UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X]Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the period ended September 30, 1999 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission File Number: 1-13004 CITIZENS, INC. (Exact name of registrant as specified in its charter) Colorado 84-0755371 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 400 East Anderson Lane, Austin, Texas 78752 (Address of principal executive offices) (Zip Code) (512) 837-7100 (Registrant's telephone number, including area code) 7801 North Interstate 35, Austin, Texas 78753 (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No As of September 30, 1999, Registrant had 21,374,357 shares of Class A common stock, No Par Value, outstanding and 621,049 shares of Class B common stock, No Par Value, outstanding. CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES INDEX Page Number Part I. Financial Information Item 1. Financial Statements Consolidated Statements of Financial Position, September 30, 1999 (Unaudited) and December 31, 1998 3 Consolidated Statements of Operations, Three-Months Ended September 30, 1999 and 1998 (Unaudited) 5 Consolidated Statements of Operations, Nine-Months Ended September 30, 1999 and 1998 (Unaudited) 6 Consolidated Statements of Cash Flows, Nine-Months Ended September 30, 1999 and 1998 (Unaudited) 7 Notes to Consolidated Financial Statements 9 Item 2. Management's Discussion and Analysis of Financial Conditions and Results of Operations 12 Part Other Information II. CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL POSITION September 30, 1999 and December 31, 1998 (Unaudited) September December 30,1999 31,1998 Assets Investments: Fixed maturities held for investment, at amortized cost (fair value $5,426,500 in 1999 and $6,169,000 in 1998) $5,597,802 $5,606,374 Fixed maturities available for sale, at fair value (amortized cost $147,520,893 in 1999 and 144,491,429 146,645,842 $141,202,761 in 1998) Equity securities, at fair value (cost $716,294 in 1999 and $815,271 in 730,344 862,287 1998) Mortgage loans on real estate (net of reserve of $50,000 in 1999 and 1998) 1,398,950 1,560,757 Policy loans 22,004,589 20,996,919 Guaranteed student loans 10,960 4,673 Other long-term investments 694,823 595,271 Total investments 174,928,897 176,272,123 Cash and cash equivalents 11,269,820 10,168,728 Prepaid reinsurance 475,757 - Reinsurance recoverable 1,868,468 1,755,561 Other receivables 238,572 433,320 Accrued investment income 1,215,943 1,806,065 Deferred policy acquisition costs 35,304,339 37,259,386 Cost of insurance acquired 7,459,959 8,290,853 Excess of cost over net assets acquired 8,185,691 8,375,799 Other intangible assets 2,059,325 2,289,725 Property, plant and equipment 5,157,110 5,155,088 Federal income tax recoverable 57,349 - Deferred federal income tax 3,606,974 699,848 Other assets 900,263 877,699 Total assets 252,728,467 253,384,195 See accompanying Notes to Consolidated Financial Statements (Continued) CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL POSITION, CONTINUED September 30, 1999 and December 31, 1998 (Unaudited) September December 30,1999 31,1998 Liabilities and Stockholders' Equity Liabilities: Future policy benefit reserves 163,678,545 160,176,329 Dividend accumulations 4,855,773 4,818,915 Premium deposits 2,660,305 2,013,274 Policy claims payable 3,405,615 4,801,548 Other policyholders' funds 2,176,864 1,632,662 Total policy liabilities 176,777,102 173,442,728 Other liabilities 1,357,604 2,067,392 Commissions payable 624,327 833,881 Notes payable - 333,333 Federal income tax payable - 1,534,269 Amounts held on deposit 195,144 268,913 Total liabilities 178,954,177 178,480,516 Stockholders' Equity: Common stock: Class A, no par value, 50,000,000 shares authorized, 23,318,179 shares issued in 1999 and 22,708,910 in 1998, including shares in treasury of 1,943,822 in 1999 and 1998 56,217,781 52,790,643 Class B, no par value, 1,000,000 shares authorized, 621,049 shares issued and outstanding in 1999 and 1998 283,262 283,262 Accumulated other comprehensive income: Unrealized investment gains (1,990,173) 3,623,464 (losses), net of tax Retained earnings 21,192,574 20,135,464 75,703,444 76,832,833 Treasury stock, at cost (1,929,154) (1,929,154) Total stockholders' equity 73,774,290 74,903,679 Total liabilities and stockholders' equity 252,728,467 253,384,195 See accompanying Notes to Consolidated Financial Statements CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Three-Months Ended September 30, 1999 and 1998 (Unaudited) Three-months ended September 30, 1999 1998 Revenues: Premiums $4,941,875 $15,411,935 Annuity and universal life considerations 71,136 62,035 Net investment income 2,771,693 2,874,351 Other income 148,663 192,964 Realized gains on investments 13,818 513,594 Interest expense (369) (5,683) 17,946,816 19,049,196 Benefits and expenses: Insurance benefits paid or provided: Increase in future policy benefit 528,123 1,944,907 reserves Policyholders' dividends 825,872 780,337 Claims and surrenders 8,491,343 9,401,832 Annuity expenses 133,841 204,017 9,979,179 12,331,093 Commissions 3,213,661 3,204,024 Underwriting, acquisition and 2,699,213 2,470,486 insurance expenses Capitalization of deferred policy (1,287,119) (2,227,671) acquisition costs Amortization of deferred policy 1,727,805 1,588,026 acquisition costs Amortization of cost of insurance acquired and excess of cost over net assets acquired 484,171 10,121,878 16,816,910 27,487,836 Income (loss) before federal income $1,129, $(8,438, tax 906 640) Federal income tax: Federal income tax expense 239,427 200,870 Net income (loss) $890,479 (8,639,510) Per Share Amounts: Basic and diluted earnings (loss) per share of common stock $0.04 $(0.40) Weighted average shares outstanding 21,995,406 21,386,137 See accompanying Notes to Consolidated Financial Statements CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Nine-Months Ended September 30, 1999 and 1998 (Unaudited) Nine-months ended September 30, 1999 1998 Revenues: Premiums $43,334,017 $43,382,121 Annuity and universal life 199,031 192,737 considerations Net investment income 8,688,924 8,378,415 Other income 500,094 582,961 Realized gains on investments 292,154 1,168,330 Interest expense (20,167) (32,706) 52,994,053 53,671,858 Benefits and expenses: Insurance benefits paid or provided: Increase in future policy benefit 3,627,933 5,779,960 reserves Policyholders' dividends 2,064,233 2,221,872 Claims and surrenders 25,064,170 24,364,150 Annuity expenses 444,202 394,304 31,200,538 32,760,286 Commissions 8,908,294 9,161,577 Underwriting, acquisition and 8,085,531 8,351,083 insurance expenses Capitalization of deferred policy (4,680,784) (5,641,993) acquisition costs Amortization of deferred policy 6,635,831 5,539,667 acquisition costs Amortization of cost of insurance acquired and excess of cost over net assets acquired 1,605,106 11,518,000 51,754,516 61,688,620 Income (loss) before federal income (8,016, tax 1,239,537 762) Federal income tax: Federal income tax expense 182,427 310,308 Net income (loss) $1,057,110 (8,327,070) Per Share Amounts: Basic and diluted earnings (loss) per share of common stock $0.05 $(0.39) Weighted average shares outstanding 21,939,612 21,386,137 See accompanying Notes to Consolidated Financial Statements CITIZENS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Nine-Months Ended September 30, 1999 and 1998 (Unaudited) Nine-months ended September 30, 1999 1998 Cash flows from operating activities: Net income (loss) $1,057,110 (8,327,070) Adjustments to reconcile net gain to net cash provided by operating activities: Accrued investment income 624,447 724,934 Realized gains on sale of investments and other assets (292,154) (1,168,330) Deferred policy acquisition costs 1,955,047 (102,326) Amortization of cost of insurance acquired, excess cost over net assets acquired, and other intangibles 1,605,106 11,860,711 Depreciation 386,698 365,292 Prepaid reinsurance (475,757) (474,955) Reinsurance recoverable (112,550) (332,248) Other receivables 433,762 547,270 Deferred Federal income tax (15,253) 515,308 Future policy benefit reserves 3,434,502 5,779,960 Other policy liabilities (168,869) 2,239,308 Commissions payable and other liabilities (943,059) (806,224) Amounts paid out as trustee (73,769) (110,083) Federal income tax recoverable/payable (1,591,618) (967,992) Other, net (127,836) 722,363 Net cash provided by operating activities 5,695,807 10,465,918 Cash flows from investing activities: Maturity of fixed maturities available- 7,384,153 8,473,257 for-sale Sale of fixed maturities available-for- 354,072 9,148,665 sale Purchase of fixed maturities available- (12,263,798) (24,902,624) for-sale Sale of equity securities 92,500 154,548 Net change in mortgage loans 161,807 (409,859) Net change in guaranteed student loans (6,287) 85,566 Sale of other long-term investments and property plant equipment 6,834 933,225 See accompanying Notes to Consolidated Financial Statements (Continued) CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Nine-Months Ended September 30, 1999 and 1998 (Unaudited) Nine-months ended September 30, 1999 1998 Cash from acquisition $1,512,255 $ - Purchase of other long-term investments and property plant and equipment (495,248) (489,137) Increase in policy loans (net) (1,007,670) (194,143) Net cash (used) by investing activities (4,261,382) (7,200,502) Cash flows from financing activities: Repayment of note payable (333,333) (604,097) Net cash (used) by financing activities (333,333) (604,097) Net increase in cash and cash equivalents 1,101,092 2,661,319 Cash and cash equivalents at beginning of period 10,168,728 6,754,956 Cash and cash equivalents at end of period 11,269,820 9,416,275 Supplemental Disclosure of Non-Cash Investing and Financing Activities: In 1999, the Company issued 609,269 Class A stock to purchase all of the capital stock of First Investors Group, Inc. (First Investors). In conjunction with the acquisition, liabilities were assumed as follows: Fair value of tangible 3,170,802 assets acquired Fair value of intangible 353,703 assets acquired Net assets acquired 3,524,505 Capital stock issued (3,427,138) Liabilities assumed 97,367 See accompanying Notes to Consolidated Financial Statements CITIZENS, INC. AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1999 (Unaudited) (1) Financial Statements The statement of financial position as of September 30, 1999, the statements of operations for the three and nine-month periods ended September 30, 1999 and 1998, and the statements of cash flows for the nine-month periods then ended have been prepared by the Company without audit. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and changes in cash flows as of and for the period ended September 30, 1999 and for comparative periods presented have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles ("GAAP") have been omitted. It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in the Company's December 31, 1998 annual 10-K report filed with the Securities and Exchange Commission. The results of operations for the period ended September 30, 1999 are not necessarily indicative of the operating results for the full year. (2) Acquisition On September 15, 1998, Citizens, Inc. ("Citizens") announced that a definitive agreement had been reached between Citizens and First Investors Group, Inc. ("Investors") of Springfield, Illinois whereby Citizens would acquire 100% of the outstanding shares of Investors for shares of Citizens Class A Common stock. Investors is the parent of Excalibur Insurance Corporation (Excalibur), also of Springfield, Illinois. Pursuant to the terms of the Agreement, which was approved by Investors' shareholders and regulatory authorities, Citizens issued one share of Citizens Class A Common stock for each 6.6836 shares of Investors common and preferred stock issued and outstanding. The transaction closed on January 26, 1999. Citizens issued 609,269 shares of its Class A Common stock to consummate the transaction, which was accounted for as a purchase. (3) Segment Information The Company has two reportable segments identified by geographic area: International Business and Domestic Business. International Business consisting of ordinary whole-life business is sold throughout Central and South America. The Company has no assets, offices or employees outside of the United States of America ("U.S.") and requires that all transactions be in U.S. dollars paid in the U.S. Domestic Business consisting of traditional life and burial insurance, pre-need policies, accident and health specified disease, hospital indemnity and accidental death policies is sold throughout the Southern U.S. The accounting policies of the segments are in accordance with GAAP and are the same as those used in preparing unaudited financial statements. The Company evaluates performance based on GAAP net income (loss) before federal income taxes for its two reportable segments. Geographic Areas - The following summary represents financial data of the Company's continuing operations based on their location for the nine-months ended September 30, 1999 and 1998. 1999 1998 Revenues U.S. Domestic $15,382,743 $15,118,124 International 37,611,310 38,553,734 Total Revenues $52,994,053 $53,671,858 The following summary represents revenues and pretax income from continuing operations and identifiable assets for the Company's reportable segments as of and for the nine-month periods September 30, 1999 and 1998, is as follows: Nine-months ended September 30 1999 1998 Revenue, excluding net investment income and realized gain (loss) on investments: Domestic 12,775,779 12,351,838 International 31,237,196 31,499,245 Total consolidated revenue $ 44,012, $43,851,083 975 Net investment income: Domestic 2,522,160 2,360,006 International 6,166,764 6,018,409 Total consolidated net investment income 8,688,924 8,378,415 Amortization expense: Domestic 2,392,122 4,804,751 International 5,848,815 12,252,916 Total consolidated amortization expense 8,240,937 17,057,667 Realized gain (loss) on investments: Domestic 84,804 329,092 International 207,350 839,238 Total consolidated realized gain (loss) on investments 292,154 1,168,330 Income (loss) before federal income tax: Domestic 359,804 (2,258,137) International 879,733 (5,758,625) Total consolidated income (loss) before federal income taxes 1,239,537 (8,016,762) Assets: Domestic 79,862,196 80,069,406 International 172,866,271 173,314,789 Total 252,728,467 253,384,195 (4) Accumulated Other Comprehensive Income (Loss) For the three and nine-months ended September 30, 1999, the other comprehensive loss amounts included in total comprehensive loss consisted of unrealized losses on investments in debt and equity securities of $(1,182,633) and $(5,613,637), net of tax, and for the same periods in 1998, gains of $3,926,081 and $3,328,209, respectively. Total comprehensive loss for the three and nine-months ended September 30, 1999, was $(292,154) and $(4,556,526), and for 1998, $(4,713,429) and $(4,998,861), respectively. ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS Certain statements contained in this Form 10Q are not statements of historical fact and constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act (the "Act"), including, without limitation, the italicized statements and the statements specifically identified as forward- looking statements within this document. In addition, certain statements in future filings by the Company with the Securities and Exchange Commission, in press releases, and in oral and written statements made by or with the approval of the Company which are not statements of historical fact constitute forward- looking statements within the meaning of the Act. Examples of forward-looking statements, include, but are not limited to: (i) projections of revenues, income or loss, earnings or loss per share, the payment or non-payment of dividends, capital structure, and other financial items, (ii) statements of plans and objectives of the Company or its management or Board of Directors including those relating to products or services, (iii) statements of future economic performance and (iv) statements of assumptions underlying such statements. Words such as "believes", "anticipates", "expects", "intends", "targeted", "may", "will" and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements involve risks and uncertainties which may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to: (i) the strength of foreign and U.S. economies in general and the strength of the local economies in which operations are conducted; (ii) the effects of and changes in trade, monetary and fiscal policies and laws; (iii) inflation, interest rates, market and monetary fluctuations and volatility; (iv) the timely development and acceptance of new products and services and perceived overall value of these products and services by existing and potential customers; (v) changes in consumer spending, borrowing and saving habits; (vi) concentrations of business from persons residing in third world countries; (vii) acquisitions; (viii) the persistency of existing and future insurance policies sold by the Company and its subsidiaries; (ix) the dependence of the Company on its Chairman of the Board; (x) the ability to control expenses; (xi) the effect of changes in laws and regulations (including laws and regulations concerning insurance) with which the Company and its subsidiaries must comply, (xii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as the Financial Accounting Standards Board, (xiii) changes in the Company's organization and compensation plans; (xiv) the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; and (xv) the success of the Company at managing the risks involved in the foregoing. Such forward-looking statements speak only as of the date on which such statements are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events. Nine-months ended September 30, 1999 and 1998 Net income of $1,057,110, or $0.05 per share was earned for the nine-months ended September 30, 1999 compared to a net loss of $8,327,070, or $0.39 per share for the same period in 1998. The significant increase in earnings was primarily related to the write-off of $9.5 million of excess of cost over net assets acquired ("goodwill") during the third quarter of 1998. Additionally, increased investment income, coupled with a smaller increase in policy reserves and the achievement of expense reductions, contributed to the 1999 earnings. The 1998 write-off was related to goodwill recorded in the 1995 acquisition of American Liberty Financial Corporation ("American Liberty") and was caused by a decline in production from agents formerly associated with American Liberty during 1998. Subsequent to the acquisition, management implemented a 50% reduction in the amount of commission paid to these agents. The commission reductions were necessary to preserve the profitability of the accident and health business written by these agents which was negatively impacted by changes in state laws that established minimum claims ratios that severely limited profit margins, as well as a mandated change in interest rates used to compute reserves on this business. In order to ascertain the recoverability of the goodwill balance, the Company performed an analysis of the relevant cash flows based upon estimated production, net of policy acquisition costs, policyholder benefits and other general expenses. As a result of this analysis, it was determined that the production of future business did not support goodwill of $9.5 million which was charged to earnings for the period ended September 30, 1998. Management's estimate of future production has been reevaluated based upon the sales activity, the size of the active agency force, and the anticipated future production to be achieved in subsequent years. Management has continued to monitor production associated with these products. During 1998, management was successful in reviving production from some of the largest producers of American Liberty. During 1999, the assumed production levels have been met. Revenues decreased to $52,994,053 in 1999 compared to the first nine-months of 1998 when revenues were $53,671,858. The decrease in revenues was related to a 75.0% decrease in realized gains on investments which were $292,154 for the nine months ended September 30, 1999 compared to $1,168,330 for the same period in 1998. Premium income for the first nine-months of 1999 was $43,334,017 compared to $43,382,121 for the same period in 1998. There was a significant increase in group dental business sold by the agents of United Security Life Insurance Company ("USLIC") from July 1998 through March 1999. This new business did not fully offset a decrease in the Company's core book of ordinary life business resulting from the continued turmoil in Latin America caused by economic downturns in several countries, as well as increased competition from several U.S. companies entering the market. Management introduced a new line of ordinary life products in late 1998 and had anticipated growth in new international sales; however, due to the above-described conditions, such expected growth has not materialized as rapidly as expected. During the first nine months of 1999, management has intensified its recruiting and training efforts in Latin America, as well as other parts of the world and management believes such efforts will prove successful in the long-term in restoring sales to historical levels. Additionally, management has been developing a domestic ordinary life sales program during 1999 and began to file such with regulatory authorities for approval during the third quarter. This program, targeting rural areas of the United States, is expected to be a major market for the Company in future years. Management expects to begin sales and recruiting efforts in the State of Texas with this new product in early 2000. Net investment income increased 3.7% in the first nine-months of 1999 to $8,688,924 compared to $8,378,415 in 1998. This increase reflects a higher yield on invested assets as interest rates have risen. Management has maintained a greater level of liquidity over the past two quarters of 1999 so as to be in a position to take advantage of increases in yield available in the bond market. Claims and surrenders increased from $24,364,150 for the nine months ended September 30, 1998 to $25,064,170 for the same period in 1999, an increase of 2.9%. Death claims decreased from $3,905,119 in 1998 to $3,851,125 in 1999. Surrender expense increased to $10,465,936 in 1999 from $10,288,525 in 1998. Coupons and endowments decreased slightly to $3,603,523 in 1999 from $3,719,023 in 1998. Accident and Health benefits increased 18.2% in the first nine months of 1999 compared to the same period in 1998. Such benefits for the nine months ended September 30, 1999 were $6,206,073 compared to $5,252,303 in 1998. This increase is directly related to the USLIC and National Security Life and Accident Insurance Company ("NSLIC") blocks of business which consist of large amounts of scheduled benefit daily indemnity policies, major medical coverages, and group dental business. During the second half of 1998, the Company began to experience a significant increase in the volume of claims, which resulted in a processing backlog. The backlog was created by the high early utilization by holders of the dental certificates, and although processing delays resulted, all such pending items were considered in the establishment of claim reserves. During the fourth quarter of 1998, management increased the number of individuals processing claims from approximately 13 to 30 and the backlog has been significantly reduced during the first nine months of 1999. As a result of the substantial increase in the volume of claims plus an increase in the accident and health loss ratio, management has moved to cancel a large portion of these existing blocks of group dental and major medical business in order to curtail both claims and operation expenses. Most of the terminations will be effective prior to January 1, 2000. This action will result in the loss of approximately $5 million of annual premium income; however, due to the claims experience as well as the overhead necessary to administer such, management believes this action will enhance near and long-term profitability. The remaining components of claims and expenses, consisting of supplemental contracts and payments of dividends and endowments previously earned and held at interest, amounted to $937,513 in 1999, compared to $1,199,180 in 1998. The increase in future policy benefit reserves decreased from $5,779,960 in 1998 to $3,627,933 in 1999. This 37.2% decrease is related to the termination of the USLIC and NSLIC blocks of group accident and health insurance and the corresponding decrease in exposure as policyholders' coverage is cancelled. Commission expense for the first nine months of 1999 was $8,908,294 compared to $9,161,577 for the same period in 1998. The decrease reflects the decline in the production of new premiums by the agents of Citizens Insurance Company of America ("CICA") during 1999 as well as the above-described termination of business. Although group accident and health business produced by USLIC increased through March, this business carries a relatively low commission. Deferred policy acquisition costs capitalized in 1998 were $5,641,993 compared to $4,680,784 in the current year. Amortization of these costs was $6,635,831 through the third quarter of 1999 compared to $5,539,667 for 1998. The increased amortization results from increases in the surrender activity. Underwriting, acquisition and insurance expenses decreased from $8,351,083 through the first nine months of 1998 to $8,085,531 in 1999, a reduction of 3.2%. This decrease can be attributed to the economies of scale being achieved after the consolidation of the administration of the business of USLIC and NSLIC, although such decrease was partially offset by the additional staff used to administer the claims volume. Management believes that significant expense reduction will be achieved beginning in the second quarter of 2000 as the dental and major medical blocks significantly decrease, permitting staff reductions. Amortization of excess of cost of insurance acquired and excess of cost over net assets acquired was $1,605,106 through September 30, 1999 compared to $11,518,000 for the same period in 1998. The reason for the decrease was the charge incurred in the third quarter of 1998. Management does not anticipate future write- offs of such goodwill; however, recoverability is being monitored on a quarterly basis. As was mentioned above, the Company has met the 1999 production levels necessary to preserve the recoverability. There remains approximately $3.0 million of goodwill relating to the American Liberty acquisition on the Company's books. Three-months ended September 30, 1999 and 1998 Net income of $890,479 or $0.04 per share was earned for the three-months ended September 30, 1999 compared to a net loss of $8,639,510 or $0.40 per share for the same period in 1998. The write-off of $9.5 million of goodwill during third quarter 1998 was the primary reason for the loss in the previous year. Decreases in claims and policy reserves were the factors contributing to the improved profits in 1999. Revenues decreased by $1,102,380 to $17,946,816 compared to 1998 when revenues were $19,049,196. The decrease in revenues was primarily related to a $470,060 decrease in premium income, a $102,658 decrease in net investment income, and a $499,776 decrease in realized gains on investments. Premium income for the third quarter of 1999 was $14,941,875, compared to $15,411,935 in 1998. Production from USLIC and NSLIC began to decline with management's announcement of cancellation of the domestic group dental and individual major medical business and offset the writing of new international business by CICA, which began to increase in the quarter. Investment income decreased to $2,771,693 in 1999 from $2,874,351 in 1998. The decrease relates to a slight decline in the investment asset base of the Company as maturing funds were not completely reinvested and were liquidated to pay some USLIC and NSLIC group accident and health insurance claims. Death benefits decreased from $1,617,246 in 1998 to $1,362,783 in 1999. Surrenders decreased 2.5% in the third quarter of 1999 compared to the same period in 1998. Surrender expense for the three months ended September 30, 1999 was $3,533,945 compared to $3,626,059 in 1998. Coupons and endowments decreased to $1,270,006 in 1999 from $1,360,767 in 1998. The endowment benefits, a significant component of the Company's international life insurance products, are factored into the premium much like dividends and therefore, the amount does not pose a threat to future profitability. Accident and Health benefits were $1,871,557 in 1999, compared to $2,108,359 in 1998. These expenses can be attributed to the USLIC and NSLIC blocks of business, which consist of large amounts of individual major medical and group dental business. In order to slow the growth of such benefits, management began terminating all major medical and group accident and health insurance during third quarter 1999. The remaining components of claims and surrenders, consisting of matured endowments, supplemental contracts and payments of dividends and endowments previously earned and held at interest, amounted to $453,052 in 1999, compared to $689,401 in 1998. The increase in future policy benefit reserves decreased from $1,944,907 in 1998 to $528,123 in 1999. This 72.9% decrease is related to the termination of the USLIC and NSLIC blocks of group accident and health insurance and the corresponding decrease in exposure. Commission expense increased slightly to $3,213,661 from $3,204,024. The increase reflects a higher commission paid on the growing NSLIC block of business of credit life and credit accident and health insurance. Underwriting, acquisition and insurance expenses increased slightly to $2,699,213 in the third quarter of 1999 from $2,470,486 in 1998. The increase is related to the staff additions necessitated by the claims backlog discussed above. Amortization of cost of insurance acquired and excess of cost over net assets acquired decreased from $10,121,878 in 1998 to $484,171 in 1999. The decrease is attributable to the write-off of $9.5 million of goodwill during third quarter 1998. Liquidity and Capital Resources Stockholders' equity decreased to $73,744,290 at September 30, 1999 from $74,903,679 at December 31, 1998. The decrease was attributable to unrealized gains declining by $5,613,637 during the nine-months ended September 30, 1999 resulting in an unrealized loss of $1,990,173, net of tax, at September 30, 1999. Declines in the market value of the Company's bond portfolio caused by higher market interest rates caused the change in unrealized gains (losses), net of tax. Invested assets decreased to $174,928,897 in 1999 from $176,272,123 at December 31, 1998. The 1.4% decrease in fixed maturities available-for-sale more than offset the 4.8% increase in policy loans. At September 30, 1999 and December 31, 1998, fixed maturities have been categorized into two classifications: Fixed maturities held to maturity, which are valued at amortized cost, and fixed maturities available-for-sale which are valued at fair value. The Company does not have a plan to make material dispositions of fixed maturities during 1999; however, because of continued uncertainty regarding long-term interest rates, management cannot rule out sales during 1999. Fixed maturities held to maturity, amounting to $5,597,802 consist primarily of U.S. Treasury securities. Management has the intent and believes the Company has the ability to hold the securities to maturity. In order to monitor the market risk associated with the Company's investment policy, management measures the sensitivity of the portfolio to instantaneous interest rate changes. At December 31, 1998, decreases in interest rates of 100, 200 and 300 basis points, respectively, would result in increases in market values of approximately $12,402,000, $19,666,000 and $23,588,000, respectively. Conversely, increases in rates of 100, 200 and 300 basis points would generate losses of $1,041,000, $7,484,000 and $13,738,000, respectively. Under either interest rate scenario, the portfolio carries positive convexity. At September 30, 1999, decreases of 100, 200 and 300 basis points, respectively, would result in increases in market values of $3,928,000, $10,849,000 and $18,060,000, respectively. Increases in rates of 100, 200 and 300 basis points would generate losses of $9,811,000, $16,226,000 and $22,219,000, respectively. The Company's mortgage loan portfolio, which constitutes 0.8% of invested assets at December 31, 1998 and September 30, 1999, has historically been composed of small residential loans in Texas. Management has established a reserve of $50,000 at September 30, 1999 and December 31, 1998 (approximately 3.5% of the mortgage portfolio's balance) to cover potential losses in the Company's mortgage portfolio. Policy loans comprise 12.6% of invested assets at September 30, 1999. These loans, which are secured by the underlying policy values, have yields ranging from 5% to 10% percent and maturities that are related to the maturity or termination of the applicable policies. Management believes that the Company maintains more than adequate liquidity despite the uncertain maturities of these loans. Cash balances of the Company in its primary depository, Chase Bank, Texas, were significantly in excess of Federal Deposit Insurance Corporation ("FDIC") coverage at September 30, 1999 and December 31, 1998. Management monitors the solvency of all financial institutions in which it has funds to minimize the exposure for loss. At September 30, 1999, management does not believe the Company is at significant risk for such a loss. During 1999, the Company intends to utilize short-term Treasury Bills and highly rated commercial paper as cash management tools to minimize excess cash balances and enhance return. In February 1992, the Company purchased an 80,000 square foot office building in Austin, Texas to serve as its primary office. The Company relocated to the building in September 1993. The Company occupies approximately 45,000 square feet of space in the building, which is 100% leased. This building will, in the opinion of management, provide adequate space for the Company's operations for many years. CICA owned 1,822,332 shares of Citizens Class A common stock at September 30, 1999 and December 31, 1998. Statutory accounting practices prescribed by the National Association of Insurance Commissioners and the State of Colorado require that the Company carry its investment at market value reduced by the percentage ownership of Citizens by CICA, limited to 2% of admitted assets. As of September 30, 1999 and December 31, 1998, the Company valued the shares in accordance with prescribed statutory accounting practices. In the Citizens' consolidated financial statements, this stock is shown as treasury stock. At September 30, 1999 and December 31, 1998, CICA had outstanding a surplus debenture payable to Citizens for $266,667 and $333,333, respectively. For statutory accounting purposes, this debenture is a component of CICA's surplus, while for GAAP it is eliminated in consolidation. Citizens has historically recognized a liability for its related obligation to a bank in a like amount; however, in April 1999, Citizens paid off the corresponding note to Chase Bank. On November 2, 1999, the Company's Board of Directors approved a 7% stock dividend payable on December 31, 1999. As a result of the issuance of shares, the Company expects to transfer approximately $10 million from retained earnings to capital reflecting the market value of the shares issued. The National Association of Insurance Commissioners ("NAIC")National Association of Insurance Commissioners ("NAIC") has established minimum capital requirements in the form of Risk- Based Capital ("RBC"). Risk-based capital factors the type of business written by a company, the quality of its assets, and various other factors into account to develop a minimum level of capital called "authorized control level risk-based capital" and compares this level to an adjusted statutory capital that includes capital and surplus as reported under Statutory Accounting Practices, plus certain investment reserves. Should the ratio of adjusted statutory capital to control level risk- based capital fall below 200%, a series of actions by the Company would begin. At December 31, 1998, CICA and Central Investors Life Insurance Company of Illinois ("CILIC") were well above required minimum levels. NSLIC and USLIC fell below the 200% level as reported on their December 31, 1998 Annual Statement to insurance regulatory authorities. Management immediately made capital contributions to both companies to raise them above the minimum levels. Further evaluation of the estimate of claims reserves indicated provisions for pending claims for NSLIC were overstated. Management amended the 1998 statutory financial statements of NSLIC to increase surplus by approximately $1,000,000, as a result of the overstatement, bringing the Company well above the 200% level of RBC. Information Systems and the Year 2000 Company personnel have been actively planning, identifying and resolving year 2000 issues for more than a year. These activities have continued throughout 1999 with parallel testing and final remediation actions that concluded in August, 1999. In the late 1980's, the Company began developing software to routinely audit its data bases and its source code. These internal audit tools run daily and provide perpetual balancing of the Company's policy and agency master files to its general ledger. The source code audit tool has been an instrumental key to identifying system code that may need year 2000 remediation. By using this automated "bloodhound" combined with visual review of record and screen layouts/documentation, the Company's Electronic Systems Department ("ESD") staff have identified and addressed the "worst case" scenario for a year 2000 impact. The overall expenditure for addressing year 2000 issues is minimal because all planning, remediation and testing have been, and will continue to be, performed with existing staff during normal business hours. The Company utilizes a Wang VS 7160 for providing core processing and on-line support in conjunction with a local-area-network ("LAN") based upon CISCO 5500 and 2900 intelligent switching components. The Company's Mitel telephone system was replaced during 1998 with a Mitel 2000 Light, nodal, fiber-optic system which is year 2000 compliant. Wang has certified the 7.53.00 operating system to be year 2000 compliant and the Company successfully completed installation and testing of this system in July 1998. The Company uses Microsoft's WFW 3.11 and NT Server 3.51 (SP5), for its LAN, both of which are certified by Microsoft to be year 2000 compliant. The Company uses Word 6.0, EXCEL 5.0, and Notes 3.3 as applications on the LAN which are certified to be compliant except for the Notes product which is not compliant, but is reported to have no loss of data or functionality. However, only the Wang system is mission-critical with the in-house developed code for Host Daily Cycle systems being considered a part thereof. As for electronic data exchanges, the Company interacts with Chase Bank, Rudd and Wisdom, Dataplex, PCS Health Systems and certain reinsurance companies. The Chase Bank relationship is the only third-party interface that could be considered mission- critical and it can be circumvented (in less than one man-hour) by using paper drafts instead of electronic transactions should the Company find such to be desirable. Other vendor interfaces can be circumvented with hard-copy reporting should an electronic interface become untenable for some reason. The Company believes it has addressed its Year 2000 concerns, and developed contingency and recovery plans aimed at insuring the continuity of critical business functions before, on and after December 31, 1999. The Year 2000 contingency plans will be reviewed periodically throughout 1999 and revised as needed. The Company believes its Year 2000 contingency plan, coupled with existing "disaster recovery" and "business resumption" plans, minimize the impact Year 2000 issues may have on the organization. Financial Accounting Standards In December 1997, the American Association of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 97-3. SOP 97-3 provides: 1) guidance for determining when an entity should recognize a liability for guaranty fund and other insurance-related assessments, 2) guidance on how to measure a liability, 3) guidance on when an asset may be recognized for a portion or all of the assessment liability or paid assessment that can be recovered through premium tax offsets or policy surcharges, and 4) requirements for disclosure of certain information. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998. The Company does not anticipate implementation of SOP 97-3 to have a material impact on the Company's consolidated financial statements. In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." This SOP provides guidance for determining whether costs of software developed or obtained for internal use should be capitalized or expensed when incurred. In the past, the Company has expensed such costs as they were incurred. This SOP is also effective for fiscal years beginning after December 15, 1998. The Company does not anticipate implementation of SOP 98-1 to have a material impact on the Company's consolidated financial statements. In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." Statement No. 133 establishes accounting and reporting standards for derivative instruments, including derivative instruments embedded in other contracts, and for hedging activities. The Company does not anticipate implementation of Statement No. 133 to have a material impact on the Company's consolidated financial statements. In June 1999, the FASB issued Statement No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133." Statement No. 137 defers the effective date Statement No. 133 for one year. PART II. OTHER INFORMATION Item 1. Legal Proceedings In March 1999, the Company was served with a summons regarding an action entitled Berdeaux Living Trust v. First Investors Group, Inc., Donald L. Dennis, H. Marie Dennis, Winona Drewes and Citizens, Inc. in U.S. District Court, Southern District of Illinois. The complaint alleged that the defendants defrauded the plaintiffs and other persons who were preferred shareholders of First Investors Group, Inc. in connection with an acquisition of First Investors completed by the Company in early 1999. In the acquisition, the Company issued approximately 610,000 shares of its Class A Common Stock to shareholders of First Investors pursuant to a registration statement declared effective by the Securities and Exchange Commission in December 1998. The plaintiffs sought class action certification on behalf of approximately 1,860 persons who were preferred shareholders of First Investors. Damages were alleged based upon alleged violations of Section 10(b) of the Securities Exchange Act of 1934 and the Illinois securities laws as well as under Illinois common law fraud and against the defendants other than the Company, for breach of fiduciary duty. The Company prepared an answer which vigorously denied the allegations, on October 22, 1999, the District Court dismissed the complaint without prejudice. Item 2 Changes in Securities On November 2, 1999, the Company's Board of Directors declared a 7% stock dividend, payable on December 31, 1999 to holders of record as of December 1, 1999. Item 3. Defaults upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information The Company's Annual Meeting of Stockholders has been set for June 6, 2000 at 10:00 A.M. The record date for the meeting is April 20, 2000. Item 6. Exhibits and Reports on Form 8-K None. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CITIZENS, INC. By: /s/ Mark A. Oliver Mark A. Oliver, FLMI President By: /s/ Jeffrey J. Wood Jeffrey J. Wood, CPA Executive Vice President, Secretary/Treasurer and CFO Date: November 9, 1999