10 $ 6
December 31, 1997 $ 7.75 $ 5.63
September 30, 1997 $ 6.13 $ 4.75
June 30, 1997 $ 5.75 $ 4.75
March 31, 1997 $ 6 $ 5
The Company has not paid a dividend on the Class A Stock. The Board of
Directors of the Company has not adopted a dividend payment policy; however,
dividends must necessarily depend upon the Company's earnings and financial
condition, applicable legal restrictions, and other factors relevant at the
time the Board of Directors considers a dividend policy. The Company is
subject to a loan agreement covenant that prevents it from paying dividends
on the Class A Stock without the consent of the lender except to the extent
it can meet certain requirements relating to the ratio of its income before
interest and tax expense plus dividends, to its interest expense and dividend
payments for five (5) consecutive quarters and provided that there is no
default or potential default under the loan agreement. As of January, 1999,
the Company could pay dividends in the maximum amount of approximately
$1,850,000 without violating the loan agreement covenant. Cash available for
dividends to shareholders of the Company must initially come from income and
capital gains earned on its investment portfolio, management service fees and
dividends paid by the Insurance Subsidiaries, and Citizens Security's
repurchase of its preferred stock owned by the Company. Provisions of the
Kentucky Insurance Code relating to insurance holding companies subject
transactions between the Company and the Insurance Subsidiaries, including
dividends paid to the Company, to certain standards generally intended to
prevent such transactions from adversely affecting the adequacy of the
Insurance Subsidiaries' capital and surplus available to support policyholder
obligations. See Item 1. "Description of Business -- State Insurance
Regulation." In addition, under the Kentucky Business Corporation Act, the
Company may not pay dividends if, after giving effect to a dividend, it would
not be able to pay its debts as they become due in the usual course of
business or if its total liabilities would exceed its total assets.
ITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS
OR PLAN OF OPERATIONS
During 1998 the Company achieved record income and equity per common share
and a 53% increase in assets. Net income applicable to common shares
increased 91% to $3,020,000 compared to the prior year while equity per share
increased 19% to $12.06. A significant portion of these record results are
attributable to successful management of the Company's investment portfolio.
As detailed below, during the past three years the Company has maintained an
equity portfolio averaging approximately $11,100,000 (cost basis) which
yielded an average annual pretax total return in excess of 23%. Pretax
income from insurance operations increased 43% to $398,000, excluding
realized investment gains. On May 12, 1998, the Company completed the
acquisition of United Liberty for a total purchase price of approximately
$7,076,000. In addition, due to growth in the Company's common stock market
price, it was able to call its convertible preferred stock for redemption.
The preferred shareholders converted 98% of the preferred shares to common
shares, thus increasing outstanding shareholders' equity by a net total of
$3,875,000.
In accordance with a new accounting pronouncement effective in 1998, the
Company has revised its approach for reporting income by product line
(business segment). In prior years, the Company reported results using two
business segments: Life insurance and Accident and Health insurance.
However, beginning in 1998, the Company is reporting five segments: Home
Service Life, Broker Life, Preneed Life, Dental, and Other Health.
Products in all five segments 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
the Broker Life segment which comprise a significant portion of existing
business include group life, universal life, annuities and participating life
coverages. Preneed Life products are sold to individuals in connection with
prearrangement of their funeral and include single and multi-pay coverages,
generally in amounts of $10,000 and less. These policies are generally sold
to older individuals at increased premium rates. Dental products are term
coverages generally sold to small and intermediate size employer groups.
Other Health products include various accident and health coverages sold to
individuals and employer groups.
Profit or loss for each segment is reported on a pretax basis, without an
allocation of realized investment gains or interest expense.
ACQUISITIONS
United Liberty Life Insurance Company
On May 12, 1998 the Company acquired 100% of the common stock of United
Liberty from an unaffiliated insurance holding company (the "United
Acquisitio"). The United Acquisition was accounted for as a purchase and
United Liberty's results of operations are included in the consolidated
statements since the date of acquisition. United Liberty's primary business
is traditional life insurance, including a presence in the pre-need funeral
funding segment. This acquisition provided the Company with its Preneed Life
business segment, approximately 11% of the premium in its overall Broker Life
segment, and 3% of premium in the Other Health segment.
The aggregate purchase price for the United Acquisition was approximately
$7,076,000 (including net costs associated with the acquisition of
approximately $445,000). In conjunction with the acquisition, the seller
retained approximately $2,100,000 of United Liberty's real estate related and
other assets, which were replaced with cash by Citizens Security.
The United Acquisition was financed with the working capital of Citizens
Security and with approximately $3,400,000 of the $6,710,000 of proceeds
under a Term Loan Agreement dated as of May 8, 1998 between the Company and a
commercial bank (the "Term Loan Agreement"). The remaining borrowing under
the Term Loan Agreement represented refinancing of debt relating to a prior
acquisition. The Term Loan Agreement calls for quarterly payments of
principal and interest through July 2006.
Integrity National Life Insurance Company
In September, 1995, the Company and Citizens Security Life Insurance Company
"Citizens Security") acquired the common stock of Integrity National Life
Insurance Company (the "Integrity Acquisition") from an unaffiliated
insurance holding company. The aggregate purchase price for the Integrity
acquisition, as finally adjusted, was $9,419,000 (including $437,000 of net
transaction costs). This acquisition provided the Company with its Home
Service Life segment and approximately one-third of its Other Health segment.
FINANCIAL POSITION
Assets. At December 31, 1998, the Company's available-for-sale fixed
maturities had a fair value of $77,583,000 and amortized cost of
$75,235,000. The available-for-sale portfolio consists of fixed maturities
and equity securities that the Company, given the proper market condition,
would sell prior to maturity. This portfolio is reported at fair value with
unrealized gains and losses, net of applicable deferred taxes and adjustments
to deferred policy acquisition costs, reflected as a separate component in
shareholders' equity. The Company's fixed maturities portfolio increased
approximately 80% in 1998 and decreased approximately 11% in 1997, on an
amortized cost basis. The 1998 increase resulted primarily from the United
Acquisition while the 1997 decrease resulted from increased positions in the
favorable equities market and somewhat higher year-end cash balances. Shown
below is a distribution by rating category of the Company's fixed maturities
portfolio as of December 31, 1998.
Standard & Poor's Fair
Corporation Rating Amortized Cost1 Value 2
---------------------------------------------------------
Investment grade:
AAA to A- $ 55,684,000 $57,646,000
BBB+ to BBB- 10,835,000 11,124,000
---------------------------------------------------------
Total investment grade 66,519,000 68,770,000
Non-investment grade:
BB+ to BB- 3,797,000 3,815,000
B+ to B- 2,897,000 2,892,000
CCC+ to C 2,022,000 2,106,000
---------------------------------------------------------
Total non-investment grade 8,716,000 8,813,000
---------------------------------------------------------
Total fixed maturities $ 75,235,000 $77,583,000
---------------------------------------------------------
1 Net of write-downs on bonds whose decline in value is believed
to be other-than-temporary
2 Fair values as of December 31, 1998 were obtained from the
Company's investment advisor's portfolio review,
which used market prices from Shaw Data Services
The Company believes it has a well diversified portfolio and has no
definitive plans to decrease its non-investment grade portfolio significantly
below its current level, unless necessary to satisfy requirements of state
regulators or rating agencies. The Company purchases non-investment grade
bonds to obtain higher yields or convertible features and attempts to reduce
credit risk by portfolio diversification. Non-investment grade securities
comprised 11.6% and 14.1% of the fixed maturities portfolio, on an amortized
cost basis at December 31, 1998 and 1997 respectively.
Shown below are the Company's four largest holdings in non-investment grade
bonds by a single issuer as of December 31, 1998.
Non-Investment Grade
December 31, 1998 Book Value Fair Value
------------------------------------------------
Largest $ 1,378,000 $ 1,487,000
Second largest 915,000 854,000
Third largest 538,000 537,000
Fourth largest 502,000 493,000
------------------------------------------------
Total $ 3,333,000 $ 3,371,000
------------------------------------------------
The Company had no guarantee or other type of investment associated with the
issuers represented above.
The Company's investment in equity securities increased $2,720,000 and
$2,266,000 during 1998 on a cost (net of write-downs) and fair value basis,
respectively, after increasing $4,929,000 and $6,979,000 on the same basis in
1997. As of December 31, 1998, there were $2,474,000 of net unrealized gains
in equity securities, as compared with $2,929,000 and $878,000 at December
31, 1997 and December 31, 1996, respectively. One security represented
$383,000 of such gains at December 31, 1998.
The Company reviews its marketable investments each quarter to determine if
there have been declines in their value that in management's opinion are
other-than-temporary. These reviews resulted in the recognition of
impairment losses on equity securities totaling $1,356,000 during 1998
($40,000, $190,000, $846,000 and $280,000 for the first through fourth
quarters, respectively). In addition, $150,000 of impairment losses were
recognized on fixed maturities in the fourth quarter of 1998. During 1998,
equity securities were sold which contained impairment writedowns of $209,000.
As more extensively discussed under Consolidated Results and Analysis, below,
the Company realized significant net capital gains from its marketable
investments over the three-year period ended December 31, 1998. Management
believes these net gains, which total $6,783,000, ($3,675,000, $2,193,000 and
$915,000 for 1998, 1997 and 1996, respectively), are greater than would have
been obtained from a more conservative investment strategy involving only
investment grade bonds. The Company's strategy has in some years subjected
it to fluctuations in income and shareholders' equity of a magnitude
significantly larger than would be anticipated under a more conservative
investment strategy. Net capital gains or losses for a given period are not
necessarily indicative of those for future periods.
Citizens Security owns the building in which the Company and the Insurance
Subsidiaries maintain their home offices. Approximately 75% of the building
is leased to third-party tenants. Although leases covering approximately 40%
of the building expire during 1999, market conditions for this property are
favorable and the Company does not anticipate significant difficulty in
leasing available space. An appraisal obtained during 1996 indicates that
the current market value of the property is approximately $1,700,000 higher
than its carrying value.
The Company has maintained relatively high balances in cash and short-term
securities over the past several years, principally to hedge against the
uncertainty of future interest rates.
At December 31, 1998, the Company holds a $156,000 mortgage loan from a real
estate limited partnership in which the Company also has a 20% equity
interest. The mortgage loan, maturing March 31, 2000, permits revolving
credit advances, not to exceed at any time, the lesser of $750,000 or 80% of
the collateral fair value. Stockholders of the partnership's general partner
personally guarantee 80% of the loan.
Liabilities. A comparison of total policy liabilities as of December 31,
1998, 1997 and 1996 is shown below. Approximately 81% of the 1998 total
consists of future policy benefit reserves while policyholder deposit
liabilities represent 17% of the total.
Year Ended December 31 1998 1997 1996
---------------------------------------------------------------------
Home Service Life $ 28,967,749 $ 28,116,965 $ 27,160,749
Broker Life 39,933,144 29,076,701 29,285,258
Preneed Life 23,260,792 --- ---
Dental 485,750 502,638 569,389
Other Health 2,997,162 1,642,479 2,025,057
---------------------------------------------------------------------
Total $ 95,644,597 $ 59,338,783 $ 59,040,453
---------------------------------------------------------------------
Home Service Life policy liabilities comprise approximately 30% of the
Company total. During the past two years, this segment has been relatively
stable, after experiencing some declines in the initial months after the
September 1995 acquisition of Integrity. The Broker Life segment's 1998 net
growth is essentially all due to the United Acquisition. The majority of
this acquired business consists of traditional life participating policies,
which are no longer being sold. Aside from the United Acquisition, the
primary growth elements in the Broker Life segment relate to simplified issue
and graded-benefit life sales. However, from a policy liability standpoint,
this growth is offset by reductions in universal life and annuity products,
which are not actively marketed. Most of the Preneed Life business was
obtained in the United Acquisition; however, the Company is encouraged by its
initial marketing progress in this segment, as further described below. The
Dental segment consists of annual term accident and health coverages.
Accordingly, policy liabilities for this segment are not significant. Growth
during 1998 in the Other Health segment relates primarily to group medical
policies obtained in the United Acquisition. However, these policies are
100% reinsured to another carrier.
Shown below is a progression of the Company's policyholder deposit activity
for the year ended December 31, 1998.
Year Ended December 31, Universal
1998 Total Annuity Life Other
---------------------------------------------------------------------
Beginning Balance $15,538,891 $9,181,758 $5,246,028 $1,111,105
United Acquisition 999,623 --- --- 999,623
Deposits 817,372 232,449 486,498 98,425
Withdrawals (2,158,681)(1,192,948) (865,566) (100,167)
Interest credited 845,608 504,670 296,896 44,042
---------------------------------------------------------------------
Ending Balance $16,042,813 $8,725,929 $5,163,856 $2,153,028
---------------------------------------------------------------------
Aside from the impact of the United Acquisition, 1998 policyholder deposit
activity is similar to 1997 activity. Total deposits, withdrawals, and
interest credited for 1997 were $787,910, $(2,093,351), and $914,061,
respectively. The Company is not devoting significant marketing effort
toward these products.
CONSOLIDATED RESULTS AND ANALYSIS
Premiums and Other Considerations. The following table details premiums and
other considerations received during the past three fiscal years.
----------------------------------------------------------------
Year Ended December 31
1998 1997 1996
Home Service Life $6,551,375 $6,548,450 $6,742,099
Broker Life 3,040,231 2,579,345 2,748,252
Preneed Life 1,066,069 --- ---
Dental 6,414,720 7,194,952 6,910,310
Other Health 1,299,233 1,368,130 1,546,962
Total $ 18,371,628 $ 17,690,877 $ 17,947,623
----------------------------------------------------------------
Home Service Life premium has remained relatively stable during the past two
years, after experiencing an approximate 3% decline in 1997, from 1996.
During 1998, the Company introduced redesigned products based on feedback
obtained from its agency force. This redesign included raising premium rates
approximately 15%, increasing the base renewal commission rates by
approximately 5% of premium, simplifying the policy application form, and
streamlining the policy underwriting process for qualifying agents. These
changes have been favorably received by the Home Service Life agency force
and production began increasing during the fourth quarter. The 1997
reduction in Home Service Life premium, compared to 1996, resulted primarily
from a modest decline in the number of producing agents after the late 1995
acquisition of Integrity.
The $461,000 increase in Broker Life premium during 1998 includes $340,000 of
participating life premium from the United Acquisition, an approximate
$123,000 net increase from simplified issue and graded benefit life policies
partially offset by reductions in other traditional life plans, $46,000 of
additional group life premium, and $48,000 less universal life premium/policy
charges. The participating United Liberty plans are no longer issued.
During mid-1997, the Company introduced a revised graded-benefit life plan
with a more conservative benefit structure and, in late 1997 a companion
simplified issue product targeted towards the "final expense market". Sales
of the graded-benefit product declined in 1997 due to adoption of the more
conservative benefit structure. However, these sales have recovered modestly
in 1998 and the simplified issue product has been favorably received
(approximately $620,000 of annual premium is inforce for these two plans at
December 31, 1998). Although the Company is not aggressively marketing its
group life products, enhancements to product design were made during 1998 and
a modest increase in volume was achieved as noted above. The $169,000 Broker
Life decline in 1997 was approximately two-thirds attributable to universal
life and group life reductions and one-third related to traditional life
plans.
United Liberty's Preneed Life sales were controlled exclusively by a
third-party marketing organization prior to the acquisition by the Company.
This organization lost its producing marketing representatives prior to the
United Acquisition; however the Company is encouraged by progress achieved to
date by its regional representatives and is reestablishing relationships with
funeral homes which served as United Liberty agents during the past several
years.
The 1998 decrease in Dental premium is due to termination of a large
association group, which offered dental coverage to a diverse membership.
Although this group had built annual premium volume of approximately $1
million, their claim ratios were excessive and accordingly, coverage was
cancelled effective March 1, 1998.
The $69,000 decrease in 1998 Other Health premium consists of $39,000 of
additional premium from the United Acquisition offset by a $108,000 decline
in individual supplemental health coverages. The Company has not been
actively marketing these coverages for several years. However, in response
to agent requests, during late 1998 the Company began offering a new
disability product. Pricing, underwriting, and claims experience on this
product will be closely monitored and it is expected to provide a competitive
advantage in building relationships with effective agents.
Investments. The Company monitors its available-for-sale fixed maturities
and equity securities to assure they are strategically positioned within the
current interest rate environment. This practice has historically resulted
in equity securities comprising 10% to 20% of the Compan's cash and invested
assets, which tends to dampen current income yields in favor of an overall
total return focus.
Investment income yields were 5.3%, 5.4%, and 5.9% for 1998, 1997, and 1996,
respectively. The investment income yield declines in 1998 and 1997 resulted
primarily from, higher equity security balances, lower market rates,
recognition of gains on fixed maturity securities, and somewhat higher cash
and short-term balances.
As noted above, although increased equity security balances have dampened
investment income yields and segment operating income results, total return
performance for the past three years has been very favorable. As illustrated
below, during the past three years the Company's equity securities have
generated approximately $5,600,000 of additional pre-tax return, above a
hypothetical 6.5% fixed-maturity return. During this period, the Company's
annual net pretax total return on its equity portfolio has averaged 23.4%.
Equity Portfolio - Pretax Total Return
-------------------------------------------------------------------------
Year Ended
December Total/Average 1998 1997 1996
-------------------------------------------------------------------------
Average Equities
Cost $11,050,750 $14,442,021 $11,585,228 $7,125,001
-------------------------------------------------------------------------
Realized Gains1 $ 6,752,126 $ 3,186,308 $ 2,773,809 $ 792,009
Change in
Unrealized
Gains (Losses) 994,821 (454,225) 2,050,241 (601,195)
Dividends 892,571 422,847 317,699 152,025
-------------------------------------------------------------------------
Gross Return 8,639,518 3,154,930 5,141,749 342,839
Direct Expenses (870,899) (237,094) (581,930) (51,875)
-------------------------------------------------------------------------
Net Return 7,768,619 2,917,836 4,559,819 290,964
6.5% Base Return (2,154,896) (938,731) (753,040) (463,125)
-------------------------------------------------------------------------
Excess Return $ 5,613,723 $ 1,979,105 $ 3,806,779 $(172,161)
-------------------------------------------------------------------------
Total Return -
Gross 26.06% 21.85% 44.38% 4.81%
Total Return -
Net 23.43% 20.20% 39.36% 4.08%
1 Excludes adjustments for incentive and guaranty fees incurred by the
Company for investment management services.
These amounts are included separately as"Direct Expenses".
Net realized gains on equity securities were $2,848,000, $2,132,000, and
$697,000 for 1998, 1997, and 1996, respectively. These amounts reflect the
direct expenses shown above, as well as reductions for amortization of
deferred policy acquisition costs of $139,027, $59,904 and $43,260 in 1998,
1997, and 1996, respectively. Also included in gross realized losses during
1998, 1997 and 1996 are adjustments to the carrying value of
available-for-sale equity securities of $1,356,000, $232,544, and $666,871,
respectively, relating to declines in value which were considered by
management to be other than temporary. The equity portfolio had $2,474,000
of net after-tax unrealized gains as of December 31, 1998 compared to net
after-tax unrealized gains of $2,929,000 and $878,000 at December 31, 1997
and 1996, respectively.
Segment Earnings.
During 1998, pretax income increased by $1,603,000 [65%] to $4,074,000, while
also increasing during 1997 by $1,135,000 [85%] to $2,471,000. Pretax
profits (loss) are shown below for the Company's five business segments,
along with total realized investment gains and interest expense. As
previously indicated, the Company's equity investments have produced very
total favorable returns; however, if these funds had been invested in
fixed-maturities yielding 6.5%, the segment profit totals below would have
increased by an additional $516,000, $435,000, and $311,000 in 1998, 1997,
and 1996 respectively.
Year Ended December 31 1998 1997 1996
- -------------------------------------------------------------------------
Home Service Life $ 211,713 97,098 703,509
Broker Life 254,189 100,655 223,739
Preneed Life 15,325 --- ---
Dental 295,038 214,495 (105,254)
Other Health 90,174 206,591 382,895
- -------------------------------------------------------------------------
Segment Profit 866,439 618,839 1,204,889
Net realized investment gains, 3,675,489 2,193,148 915,062
net of expenses
Interest expense 468,268 341,275 784,325
- -------------------------------------------------------------------------
Income before Federal Income Tax $ 4,073,66$ 2,470,71$ 1,335,626
- -------------------------------------------------------------------------
The 1998 increase in Home Service Life profit resulted primarily from an
improvement in mortality results. The Company expects continued, gradual
improvement in this area due to the more structured underwriting practices
implemented upon acquisition of this business in late 1995. The 1998 Broker
Life improvement is due to premium growth for the new simplified issue
products, improved mortality on universal life and group life plans, and a
decrease in the interest crediting rates for annuity contracts. These
improvements were partially offset by increased mortality on graded-benefit
life plans. Preneed Life profit includes an amortization charge for the
value of purchased business. Accordingly, the Company is devoting
significant attention towards growing Preneed Life business volume. Two
experienced regional representatives have been hired to lead this growth and
a number of marketing / customer service initiatives have been launched and
been very favorably received. These initiatives include implementing an
automated voice response system for the client funeral homes, providing
pre-programmed hand held computer to assist the agents, and creating
customized marketing material packages to assist the funeral homes with
generating preneed business. Information regarding Dental profitability is
included below. The "contribution margin" shown below is a direct margin
without allocable investment income and general expense.
---------------------------------------------------------
Year Ended December 31
1998 1997 1996
Premium $6,414,720 $7,194,952 $6,910,310
Claims and Reserves $4,370,499 $5,109,221 $5,223,582
Contribution Margin $1,224,470 $1,150,920 $ 741,525
Claim Ratio 68.1% 71.0% 75.6%
---------------------------------------------------------
The significant improvement in Dental profitability during the past two years
resulted from a number of initiatives. A large portion of the 1998
improvement is due to termination of a large association group described
above. Other initiatives included reconfiguring products to provide
additional margins for certain more costly dental procedures, engaging a
company to provide expert assistance with ongoing adjudication of claims, and
implementing a program of aggressive renewal underwriting and re-rating.
After completing these profitability initiatives, the Company is now
launching initiatives aimed at increasing premium volume, including agent
incentive and referral programs for new business. The Company has not been
actively marketing its Other Health products in recent years, although the
inforce business has produced favorable benefit ratios (less than 50%) during
1997 and 1996. During 1998, margins declined due to increased claim rates on
certain municipal employee indemnity plans. The Company is currently
rerating these plans. As noted above, during late 1998 the Company began
providing a new group disability product to certain qualifying agents.
The 1997 reductions in earnings compared to 1996 for Home Service Life and
Broker Life are partly due to lower levels of overall investment income, as a
result of increased equity positions described above and prepayment of a $4.2
million mortgage loan on the Compan's office building in late 1996. In
addition, Home Service mortality increased in 1997 while 1996 earnings
benefited from higher surrender gains. Although 1997 Broker Life earnings
benefited from favorable mortality, this improvement was offset by
unfavorable persistency and reduced investment income.
Federal Income Taxes. The Company has a relatively low effective federal
income tax rate, which can fluctuate significantly due to the application of
Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for
Income Taxes." The most significant provision under SFAS No. 109 affecting
the Company is the disallowance of the small life insurance company deduction
when computing deferred taxes. The small life insurance deduction allows the
Insurance Subsidiaries to reduce their taxable income by 60% before computing
its current provision for regular or alternative minimum tax. By disallowing
this deduction in the computation of deferred taxes, SFAS No. 109
significantly increases the deferred taxes on the Insurance Subsidiaries'
temporary differences. Thus, when a significant increase or decrease occurs
in the Company's net temporary differences, the related deferred tax is
computed using the 34% federal tax rate, whereas tax will actually be paid on
these net liabilities (when realized) at a 17% rate (the alternative minimum
tax rate after application of the allowable small life insurance company
deduction). The Company's gross deferred federal income tax liabilities and
assets are more fully discussed in Note 8 to the Consolidated Financial
Statements. All operating deferred tax assets of the Company are realizable
by offset against existing deferred tax liabilities. Capital deferred tax
assets of the Insurance Subsidiaries can be realized through the carry back
of such assets to recapture prior years' taxes paid on capital assets.
Capital deferred tax assets of the Company must be offset against future
capital gains. The Company believes such gains will materialize and the
deferred tax assets will be realized. The deferred tax assets are offset, to
some extent, by valuation allowances related to the Company and to the
Insurance Subsidiaries. Due to the impact of the small life insurance
company deduction, the Insurance Subsidiaries record a valuation allowance to
reduce deferred tax assets (associated with temporary differences) to their
expected benefit rate of 17%, rather than 34%. The Company's valuation
allowance is designed to reduce deferred tax assets to their estimated
ultimate realization value.
Statutory Insurance Information. For insurance regulatory and rating
purposes, the Insurance Subsidiaries report on the basis of statutory
accounting principles ("SAP"). During 1996, A.M. Best Company ("Best")
upgraded Citizens Security's rating to B- from C++. United Liberty was rated
B- by Best when it was acquired in 1998. Citizens Security reports its
investment in United Liberty on the equity method of accounting for statutory
accounting purposes. Accordingly, the admitted value of Citizens Security's
investment in United Liberty equals United Liberty's statutory capital and
surplus total of $3,302,107 at December 31, 1998. Citizens Security's 1998
net statutory net income includes $404,553 of United Liberty statutory
earnings arising since its acquisition. To provide a more detailed
understanding of Citizens Security's operations, shown below are SAP basis
net income, net operating income, statutory capital and surplus, asset
reserves, and capital ratios for Citizens Security for the five years ended
December 31, 1998.
Statutory
Net Capital Asset
Year Ended Net Operating and Valuation Capital
December 31 Income Income Surplus Reserves1 Ratio2
-------------------------------------------------------------------
1998 $3,662,18 $1,105,631 $11,227,528 $3,606,655 20.51%
1997 $1,708,884 $762,357 $9,627,479 $2,753,064 18.22%
19963 $3,062,421 $871,089 $9,145,830 $1,426,918 16.05%
1995 $883,003 $494,588 $8,406,313 $1,087,020 14.63%
1994 $591,998 $296,809 $5,651,136 $768,664 18.46%
-------------------------------------------------------------------
1 Asset Valuation Reserves are statutory liabilities that act as
contingency reserves in the event of extraordinary losses on
invested assets and as a buffer for policyholders' surplus to
reduce the impact of realized and unrealized investment losses.
The December 31, 1998 amount also includes United Liberty's total.
2 Represents Statutory Capital and Surplus plus Asset Valuation
Reserves divided by invested assets plus cash.
3 Statutory Capital and Surplus amounts and Asset Valuation Reserve
amounts include Integrity beginning in 1995, while Income amounts
include Integrity beginning in 1996.
During 1998, statutory capital and surplus and asset reserves increased by
approximately $2,454,000. This increase resulted primarily from $3,662,000
of statutory net income offset by a $1,500,000 redemption of Citizens
Security's preferred capital stock, along with unrealized investment gains.
During 1997, statutory capital and surplus and asset reserves increased by
approximately $1,808,000. This increase resulted primarily from $1,709,000
of statutory net income and $1,130,000 of unrealized investment gains,
partially offset by a $1,050,000 redemption of Citizens Security's preferred
capital stock. During 1996, capital and surplus and asset reserves
increased by approximately $1,079,000. This increase resulted primarily from
statutory net income of $3,062,000 and unrealized investment losses of
$904,000, partially offset by a $1,000,000 redemption of Citizens Security's
preferred capital stock. Net income earned in 1996 includes an approximate
$1,200,000 net gain from an investment transaction between Citizens Security
and an affiliate.
The merger of Integrity into Citizens Security resulted in $1,832,000 of the
increase in statutory capital and surplus in 1995. The remaining $924,000
increase was the result of operating income and unrealized investment gains
partially offset by $945,000 of dividends paid to the Company.
Statutory capital and surplus, specifically the component called surplus, is
used to fund the expansion of an insurance company's first year individual
life and accident and health sales. The first year commission and
underwriting expenses on such sales will normally consume a very high
percentage of, if not exceed, first year premiums. Accordingly, a statutory
loss often occurs on these sales the first year of the policy. The Insurance
Subsidiaries' first year sales of these type of products have not been of a
magnitude to have a significant impact on statutory surplus.
Year 2000 Issue
Some of the Company's older computer programs were written using two digits
rather than four to define the applicable year. As a result, those computer
programs could fail to properly distinguish between dates in the 1900's and
2000's. This could cause system failures or miscalculations, creating
disruption of operations, including, among other things, a temporary
inability to process insurance transactions, conduct banking activities, or
engage in other normal business activities. Also, some systems and equipment
that are not typically thought of as "computer-related" ("non-IT") contain
imbedded hardware or software that may not perform properly after 1999.
The Company has completed an internal assessment of the year 2000 issue and
implemented a program to install updated releases or modify its software so
that its computer systems will function properly with respect to dates in the
year 2000 and thereafter. The Company's two primary insurance administrative
systems (Individual and Group) are vendor supplied programs, which have been,
or are being, modified as part of the ongoing vendor maintenance process.
Modification of the Individual insurance system is complete. Vendor
modification to the Group insurance system have been installed and are being
tested by the Company. Most of the peripheral, internally developed programs
associated with these systems have also been modified, and those remaining
are scheduled to be completed by June 30, 1999. The Compan's investment
accounting and general ledger systems are also vendor supplied programs,
which have been properly updated. The Company's primary non-IT systems
involve building equipment control modules at its home office. The Company
has verified these systems are year 2000 compliant.
The most significant third-parties potentially impacting the Company are
banks, investment brokers, and suppliers of utility and telecommunication
services. Their critical functions include safekeeping and managing
investment portfolios, processing the Company's operating bank accounts, and
supplying utilities. Assurances of year 2000 compliance have been received
from the Company's primary banking service provider and many other key
providers. Efforts are ongoing to obtain additional assurances.
The total year 2000 project cost is estimated at approximately $100,000,
which is primarily internal salary cost for testing and modifying peripheral
programs associated with the Individual and Group insurance systems.
Approximately half of this total has been incurred and expensed with the
remaining half to be incurred and expensed over the next two quarters. The
direct cost of modifying the Individual and Group system vendor programs is
included in annual maintenance fees, which total approximately $25,000.
The Company has investments in publicly and privately placed securities and
loans. The Company may be exposed to credit risk to the extent that related
borrowers are materially adversely impacted by the year 2000 issue.
Portfolio diversification reduces the overall risk. Although the Company
expects its critical systems to be compliant by June 30, 1999, there is no
guarantee that these results will be achieved. Specifically, from year 2000
problems, the Company could experience an interruption in its ability to
collect and process premiums, process claim payments, safeguard and manage
its invested assets and operating cash accounts, accurately maintain
policyholder information, accurately maintain accounting records, issue new
policies and/or perform adequate customer service. While the Company
believes the occurrence of such a situation is unlikely, a possible worst
case scenario might include one or more of the Company's significant
insurance systems being non-compliant. Such an event could result in a
material disruption to the Company's operations. Should the worst case
scenario occur, it could, depending on its duration, have a material impact
on the Company's results of operations and liquidity and ultimately on its
financial position.
With respect to contingency plans for the Group insurance system, if
unforeseen delays are encountered during the next few months, the Company
will develop supplemental manual processing procedures to assist with group
claims adjudication. This is not expected to be a significant issue, as most
group insurance processing is not dependent on date sensitive data.
Regarding third-party systems, the Company is continuing to assess their
compliance and will continue to reassess the need for formal contingency
plans, based on progress of year 2000 efforts by the Company and third
parties.
CASH FLOW AND LIQUIDITY
During 1998, the Company generated $1,620,000 of positive cash flow from
operations compared to $2,191,000 in 1997 and $1,570,000 in 1996. The 1998
decrease can be attributed to increased reinsurance receivable amounts
associated with additional graded-benefit life reinsurance volume. The 1997
increase resulted from a significant improvement in group dental claim ratios
and growth in other liabilities at December 31, 1997.
Cash used in investing activities during 1998 includes payment of
approximately $7,076,000 for the United Acquisition, less $3,288,000 of cash
held by United Liberty on the effective acquisition date, for a net outflow
of $3,788,000. Cash provided by financing activities in 1998 includes
$3,400,000 of additional bank borrowings, which were used, along with
available funds at Citizens Security, to acquire United Liberty on May 12,
1998. Cash payments on bank notes during 1997 include $140,000 of
prepayments and exclude a $75,000 scheduled installment that was prepaid in
late 1996. In order to enhance net investment spreads, during late 1996 the
Company elected to repay an outstanding $4,202,000, 8% mortgage loan, the
majority of which was due in 1998. In addition, during 1996, $825,000 of
bank note prepayments were made, including the $75,000 installment noted
above.
The Company is subject to various market risks. However, the most
significant such risks relate to fluctuations in interest rates and in prices
of equity securities. Regarding interest rates, the value of the Company's
fixed-maturity investment portfolio will increase or decrease in an inverse
relationship with fluctuations in interest rates while net investment income
earned on newly-acquired fixed-maturities increases or decreases in direct
relationship with interest rate changes. From an income perspective, the
Company does not believe rising interest rates present a significant risk, as
essentially all of the Company's policy liabilities bear fixed rates.
Approximately 39% of policy liabilities contain provisions permitting
interest or benefit adjustments at the discretion of the Boards of Directors
of the Insurance Subsidiaries. The Company's cash flow testing (described
below) indicates that overall profitability will generally be enhanced in
rising interest rate scenarios. From a liquidity perspective, the Company's
fixed rate policy liabilities have been relatively insensitive to interest
rate fluctuations. Accordingly, the Company believes gradual increases in
interest rates do not present a significant liquidity exposure. The Company
monitors economic conditions on a regular basis and manages this interest
rate risk primarily by adjusting the duration of its fixed-maturity
portfolio. Historically, the Company has maintained conservative durations
in its fixed-maturity portfolio. At December 31, 1998 cash and
fixed-maturity investments with maturities of less than five years equaled
more than fifty percent of total policy liabilities. Notwithstanding the
foregoing, if interest rates rise significantly in a short timeframe, there
can be no assurance that the life insurance industry, including the Company,
would not experience increased levels of surrenders and reduced sales, and
thereby be materially adversely affected.
Interest expense on the Company's commercial bank debt is also subject to
interest rate risk. The rate on this debt is variable and equals 100% of the
bank's prime lending rate. At December 31, 1998, the rate on the Company's
$6,510,000 of bank borrowings was 7.75%. The Company believes its current
liquidity position and profitability levels are adequate to guard against
this interest rate risk.
The Company has successfully managed the risk of equity security price
fluctuations during the past several years. The Company's Chairman and his
investment management firm, SMC Advisors, Inc. devote significant attention
to the equity markets and reposition the Company's portfolio upon detection
of adverse risk trends associated with individual securities or overall
markets. The Chairman also manages market risks associated with investments
in option securities, as described in Item 7, Note 3 of the Notes to
Consolidated Financial Statements. As noted in the Investments section
above, the annual total return on the Company's equity securities during the
past three years has exceeded 23%.
In addition to the measures described above, the Insurance Subsidiaries
comply with the NAIC promulgated Standard Valuation Law ("SVL") which
specifies minimum reserve levels and prescribes methods for determining them,
with the intent of enhancing solvency. The SVL also requires the Company to
perform annual cash flow testing for its Insurance Subsidiaries. This
testing is designed to ensure that statutory reserve levels will maintain
adequate protection in a variety of potential interest rate scenarios. The
Actuarial Standards Board of the American Academy of Actuaries also requires
cash flow testing as a basis for the actuarial opinion on the adequacy of the
reserves which is a required part of the annual statutory reporting process.
Cash flow testing projects cash inflows from assets and cash outflows for
liabilities in various assumed economic and yield curve scenarios. This is a
dynamic process, whereby the performance of the assets and liabilities is
directly related to the scenario assumptions. (An example would involve the
credited interest rate on annuity products and how such rates vary depending
upon projected earnings rates, which are based upon asset performance under a
particular economic scenario.)
The Insurance Subsidiaries' most recent cash flow testing, which was
completed in February 1999, involved a review of two basic measures. The
first was the value of free market surplus, which is defined as the
difference between the projected market value of assets and liabilities at
the end of the analysis period (typically 10-20 years). Deficits could
indicate the need for corrective action depending upon the severity and the
number of scenarios in which a deficit appeared. A second measure involved
distributable earnings. Negative earnings for extended durations might
impair the ability of Insurance Subsidiaries to continue without exhausting
surplus. Again, depending upon severity and frequency, corrective measures
might be needed. Based on results of the testing, no corrective measures
were indicated at the current time. However, such testing is ongoing and
dynamic in nature and future events in the interest and equity markets or a
significant change in the composition of Insurance Subsidiaries' business
could negatively impact testing results and require the initiation of
corrective measures.
Any necessary corrective measures could take one or more forms. The duration
of existing assets might not match well with those of the liabilities.
Certain liabilities, such as those associated with indemnity accident and
health, short-term disability and group dental products, are short-term in
nature and are best matched with cash and short-term investments. By
contrast, whole life insurance, which involves lifetime obligations, is
usually best matched by longer duration maturities. In the event there are
insufficient assets of these types, a repositioning of the investment
portfolio might be undertaken.
Initially, balanced durations do not guarantee positive future results.
Asset type, quality, and yield will vary depending upon the economic scenario
tested. Liabilities will be similarly affected. Projected reinvestment
yields may cause overall yields to fall below those required to support
projected liabilities. In that event, portfolio realignment might involve
the type, quality and yield of investments rather than duration.
Alternatively, additional reserve amounts could be allocated to cover any
future shortfalls.
The above discussion centers around asset management. Other possible
corrective measures might involve liability realignment. The Company's
marketing plan could be modified to emphasize certain product types and
reduce others. New business levels could be varied in order to find the
optimum level. Management believes that the Company's current liquidity,
current bond portfolio maturity distribution and positive cash flow from
operations give it substantial resources to administer its existing business
and fund growth generated by direct sales. The Company will service debt
and other expenses by:
- Management fees charged to the Insurance Subsidiaries
- Redemption of Citizens Security preferred stock as necessary, with
such redemption also requiring approval by the Kentucky Department of
Insurance.
- Dividends from the Insurance Subsidiaries, which are limited by law
to the lesser of prior year net operating income or 10% of prior
year-end capital and surplus unless specifically approved by the
Kentucky Department of Insurance.
FORWARD-LOOKING INFORMATION
The Company makes forward-looking statements from time to time and desires to
take advantage of the "safe harbor" which is afforded such statements under
the Private Securities Litigation Reform Act of 1995 when they are
accompanied by meaningful cautionary statements identifying important factors
that could cause actual results to differ materially from those in the
forward-looking statements.
The statements contained in this "Management's Discussion and Analysis or
Plan of Operations," and statements contained in future filings with the
Securities and Exchange Commission and publicly-disseminated press releases,
and statements which may be made from time to time in the future by
management of the Company in presentations to shareholders, prospective
investors, and others interested in the business and financial affairs of the
Company, which are not historical facts, are forward-looking statements that
involve risks and uncertainties that could cause actual results to differ
materially from those set forth in the forward-looking statements. Any
projections of financial performance or statements concerning expectations
as to future developments should not be construed in any manner as a
guarantee such results or developments will, in fact, occur. There can be no
assurance that any forward-looking statement will be realized or actual
results will not be significantly different from those set forth in such
forward-looking statement. In addition to the risks and uncertainties of
ordinary business operations, the forward-looking statements of the Company
referred to above are also subject to risks and uncertainties.
The Company operates in a highly competitive business environment, and its
operations could be negatively affected by matters discussed under Item 1.
"Description of Business -- Competition".
ITEM 7. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
CITIZENS FINANCIAL CORPORATION AND SUBSIDIARIES
Financial Statements For Full Fiscal Years Page
Report of Independent Auditors....................................25
Consolidated Statements of Income for the
years ended December 31, 1998, 1997 and 1996 ....................26
Consolidated Statements of Financial Condition at
December 31, 1998 and 1997........................................27
Consolidated Statements of Shareholders' Equity
for the years ended December 31, 1998, 1997 and 1996..............29
Consolidated Statements of Cash Flows for the
years ended December 31, 1998, 1997 and 1996......................30
Notes to Consolidated Financial Statements........................31
REPORT OF INDEPENDENT AUDITORS
The Shareholders and Board of Directors
Citizens Financial Corporation
We have audited the consolidated financial statements of Citizens Financial
Corporation and subsidiaries listed in the accompanying index to financial
statements at Item 7. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Citizens Financial Corporation and subsidiaries at December 31, 1998 and
1997, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Louisville, Kentucky
March 25, 1999
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Income
Year Ended December 31 1998 1997 1996
- -------------------------------------------------------------------------------
Revenues:
Premiums and other considerations $ 19,402,959 $ 18,790,483 $ 18,941,875
Premiums ceded (1,031,331) (1,099,606) (994,252)
- -------------------------------------------------------------------------------
Net premiums earned 18,371,628 17,690,877 17,947,623
Net investment income 5,190,322 3,808,938 4,158,282
Net realized investment gains,
net of expenses 3,675,489 2,193,148 915,062
Other income 39,566 8,880 29,218
- -------------------------------------------------------------------------------
Total Revenues 27,277,005 23,701,843 23,050,185
Policy Benefits and Expenses:
Policyholder benefits 13,576,645 11,736,457 11,845,025
Policyholder benefits ceded (1,039,024) (834,426) (734,082)
- -------------------------------------------------------------------------------
Net benefits 12,537,621 10,902,031 11,110,943
Increase in net benefit reserves 553,673 789,135 680,263
Interest credited on
policyholder deposits 845,608 914,061 916,494
Commissions 3,775,530 3,762,482 3,956,075
General expenses 4,430,902 3,902,603 3,899,708
Interest expense 468,268 341,275 784,325
Policy acquisition costs deferred (1,106,373) (982,333) (1,189,993)
Amortization expense:
Deferred policy acquisition
costs 696,719 736,633 911,543
Value of insurance acquired 696,702 584,993 390,688
Goodwill 35,771 20,962 20,962
Depreciation expense 268,924 259,289 233,551
- -------------------------------------------------------------------------------
Total Policy Benefits and Expenses 23,203,345 21,231,131 21,714,559
- -------------------------------------------------------------------------------
Income before Federal Income Tax 4,073,660 2,470,712 1,335,626
Federal Income Tax Expense (774,000) (482,500) (226,303)
- -------------------------------------------------------------------------------
Net Income 3,299,660 1,988,212 1,109,323
Dividends on Redeemable Convertible
Preferred Stock (279,650) (407,000) (402,214)
- -------------------------------------------------------------------------------
Net Income Applicable to Common
Stock $ 3,020,010 $ 1,581,212 $ 707,109
- -------------------------------------------------------------------------------
Net Income Per Common Share:
Basic $ 2.31 $ 1.47 $ 0.66
Diluted $ 1.82 $ 1.10 $ 0.62
- -------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Financial Condition
December 31 1998 1997
- ------------------------------------------------------------------------------
ASSETS
Investments:
Securities available-for-sale, at fair value:
Fixed maturities (amortized cost of
$75,235,199
and $41,840,652 in 1998 and 1997,
respectively) $ 77,582,742 $ 43,029,609
Equity securities (cost of $14,733,876 and
$12,014,105 in 1998 and 1997, respectively) 17,208,338 14,942,792
Investment real estate 3,618,698 3,890,961
Mortgage loans on real estate 164,757 170,536
Policy loans 4,034,152 2,943,148
Short-term investments 594,805 572,492
- ------------------------------------------------------------------------------
Total Investments 103,203,492 65,549,538
Cash and cash equivalents 8,301,999 6,180,576
Accrued investment income 1,263,898 710,673
Reinsurance recoverable:
Paid benefits and losses 85,299 82,702
Unpaid benefits, losses and IBNR 3,379,063 1,537,270
Premiums receivable 407,571 442,846
Property and equipment 1,846,768 1,295,917
Deferred policy acquisition costs 4,120,215 3,819,678
Value of insurance acquired 6,135,132 4,496,872
Goodwill 513,325 104,814
Other assets 242,361 528,956
- ------------------------------------------------------------------------------
Total Assets $129,499,123 $ 84,749,842
- ------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Financial Condition
December 31 1998 1997
- ------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Policy liabilities:
Future policy benefits $ 77,946,022 $ 42,229,519
Policyholder deposits 16,042,813 15,538,891
Policy and contract claims 1,259,459 1,220,023
Unearned premiums 208,524 160,107
Other 187,779 190,243
- ------------------------------------------------------------------------------
Total Policy Liabilities 95,644,597 59,338,783
Notes payable 6,510,000 3,510,000
Accrued expenses and other liabilities 3,627,214 2,763,849
Federal income tax payable 667,013 263,500
Deferred federal income tax 1,305,018 508,918
- ------------------------------------------------------------------------------
Total Liabilities 107,753,842 66,385,050
Commitments and Contingencies
Redeemable Convertible Preferred Stock;
370 shares outstanding in 1997 --- 4,043,907
Shareholders' Equity:
Common stock, 6,000,000 shares authorized;
1,802,615 and 1,075,615 shares issued and
outstanding in 1998 and 1997, respectively 1,802,615 1,075,615
Additional paid-in capital 8,091,825 4,836,057
Accumulated other comprehensive income 3,079,616 2,594,998
Retained earnings 8,771,225 5,814,215
- ------------------------------------------------------------------------------
Total Shareholders' Equity 21,745,281 14,320,885
- ------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $129,499,123 $ 84,749,842
- ------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Shareholders' Equity
Accumulated Comprehensive
Additional Other Income
Common Paid-in Comprehensive Retained (Loss)
Stock Capital Income Earnings Total
- ------------------------------------------------------------------- -----------
Balance at
January 1, 1996 $1,075,615 $4,836,057 $1,871,652 $3,525,894
Net Income 1,109,323 $1,109,323
Net unrealized
depreciation of available for
sale securities (1,442,872) (1,442,87
===========
Comprehensive loss $(333,549)
===========
Preferred stock dividends (402,214)
- -------------------------------------------------------------------
Balance at
December 31, 1996 1,075,615 $4,836,057 428,780 4,233,003
Net Income 1,988,212 $1,988,212
Net unrealized
appreciation of available for
sale securities 2,166,218 2,166,218
===========
Comprehensive income $4,154,430
===========
Preferred stock
dividends (407,000)
- -------------------------------------------------------------------
Balance at
December 31, 1997 1,075,615 4,836,057 2,594,998 5,814,215
Net Income
3,299,660 $3,299,660
Net unrealized
appreciation of
available for 484,618 484,618
sale securities ===========
Comprehensive income $3,784,278
===========
Preferred stock
dividends (279,650)
Preferred stock 722,000 3,215,768
conversion
Preferred stock redemption (63,000)
Options exercised 5,000 40,000
- -------------------------------------------------------------------
Balance at December $1,802,615 $8,091,825 $3,079,616 $8,771,225
31, 1998
- -------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
Citizens Financial Corporation and Subsidiaries
Consolidated Statements of Cash Flows
Year Ended December 31 1998 1997 1996
- --------------------------------------------------------------------------------
Cash Flows from Operations:
Net income $3,299,660 $1,988,212 $1,109,323
Adjustments reconciling to cash from
operations:
Increase in benefit reserves 806,183 704,142 791,089
(Increase) decrease in claim 9,630 70,616
liabilities (111,746)
(Increase) decrease in reinsurance 191,602 (251,388)
recoverable (380,034)
Interest credited on policyholder 914,061 916,494
deposits 845,608
Provision for amortization and
depreciation, 619,544 366,751
net of deferrals 591,743
Amortization of premium and
accretion (7,438) (16,822)
of discount on securities
purchased, net 112,432
Net realized investment gains (3,675,489) (2,193,148) (915,062)
(Increase) decrease in accrued 62,016 (135,931)
investment income 12,304
Change in other assets and 24,919 (598,883)
liabilities (269,857)
Increase (decrease) in deferred
federal income tax liability (19,000) 141,000 (273,175)
Increase (decrease) in federal (263,500) 506,837
income taxes payable 408,000
- --------------------------------------------------------------------------------
Net Cash provided by Operations 1,619,804 2,191,040 1,569,849
Cash Flows from Investment Activities:
Securities available-for-sale:
Purchases - fixed maturities (12,642,382) (3,011,750) (24,651,316)
Purchases - equity securities (33,322,649) (24,800,144) (20,301,373)
Sales - fixed maturities 15,160,161 8,498,183 23,040,876
Sales- equity securities 33,432,382 22,570,580 18,316,750
Purchase price paid for United Liberty
Life Insurance --- ---
Company in excess of cash acquired (3,787,613)
Investment management and brokerage (297,453)
account fees (417,326) (249,841)
Short-term investments sold 320,918 (72,139)
(acquired), net (22,313)
Additions to real estate (35,270) (77,983) (24,396)
Additions to property and equipment, (163,430) (185,501)
net (512,242)
(Increase) decrease in net broker (95,000) (154,269)
receivable 245,000
Other investing activities, net 159,955 (27,798) (132,274)
- --------------------------------------------------------------------------------
Net Cash provided by (used in) 2,963,735 (4,461,095)
Investment Activities (1,742,297)
Cash Flows from Financing Activities:
Policyholder deposits 817,372 787,910 818,849
Policyholder withdrawals (2,158,681) (2,093,351) (1,730,273)
Net brokerage account loan proceeds 989,014 518,394 ---
Notes payable and interest - guarantor --- (220,869) 15,543
Proceeds from note payable - bank 3,400,000 --- ---
Payments on notes payable - bank (400,000) (365,000) (5,226,656)
Preferred stock redemption and fees (169,139) --- ---
Dividends on redeemable convertible (407,000) (300,464)
preferred stock (279,650)
Issuance of common stock 45,000 --- ---
Issuance of redeemable convertible --- 2,343,000
preferred stock ---
- --------------------------------------------------------------------------------
Net Cash provided by (used in) (1,779,916) (4,080,001)
Financing Activities 2,243,916
- --------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and 3,374,859 (6,971,247)
Cash Equivalents 2,121,423
Cash and Cash Equivalents at Beginning 2,805,717 9,776,964
of Period 6,180,576
- --------------------------------------------------------------------------------
Cash and Cash Equivalents at End of $6,180,576 $2,805,717
Period $8,301,999
- --------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1--NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Presentation. The accompanying consolidated
financial statements include the accounts of Citizens Financial Corporation,
its wholly-owned subsidiary Citizens Security Life Insurance Company
("Citizens Security"), and Citizens Security's wholly-owned subsidiary United
Liberty Life Insurance Company ("United Liberty" see Note 2 regarding May
12, 1998 acquisition). The consolidated statements also include Citizens
Financial Properties, Inc. and Marketplace I Limited Partnership which are
wholly owned and inactive. These entities are collectively hereinafter
referred to as the "Company". All significant intercompany accounts and
transactions are eliminated in consolidation. Certain balances in prior
years have been reclassified to conform to current year classifications.
Nature of Operations. The Company engages in the business of life insurance,
annuities and accident and health insurance through Citizens Security and
United Liberty ("the Insurance Subsidiaries"). The Insurance Subsidiaries
offer life, fixed-rate annuity and accident and health insurance products to
individuals and groups through independent agents.
The individual life insurance products currently offered by the Insurance
Subsidiaries consist of traditional whole life insurance and universal life
insurance policies. Citizens Security also sells group life and accidental
death and dismemberment policies. The fixed-rate annuity products offered by
Citizens Security consist of flexible premium deferred annuities, life policy
annuity riders, and single premium deferred annuities. Citizens Security's
individual accident and health insurance products provide coverage for
monthly income during periods of hospitalization, scheduled reimbursement for
specific hospital and surgical expenses and cancer treatments, and lump sum
payments for accidental death or dismemberment, while the group accident and
health products provide coverage for short and long-term disability, income
protection and dental procedures.
Citizens Security is licensed to sell products in the District of Columbia
and 20 states primarily located in the South and Southeast. United Liberty
is licensed to sell products in 23 states primarily located in the South,
Midwest and West. Prior to its acquisition, United Liberty primarily sold
pre-need life insurance through funeral homes. These sales efforts were
transferred to Citizens Security for all states in which both companies are
licensed. United Liberty's ongoing sales efforts are focused in nine states
where Citizens Security is not licensed.
The Insurance Subsidiaries market their portfolio of products through the
personal producing general agent distribution system and presently have
approximately 2,100 sales representatives. Substantially all of these agents
also represent other insurance carriers. Approximately 360 of the agents
specialize in the home service market while approximately 50 are pre-need
representatives who market through funeral homes. These markets consist
primarily of individuals who desire whole life policies with policy limits
typically below $10,000.
Use of Estimates. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Investments. The Company classifies fixed maturities and equity securities
as "available-for-sale". Available-for-sale securities are carried at fair
value, with unrealized gains and losses included in accumulated other
comprehensive income, net of applicable deferred taxes and adjustments to
related deferred policy acquisition costs.
Fixed maturities and equity securities having a decline in value considered
by management to be other than temporary are adjusted to an amount which, in
management's judgment, reflects such declines. Such amounts are included in
net realized investment gains and losses. For purposes of computing realized
gains and losses on fixed maturities and equity securities sold, the carrying
value is determined using the specific-identification method. Mortgage loans
and policy loans are carried at unpaid balances. Investment real estate is
carried at depreciated cost. Short-term investments, which consist of
certificates of deposit and treasury bills, are carried at cost, which
approximates fair value. Cash and cash equivalents consist of highly liquid
investments with maturities of three months or less at the date of purchase
and are also carried at cost, which approximates fair value.
Deferred Policy Acquisition Costs. Commissions and other policy acquisition
costs which vary with, and are primarily related to, the production of new
insurance contracts are deferred, to the extent recoverable from future
policy revenues and gross profits, and amortized over the life of the related
contracts. See Premiums, Benefits and Expenses regarding amortization
methods.
Property and Equipment. Property and equipment, including the home office
building, are carried at cost less accumulated depreciation, using
principally the straight-line method of depreciation. Accumulated
depreciation at December 31, 1998 was $1,645,577 ($1,376,653 at December 31,
1997).
Goodwill and Value of Insurance Acquired. Goodwill represents the excess of
purchase price of purchased subsidiaries, over amounts assigned (based on
estimated fair values at the date of acquisition) to the identifiable net
assets acquired. Goodwill is amortized over 15 to 20 years using the
straight-line method. At December 31, 1998, accumulated amortization was
$186,949 ($151,178 at December 31, 1997).
Value of insurance acquired is recorded for the estimated value assigned to
the insurance in force of the purchased subsidiaries at the dates of
acquisition. The assigned value is amortized over the expected remaining
life of the insurance in force using methods consistent with that used for
amortization of policy acquisition costs (as described under Premiums,
Benefits and Expenses). At December 31, 1998, accumulated amortization was
$2,805,882 ($2,109,180 at December 31, 1997).
Benefit Reserves and Policyholder Deposits. Traditional life and accident
and health insurance products include those contracts with fixed and
guaranteed premiums and benefits and consist principally of whole-life and
term insurance policies, limited-payment life insurance policies and certain
annuities with life contingencies. Reserves on such policies are based on
assumed investment yields, which range from 6% to 7%. Reserves on
traditional life and accident and health insurance products are determined
using the net level premium method based on future investment yields,
mortality, withdrawals and other assumptions, including dividends on
participating policies. Such assumptions are based on past experience and
include provisions for possible unfavorable deviation.
Benefit reserves and policyholder contract deposits on universal life, other
interest-sensitive life products and investment-type products are determined
using the retrospective deposit method and consist of policy account
balances, before deducting surrender charges, which accrue to the benefit of
the policyholder.
Participating insurance business at December 31, 1998 constituted
approximately 7% of ordinary life insurance inforce and 3% of annualized
ordinary life premium inforce. At December 31, 1997 and 1996, participating
business was approximately 1% of life insurance and annualized premium
inforce. Participating dividends are determined at the discretion of the
Board of Directors.
Reserves on insurance policies acquired by purchase are based on assumptions
considered appropriate as of the date of purchase. Assumed investment yields
for such acquired policies range from 6.6% to 9.0%.
Premiums, Benefits and Expenses. Premiums for traditional individual life
and accident and health policies are reported as earned when due. Benefit
claims (including an estimated provision for claims incurred but not
reported), benefit reserve changes and expenses (except those deferred) are
charged to expense as incurred. Deferred policy acquisition costs related to
traditional life and accident and health policies are charged to expense over
the life of the policy using methods and assumptions consistent with those
used in estimating liabilities for future policy benefits. In determining
whether a premium deficiency exists on short-duration policies, management
does not give consideration to investment income.
Revenues for universal life and investment-type products consist of
investment income and policy charges for the cost of insurance, policy
initiation, administrative surrender fees and investment income. Expenses
include interest credited to policy account balances, incurred administrative
expenses and benefit payments in excess of policy account balances. Deferred
policy acquisition costs related to universal life and investment-type
products are amortized in relation to the incidence of expected gross profits
over the life of the policies. Expected gross profits are reviewed at each
reporting period, and to the extent actual experience varies from that
previously assumed, the effects of such variances are recorded in the current
period.
Liabilities for Policy Claims. Policy claim liabilities are based on known
liabilities plus estimated future liabilities developed from trends of
historical data applied to current exposures. These liabilities are closely
monitored and adjustments for changes in experience are made in the period
identified.
Federal Income Taxes. The Company uses the liability method of accounting
for income taxes. Deferred income taxes are provided for cumulative
temporary differences between balances of assets and liabilities determined
under generally accepted accounting principles and balances determined for
tax reporting purposes.
Earnings Per Share. Basic earnings per share amounts are based on the
weighted average number of common shares outstanding during the year.
Diluted earnings per share amounts assume conversion of all outstanding Class
B Redeemable Convertible Preferred Stock at a conversion price of $5.50 per
share (see notes 7 and 8).
Comprehensive Income. As of January 1, 1998, the Company adopted Statement
of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income". SFAS No. 130 establishes new rules for the reporting and display of
comprehensive income and its components; however, the adoption of this
Statement had no impact on the Company's net income or total shareholders'
equity. SFAS No. 130 requires unrealized gains or losses on the Company's
available-for-sale securities to be included in other comprehensive income.
Prior year financial statements have been reclassified to conform to the
requirements of SFAS No. 130.
Note 2--ACQUISITION
On May 12, 1998 the Company acquired 100% of the common stock of United
Liberty from an unaffiliated insurance holding company (the "United
Acquisition"). The United Acquisition was accounted for as a purchase and
the United Liberty results of operations are included in the consolidated
statements since the date of acquisition.
The aggregate purchase price for the United Acquisition was approximately
$7,076,000 (including net costs associated with the acquisition of
approximately $445,000). In conjunction with the acquisition, the seller
retained approximately $2,100,000 of United Libert's real estate related and
other assets, which were replaced with cash by Citizens Security.
The United Acquisition was financed with the working capital of Citizens
Security and with approximately $3,400,000 of the $6,710,000 of proceeds
under a Term Loan Agreement dated as of May 8, 1998 between the Company and a
commercial bank (the "Term Loan Agreement"). The remaining borrowing under
the Term Loan Agreement represented refinancing of debt relating to a prior
acquisition. The Term Loan Agreement calls for quarterly payments of
principal and interest through July 2006.
The following proforma consolidated results of operations for the years ended
December 31, 1998 and 1997 give effect to the United Liberty acquisition as
though it had occurred at the beginning of each period presented. The
primary proforma effects relate to amortization of the acquired value of
insurance inforce, foregone investment income relating to Company funds used
in the purchase, expense savings associated with consolidating United
Liberty's operations and additional interest expense associated with
incremental bank borrowings. Goodwill of approximately $440,000 was recorded
relating to the acquisition. The proforma results are not necessarily
indicative of the consolidated results that would have occurred or which will
be obtained in the future.
Program Consolidated Results of Operations
- ---------------------------------------------------------
Year ended December 31 1998 1997
- ---------------------------------------------------------
Revenue $28,839,357 $30,687,171
Net Income $2,241,465
$3,342,392
Net Income Applicable to Common $3,062,742 $1,834,465
Stock
Earnings per share:
Basic $2.34 $1.71
Diluted $1.84 $1.23
Note 3--INVESTMENTS
The cost and fair value of investments in fixed maturities and equity
securities are shown below. The cost amounts are adjusted for amortization
of premium and accretion of discount on fixed maturities and for write-downs
of securities whose decline in value is believed to be other than temporary.
Amortized Gross Unrealized Fair Value
December 31, 1998 Cost Gains Losses (Carrying Value)
- ---------------------------------------------------------------------------
Fixed Maturities:
U.S. Government
obligations $9,656,117 $317,327 $ 30 $9,973,414
Corporate securities 59,796,816 2,283,505 465,680 61,614,641
Mortgage-backed 5,782,266 258,330 45,909 5,994,687
securities
- ----------------------------------------------------------------------------
Total $75,235,199 $2,859,162 $511,61 $77,582,742
- ----------------------------------------------------------------------------
Equity Securities $ 14,733,876 $2,887,926 $413,46 $17,208,338
- ----------------------------------------------------------------------------
December 31, 1997
- ----------------------------------------------------------------------------
Fixed Maturities:
U.S. Government $ 8,039,775 $178,570 $4,845 $8,213,500
obligations
Corporate securities 26,007,059 961,956 165,515 26,803,500
Mortgage-backed 7,793,818 246,559 27,768 8,012,609
securities
- ----------------------------------------------------------------------------
Total $ 41,840,652 $1,387,085 $ 198,128 $ 43,029,609
- ----------------------------------------------------------------------------
Equity Securities $ 12,014,105 $3,245,854 $ 317,167 $ 14,942,792
- ----------------------------------------------------------------------------
The fair values for investments in fixed maturities and equity securities are
based on quoted market prices, where available. For investments in fixed
maturities and equity securities not actively traded, fair values are
estimated using values obtained from independent pricing services.
The annual change in net unrealized investment appreciation or depreciation,
at December 31, 1998, 1997 and 1996, and the amount of net realized
investment gain or loss included in net income for the respective years then
ended are as follows:
Year Ended December 31 1998 1997 1996
- -------------------------------------------------------------------------
Fixed maturities:
Change in net unrealized $1,158,586 $ 1,386,925 $(1,745,362)
appreciation (depreciation)
Net realized gain $827,204 $ 61,17 $218,188
Equity securities:
Change in net unrealized $(454,225) $2,050,241 $(601,195)
appreciation (depreciation)
Net realized gain $2,848,285 $2,131,975 $696,874
The amortized cost and fair value of investments in fixed maturities at
December 31, 1998, by contractual maturity are shown below. Expected
maturities for investments in fixed maturities will differ from contractual
maturities because borrowers may have the right to call or prepay
obligations, sometimes without prepayment penalties.
Amortized
December 31, 1998 Cost Fair Value
- ------------------------------------------------------------------
Due in one year or less $ 3,722,443 $ 3,749,012
Due after one year through five
years 38,208,919 39,074,880
Due after five years through ten
years 24,969,279 26,035,281
Due after ten years 2,552,292 2,728,882
- ------------------------------------------------------------------
Subtotal 69,452,933 71,588,055
Mortgage-backed securities 5,782,266 5,994,687
- ------------------------------------------------------------------
Total $ 75,235,199 $ 77,582,742
- ------------------------------------------------------------------
Gross gains of $1,411,737, $171,062, and $551,881 and gross losses of
$502,680, $96,073, and $317,685 were realized on the sale of
available-for-sale fixed maturities during 1998, 1997 and 1996,
respectively. Included in gross realized losses during 1998 and 1997 are net
adjustments to the carrying value of available-for-sale fixed maturities of
$150,000 and $75,000 respectively, relating to declines in value which were
considered by management to be other than temporary. Net realized gains from
the sale of fixed maturities have been reduced by $38,098 and $3,039 in 1998
and 1997 respectively, due to amortization of deferred policy acquisition
costs. In addition, net realized gains from the sale of fixed maturities
have been reduced by $43,755 and $10,777 in 1998 and 1997, respectively, for
incentive fees earned by the portfolio manager.
Gross gains of $8,165,216, $3,520,589, and $2,481,688 and gross losses of
$4,978,908, $746,780, and $1,689,679 were realized on the sale of
available-for-sale equity securities during 1998, 1997 and 1996. Included in
gross realized losses during 1998, 1997 and 1996 are adjustments to the
carrying value of available-for-sale equity securities of $1,356,000,
$232,544, and $666,871, respectively, relating to declines in value which
were considered by management to be other than temporary. Net realized gains
from the sale of equity securities have been reduced by $100,929 and $59,904
in 1998 and 1997 respectively, due to amortization of deferred policy
acquisition costs. In addition, net realized gains from the sale of
available-for-sale equity securities have been reduced by $237,094, $581,930,
and $51,875 in 1998, 1997, and 1996, respectively, for incentive and guaranty
fees earned by the portfolio manager and costs associated with operating a
brokerage margin account. Under terms of this brokerage margin account,
Morgan Stanley & Company, Inc. permits 50% of the value of securities held in
the account to be purchased on margin, at a 5.88% interest rate. At December
31, 1998 and 1997, margin advances of $1,507,408 and $518,394 respectively,
were outstanding and are included in the financial statements with accrued
expenses and other liabilities.
Net unrealized appreciation of available-for-sale securities is summarized as
follows:
December 31 1998 1997
- ---------------------------------------------------------------------
Net appreciation (depreciation) on
available-for-sale:
Fixed maturities $2,347,543 $1,188,957
Equity securities 2,474,462 2,928,687
Adjustment of deferred policy
acquisition costs (155,919) (185,829)
Deferred income taxes (1,586,470) (1,336,817)
- ---------------------------------------------------------------------
Net Unrealized Appreciation $3,079,616 $2,594,998
- ---------------------------------------------------------------------
Investment management services are provided by a firm affiliated with certain
board members and shareholders of the Company see Related Party Transaction
Note 16.
Major categories of investment income are summarized as follows:
Year Ended December 31 1998 1997 1996
- ----------------------------------------------------------------
Fixed maturities $4,157,891 $3,033,320 $3,361,210
Equity securities 422,847 317,699 152,025
Mortgage loans on real 16,214 16,321 18,298
estate
Policy loans 210,588 174,647 154,845
Investment real estate 406,971 334,044 323,498
Short-term investments and 335,332 148,421 367,324
other
- ----------------------------------------------------------------
Subtotal $5,549,843 $4,024,452 $4,377,200
Investment expense (359,521) (215,514) (218,918)
- ----------------------------------------------------------------
Net Investment Income $5,190,322 $3,808,938 $4,158,282
- ----------------------------------------------------------------
The Company limits credit risk by diversifying its investment portfolio among
government and corporate fixed maturities and common and preferred equity
securities. It further diversifies these investment portfolios within
industry sectors. As a result, management believes that significant
concentrations of credit risk do not exist. The Company's largest investment
in any entity (other than the U.S. Government) were the following fixed
maturities: $2,715,500 of Clear Channel Communications at December 31, 1998
and $1,525,000 of Walt Disney Company at December 31, 1997. At December 31,
1998, the Company had no investments which had not been income producing for
a period of at least twelve months prior to year end.
The following table is a reconciliation of the net unrealized gain arising
during the period and the change in net unrealized gains (losses) as reported
on the accompanying statements of shareholders' equity.
Pretax Tax
Year Ended December Amount Expense Net-of-Tax
31, 1998 Amount
- ---------------------------------------------------------
Unrealized gain arising $4,409,760 $947,996 $3,461,764
Less: Reclassification
adjustment
for gains realized 3,675,489 698,343 2,977,146
in net income
- ---------------------------------------------------------
Change in net $734,271 $249,653 $484,618
unrealized gain
- ---------------------------------------------------------
In conjunction with management of its equities portfolio, the Company has
also taken certain option positions, generally on equity securities or
related market indices. Although such positions may be covered by actual
securities owned or offsetting options, hedge accounting is not used.
Accordingly, all such positions are marked to market and changes in value
reported as realized gains or losses. During 1998, options purchases totaled
approximately $5,300,000 and related net realized gains totaled approximately
$380,000. At December 31, 1998 net option asset positions outstanding had a
market value of $387,500 and a cost of $352,900. There is no
off-balance-sheet risk associated with these positions.
Pursuant to requirements of certain state insurance departments, the Company
has investments with a carrying value of $59,296,420, at December 31, 1998,
placed on deposit at various financial institutions, which are restricted
from withdrawal without prior regulatory approval.
The Company owns the building and land in which it currently resides. At
December 31, 1998 and 1997, the Company occupied approximately 25% and 21%
respectively, of the building with the remaining space leased to third-party
tenants. The accompanying financial statements reflect the proportionate
Company occupied share of the building and related operating expense as
property and equipment and general expense, respectively. The remaining
portion is reflected as investment real estate and as a reduction of
investment income, respectively. Accumulated depreciation at December 31,
1998 and 1997 on the investment real estate portion of the building was
$772,213 and $699,603, respectively.
The Company leases office space to third-party tenants under noncancellable
lease agreements. Future minimum rental income is $304,632, $111,998,
$58,573, $40,896, and $34,080 for years 1999 through 2003, respectively.
Note 4--VALUE OF INSURANCE ACQUIRED
The value of insurance acquired is an asset, which represents the present
value of future profits on business acquired, using interest rates of 6.6% to
9%. Balances outstanding prior to the purchase of United Liberty relate to
the acquisitions of Integrity National Life Insurance Company and Old South
Life Insurance Company ("Integrity" and "Old South", respectively) both of
which were merged into Citizens Security. An analysis of the value of
insurance acquired for the years ended December 31, 1998, 1997 and 1996 is as
follows:
Year Ended December 31 1998 1997 1996
- ----------------------------------------------------------------
Balance at beginning of $4,496,872 $5,081,865 $6,059,095
year
Purchase of United Liberty 2,334,962 --- ---
Adjustment to 1995 --- --- (586,542)
acquisition
Accretion of interest 372,629 321,166 354,312
Amortization (1,069,331) (906,159) (745,000)
- ----------------------------------------------------------------
Balance at end of year $6,135,132 $4,496,872 $5,081,865
- ----------------------------------------------------------------
During the first twelve months after the September 22, 1995 acquisition of
Integrity, the assumptions used to establish the value of insurance acquired
were reconfirmed. Based on this review, the value of insurance acquired was
decreased and, the value of other net assets acquired was increased by
$586,542. This revision relates primarily to a reduction in the amount of
assumed future policy benefits associated with certain individual life
insurance policies that cover multiple family members.
Amortization of the value of insurance acquired (net of interest accretion)
in each of the following five years will be approximately: 1999 - $814,000;
2000 - $697,000; 2001 - $626,000; 2002 - $540,000; and 2003 - $460,000.
Note 5--LIABILITY FOR ACCIDENT AND HEALTH UNPAID CLAIMS AND INCURRED, BUT NOT
REPORTED CLAIMS PORTION OF RESERVES
Activity in the accident and health liability portion of policy and contract
claims ($391,311 and $384,162 at December 31, 1998 and 1997, respectively)
and the incurred but not reported portion of accident and health reserves
($2,016,205 and $789,612 at December 31, 1998 and 1997, respectively) are
summarized as follows:
Year Ended December 31 1998 1997
- -------------------------------------------------------------------
Balance at January 1 $1,173,774 $1,620,456
Less: reinsurance recoverable 292,327 576,015
- ------------------------------------------------------------------
Net balance at January 1 881,447 1,044,441
United Liberty balance at acquisition 71,090 ---
Total incurred - current year 5,027,678 5,694,456
Paid related to:
Current year 4,639,810 5,353,405
Prior years 482,223 504,045
- ------------------------------------------------------------------
Total paid 5,122,033 5,857,450
Net balance at December 31 858,182 881,447
Plus reinsurance recoverable 1,549,334 292,327
- ------------------------------------------------------------------
Balance at December 31 $2,407,516 $1,173,774
- ------------------------------------------------------------------
Note 6--DEBT
Long term debt consists of the following:
December 31 1998 1997
- ---------------------------------------------------------------------
Commercial bank note, prime, due 2006 $6,510,000 $ ---
Commercial bank note, prime plus 1/2%, due
2001 --- 1,900,000
Commercial bank note, prime due 2003 --- 1,610,000
- ---------------------------------------------------------------------
Total 6,510,000 3,510,000
Less: Current Portion (510,000) (400,000)
- ---------------------------------------------------------------------
Long Term Portion $6,000,000 $3,110,000
- ---------------------------------------------------------------------
On May 12, 1998, the Company borrowed an additional $3,400,000 in conjunction
with the United Acquisition and refinanced $3,310,000 of existing borrowings
under a single commercial bank note, with interest payable quarterly at the
bank's prime lending rate. Principal installments due on the Note total
$510,000 in 1999; $500,000 in 2000; $800,000 in 2001; $900,000 in 2002, 2003,
and 2004; and $1,000,000 in 2005 and 2006. The Company has pledged the
issued and outstanding common and preferred stock of Citizens Security as
collateral for the commercial bank note. The bank note also contains
covenants regarding asset acquisitions, shareholder dividends and maintenance
of certain operating ratios.
Cash paid for interest on debt was $524,765, $367,539, and $835,426, during
1998, 1997, and 1996, respectively; including $108,514, $103,227 and $51,875
in 1998, 1997 and 1996, respectively, related to brokerage account borrowings.
Note 7--REDEEMABLE CONVERTIBLE PREFERRED STOCK
During the third quarter of 1998, the Company converted approximately 98% of
its Class B redeemable convertible preferred stock ("Preferred Stock") to
common stock and repurchased the remaining 2% for cash. This conversion of
361 preferred shares resulted in issuance of 722,000 additional common shares
and increased common shareholders' equity by $3,937,768. The remaining 9
preferred shares were repurchased for $162,000, resulting in a net
shareholders' equity reduction of $63,000.
The Company originally issued 213 and 157 shares of Preferred Stock on
January 19, 1996 and December 15, 1995 respectively, for cash in the amount
of $11,000 per share ($4,070,000 in the aggregate). Holders of the Preferred
Stock were entitled to cumulative quarterly dividends, at the rate of $275
per share ($1,100 per annum). The Preferred Stock was mandatorily redeemable
in 12 equal quarterly installments beginning January 1, 2003. The Preferred
Stock holders could also elect to have their shares redeemed not later than
January 1, 2002. The Company was entitled to call the Preferred Stock for
redemption, at any time after January 1, 1999. The Company also had the
right to call the Preferred Stock for redemption at any time after January 1,
1998, if the market price for the Company's Class A Stock exceeded $8.25 per
share for at least 20 out of 30 consecutive trading days. In each case, the
redemption price was $11,000 per share. Until five (5) days prior to any
redemption date, each share of Preferred Stock was convertible into a
specified number of shares of the Company's common shares (2,000 on the date
of conversion).
Note 8--EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
per share. See Note 7 above for additional disclosures regarding the
outstanding preferred stock.
Year Ended December 31 1998 1997 1996
- --------------------------------------------------------------------------------
Numerator:
Diluted: Net income $3,299,660 $1,988,212 $1,109,323
Less: Preferred stock dividends 279,650 407,000 402,214
-------------------------------------------------------------------------------
Basic: Net income applicable to $1,581,212
common stock $3,020,010 $707,109
-------------------------------------------------------------------------------
Denominator:
Basic: Weighted average common shares
1,306,894 1,075,615 1,075,615
Plus: Assumed conversion
of preferred stock 505,233 740,000 717,533
- --------------------------------------------------------------------------------
Diluted: Weighted average shares
assuming preferred conversions 1,812,127 1,815,615 1,793,148
- -------------------------------------------------------------------------------
Basic earnings per share $2.31 $1.47 $0.66
Diluted earnings per share $1.82 $1.10 $0.62
Options to purchase 5,000 shares of the Company's common stock at $9 per
share were outstanding during 1997 but were not included in the computation
of diluted earnings per share because the options' exercise price was greater
than the average market price of the common shares and, therefore, the effect
would be antidilutive. These options were exercised during 1998.
Note 9--FEDERAL INCOME TAXES
Federal income taxes consist of the following:
Year Ended December 31 1998 1997 1996
- ----------------------------------------------------------------
Current tax expense $(793,000) $(341,500) $(479,033)
Deferred tax benefit 19,000 (141,000) 252,730
(expense)
- ----------------------------------------------------------------
Federal income tax expense $(774,000) $(482,500) $(226,303)
- ----------------------------------------------------------------
Deferred income taxes are provided for cumulative temporary differences
Deferred income taxes are provided for cumulative temporary differences
between balances of assets and liabilities determined under generally
accepted accounting principles and balances determined for tax reporting
purposes. Significant components of the Company's deferred tax liabilities
and assets as of December 31, 1998 and 1997 are as follows:
December 31 1998 1997
- ---------------------------------------------------------------------
Deferred Tax Liabilities:
Value of insurance acquired $ 2,085,945 $ 1,528,936
Net unrealized gains on
available-for-sale securities 1,586,470 1,336,817
Other 223,901 156,121
- ---------------------------------------------------------------------
Total deferred tax liabilities 3,896,316 3,021,874
Deferred Tax Assets:
Policy and contract reserves 1,591,595 1,783,158
Deferred policy acquisition costs 543,132 285,193
Fixed maturities and equity securities 338,474 169,552
Real estate 548,668 548,668
Alternative minimum tax credit
carryforwards 508,688 474,757
Net operating loss carryforwards 88,766 235,666
Other 348,377 212,272
- ---------------------------------------------------------------------
Total deferred tax assets 3,967,700 3,709,266
Valuation allowance for deferred tax
assets (1,376,402) (1,196,310)
- ---------------------------------------------------------------------
Net deferred tax assets 2,591,298 2,512,956
- ---------------------------------------------------------------------
Net Deferred Tax Liabilities $ 1,305,018 $ 508,918
- ---------------------------------------------------------------------
The following is a reconciliation of the federal statutory income tax rate to
the Company's effective income tax rate:
December 31 1998 1997 1996
- -------------------------------------------------------------------
Statutory rate of income tax 34.00 % 34.00 % 34.00 %
Dividend exclusion (1.52)% (1.71)% (1.65) %
Alternative minimum tax (2.69)% 5.28 % 9.00 %
(credit)
Small life deduction (13.90)% (18.32)% (39.48) %
Surtax exemption and other 1.01 % (3.76)% 1.17 %
Increase in valuation 2.10 % 4.04 % 13.96 %
allowance
- -------------------------------------------------------------------
Effective rate of income tax 19.00 % 19.53 % 17.00 %
- -------------------------------------------------------------------
Federal income taxes paid in 1998, 1997, and 1996 were $385,000, $610,000,
and $91,766, respectively. The Company utilized $430,418 and $508,488 of net
operating loss carry forwards in 1998 and 1997, respectively. The Company
has $261,077 of net operating loss carry forwards which will expire between
2007 and 2011.
Under the tax law in effect prior to 1984, a portion of income of Citizens
Security was not taxed when earned. It was accumulated in a tax account
known as policyholders' surplus. Under the provisions of the Deficit
Reduction Act of 1984, policyholders' surplus accounts were frozen at their
December 31, 1983 balance of $859,000 for Citizens Security on a merged
basis. Distributions from the policyholders' surplus would be subject to
income tax. At December 31, 1998, Citizens Security could have paid
additional dividends of approximately $7,875,000 before paying tax on any
part of its policyholders' surplus accounts. No provision has been made for
the related deferred income taxes which total $292,000, based on current tax
rates as of December 31, 1998.
Note 10--STATUTORY ACCOUNTING PRACTICES AND SHAREHOLDERS' EQUITY
The Insurance Subsidiaries are domiciled in Kentucky and prepare their
statutory-basis financial statements in accordance with statutory accounting
practices ("SAP") prescribed or permitted by the Kentucky Department of
Insurance ("KDI"). Net income and capital and surplus for the Company's
insurance operations, as reported in accordance with SAP, for the three years
ended December 31, 1998 are shown below.
Year Ended December 31 1998 1997 1996
- ----------------------------------------------------------------
Net Income $3,662,188 $1,708,884 $3,062,421
Capital and Surplus $11,227,528 $9,627,479 $9,145,830
Citizens Security reports its investment in United Liberty on the equity
method of accounting for statutory accounting purposes. Accordingly, the
admitted value of Citizens Security's investment in United Liberty equals
United Liberty's statutory capital and surplus total of $3,302,107 at
December 31, 1998. Citizens Security's 1998 net income includes $404,553 of
United Liberty statutory earnings arising since its acquisition.
Principal differences between SAP and GAAP include: a) costs of acquiring new
policies are deferred and amortized for GAAP; b) value of insurance inforce
acquired is established as an asset for GAAP; c) benefit reserves are
calculated using more realistic investment, mortality and withdrawal
assumptions for GAAP; d) deferred income taxes are provided for GAAP; e)
assets and liabilities of acquired companies are adjusted to their fair
values at acquisition with the excess purchase price over such fair values
recorded as goodwill under GAAP; f) available-for-sale fixed maturity
investments are reported at fair value with unrealized gain and losses
reported as a separate component of shareholders' equity for GAAP; and g)
statutory asset valuation reserves and interest maintenance reserves are not
required for GAAP.
"Prescribed" statutory accounting practices include state insurance laws,
regulations, and general administrative rules, as well as a variety of
publications of the National Association of Insurance Commissioners
("NAIC"). "Permitted" statutory accounting practices encompass all
accounting practices that are not prescribed; such practices may differ from
state to state, may differ from company to company within a state, and may
change in the future. During 1998, the NAIC adopted codified statutory
accounting principles ("Codification"). Codification will likely change, to
some extent, prescribed statutory accounting practices that the Insurance
Subsidiaries use to prepare their statutory-basis financial statements.
Codification will require adoption by the various states before it becomes
the prescribed statutory basis of accounting for insurance companies
domesticated within those states. Accordingly, before Codification becomes
effective for the Insurance Subsidiaries, the KDI must adopt Codification as
the prescribed basis of accounting on which domestic insurers must report
their statutory-basis results to the KDI. At this time it is anticipated
that the KDI will adopt Codification. Based on current draft guidance,
management believes that the impact of Codification will not be material to
the Insurance Subsidiaries' statutory-basis financial statements.
Statutory restrictions limit the amount of dividends which the Insurance
Subsidiaries may pay. Generally, dividends during any year may not be paid,
without prior regulatory approval, in excess of the lesser of (a) 10% of
statutory shareholder's surplus as of the preceding December 31, or (b)
statutory net operating income for the preceding year. During 1998, 1997 and
1996, with appropriate prior regulatory approval, Citizens Security redeemed
$1,500,000, $1,050,000 and $1,000,000, respectively, of its outstanding
preferred stock. In addition, during 1996, with appropriate regulatory
approval, Citizens Security paid an extraordinary dividend of $750,000 to the
Company. During 1998, United Liberty paid a $325,000 dividend to Citizens
Security. The Insurance Subsidiaries must each maintain $1,250,000 of
capital and surplus, the minimum required for life insurance companies
domiciled in Kentucky. The KDI imposes minimum risk-based capital ("RBC")
requirements on insurance enterprises that were developed by the NAIC. The
formulas for determining the amount of RBC specify various weighting factors
that are applied to financial balances and various levels of activity based
on the perceived degree of risk. Regulatory compliance is determined by a
ratio (the "Ratio") of the enterprise's regulatory total adjusted capital, as
defined by the NAIC, to its authorized control level RBC, as defined by the
NAIC. Enterprises below specific trigger points or ratios are classified
within certain levels, each of which requires specified corrective action.
The Insurance Subsidiaries each have a Ratio that is at least 400% of the
minimum RBC requirements; accordingly, both meet the RBC requirements.
Under a prior year agreement, an option to purchase 5,000 shares of the
Company's common stock was granted to an officer and was outstanding at the
beginning of 1998. The stock option vested as of June 16, 1995, at an
exercise price of $9 per share, and was scheduled to expire on June 16,
1998. This option was exercised during the second quarter of 1998, resulting
in an increase to shareholders' equity of $45,000. The Company accounts for
its stock option grants in accordance with APB Opinion No. 25, "Accounting
for Stock Issued to Employees." No compensation expense has been recognized
for this stock option. No options were exercised during 1997 or 1996. The
effect of applying the fair value method of accounting for the Company's
stock based awards results in net income and earnings per share that are not
materially different from amounts reported.
Note 11--SEGMENT INFORMATION
Effective December 31, 1998, the Company adopted SFAS No. 131 "Disclosures
about Segments of an Enterprise and Related Information." SFAS No. 131
supersedes SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise." SFAS No. 131 establishes standards for the way in which public
business enterprises report information about operating segments. SFAS No.
131 also establishes standards for related disclosures about products and
services, geographic areas, and major customers. The adoption of SFAS No.
131 did not affect results of operations or financial position, but did
affect the disclosure of 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 coverages. Preneed Life
products are sold to individuals in connection with prearrangement of their
funeral and include single premium and multi-pay policies with coverages
generally in amounts of $10,000 and less. These policies are generally sold
to older individuals at increased premium rates. Dental products are term
coverages generally sold to small and intermediate size employer groups.
Other Health products include various accident and health coverages sold to
individuals and employer groups.
Segment information as of December 31, 1998, 1997 and 1996, and for the years
then ended is as follows:
Year Ended December 31 1998 1997 1996
- -------------------------------------------------------------------------
Revenue:
Home Service Life $ 8,315,66 $8,322,33 $8,660,688
Broker Life 5,341,104 4,482,486 4,860,066
Preneed Life 2,099,584 --- ---
Dental 6,435,680 7,218,575 6,938,889
Other Health 1,409,483 1,485,301 1,675,480
- -------------------------------------------------------------------------
Segment Totals 23,601,516 21,508,695 22,135,123
Net realized investment gains, 3,675,489 2,193,148 915,062
net of expenses
- -------------------------------------------------------------------------
Total Revenue $ 27,277,00$ 23,701,84$ 23,050,185
- -------------------------------------------------------------------------
Below are the net investment income amounts which are included in the revenue
totals above.
Year Ended December 31 1998 1997 1996
- -------------------------------------------------------------------------
Net Investment Income:
Home Service Life $ 1,750,94 $1,769,75 $1,905,202
Broker Life 2,283,466 1,898,714 2,097,079
Preneed Life 1,025,696 --- ---
Dental 20,801 23,568 28,380
Other Health 109,417 116,899 127,621
- -------------------------------------------------------------------------
Segment Totals $ 5,190,32 $3,808,93 $4,158,282
- -------------------------------------------------------------------------
The Company evaluates performance based on several factors, of which the
primary financial measure is segment profit. Segment profit represents
pretax earnings, determined in accordance with the accounting policies
described in Note 1, except net realized investment gains and income tax
expense are excluded. The majority of the Company's realized investment
gains are generated from investment in equity securities. The equities
portfolio has averaged approximately $11,051,000 (cost basis) during the past
three years. If these funds had been invested in fixed-maturities yielding
6.5%, realized investment gains would have declined and the segment profit
totals below would have increased by an additional $516,000, $435,000, and
$311,000 in 1998, 1997, and 1996 respectively. The decline in Segment
profit from 1996 to 1997 is also impacted by reduced investment income
associated with prepayment of a $4.2 million mortgage loan on the Company's
headquarters building in late 1996.
Year Ended December 31 1998 1997 1996
- -------------------------------------------------------------------------
Segment Profit (Loss):
Home Service Life $ 211,71 97,098 703,509
Broker Life 254,189 100,655 223,739
Preneed Life 15,325 --- ---
Dental 295,038 214,495 (105,254)
Other Health 90,174 206,591 382,895
- -------------------------------------------------------------------------
Segment Totals 866,439 618,839 1,204,889
Net realized investment gains, 3,675,489 2,193,148 915,062
net of expenses
Interest expense 468,268 341,275 784,325
- -------------------------------------------------------------------------
Income before Federal Income Tax $ 4,073,66$ 2,470,71$ 1,335,626
- -------------------------------------------------------------------------
Depreciation and amortization amounts below consist of amortization of the
value of insurance acquired, deferred policy acquisition costs and goodwill,
along with depreciation expense.
Year Ended December 31 1998 1997 1996
- -------------------------------------------------------------------------
Depreciation and Amortization:
Home Service Life $ 710,150 $ 736,651 $ 517,018
Broker Life 757,154 760,311 955,249
Preneed Life 135,723 --- ---
Dental 54,381 59,812 49,462
Other Health 40,708 45,103 35,015
- -------------------------------------------------------------------------
Segment Totals $1,698,116 $1,601,877 $1,556,744
- -------------------------------------------------------------------------
Segment asset totals are determined based on policy liabilities outstanding
in each segment.
December 31 1998 1997 1996
- -------------------------------------------------------------------------
Assets:
Home Service Life $ 43,299,03 $42,944,97 $39,484,726
Broker Life 52,783,159 39,165,663 38,063,665
Preneed Life 30,869,962 --- ---
Dental 674,728 699,382 747,463
Other Health 1,872,237 1,939,822 1,966,854
- -------------------------------------------------------------------------
Total Assets $129,499,123 $84,749,84 $80,262,708
- -------------------------------------------------------------------------
Note 12--REINSURANCE
The Company currently follows the general practice of reinsuring that portion
of risk on the life of any individual which is in excess of $40,000 for
individual policies (under yearly renewable term and coinsurance agreements)
and $15,000 for group policies (under a group yearly renewable term
agreement). Graded death benefit coverages above $4,000 are generally 50%
reinsured, with the Insurance Subsidiaries maintaining a maximum $10,000 risk
on any one policyholder. Individual and group accidental death coverage and
major medical accident and health coverages are 100% reinsured. To the
extent that reinsuring companies are unable to meet obligations under
reinsurance agreements, the Company would remain liable.
Note 13--CONTINGENCIES
In the normal course of business, the Company is party to a number of
lawsuits. Management believes recorded claims liabilities are adequate to
ensure these suits will be resolved without material financial impact to the
Company.
Note 14--FAIR VALUES OF FINANCIAL INSTRUMENTS
The fair values of financial instruments, and the methods and assumptions
used in estimating their fair values, are as follows:
Fixed Maturities: The fair values for fixed maturities are based on quoted
market prices, where available. For those fixed maturities which are not
actively traded, fair values are estimated using values obtained from
independent pricing services. Available-for-sale fixed maturities are
carried at fair value in the accompanying statements of financial condition.
At December 31, 1998 and 1997, the fair value of available-for-sale fixed
maturities was $77,582,742 and $43,029,609, respectively.
Equity Securities: The fair values for equity securities are based on quoted
market prices. Equity securities are carried at fair value in the
accompanying statements of financial condition. At December 31, 1998 and
1997, the fair value of equity securities was $17,208,338 and $14,942,792,
respectively.
Short-Term Investments: The carrying amount of short-term investments
approximates their fair value. At December 31, 1998 and 1997, the fair value
of short-term investments was $594,805 and $572,492, respectively.
Cash and Cash Equivalents: The carrying amount of cash and cash equivalents
approximates their fair value. At December 31, 1998 and 1997, the fair value
of cash and cash equivalents was $8,301,999 and $6,180,576, respectively.
Mortgage Loans: The carrying amount of mortgage loans approximates their
fair value. At December 31, 1998 and 1997, the fair value of mortgage loans
was $164,757 and $170,536, respectively.
Policy Loans: The carrying amount of policy loans approximates their fair
value. At December 31, 1998 and 1997, the fair value of policy loans was
$4,034,152 and $2,943,148, respectively.
Investment Contracts: The carrying amount of investment-type fixed annuity
contracts approximates their fair value. At December 31, 1998 and 1997, the
fair value of investment-type fixed annuity contracts was $8,726,975 and
$9,181,758, respectively.
Notes Payable: The carrying amounts of notes payable approximate their fair
values. At December 31, 1998 and 1997, the fair value of notes payable was
$6,510,000 and $3,510,000, respectively.
Note 15--BENEFIT PLANS
During 1997, the Company adopted a 401(k) savings plan for its full-time
employees. The Company contributes matching contributions at the discretion
its Board of Directors. Company expense associated with this plan totaled
$24,337 and $15,238 in 1998 and 1997, respectively.
Note 16--RELATED PARTY TRANSACTIONS
The Company has various transactions with its President and Chairman of the
Board (the "Chairman") or entities he controls. The Chairman provides
investment portfolio management for the Company and the Insurance
Subsidiaries, through SMC Advisors, Incorporated (of which the Chairman is
the principal officer, a director, and the sole shareholder). The investment
portfolio management contracts provide for total annual fixed fees of $39,000
($30,000 prior to the United Acquisition) and incentive compensation equal to
five percent (5%) of the sum of the net realized and unrealized capital gains
in the fixed maturities and equity securities portfolios of the Company and
the Insurance Subsidiaries during each contract year. Any excess of net
realized and unrealized capital losses over net realized and unrealized
capital gains at the end of a contract year is not carried forward to the
next contract year. Fixed fees totaled $34,500 in 1998 and $30,000 in each of
1997 and 1996. Incentive fees of $196,904 and $306,747 were incurred and
paid for 1998 and 1997, respectively. Such fees were paid within
seventy-five days of the respective year-ends. No incentive fees were
incurred for 1996. Previously, the Chairman, personally guaranteed a portion
of the Company's commercial bank debt in return for a fee. Effective June
15, 1998 the commercial bank unilaterally released the Chairman's personal
guarantee. Fees earned in connection with the Chairman's guarantee totaled
$169,583 and $160,749 for 1997 and 1996, respectively. No guaranty fees were
earned for 1998. The Company also maintains a portion of its investments
under a Trust Agreement with a bank controlled by the Chairman. Fees to the
bank are based on assets held. Such fees were $35,612, $26,451, and $17,316
in 1998, 1997, and 1996, respectively.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There has been no change in accountants nor have there been any disagreements
on accounting and financial disclosure requiring disclosure pursuant to the
Instructions to this Item.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS,
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
The information required by this Item is set forth under the captions
"Election of Directors", "Executive Officers of the Company", and "Section
16(a) Beneficial Ownership Reporting Compliance" in the Board of Director's
Proxy Statement for the Annual Meeting of Shareholders of the Company now
scheduled for May 20, 1999, and such information is here incorporated by
reference.
ITEM 10. EXECUTIVE COMPENSATION
The information required by this Item is set forth under the caption
"Executive Compensation" in the Board of Directors' Proxy Statement for the
Annual Meeting of Shareholders of the Company now scheduled for May 20, 1999,
and such information is here incorporated by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The information required by this Item is set forth under the captions
"Security Ownership of Certain Beneficial Owners and Management" and
"Election of Directors" in the Board of Directors' Proxy Statement for the
Annual Meeting of Shareholders of the Company now scheduled for May 20, 1999,
and such information is here incorporated by reference.
ITEM 12. CERTAIN RELATIONSHIPS
AND RELATED TRANSACTIONS
The information required by this Item is set forth under the captions
"Certain Transactions Involving Directors and Securities Officers" in the
Board of Directors' Proxy Statement for the Annual Meeting of Shareholders of
the Company now scheduled for May 20, 1999, and such information is here
incorporated by reference.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
The following documents are filed as part of this Form 10-KSB:
(a) Exhibits.
The exhibits listed in the Index to Exhibits appearing on page 49.
(b) Reports on Form 8-K.
None.
SIGNATURES
In accordance with of Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
CITIZENS FINANCIAL CORPORATION
March 31, 1999 By: /s/ Darrell R. Wells
---------------------------------
Darrell R. Wells
President
In accordance with the requirements of the Exchange Act, this Report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
/s/ Darrell R. Wells
- ---------------------------
Darrell R. Wells Director and President March 31, 1999
(principal executive officer)
/s/ Lane A. Hersman
- ---------------------------
Lane A. Hersman Director and Executive March 31, 1999
Vice President
/s/ Brent L. Nemec
- ---------------------------
Brent L. Nemec Vice President,Accounting, March 31, 1999
Chief Financial Officer,
and Treasurer (principal financial
/s/ John H. Harralson, Jr.
- ---------------------------
John H. Harralson, Jr. Director March 31, 1999
/s/ Frank T. Kiley
- ---------------------------
Frank T. Kiley Director March 31, 1999
/s/ Charles A. Mays
- ---------------------------
Charles A. Mays Director March 31, 1999
/s/ Earle V. Powell
- ---------------------------
Earle V. Powell Director March 31, 1999
/s/ Thomas G. Ward
- ---------------------------
Thomas G. Ward Director March 31, 1999
/s/ Margaret A. Wells
- ---------------------------
Margaret A. Wells Director March 31, 1999
INDEX TO EXHIBITS
INDEX TO EXHIBITS
(Item 13(b))
The documents listed in the following table are filed as Exhibits in response
to Item 13(b). Exhibits listed that are not filed herewith are incorporated
herein by reference.
Exhibit Sequential
No. Description Page No.
2.1 Stock Purchase Agreement dated March 24,
1995 between Southwestern Life Corporation
and the Company (Exhibit B omitted) (filed
as Exhibit 2.1 to the Company's Form 8-K
dated September 22, 1995)
2.2 Amendment to Stock Purchase Agreement dated
September 22, 1995 between Southwestern Life
Corporation and the Company (Exhibits
omitted) (filed as Exhibit 2.2 to the
Company's Form 8-K dated September 22, 1995)
3.1 Articles of Incorporation of the Company
dated September 11, 1990 as amended December
14, 1995 and June 5, 1996) (filed as Exhibit
3.1 to the Company's Form 10-Q for the
quarter ended June 30, 1996)
3.2 Bylaws of the Company adopted September 12,
1990 as amended March 25, 1994 (filed as
Exhibit 3.2 to the Company's Form 10-K dated
March 28, 1996)
4 Provisions of Articles of Incorporation of
the Company Defining the Rights of Holders
of Class A Stock (filed as Exhibit 4 to the
Company's Form 10 Registration Statement)
10.1 Investment Management Agreements dated July
1, 1994 between Citizens Security and the
Company and SMC Advisors, Incorporated
(filed as Exhibit 10.1 to the Company's Form
10-K dated March 29, 1995)
10.2 Resolution of Board of Directors of the
Company adopted February 4, 1992 granting
stock options to Lane A. Hersman (filed as
Exhibit 10.2 to the Company's Form 10
Registration Statement)
10.6 Quota Share Coinsurance and Assumption
Reinsurance Agreement dated September 21,
1995 between Integrity Life Insurance
Company and Union Bankers Insurance Company
(Exhibits omitted) (filed as Exhibit 10.6 to
the Company's Form 8-K dated September 22,
1995)
10.8 Guarantor's Compensation Agreement dated as
of September 22, 1995 between the Company
and Darrell R. Wells (including Exhibit C,
form of Guaranty Note) (Other exhibits
omitted) (filed as Exhibit 10.8 to the
Company's Form 8-K dated September 22, 1995)
10.8A First Amendment to Guarantor's Compensation
Agreement dated September 21, 1996 between
the Company and Darrell R. Wells (filed as
Exhibit 10.8A to the Company's Form 10-Q for
the quarter ended September 30, 1996)
10.8B Second Amendment to Guarantor's Compensation
Agreement dated September 22, 1997 between
the Company and Darrell R. Wells (filed
herewith)
10.9 Form of Employment Agreement with Certain
Executives of the Company and Schedule of
Data (filed as Exhibit 10.9 to the Company's
Form 10-K dated March 28, 1996)
21.1 Subsidiaries of the Registrant (filed 51
herewith)
27 Financial Data Schedule (electronic filing
only)
- --------------- ---------------------------------------------- ----------------
The Company agrees to furnish supplementally to the Commission upon request a
copy of the omitted schedules to Exhibits Nos. 2.1 and 2.2 as contemplated by
Rule 601(b)(2).
EXHIBIT 21.1
EXHIBIT 21.1
Subsidiaries of the Registrant
-----------------------------------------
Citizens Financial Corporation
(Kentucky corporation)
-----------------------------------------
-----------------------------------------
100% 100%
- ------------------------- ------------------------
Citizens Security Life Citizens Financial
Insurance Company Properties, Inc.*
(Kentucky corporation) (Kentucky corporation)
- ------------------------- ------------------------
100%
- -------------------------
United Liberty Life
Insurance Company
(Kentucky corporation)
- -------------------------
* Citizens Financial Properties, Inc. is presently inactive and has
no material assets or liabilities.
RESTATED ARTICLES OF INCORPORATION
OF
CITIZENS FINANCIAL CORPORATION
Pursuant to the provisions of KRS 271B.10-070, the undersigned
corporation executes these Restated Articles of Incorporation:
FIRST: The name of the corporation is CITIZENS FINANCIAL
CORPORATION.
SECOND: The text of the corporation's Restated Articles of
Incorporation is as follows:
RESTATED ARTICLES OF INCORPORATION
OF
CITIZENS FINANCIAL CORPORATION
The undersigned Incorporator, H. Alexander Campbell, executes
these Articles of Incorporation for the purpose of forming and does hereby
form a corporation under the laws of the Commonwealth of Kentucky in
accordance with the following provisions:
ARTICLE I
The name of the corporation is CITIZENS FINANCIAL CORPORATION.
ARTICLE II
The purpose for which the corporation is organized is the
transaction of any or all lawful business for which corporations may be
organized under the Kentucky Business Corporation Act, or any act amendatory
thereof, supplemental thereto or substituted therefor (the "Act"), and to do
all things necessary, convenient, proper or desirable in connection with or
incident to any of the corporation's businesses.
ARTICLE III
The street address of the initial registered office of the
corporation in the Commonwealth of Kentucky is Suite 300, The Marketplace,
12910 Shelbyville Road, Louisville, Kentucky 40243. The initial registered
agent at the same address is Theodore Rich.
ARTICLE IV
The mailing address of the principal office of the corporation is
Suite 300, The Marketplace, 12910 Shelbyville Road, Louisville, Kentucky
40243.
ARTICLE V
The name and address of the Incorporator is H. Alexander
Campbell, 2800 Citizens Plaza, Louisville, Kentucky 40202.
ARTICLE VI
Capital Stock
A. The aggregate number of shares of capital stock that the
corporation is authorized to issue is 6,000,000 shares of Class A Stock,
without par value ("Class A Stock") and 500,000 shares of Class B Stock,
without par value ("Class B Stock").
B. Class A Stock
[1] The holders of Class A Stock of the corporation shall
be entitled to one vote for each share of Class A Stock held by them on
all matters properly presented to shareholders, except as otherwise
provided herein or by the Act.
[2] Subject to any preferential rights of any series of
Class B Stock set forth in the resolution adopted by the Board of
Directors establishing such series, the holders of the Class A Stock
shall be entitled to receive dividends, when and as declared by the
Board of Directors, out of funds legally available therefor.
C. Class B Stock
[1] To the extent permitted by the Act, the Board of
Directors is authorized, by resolution, to cause Class B Stock to be
divided into and issued from time to time in one or more series and to
fix and determine the designation and number of the shares and the
relative rights and preferences of the shares of each such series and
to change shares of one series that have been redeemed or reacquired
into shares of another series.
[2] All shares of Class B Stock shall rank equally and be
identical in all respects except as to the relative rights and
preferences of any series fixed and determined by the Board of
Directors, which may vary to the extent permitted by the Act.
[3] The holders of Class B Stock of each series shall be
entitled to receive such dividends, when and as declared by the Board
of Directors, out of funds legally available therefor, as they may be
entitled to in accordance with the resolution or resolutions adopted by
the Board of Directors establishing such series, payable on such dates
as may be fixed in such resolution or resolutions. So long as there
shall be outstanding any shares of Class B Stock of any series entitled
to cumulative dividends pursuant to the resolution or resolutions
providing for the issuance of such series, no dividend, whether in cash
or property, shall be paid or declared, nor shall any distribution be
made, on Class A Stock, nor shall any shares of Class A Stock be
purchased, redeemed or otherwise acquired for value by the corporation,
if at the time of making such payment, declaration, distribution,
purchase, redemption or acquisition the corporation shall be in default
with respect to any dividend payable on, or obligation to maintain a
purchase, retirement or sinking fund with respect to, or to redeem,
shares of Class B Stock of any series. The foregoing provisions of
this paragraph 3 of Section C of this Article VI shall not, however,
apply to a dividend payable in Class A Stock or to the acquisition of
shares of Class A Stock in exchange for, or through application of the
proceeds of the sale of, shares of Class A Stock.
[4] Class B Stock shall be preferred over Class A Stock
as to assets so that the holders of a series of Class B Stock shall be
entitled to be paid, upon the voluntary or involuntary liquidation,
dissolution or winding up of the corporation and before any
distribution is made to the holders of Class A Stock, but only if and
to the extent of the amount fixed in the resolution adopted by the
Board of Directors establishing such series, without prejudice to any
entitlement to any other or further payment fixed in such resolution.
If upon any such liquidation, dissolution or winding up of the
corporation, its net assets shall be insufficient to permit the payment
in full of the respective amounts to which the holders of all
outstanding Class B Stock are entitled, the entire remaining net assets
of the corporation shall be distributed among the holders of each
series of Class B Stock in amounts proportionate to the full amounts to
which the holders of each such series are respectively entitled. For
purposes of this paragraph 4, the voluntary sale, lease, exchange or
transfer of all or substantially all of the corporation's property or
assets to, or its consolidation or merger with, one or more
corporations shall not be deemed to be a voluntary or involuntary
liquidation, dissolution or winding up of the corporation.
[5] All shares of any series of Class B stock shall be
redeemable but only if and to the extent permitted by the Act and fixed
in the resolution adopted by the Board of Directors establishing such
series. All shares of any series of Class B Stock shall be convertible
into shares of Class A Stock or into shares of any other series of
Class B Stock but only if and to the extent permitted by the Act and
fixed in the resolution adopted by the Board of Directors establishing
such series.
[6] Unless otherwise provided herein or by the Act, or
unless otherwise provided in the resolution adopted by the Board of
Directors establishing any series of Class B Stock, the holders of
shares of Class B Stock shall be entitled to one vote for each share of
Class B Stock held by them on all matters properly presented to
shareholders, and in that case the holders of Class A Stock and the
holders of all series of Class B Stock so entitled to vote shall vote
together as one class.
D. No holder of shares of any class of stock of the
corporation shall have any preemptive rights to subscribe to stock,
obligations, warrants, subscription rights or other securities of the
corporation of any class, whether now or hereafter authorized.
E. 1995 Class B Convertible Preferred Stock
[1] Designation. The series of Class B Stock provided
for by this resolution and amendment shall be designated "1995 Class B
Convertible Preferred Stock" (hereinafter referred to as the "1995
Class B Stock").
[2] Authorization. The number of shares constituting the
Series B Stock shall be 370 shares.
[3] Dividends.
[a] The holders of shares of the 1995 Class B Stock
shall be entitled to receive, when and as declared by the Board
of Directors, out of funds legally available therefor, cumulative
quarterly dividends payable in cash on the first business day of
January, April, July, and October in each year, beginning April
1, 1996, at the annual rate of $1,100.00 per share (as adjusted
for any stock dividends, combinations or splits with respect to
such shares) and no more. Dividends payable on the 1995 Class B
Stock for each full dividend period shall be computed by dividing
the annual dividend rate of $1,100.00 by four (4). Dividends
payable on the 1995 Class B Stock [i] for the period from the
date of original issuance thereof to the first subsequent regular
dividend payment date and [ii] in the case of shares called for
redemption, from the last regular dividend payment date to the
date of payment, shall be prorated according to the number of
days elapsed prior to the date of payment over an assumed year of
365 days. The Board of Directors shall fix a record date for the
determination of holders of shares of the 1995 Class B Stock
entitled to receive payment of each dividend or distribution
declared thereon.
[b] No dividends (other than those payable solely
in the Class A Stock of the corporation) shall be paid on any
Class A Stock of the corporation at any time and for so long as
there shall not have been declared and paid or set apart for
payment all amounts necessary to eliminate any arrearage in
payment of the aforesaid dividends on the 1995 Class B Stock.
[4] Liquidation Preference.
[a] In the event of any liquidation, dissolution or
winding up of the corporation, whether voluntary or involuntary,
the holders of the 1995 Class B Stock shall be entitled to
receive out of funds legally available therefor, prior and in
preference to any distribution of any of the assets or surplus
funds of the corporation to the holders of the Class A Stock by
reason of their ownership thereof, the amount of $11,000.00 per
share (as adjusted for any stock dividends, combinations or
splits with respect to such shares), plus all accrued or declared
but unpaid dividends including a pro rata dividend according to
the number of days elapsed prior to the date of payment over an
assumed year of 365 days (collectively, "Accrued Dividends") on
such share for each share of 1995 Class B Stock then held by
them. If upon the occurrence of such event, the assets and funds
thus distributed among the holders of the 1995 Class B Stock
shall be insufficient to permit the payment to such holders of
the full aforesaid preferential amount, then the entire assets
and funds of the corporation legally available for distribution
shall be distributed ratably among the holders of the 1995 Class
B Stock in proportion to the preferential amount each such holder
is otherwise entitled to receive.
[b] Whenever the distribution provided for in this
paragraph 4 shall be payable in securities or property other than
cash, the value of such distribution shall be the fair market
value of such securities or other property as determined in good
faith by the Board of Directors.
[5] Redemption.
[a] Scheduled Redemption. The corporation shall
redeem, from any source of funds legally available therefor, the
1995 Class B Stock in twelve quarterly installments beginning on
January 1, 2003, and continuing thereafter on each April 1, July
1, October 1, and January 1, until October 1, 2005 (each such
date a "1995 Class B Scheduled Redemption Date"), whereupon the
remaining 1995 Class B Stock outstanding shall be redeemed. The
corporation shall effect such redemptions on the applicable 1995
Class B Scheduled Redemption Dates by paying in cash in exchange
for the shares of 1995 Class B Stock to be redeemed a sum equal
to $11,000.00 per share of 1995 Class B Stock (as adjusted for
any stock dividends, combinations or splits with respect to such
shares) plus all Accrued Dividends (the "1995 Class B Redemption
Price"). The number of shares of 1995 Class B Stock that the
corporation shall be required under this paragraph 5.a to redeem
on any one 1995 Class B Scheduled Redemption Date shall be equal
to the amount determined by dividing [i] the aggregate number of
shares of 1995 Class B Stock outstanding immediately prior to the
1995 Class B Scheduled Redemption Date by [ii] the number of
remaining 1995 Class B Scheduled Redemption Dates (including the
1995 Class B Redemption Date to which such calculation applies).
Any redemption effected pursuant to this paragraph 5.a shall be
made on a pro-rata basis among the holders of the 1995 Class B
Stock in proportion to the shares of 1995 Class B Stock then held
by them.
[b] Holder's Optional Redemption. At the
individual option of each holder of shares of 1995 Class B Stock,
the corporation shall redeem, on a date selected by it on or
before January 1, 2002 (the "1995 Class B Holder's Optional
Redemption Date"), the number of shares of 1995 Class B Stock
held by such holder that is specified in a request for redemption
delivered to the corporation by the holder on or prior to
December 31, 2000, by paying in cash therefor the 1995 Class B
Redemption Price.
[c] Issuer's Optional Redemption. At its option,
the corporation may redeem, in whole or from time to time in
part, at any time after January 1, 1998, any or all of the
outstanding shares of 1995 Class B Stock by paying in cash
therefor the 1995 Class B Redemption Price, but only if for any
20 trading days within any period of 30 consecutive trading days,
including the last trading day of such period, the current market
price of the Class A Stock on each of such 20 trading days has
exceeded 150% of the 1995 Class B Conversion Price in effect on
such trading day. In addition, at its option, the corporation
may redeem, in whole or from time to time in part, at any time
after January 1, 1999, any or all of the outstanding shares of
1995 Class B Stock by paying in cash therefor the 1995 Class B
Redemption Price. The corporation shall give written notice of
any such redemption to each holder of record (at the close of
business on the business day next preceding the day on which
notice is given) of the 1995 Class B Stock, which notice shall be
mailed, first class postage prepaid, at the address last shown on
the record of the corporation for such holder, and shall specify
a date not less than 15 nor more than 45 days after the date of
such notice as the date for such redemption (each a "1995 Class B
Issuer's Optional Redemption Date"). Any redemption effected
pursuant to this paragraph 5.c shall be made on a pro-rata basis
among the holders of the 1995 Class B Stock in proportion to the
shares of 1995 Class B Stock then held by them.
[d] At least 15 but no more than 30 days prior to
each 1995 Class B Scheduled Redemption Date, each 1995 Class B
Holder's Optional Redemption Date, and 1995 Class B Issuer's
Optional Redemption Date (each hereinafter, a "Redemption Date"),
written notice shall be mailed, first class postage prepaid, to
each holder of record (at the close of business on the business
day next preceding the day on which notice is given) of the 1995
Class B Stock to be redeemed, at the address last shown on the
record of the corporation for such holder, notifying such holder
of the redemption to be effected, specifying the number of shares
to be redeemed from such holder, the date of the redemption, the
1995 Class B Redemption Price, the place at which payment may be
obtained and calling upon such holder to surrender to the
corporation, in the manner and at the place designated, the
holder's certificate or certificates representing the shares to
be redeemed (the "Redemption Notice"). Except as provided in
paragraph 5.E, on or after the date specified in the Redemption
Notice, each holder of 1995 Class B Stock to be redeemed shall
surrender to the corporation the certificate or certificates
representing such shares, in the manner and at the place
designated in the Redemption Notice, and thereupon the 1995 Class
B Redemption Price of such shares shall be payable to the order
of the person whose name appears on such certificate or
certificates as the owner thereof and each surrendered
certificate shall be cancelled. In the event less than all the
shares represented by any such certificate are redeemed, a new
certificate shall be issued representing the unredeemed shares.
[e] From and after any Redemption Date, unless
there shall have been a default in payment of the 1995 Class B
Redemption Price, all rights of the holders of shares of 1995
Class B Stock designated for redemption in the Redemption Notice
as holders of 1995 Class B Stock (except the right to receive the
1995 Class B Redemption Price without interest upon surrender of
their certificate or certificates) shall cease with respect to
such shares, and such shares shall not thereafter be transferred
on the books of the corporation or be deemed to be outstanding
for any purpose whatsoever. If the funds of the corporation
legally available for redemption of shares of 1995 Class B Stock
on any Redemption Date are insufficient to redeem the total
number of shares of 1995 Class B Stock to be redeemed on such
date, those funds which are legally available will be used to
redeem the maximum possible number of such shares ratably among
the holders of such shares to be redeemed based upon their
holdings of 1995 Class B Stock. The shares of 1995 Class B Stock
not redeemed shall remain outstanding and entitled to all the
rights and preferences provided herein. At any time thereafter
when additional funds of the corporation are legally available
for the redemption of shares of 1995 Class B Stock, such funds
will immediately be used to redeem the balance of the shares that
the corporation has become obliged to redeem on any Redemption
Date, but which it has not redeemed, in accordance with a
procedure substantially similar to that described above and
approved by the Board of Directors.
[f] On or prior to each Redemption Date, the
corporation shall deposit the 1995 Class B Redemption Price of
all shares of 1995 Class B Stock designated for redemption in the
Redemption Notice and not yet redeemed with a bank or trust
company having aggregate capital and surplus in excess of
$10,000,000 as a trust fund for the benefit of the respective
holders of the shares designated for redemption and not yet
redeemed, with irrevocable instructions and authority to the bank
or trust company to pay the 1995 Class B Redemption Price for
such shares to the respective holders on or after the Redemption
Date upon receipt of notification from the corporation that such
holder has surrendered his share certificate to the corporation
pursuant to paragraph 5.e of this Section E. As of the
Redemption Date, the deposit shall constitute full payment of the
shares to their holders, and from and after the Redemption Date
the shares so called for redemption shall be redeemed and shall
be deemed to be no longer outstanding, and the holders thereof
shall cease to be stockholders with respect to such shares and
shall have no rights with respect thereto except the rights to
receive from the bank or trust company payment of the 1995 Class
B Redemption Price of the shares, without interest, upon
surrender of their certificates therefor. Such instructions
shall also provide that any moneys deposited by the corporation
pursuant to this paragraph 5.f for the redemption of shares
thereafter converted into shares of the corporation's Class A
Stock pursuant to paragraph 7 of this Section E prior to the
Redemption Date shall be returned to the corporation forthwith
upon such conversion. The balance of any moneys deposited by the
corporation pursuant to this paragraph 5.f remaining unclaimed at
the expiration of two (2) years following the Redemption Date
shall thereafter be returned to the corporation upon its request
expressed in a resolution of its Board of Directors.
[6] Voting Rights; Directors.
[a] So long as any shares of the 1995 Class B Stock
remaining outstanding, in the event of a failure of the
corporation to pay dividends on the 1995 Class B Stock for six
(6) quarterly periods or to redeem shares of the 1995 Class B
Stock as required pursuant to paragraph 5 of this Section E (the
"Events of Default"), then until such Events of Default have been
fully cured (including declaration and payment or setting aside
funds sufficient for payment of all such unpaid dividends)
[i] the authorized number of members of the Board of Directors of
the corporation shall be increased by two (2) persons (the "1995
Class B Directorships") and [ii] the holders of the 1995 Class B
Stock shall (immediately upon the giving of written notice the
corporation by the holders of a majority of the then outstanding
shares of 1995 Class B Stock), voting together as a single class,
be entitled to elect two (2) members of the Board of Directors of
the corporation to full the vacancies thereby created (the "1995
Class B Directors"). If, after the election of a new Board of
Directors pursuant to this paragraph 6, the Events of Default are
cured, then [i] the 1995 Class B Directorships shall terminate
and [ii] the holders of the 1995 Class B Stock shall be divested
of the special voting rights specified in this paragraph a.
However, such special voting rights shall again accrue to the
holders of the shares of the 1995 Class B Stock in case of any
later occurrence of an Event of Default.
[b] Whenever under the provisions of this paragraph
6, the right shall have accrued to the holders of the 1995 Class
B Stock to vote as a single class to elect the 1995 Class B
Directors, the Board of Directors shall, within ten (10) days
after delivery to the corporation at its principal office of a
request to such effect by the holders of a majority of the then
outstanding shares of the 1995 Class B Stock, call a special
meeting of such holders for the election of the 1995 Class B
Directors, to be held upon not less than ten (10) nor more than
twenty (20) days' notice to such holder. If such notice of
meeting is not given within the ten (10) days required above, the
holders of 1995 Class B Stock requesting such meeting may also
call such meeting and for such purposes shall have access to the
stock books and records of the corporation. At any meeting so
called or at any other meeting held while the holders of shares
of 1995 Class B Stock shall have the voting power provided in
this paragraph, the holders of a majority of the shares of 1995
Class B Stock present in person or by proxy or voting by written
consent, shall be sufficient to constitute a quorum for the
election of directors as herein provided. In the case of any
vacancy a 1995 Class B Directorship, the remaining 1995 Class B
Director may appoint a successor to hold office for the unexpired
term of the director whose 1995 Class B Directorship shall be
vacant, provided that if there are no remaining 1995 Class B
Directors, the vacancies may be filled by the affirmative vote of
the holders of a majority of the shares of 1995 Class B Stock,
voting together as a single class, given either at a special
meeting of such holders duly called for that purpose or pursuant
to a written consent of stockholders. Any 1995 Class B directors
who shall have been elected by the holders of 1995 Class B Stock
or appointed by any directors so elected as provided in the next
preceding sentence hereof may be removed during the aforesaid
term of office, either with or without cause, by, and only by,
the affirmative vote of the holders of a majority of the shares
of the 1995 Class B Stock who elected such director or directors,
given either at a special meeting of such holders duly called for
that purpose or pursuant to a written consent of such holders,
and any vacancy thereby created may be filled by the holders of
the 1995 Class B Stock represented at such meeting or pursuant to
such written consent.
[7] Conversion. The 1995 Class B Stock shall be
convertible into Class A Stock as follows:
[a] Right to Convert. Each share of 1995 Class B
Stock shall be convertible, at the option of the holder thereof,
at any time after the date of issuance of such share and on or
prior to the fifth (5th) day prior to any Redemption Date, if
any, as may have been fixed in any Redemption Notice with respect
to the 1995 Class B Stock, at the office of the corporation or
any transfer agent for such stock, into such number of fully paid
and nonassessable shares of Class A Stock as is determined by
dividing $11,000.00 by the 1995 Class B Conversion Price
applicable to such share, determined as hereinafter provided, in
effect on the date the certificate is surrendered for
conversion. The price at which shares of Class A Stock shall be
delivered upon conversion of shares of the 1995 Class B Stock
shall be $5.50 per share of Class A Stock, adjusted as
hereinafter provided (as so adjusted, the "1995 Class B
Conversion Price").
[b] Mechanics of Conversion.
(1) Before any holder of 1995 Class B Stock
shall be entitled to receive shares of Class A Stock
pursuant to paragraph 7.a above, the holder shall surrender
the certificate or certificates therefor, duly endorsed, at
the office of the corporation or of any transfer agent for
such stock, and shall give written notice to the
corporation at such office that the holder elects to
convert the same, and shall state therein the name or names
in which the holder wishes the certificate or certificates
for shares of Class A Stock to be issued. The corporation
shall, as soon as practicable thereafter, issue and deliver
at such office to such holder of 1995 Class B Stock, a
certificate or certificates for the number of shares of
Class A Stock to which the holder shall be entitled as
aforesaid. Such conversion shall be deemed to have been
made immediately prior to the close of business on the date
of surrender of the shares of 1995 Class B Stock to be
converted, and the person or persons entitled to receive
the shares of Class A Stock issuable upon such conversion
shall be treated for all purposes as the record holder or
holders of such shares of Class A Stock on such date.
(2) If the conversion is in connection with
an underwritten offering of securities pursuant to the
Securities Act of 1933, as amended, the conversion may, at
the option of any holder tendering shares of 1995 Class B
Stock for conversion, be conditioned upon the closing with
the underwriters of the sale of securities pursuant to such
offering, in which event the person(s) entitled to receive
the Class A Stock upon conversion of the 1995 Class B Stock
shall not be deemed to have converted such 1995 Class B
Stock until immediately prior to the closing of such sale
of securities.
[c] Adjustments to 1995 Class B Conversion Price
for Certain Diluting Issues.
(1) Special Definitions.
[a] "Options" shall mean rights,
options, or warrants to subscribe for, purchase or
otherwise acquire either Class A Stock or Convertible
Securities (defined below).
[b] "Original Issue Date" shall mean
the date on which a given share of 1995 Class B Stock
was first issued.
[c] "Convertible Securities" shall mean
any evidences of indebtedness, shares (other than
Class A Stock and 1995 Class B Stock) or other
securities convertible into or exchangeable for Class
A Stock.
[d] "Additional Shares of Class A
Stock" shall mean all shares of Class A Stock issued
(or, pursuant to paragraph 7.c(3) below, deemed to be
issued) by the corporation after the Original Issue
Date, other than shares of Class A Stock issued or
issuable:
[i] upon conversion of shares of
1995 Class B Stock;
[ii] to officers, directors or
employees of, or consultants to, the
corporation pursuant to stock option or stock
purchase plans or agreements on terms approved
by the Board of Directors, but not exceeding
100,000 shares of Class A Stock (net of any
repurchases of such shares or cancellations or
expirations of options), subject to adjustment
for all subdivisions and combinations.
[iii] as a dividend or
distribution on 1995 Class B Stock; or
[iv] for which adjustment of the
1995 Class B Conversion Price is made pursuant
to paragraph 7.c(4) below.
(2) No Adjustment of Conversion Price. Any
provision herein to the contrary notwithstanding, no
adjustment in the 1995 Class B Conversion Price shall be
made in respect of the issuance of Additional Shares of
Class A Stock unless the consideration per share
(determined pursuant to paragraph 7.c(5) below) for an
Additional Share of Class A Stock issued or deemed to be
issued by the corporation is less than the 1995 Class B
Conversion Price in effect on the date of, and immediately
prior to, such issue.
(3) Deemed Issue of Additional Shares of
Class A Stock. In the event the corporation at any time or
from time to time after the Original Issue Date shall issue
any Options or Convertible Securities or shall fix a record
date for the determination of holders of any class of
securities then entitled to receive any such Options or
Convertible Securities, then the maximum number of shares
(as set forth in the instrument relating thereto without
regard to any provisions contained therein designed to
protect against dilution) of Class A Stock issuable upon
the exercise of such Options or, in the case of Convertible
Securities and Options therefor, the conversion or exchange
of such Convertible Securities and Options therefor, shall
be deemed to be Additional Shares of Class A Stock issued
as of the time of such issue or, in case such a record date
shall have been fixed, as of the close of business on such
record date, provided that in any such case in which
Additional Shares of Class A Stock are deemed to be issued:
[a] no further adjustments in the 1995
Class B Conversion Price shall be made upon the
subsequent issue of Convertible Securities or shares
of Class A Stock upon the exercise of such Options or
conversion or exchange of such Convertible Securities;
[b] if such Options or Convertible
Securities by their terms provide, with the passage
of time or otherwise, for any increase or decrease in
the consideration payable to the corporation, or
decrease or increase in the number of shares of Class
A Stock issuable, upon the exercise, conversion or
exchange thereof, the 1995 Class B Conversion Price
computed upon the original issue thereof (or upon the
occurrence of a record date with respect thereto),
and any subsequent adjustments based thereon, shall,
upon any such increase or decrease becoming
effective, be recomputed to reflect such increase or
decrease insofar as it affects such Options or the
rights of conversion or exchange under such
Convertible Securities (provided, however, that no
such adjustment of the 1995 Class B Conversion Price
shall affect Class A Stock previously issued upon
conversion of the 1995 Class B Stock);
[c] upon the expiration of any such
Options or any rights of conversion or exchange under
such Convertible Securities which shall not have been
exercised, the 1995 Class B Conversion Price computed
upon the original issue thereof (or upon the
occurrence of a record date with respect thereto),
and any subsequent adjustments based thereon, shall,
upon such expiration, be recomputed as if:
[i] in the case of Convertible
Securities or Options for Class A Stock the
only Additional Shares of Class A Stock issued
were the shares of Class A Stock, if any,
actually issued upon the exercise of such
Options or the conversion or exchange of such
Convertible Securities and the consideration
received therefor was the consideration
actually received by the corporation for the
issue of all such Options, whether or not
exercised, plus the consideration actually
received by the corporation upon such exercise,
or for the issue of all such Convertible
Securities which were actually converted or
exchanged, plus the additional consideration,
if any, actually received by the corporation
upon such conversion or exchange; and
[ii] in the case of Options for
Convertible Securities, only the Convertible
Securities, if any, actually issued upon the
exercise thereof were issued at the time of
issue of Such Options, and the consideration
received by the corporation for the Additional
Shares of Class A Stock deemed to have been
then issued was the consideration actually
received by the corporation for the issue of
all such Options, whether or not exercised,
plus the consideration deemed to have been
received by the corporation (determined
pursuant to paragraph 7.c(5) below) upon the
issue of the Convertible Securities with
respect to which such Options were actually
exercised;
[d] no readjustment pursuant to clause
(b) or (c) above shall have the effect of increasing
the 1995 Class B Conversion Price to an amount which
exceeds the lower of [a] the 1995 Class B Conversion
Price on the original adjustment date, or [b] the
1995 Class B Conversion Price that would have
resulted from any issuance of Additional Shares of
Class A Stock between the original adjustment date
and such readjustment date;
[e] in the case of any Options which
expire by their terms not more than 30 days after the
date of issue thereof, no adjustment of the
Conversion Price shall be made until the expiration
or exercise of all such Options, whereupon such
adjustment shall be made in the same manner provided
in clause (c) above.
(4) Adjustment of Conversion Price Upon
Issuance of Additional Shares of Class A Stock. In the
event the corporation, at any time after the Original Issue
Date shall issue Additional Shares of Stock (including
Additional Shares of Class A Stock deemed to be issued
pursuant to paragraph 7.c(3) above) without consideration
or for a consideration per share less than the 1995 Class B
Conversion Price in effect on the date of and immediately
prior to such issue, then and in such event, the 1995 Class
B Conversion Price shall be reduced, concurrently with such
issue, to a price (calculated to the nearest cent)
determined by multiplying such 1995 Class B Conversion
Price by a fraction, the numerator of which shall be the
number of shares of Class A Stock outstanding immediately
prior to such issue plus the number of shares of Class A
Stock which the aggregate consideration received by the
corporation for the total number of Additional Shares of
Class A Stock so issued would purchase at such 1995 Class B
Conversion Price in effect immediately prior to such issue
and the denominator of which shall be the number of shares
of Class A Stock outstanding immediately prior to such
issue plus the number of such Additional Shares of Class A
stock so issued. For the purpose of the above calculation,
the number of shares of Class A stock outstanding
immediately prior to such issue shall be calculated on a
fully diluted basis, as if all shares of 1995 Class B Stock
and all Convertible Securities had been fully converted
into shares of Class A Stock immediately prior to such
issuance and any outstanding warrants, options or other
rights for the purchase of shares of stock or convertible
securities had been fully exercised immediately prior to
such issuance (and the resulting securities fully converted
into shares of Class A Stock, if so convertible) as of such
date, but not including in such calculation any additional
shares of Class A stock issuable with respect to shares of
1995 Class B Stock, or outstanding options, warrants or
other rights for the purchase of shares of stock or
convertible securities, solely as a result of the
adjustment of the respective 1995 Class B Conversion Prices
(or other conversion ratios) resulting from the issuance of
the Additional Shares of Class A Stock causing the
adjustment in question.
(5) Determination of Consideration. For
purposes of this paragraph 7.c, the consideration received
by the corporation for the issue of any Additional Shares
of Class A Stock shall be computed as follows:
[a] Cash and Property. Such
consideration shall:
[i] insofar as it consists of
cash, be computed at the aggregate amount of
cash received by the corporation excluding
amounts paid or payable or Accrued Dividends;
[ii] insofar as it consists of
property other than cash, be computed at the
fair value thereof at the time of such issue,
as determined in good faith by the Board of
Directors; and
[iii] in the event Additional
Shares of Class A Stock are issued together
with other shares or securities or other assets
of the corporation for consideration which
covers both, be the proportion of such
consideration so received, computed as provided
in clauses [i] and [ii] above, as determined in
good faith by the Board of Directors.
[b] Options and Convertible
Securities. The consideration per share received by
the corporation of Additional Shares of Class A Stock
deemed to have been issued pursuant to this paragraph
7.c relating to Options and Convertible Securities
shall be determined by dividing:
[i] the total amount, if any,
received or receivable by the corporation as
consideration for the issue of such Options or
Convertible Securities, plus the minimum
aggregate amount of additional consideration
(as set forth in the instruments relating
thereto, without regard to any provision
contained therein designed to protect against
dilution) payable to the corporation upon the
exercise of such Options or Convertible
Securities and the conversion or exchange of
such Convertible Securities by
[ii] the maximum number of shares
of Class A Stock (as set forth in the
instruments relating thereto, without regard to
any provision contained therein designed to
protect against the dilution) issuable upon the
exercise of such Options or conversion or
exchange of such Convertible Securities.
[d] Adjustments to Conversion Prices for Stock
Dividends and for Combinations or Subdivisions of Class A Stock.
In the event that this corporation at any time or from time to
time after the Original Issue Date shall declare or pay, without
consideration, any dividend on the Class A Stock payable in Class
A Stock or in any right to acquire Class A Stock for no
consideration, or shall effect a subdivision of the outstanding
shares of Class A Stock into a greater number of shares of Class
A Stock (by stock split, reclassification or otherwise than by
payment of a dividend in Class A Stock or in any right to acquire
Class A Stock), or in the event the outstanding shares of Class A
Stock shall be combined or consolidated, by reclassification or
otherwise, into a lesser number of shares of Class A Stock, then
the 1995 Class B Conversion Price in effect immediately prior to
such event shall, concurrently with the effectiveness of such
event, be proportionately decreased or increased, as
appropriate. In the event that this corporation shall declare or
pay, without consideration, any dividend on the Class A Stock
payable in any right to acquire Class A Stock for no
consideration, then the corporation shall be deemed to have made
a dividend payable in Class A Stock in an amount of shares equal
to the maximum number of shares issuable upon exercise of such
rights to acquire Class A Stock.
[e] Adjustments for Reclassification and
Reorganization. If the Class A Stock issuable upon conversion of
the 1995 Class B Stock shall be changed into the same or a
different number of shares of any other class or classes of
stock, whether by capital reorganization, reclassification or
otherwise (other than a subdivision or combination of shares
provided for in paragraph 7.d above), the 1995 Class B Conversion
Price then in effect shall, concurrently with the effectiveness
of such reorganization or reclassification, be proportionately
adjusted so that the 1995 Class B Stock shall be convertible
into, in lieu of the number of shares of Class A Stock which the
holders would otherwise have been entitled to receive, a number
of shares of such other class or classes of stock equivalent to
the number of shares of Class A Stock that would have been
subject to receipt by the holders upon conversion of the 1995
Class B Stock immediately before that change.
[f] No Impairment. The corporation will not, by
amendment of its Articles of Incorporation or through any
reorganization, transfer of assets, consolidation, merger,
dissolution, issue or sale of securities or any other voluntary
action, avoid, or seek to avoid, the observance or performance of
any of the terms to be observed or performed hereunder by the
corporation, but will at all times in good faith assist in the
carrying out of all the provisions of this paragraph 7 and in the
taking of all such action as may be necessary or appropriate in
order to protect the rights of the holders of the 1995 Class B
Stock under this paragraph 7 against impairment.
[g] Certificates as to Adjustments. Upon the
occurrence of each adjustment or readjustment of the 1995 Class B
Conversion Price pursuant to this paragraph 7, the corporation at
its expense shall promptly compute such adjustment or
readjustment in accordance with the terms hereof and prepare a
certificate executed by the corporation's President or Chief
Financial Officer setting forth such adjustment or readjustment
and showing in detail the facts upon which such adjustment or
readjustment is based. The corporation shall, upon the written
request at any time of any holder of 1995 Class B Stock, furnish
or cause to be furnished to such holder a like certificate
setting forth [i] such adjustments and readjustments, [ii] the
1995 Class B Conversion Price at the time in effect, and [iii]
the number of shares of Class A Stock and the amount, if any, of
other property which at the time would be received upon the
conversion of the 1995 Class B Stock.
[h] Notices of Record Dates. In the event that the
corporation shall propose at any time: [i] to declare any
dividend or distribution upon its Class A Stock, whether in cash,
property, stock or other securities, whether or not a regular
cash dividend and whether or not out of earnings or earned
surplus; [ii] to offer for subscription pro rata to the holders
of any class or series of its stock any additional shares of
stock of any class or series or other rights; [iii] to effect any
reclassification or recapitalization of its Class A Stock
outstanding involving a change in the Class A Stock; or [iv] to
merge or consolidate with or into any other corporation, or sell,
lease or convey all or substantially all of its assets, or to
liquidate, dissolve or wind up, then, in connection with each
such event, the corporation shall send to the holders of 1995
Class B Stock;
[a] at least twenty (20) days' prior
written notice of the date on which a record shall be
taken for such dividend, distribution or subscription
rights (and specifying the date on which the holders
of Class A Stock shall be entitled thereto) or for
determining rights to vote, if any, in respect of the
matters referred to in clauses [iii] and [iv] above;
[b] in the case of the matters referred
to in clauses [iii] and [iv] above, at least twenty
(20) days' prior written notice of the date when the
same shall take place (and specifying the date on
which the holders of Class A Stock shall be entitled
to exchange their Class A Stock for securities or
other property delivered upon the occurrence of such
event).
[i] Issue Taxes. The corporation shall pay any and
all issue and other taxes that may be payable in respect of any
issue or delivery of shares of Class A Stock on conversion of
1995 Class B Stock pursuant hereto; provided, however, that the
corporation shall not be obligated to pay any transfer taxes
resulting from any transfer requested by any holder in connection
with any such conversion.
[j] Reservation of Stock Issuable Upon Conversion.
The corporation shall at all times reserve and keep available out
of its authorized but unissued shares of Class A Stock, solely
for the purpose of effecting the conversion of the shares of the
1995 Class B Stock, such number of its shares of Class A Stock as
shall from time to time be sufficient to effect the conversion of
all outstanding shares of the 1995 Class B Stock; and if at any
time the number of authorized but unissued shares of Class A
Stock shall not be sufficient to effect the conversion of all
then outstanding shares of the 1995 Class B Stock, the
corporation will take such corporate action as may, in the
opinion of its counsel, be necessary to increase its authorized
but unissued shares of Class A Stock to such number of shares as
shall be sufficient for such purpose, including, without
limitation, engaging in best efforts to obtain the requisite
stockholder approval of any necessary amendment to the
corporation's Articles of Incorporation.
[k] Fractional Shares. No fractional share shall
be issued upon the conversion of any share or shares of 1995
Class B Stock. All shares of Class A Stock (including fractions
hereof) issuable upon conversion of more than one share of 1995
Class B Stock by a holder thereof shall be aggregated for
purposes of determining whether the conversion would result in
the issuance of any fractional share. If, after the
aforementioned aggregation, the conversion would result in the
issuance of a fraction of a share of Class A Stock, the
corporation shall, in lieu of issuing any fractional share, pay
the holder otherwise entitled to such fraction a sum in cash
equal to the fair market value of such fraction on the date of
conversion (as determined in good faith by the Board of
Directors).
[l] Notices. Any notice required by the provisions
of this paragraph 7 to be given to the holders of shares of 1995
Class B Stock shall be deemed given if deposited in the United
States mail, postage prepaid, or if sent by facsimile or
delivered personally by hand or nationally recognized courier and
addressed to each holder of record at such holder's address or
facsimile number appearing in the records of the corporation.
[8] Restrictions and Limitations.
[a] So long as any shares of 1995 Class B Stock
remain outstanding, the corporation shall not, without the vote
or written consent by the holders of at least 66b% of the then
outstanding shares of 1995 Class B Stock, voting together as a
single class, at any time that its shareholders' equity
(including amounts attributable to the 1995 Class B Stock) is
less than $8,000,000:
(1) Redeem, purchase or otherwise acquire for
value (or pay into or set aside for a sinking fund for such
purpose) any share or shares of 1995 Class B Stock
otherwise than by redemption in accordance with paragraph 5
of this Section E or by conversion in accordance with
paragraph 7 of this Section E;
(2) Redeem, purchase or otherwise acquire (or
pay into or set aside for a sinking fund for such purpose)
any of the Class A Stock; provided, however, that this
restriction shall not apply to the repurchase of shares of
Class A Stock from employees, officers, directors,
consultants or other persons performing services for the
Company or any subsidiary pursuant to agreements under
which the corporation has the option to repurchase such
shares at cost or at cost plus interest at a rate not to
exceed nine percent (9%) per annum upon the occurrence of
certain events, such as the termination of employment,
provided further, however, that the total amount applied to
the repurchase of shares of Class A Stock shall not exceed
$100,000 during any twelve (12) month period.
[b] The corporation shall not amend its Articles of
Incorporation or Bylaws without the approval, by vote or written
consent, by the holders of 66b% of the then outstanding shares of
1995 Class B Stock if such amendment would change any of the
preferences, limitations or relative rights provided for herein
for the benefit of any shares of the 1995 Class B Stock. Without
limiting the generality of the preceding sentence, the
corporation will not amend its Articles of Incorporation or
Bylaws without the approval of the holders of 66b% of the then
outstanding shares of 1995 Class B Stock if such amendment would:
(1) Reduce the dividend rates on the 1995
Class B Stock provided for herein, or make such dividends
noncumulative, or defer the date from which dividends will
accrue, or cancel accrued and unpaid dividends, or change
the relative seniority rights of the holders of the 1995
Class B Stock as to the payment of dividends in relation to
the holders of any other capital stock of the corporation;
(2) Reduce the amount payable to the holders
of the 1995 Class B Stock upon the voluntary or involuntary
liquidation, dissolution, or winding up of the corporation,
or change the relative seniority of the liquidation
preferences of the holders of the 1995 Class B Stock to the
rights upon liquidation of the holders of any other capital
stock of the corporation;
(3) Reduce the 1995 Class B Redemption Price
specified in paragraph 5 of this Section E with respect to
the 1995 Class B Stock;
(4) Delay any of the Redemption Dates
provided for in paragraph 5 of this Section E;
(5) Cancel or modify the conversion rights of
the 1995 Class B Stock provided for in paragraph 7 of this
Section E; or
(6) Change the authorized number of directors
of the corporation.
[9] No Reissuance of 1995 Class B Stock.
No share or shares of 1995 Class B Stock acquired by the
corporation by reason of redemption, purchase, conversion or otherwise shall
be reissued, and all such shares shall be cancelled, retired and eliminated
from the shares which the corporation shall be authorized to issue.
ARTICLE VII
A. The business and affairs of the corporation shall be
managed by or under the direction of a Board of Directors.
B. Subject to the restriction that the number of directors
shall not be less than the number required by the laws of the Commonwealth of
Kentucky, the number of directors may be fixed, from time to time, pursuant
to the Bylaws of the corporation.
C. The members of the Board of Directors (other than those who
may be elected by the holders of any series of capital stock of the
corporation having a preference over Class A Stock as to dividends or upon
liquidation pursuant to the terms of these Articles of Incorporation or of
the resolution adopted by the Board of Directors establishing such series of
stock) shall be classified when and so long as the Board of Directors shall
consist of at least eleven (11) members pursuant to the Bylaws, with respect
to the time for which they severally hold office, into three (3) classes, as
nearly equal in number as possible, as shall be determined by the Board of
Directors of the corporation, one class to be originally elected for a term
expiring at the first annual meeting of the shareholders after their
election, another class to be originally elected for a term expiring at the
second annual meeting of the shareholders after their election, and another
class to be originally elected for a term expiring at the third annual
meeting of the shareholders after their election, each class to hold office
until the successors of such class are elected and qualified. At each annual
meeting of the shareholders, the date of which shall be fixed by or pursuant
to the Bylaws of the corporation, the successors of the class of directors
whose term expires at that meeting shall be elected to hold office for a term
expiring at the annual meeting of the shareholders held in the third year
following the year of their election.
D. Subject to any requirements of law and the rights of any
series of capital stock of the corporation having a preference over Class A
Stock as to dividends or upon liquidation pursuant to the terms of these
Articles of Incorporation or of the resolution adopted by the Board of
Directors establishing such series of stock (and notwithstanding the fact
that a lesser percentage may be specified by law, these Articles of
Incorporation or the terms of such series), the affirmative vote of the
holders of 80% or more of the voting power of the then outstanding Voting
Stock of the corporation, voting together as a single class, shall be
required to remove any director without cause. For purposes of this Article
VII, "cause" shall mean the willful and continuous failure of a director
substantially to perform such director's duties to the corporation, other
than any such failure resulting from incapacity due to physical or mental
illness, or the willful engaging by a director in gross misconduct materially
and demonstrably injurious to the corporation. As used in these Articles of
Incorporation, "Voting Stock" shall mean shares of capital stock of the
corporation entitled to vote generally in an election of directors.
E. Subject to any requirements of law and the rights of any
series of capital stock of the corporation having a preference over Class A
Stock as to dividends or upon liquidation pursuant to the terms of these
Articles of Incorporation or of the resolution adopted by the Board of
Directors establishing such series of stock, newly created directorships
resulting from any increase in the number of directors may be filled by the
Board of Directors, or as otherwise provided in the Bylaws, and any vacancies
on the Board of Directors resulting from death, resignation, removal or other
cause shall only be filled by the affirmative vote of a majority of the
remaining directors then in office, even though less than a quorum of the
Board of Directors, or by a sole remaining director, or as otherwise provided
in the Bylaws. Any director elected in accordance with the preceding
sentence shall hold office until the next annual election of directors or, if
the Board of Directors is then classified in three classes as hereinabove
provided, for the remainder of the full term of the class of directors in
which the new directorship was created or the vacancy occurred and in either
case unless such director's successor shall have been elected and qualified.
F. When considering a merger, consolidation, sale of assets,
business combination or other transaction, the Board of Directors or any
committee thereof, the directors, and the officers of the corporation may, in
considering the best interests of the corporation and its shareholders,
consider the interests of and the effects of such transaction upon the
employees, customers and suppliers of the corporation and its subsidiaries
and upon communities in which the corporation and its subsidiaries are
located or do business.
G. The Board of Directors may from time to time determine
whether, to what extent, at what times and places and under what conditions
and regulations the accounts, books and records of the corporation, or any of
them, shall be open to the inspection of the shareholders, and no shareholder
shall have any right to inspect any account, book or document of the
corporation except as and to the extent expressly provided by law or
expressly authorized by resolution of the Board of Directors.
H. In addition to the powers and authority herein or by law
expressly conferred upon them, the directors are hereby empowered to exercise
all such powers and do all such acts and things as may be exercised or done
by the corporation, subject, nevertheless, to the provisions of the laws of
the Commonwealth of Kentucky, these Articles of Incorporation, or any Bylaws
adopted by the shareholders; provided, however, that no Bylaws hereafter
adopted by the shareholders shall invalidate any prior act of the directors
that would have been valid if such Bylaws had not been adopted.
I. The initial board of directors of the corporation shall
consist of seven persons who shall serve until the first annual meeting of
shareholders and until their successors are elected and qualified. The names
and addresses of the initial directors are deleted as permitted by KRS
271B.10-020(2).
ARTICLE VIII
In making a distribution, the corporation may, for the purpose of
measuring the legal permissibility of the distribution, disregard the
preferential rights on dissolution of shareholders whose preferential rights
are superior to those receiving the distribution.
ARTICLE IX
As permitted by Section 271B.12-220(5)(a)(2) of the Act, the
corporation elects not to be governed by KRS 271B.12-210 of the Act.
ARTICLE X
In furtherance and not in limitation of the powers conferred upon
it by law, the Board of Directors is expressly authorized to:
A. adopt any By-laws that the Board of Directors may deem
necessary or desirable for the efficient conduct of the affairs of the
corporation, including, but not limited to, provisions governing the conduct
of, and the matters that may properly be brought before, annual or special
meetings of the shareholders and provisions specifying the manner and extent
to which prior notice shall be given of the submission of proposals to be
considered at any such meeting or of nominations for election of directors be
held at any such meeting; and
B. repeal, alter or amend the Bylaws.
In addition to any requirements of law and any other provisions
of these Articles of Incorporation or the terms of the resolution adopted by
the Board of Directors establishing any series of capital stock having a
preference over Class A Stock as to dividends or upon liquidation (and
notwithstanding the fact that a lesser percentage may be specified by law,
these Articles of Incorporation or the terms of such class or series), the
affirmative vote of the holders of 80% or more of the voting power of the
then outstanding Voting Stock of the corporation, voting together as a single
class, shall be required to amend, alter or repeal any provision of the
By-laws.
ARTICLE XI
In addition to any requirements of law and any other provisions
of these Articles of Incorporation or the terms of the resolution adopted by
the Board of Directors establishing any series of capital stock having a
preference over Class A Stock as to dividends or upon liquidation (and
notwithstanding the fact that a lesser percentage may be specified by law,
these Articles of Incorporation or the terms of such class or series), the
affirmative vote of the holders of 80% or more of the voting power of the
then outstanding Voting Stock of the corporation, voting together as a single
class, shall be required to amend, alter or repeal, or adopt any provision
inconsistent with, this Article XI or Article VII or Article IX or Article X
or Article XIII of these Articles of Incorporation. Subject to the foregoing
provisions of this Article XI, the corporation reserves the right from time
to time to amend, alter, change, add to or repeal any provision contained in
these Articles of Incorporation in any manner now or hereafter prescribed by
law and in these Articles of Incorporation, and all rights and powers at any
time conferred upon shareholders, directors and officers of the corporation
by these Articles of Incorporation or any amendment thereof are subject to
the provisions of this Article XI.
ARTICLE XII
The corporation shall, to the maximum extent permitted by law,
indemnify any officer or director against costs and expenses (including but
not limited to attorneys' fees) and any liabilities (including but not
limited to judgments, fees, penalties and settlements) paid by or imposed
against any such person in connection with any actual or threatened claim,
action, suit or proceeding, whether civil, criminal, administrative,
legislative, investigative or other (including any appeal relating thereto)
and whether made or brought by or in the right of the corporation, or
otherwise, because he or she is or was a director or officer of the
corporation or was serving as a director, officer, partner, trustee, employee
or agent of any other corporation, partnership, employee benefit plan or
other entity at the request of the corporation.
Notwithstanding any right to indemnification provided by the Act
to any employee or agent of the corporation, the corporation may, but shall
not be required to, to the maximum extent permitted by law, indemnify any
such person against costs and expenses (including but not limited to
attorneys' fees) and any liabilities (including but not limited to judgments,
fines, penalties and settlements) paid by or imposed against any such person
in connection with any actual or threatened claim, action, suit or
proceeding, whether civil, criminal, administrative, legislative,
investigative or other (including any appeal relating thereto) and whether
made or brought by or in the right of the corporation, or otherwise, because
he or she is or was an employee or agent of the corporation or was serving as
a director, officer, partner, trustee, employee or agent of any other
corporation, partnership, employee benefit plan or other entity at the
request of the corporation.
The indemnification authorized by this Article XII shall not
supersede or be exclusive of any other right of indemnification that any such
person may have or hereafter acquire under any provision of these Articles of
Incorporation or the Bylaws of the corporation, or any agreement, vote of
shareholders or disinterested directors or otherwise. The corporation may
take such steps as may be deemed appropriate by the Board of Directors to
provide indemnification to any such person, including, without limitation,
entering into contracts for indemnification between the corporation and
individual directors, officers, employees or agents, which may provide rights
to indemnification that are broader or otherwise different from the rights
authorized by this Article XII. The corporation may take such steps as may
be deemed appropriate by the Board of Directors to secure, subject to the
occurrence of such conditions or events as may be determined by the Board of
Directors, the payment of such amounts as are required to effect any
indemnification permitted or authorized by this Article XII, including,
without limitation, purchasing and maintaining insurance, creating trust
funds, granting security interests or using other means.
ARTICLE XIII
No director of the corporation shall be personally liable to the
corporation or its shareholders for monetary damages for a breach of his or
her duties as a director except for liability:
A. for any transaction in which the director's personal
financial interest is in conflict with the financial interest of the
corporation or its shareholders;
B. for acts or omissions not in good faith or that involve
intentional misconduct or are known to the director to be a violation of law;
C. for distributions made in violation of the Act; or
D. for any transaction from which the director derives an
improper personal benefit.
If the Kentucky Revised Statutes are hereafter amended to
authorize corporate action further eliminating or limiting the personal
liability of directors, then the liability of a director of the corporation
shall be eliminated or limited to the fullest extent permitted by the
Kentucky Revised Statutes, as so amended. Any repeal or modification of this
Article XIII by the shareholders of the corporation shall not adversely
affect any right or protection of a director of the corporation existing at
the time of such repeal or modification.
THIRD: The Restated Articles of Incorporation do not contain any
amendments requiring shareholder approval. The Restated Articles of
Incorporation were adopted by the Board of Directors of the corporation on
August 7, 1996.
FOURTH: The foregoing Restated Articles of Incorporation
supersede the original articles of incorporation and all amendments thereto.
IN WITNESS WHEREOF, the undersigned duly authorized officer has
executed these Restated Articles of Incorporation on this _____ day of
August, 1996.
CITIZENS FINANCIAL CORPORATION
By:_______________________________________
Title:______________________________________
THIS INSTRUMENT PREPARED BY:
______________________________
Joseph L. Landenwich
WYATT, TARRANT & COMBS
Citizens Plaza
Louisville, Kentucky 40202
(502) 589-5235
E:\HAC\CFC-REST.ART.wp
