SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES ACT OF 1934
For the Quarterly Period Ended September 30, 1998
Commission File Number 0-4690
FINANCIAL INDUSTRIES CORPORATION
(Exact Name of Registrant as specified in its charter)
Texas 74-2126975
(State of Incorporation) (I.R.S. Employer Identification Number)
The Austin Centre, 701 Brazos, 12th Floor
Austin, Texas 78701
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (512) 404-5000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
Number of common shares outstanding ($.20 par value) at end of period:5,427,965.
- 1 -
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
INDEX
Page No.
Part I - Financial Information
Consolidated Balance Sheets at September 30, 1998
and December 31, 1997.................................................... 3
Consolidated Statements of Income
For the three and nine month periods ended September 30, 1998 and 1997... 5
Consolidated Statements of Cash Flows
For the three and nine month periods ended September 30, 1998 and 1997.... 7
Notes to Consolidated Financial Statements................................ 11
Item 2. Management's Discussion and Analysis of Financial Conditions and
Results of Operations..................................................... 13
Part II
Other Information........................................................ 23
Signature Page........................................................... 25
- 2 -
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)
<TABLE>
<S> <C> <C>
Sept 30, Dec. 31,
ASSETS 1998 1997
(unaudited)
Investments:
Fixed maturities available for sale,
at market value (amortized cost of
$79,427 and $79,054 at 1998 and 1997,
respectively) ................................ $ 83,019 $ 81,854
Equity securities, at market value
(cost approximates $11) ...................... 4 4
Policy loans .................................. 3,039 2,748
Short-term investments ........................ 32,851 34,475
-------- --------
Total Investments ........................ 118,913 119,081
Cash and cash equivalents .......................... 1,257 508
Investment in affiliate ............................ 71,723 66,752
Accrued investment income .......................... 918 1,184
Agent advances and other receivables ............... 7,758 6,474
Reinsurance receivables ............................ 12,473 11,134
Property and equipment, net ........................ 1,758 1,724
Deferred policy acquisition costs .................. 47,769 45,122
Present value of future profits of
acquired businesses ............................... 29,627 34,437
Due and deferred premiums .......................... 11,769 11,086
Other assets ....................................... 5,413 6,346
Separate account assets ............................ 441 476
-------- --------
Total Assets ....................................... $309,819 $304,324
======== ========
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements.
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)
<TABLE>
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY Sept 30, Dec. 31,
1998 1997
(unaudited)
Liabilities:
Policy liabilities and contract holder
deposit funds
Future policy benefits ........................... $ 60,562 $ 59,987
Contract holder deposit funds .................... 44,693 44,304
Unearned premiums ................................ 90 90
Other policy claims and benefits payable ......... 4,495 5,315
--------- ---------
109,840 109,696
Subordinated notes payable to affiliate .......... 49,182 53,792
Deferred federal income taxes .................... 23,759 21,631
Other liabilities ................................ 4,103 4,880
Separate account liabilities ..................... 441 476
--------- ---------
Total Liabilities ................................ 187,325 190,475
Shareholders' Equity:
Common stock, $.20 par value,10,000,000
shares authorized; 5,845,300 issued and
5,427,965 shares outstanding in 1998 and
1997 1,169 1,169
Additional paid-in capital ....................... 7,225 7,225
Accumulated other comprehensive income ........... 8,358 6,692
Retained earnings ................................ 106,164 99,185
--------- ---------
122,916 114,271
Common treasury stock, at cost, 417,335
shares in 1998 and 1997 ......................... (422) (422)
--------- ---------
Total Shareholders' Equity ....................... 122,494 113,849
--------- ---------
Total Liabilities and Shareholders' Equity ....... $ 309,819 $ 304,324
========= =========
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTH PERIOD ENDED
SEPTEMBER 30, 1998 AND 1997
(in thousands of dollars, except for per share data)
(unaudited)
<TABLE>
<S> <C> <C>
3 Months Ended
September 30,
Revenues: 1998 1997
Net premiums ....................................... $ 9,629 $10,003
Net investment income .............................. 1,949 2,080
Earned insurance charges ........................... 1,533 1,697
Other .............................................. 350 762
------- -------
Total ........................................... 13,461 14,542
Benefits & expenses:
Policyholder benefits and expenses ................. 4,480 4,635
Interest expense on contractholder
deposit funds .................................... 577 674
Amortization of present value of
future profits of acquired businesses ............. 1,541 1,515
Amortization of deferred policy
acquisition costs ................................. 1,272 1,234
Operating expenses ................................. 2,954 3,263
Interest expense ................................... 809 884
------- -------
Total ........................................... 11,633 12,205
------- -------
Income before federal income taxes
and equity in net earnings
of affiliate ...................................... 1,828 2,337
Provision for federal income taxes ................. 419 231
------- -------
Income before equity in net earnings
of affiliate ...................................... 1,409 2,106
------- -------
Equity in net earnings of affiliate ................ 744 497
------- -------
Net Income ....................................... $ 2,153 $ 2,603
======= =======
Net income per share:
Basic:
Weighted average common stock outstanding .......... 5,428 5,428
======= =======
Basic earnings per share ........................... $ 0.40 $ 0.48
======= =======
Diluted:
Common stock and common stock equivalents .......... 5,602 5,590
======= =======
Diluted earnings per share ......................... $ 0.38 $ 0.47
======= =======
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE NINE MONTH PERIOD ENDED
SEPTEMBER 30, 1998 AND 1997
(in thousands of dollars, except for per share data)
(unaudited)
<TABLE>
<S> <C> <C>
9 Months Ended
September 30,
Revenues: 1998 1997
Net premiums ....................................... $29,350 $30,284
Net investment income .............................. 5,870 6,583
Earned insurance charges ........................... 4,698 5,214
Other .............................................. 1,047 2,091
------- -------
Total ........................................... 40,965 44,172
Benefits & expenses:
Policyholder benefits and expenses ................. 12,384 15,028
Interest expense on contractholder
deposit funds ..................................... 1,783 1,944
Amortization of present value of
future profits of acquired businesses ............. 4,810 4,589
Amortization of deferred policy
acquisition costs ................................. 3,538 3,516
Operating expenses ................................. 9,553 9,405
Interest expense ................................... 2,210 2,623
------- -------
Total ........................................... 34,278 37,105
------- -------
Income before federal income taxes
and equity in net earnings
of affiliate ...................................... 6,687 7,067
Provision for federal income taxes ................. 1,552 1,497
Income before equity in net
earnings of affiliate ............................ 5,135 5,570
Equity in net earnings of affiliate ................ 1,844 1,482
------- -------
Net Income ......................................... $ 6,979 $ 7,052
Net income per share:
Basic:
Weighted average common stock outstanding ......... 5,428 5,428
Basic earnings per share ........................ $ 1.29 $ 1.30
Diluted:
Common stock and common stock equivalents .......... 5,604 5,586
======= =======
Diluted earnings per share ......................... $ 1.25 $ 1.26
======= =======
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTH PERIOD ENDED
SEPTEMBER 30, 1998 and 1997
(in thousands of dollars)
(unaudited)
<TABLE>
<S> <C> <C>
3 Months Ended
September 30,
1998 1997
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ......................................... $ 2,153 $ 2,603
Adjustments to reconcile net income
to net cash provided by operating
activities:
Amortization of present value of
future profits of acquired
businesses ........................................ 1,541 1,515
Amortization of deferred policy
acquisition costs ................................. 1,272 1,234
Equity in undistributed earnings
of affiliate ...................................... (1,260) (1,235)
Changes in assets and liabilities:
Decrease in accrued investment income .............. 334 304
Increase in agent advances and other
receivables ....................................... (1,357) (1,369)
Policy acquisition costs deferred .................. (2,115) (2,092)
Increase in policy liabilities and
contractholder deposit funds ...................... 23 1,887
Increase in due and deferred premiums .............. (437) (107)
Increase (decrease) in other liabilities ........... 417 (48)
Increase in deferred federal income taxes .......... 870 595
Increase in other assets ........................... (75) (537)
Other, net ......................................... (195) 1,125
------- -------
Net cash provided by operating activities .......... $ 1,171 $ 3,875
------- -------
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements.
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTH PERIOD ENDED
September 30, 1998 and 1997
(in thousands of dollars)
(unaudited)
<TABLE>
<S> <C> <C>
3 Months Ended
September 30,
1998 1997
CASH FLOWS FROM INVESTING ACTIVITIES
Investments purchased ........................... $ -0- $(3,919)
Proceeds from sales and maturities of investments 2,377 5,734
Net change in short-term investments ............ (1,886) (757)
Increase in policy loans ........................ (78) (91)
Purchases & retirements of equipment, net ....... -0- (2,790)
------- -------
Net cash used in investing activities ........... 413 (1,823)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of debt ............................... (1,537) (1,537)
------- -------
Net cash used in financing activities ........... (1,537) (1,537)
------- -------
Net increase in cash and cash equivalents ...... 47 515
Cash and cash equivalents, beginning of period .. 1,210 324
------- -------
Cash and cash equivalents, end of period ........ $ 1,257 $ 839
======= =======
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements.
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTH PERIOD ENDED
SEPTEMBER 30, 1998 and 1997
(in thousands of dollars)
(unaudited)
<TABLE>
<S> <C> <C>
9 Months Ended
Septemeber 30,
1998 1997
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .............................. $ 6,979 $ 7,052
Adjustments to reconcile net income
to net cash provided by operating
activities:
Amortization of present value of
future profits of acquired
businesses ............................. 4,810 4,589
Amortization of deferred policy
acquisition costs ...................... 3,538 3,516
Equity in undistributed earnings
of affiliate ........................... (3,733) (3,793)
Changes in assets and liabilities:
Decrease in accrued investment income ... 266 318
Increase in agent advances and other
receivables ............................ (2,623) (1,745)
Policy acquisition costs deferred ....... (6,185) (6,284)
Increase in policy liabilities and
contractholder deposit funds ........... 144 2,862
Increase in due and deferred premiums ... (683) (219)
Decrease in other liabilities ........... (777) (1,344)
Increase in deferred federal income taxes 2,128 1,327
Decrease in other assets ................ 933 525
Other, net .............................. (404) 642
------- -------
Net cash provided by operating activities $ 4,393 $ 7,446
------- -------
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements.
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTH PERIOD ENDED
September 30, 1998 and 1997
(in thousands of dollars)
(unaudited)
<TABLE>
<S> <C> <C>
9 Months Ended
September 30,
1998 1997
CASH FLOWS FROM INVESTING ACTIVITIES
Investments purchased ............................. $(9,082) $(6,975)
Proceeds from sales and maturities of investments 8,749 9,335
Net change in short-term investments .............. 1,624 1,386
Increase in policy loans .......................... (291) (290)
Purchases & retirements of equipment, net ......... (34) (5,760)
------- -------
Net cash provided by (used in) investing activities 966 (2,304)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of debt ................................. (4,610) (4,611)
------- -------
Net cash used in financing activities ............ (4,610) (4,611)
------- -------
Net increase in cash and cash equivalents ......... 749 531
Cash and cash equivalents, beginning of period .... 508 308
------- -------
Cash and cash equivalents, end of period .......... $ 1,257 $ 839
======= =======
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements.
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The financial statements included herein reflect all adjustments which are, in
the opinion of management, necessary to present a fair statement of the interim
results. The statements have been prepared to conform to the requirements of
Form 10-Q and do not necessarily include all disclosures required by generally
accepted accounting principles (GAAP). The reader should refer to Form 10-K for
the year ended December 31, 1997 previously filed with the Commission for
financial statements prepared in accordance with GAAP. Certain prior year
amounts have been reclassified to conform with current year presentation. The
consolidated financial statements include the accounts of Financial Industries
Corporation ("FIC") and its wholly-owned subsidiaries. The investment of FIC in
InterContinental Life Corporation ("ILCO") is presented using the equity method.
All significant intercompany items and transactions have been eliminated.
New Accounting Pronouncements
In June 1997, the FASB issued Statement of Financial Accounting Standard (FAS)
130, "Reporting Comprehensive Income." The new standard, which is effective for
financial statements issued for periods ending after December 15, 1997,
established standards for reporting, in addition to net income, comprehensive
income and its components including, as applicable, foreign currency income,
minimum pension liability adjustments and unrealized gains and losses on certain
investments in debt and equity services. Upon adoption, the Company is also
required to reclassify financial statements for earlier periods provided for
comparative purposes. The Company adopted this standard in the first quarter of
1998. Total comprehensive income for the nine months ended September 30, 1998
and September 30, 1997 is $8.65 million and $10.56 million, respectively.
The following is a reconciliation of accumulated other comprehensive income from
December 31, 1997 to September 30, 1998 (in thousands):
<TABLE>
<S> <C> <C> <C>
Net Total
Net unrealized appreciation accumulated
gain on investments (depreciation) other
in fixed maturities of equity comprehensive
available for sale securities income
Balance at December 31, 1997 $ 6,660 $ 32 $ 6,692
Current Period Change 1,704 (38) 1,666
--------- -------- ---------
Balance at September 30, 1998 $ 8,364 $ ( 6) $ 8,358
======== ======== ========
</TABLE>
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
New Accounting Pronouncements, continued
In June 1997, the FASB issued FAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards for reporting
information about operating segments. Generally, FAS 131 requires that financial
information be reported on the basis that is used internally for evaluating
performance. The Company adopted FAS 131 effective January 1, 1998, and
comparative information for earlier years will be restated. This statement does
not need to be applied to interim financial statements in the initial year of
application. The adoption of FAS No. 131 did not have a material impact on the
Company's results of operations, liquidity or financial position.
In February 1998, the FASB issued FAS No. 132, "Employers Disclosures about
Pensions and Other Postretirement Benefits," which revises current disclosure
requirements for employers' pension and other retiree benefits. FAS 132 does not
change the measurement or recognition of pension or other postretirement benefit
plans. The Company adopted FAS 132 effective January 1, 1998, with the effect of
such adoption to be reflected in year-end financial statements. The adoption of
FAS No. 132 is not expected to have a material impact on the Company's results
of operations, liquidity or financial position.
In December 1997, the Accounting Standards Executive Committee issued Statement
of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments," which provides guidance on accounting for
insurance-related assessments. The Company is required to adopt SOP 97-3
effective January 1, 1999. Previously issued financial statements should not be
restated unless the SOP is adopted prior to the effective date and during an
interim period. The adoption of SOP 97-3 is not expected to have a material
impact on the Company's results of operations, liquidity or financial position
In June 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives) and for
hedging activities. FAS 133 is applicable to financial statements for all fiscal
quarters of fiscal years beginning after June 15, 1999. As the Company does not
have significant investments in derivative financial instruments, the adoption
of FAS 133 does not have a material impact on the Company's results of
operations, liquidity or financial position.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Conditions and Results
of Operation:
For the nine-month period ended September 30, 1998, Financial Industries
Corporation's ("FIC") net income was $6,979,000 (basic earnings of $1.29 per
common share, or diluted earnings of $1.25 per common share) as compared to
$7,052,000 (basic earnings of $1.30 per common share, or diluted earnings of
$1.26 per common share) in the first nine months of 1997. Earnings per share are
stated in accordance with the requirements of FAS No. 128, which establishes two
measures of earnings per share: basic earnings per share and diluted earnings
per share. Basic earnings per share is computed by dividing income available to
common shareholders by the weighted average number of common shares outstanding
during the period. Diluted earnings per share reflect the potential dilution
that would occur if securities or other contracts to issue common stock were
converted or exercised. For the nine month period ended September 30, 1997,
earnings per share have been restated to reflect the effect of FAS No. 128.
Results of Operations
FIC's income from operations - as determined before federal income tax and
equity in net earnings of its affiliate, InterContinental Life Corporation - for
the nine-month period ended September 30, 1998, was $6,687,000 (on revenues of
$40,965,000), as compared to $7,067,000 (on revenues of $44,172,000) in the
first nine months of 1997.
Premiums for the first nine months of 1998, net of reinsurance ceded, were $29.4
million, as compared to $30.3 million in the first nine months of 1997.
Policyholder benefits and expenses were $12.4 million in the 1998 period, as
compared to $15.0 million in the first nine months of 1997.
As of September 30, 1998, the market value of the fixed maturities available for
sale segment was $83.0 million as compared to an amortized value of $79.4
million, or an unrealized gain of $3.6 million. The increase reflects unrealized
gains on such investments related to changes in interest rates subsequent to the
purchase of such investments. There is no assurance that this gain will be
realized in the future. The net of tax effect of this increase ($2.3 million at
September 30, 1998) has been recorded as an increase in shareholders' equity. As
required under the provisions of FAS No. 130, the determination of "Accumulated
other comprehensive income" includes separate identification of the change in
values which occurred during the current period.
The operating strategy of the Company's management emphasizes several key
objectives: expense management; marketing of competitively priced insurance
products which are designed to generate an acceptable level of profitability;
maintenance of a high quality portfolio of investment grade securities; and the
provision of quality customer service.
- 3 -
<PAGE>
Equity in Net Income of InterContinental Life Corporation
General:
Prior to the acquisition of Family Life Insurance Company ("Family Life") in
June of 1991, FIC's primary involvement in the life insurance business was
through its equity interest in InterContinental Life Corporation ("ILCO"). For
the nine-month period ended Septemeber 30, 1998, the Company's equity in the net
earnings of ILCO, net of federal income tax, was $1,844,000, as compared to
$1,482,00 for the first nine months of 1997.
FIC currently owns 1,795,146 shares of ILCO's common stock, and prior to
September 30, 1998, held options to acquire an additional 1,702,155 shares. The
options were granted under an option agreement between FIC and ILCO which was
entered into in March, 1986 ("Option Agreement"). In addition, Family Life
currently owns 171,200 shares of ILCO common stock. As a result, FIC currently
owns, directly and indirectly through Family Life, 1,966,346 shares
(approximately 45%) of ILCO's common stock. The Option Agreement provided that
it continued in effect as long as FIC guaranteed indebtedness of ILCO. Since the
Senior Loan of ILCO was fully repaid on September 30, 1998, FIC's rights under
the Option Agreement expired on September 30, 1998.
As of September 30, 1998, the market value of ILCO's fixed maturities available
for sale segment was $470.0 million as compared to an amortized cost of $447.9
million, or an unrealized gain of $22.1 million. The increase reflects
unrealized gains on such investments related to changes in interest rates
subsequent to the purchase of such investments. Since FIC owns approximately 45%
of the common stock of ILCO, the net of tax effect of this increase ($6.0
million at September 30, 1998) is included in "Accumulated other comprehensive
income" on the Consolidated Balance Sheets and has been recorded as an increase
in shareholders' equity.
Liquidity and Capital Resources of ILCO:
ILCO is a holding company whose principal assets consist of the common stock of
Investors Life Insurance Company of North America ("Investors-NA") and its
subsidiary, Investors Life Insurance Company of Indiana (formerly
InterContinental Life Insurance Company). ILCO's primary source of funds
consists of payments under the surplus debentures from Investors-NA.
On June 30, 1998, ILCO, through a subsidiary, acquired Grinnell Life Insurance
Company ("Grinnell Life") for a base purchase price of $16.4 million, subject to
certain post-closing adjustments. As part of the transaction, Grinnell Life was
immediately merged with and into that subsidiary, with that subsidiary being the
surviving entity.
The cash requirements of ILCO consist primarily of its service of the
indebtedness created in connection with the 1988 acquisition of the Investors
Life Companies and the 1995 acquisition of Meridian Life Insurance Company
(which company was subsequently merged into another life insurance subsidiary of
ILCO). As of December 31, 1997, the outstanding principal balance of
- 4 -
<PAGE>
ILCO's senior loan obligations was $11.0 million, which reflected the prepayment
by ILCO of the payment originally scheduled for January 1, 1998. A regular
payment in the amount of $3.7 million was made on April 1, 1998, and a
prepayment of the July 1, 1998 installment, in the amount of $3.7 million, was
made on June 30, 1998. The outstanding principal balance of ILCO's senior loan
obligations was $3.6 million at June 30, 1998. The final installment on the
senior loan obligation scheduled for October 1, 1998, was prepaid on September
30, 1998. As a result, the senior loan obligation of ILCO was fully discharged
effective September 30, 1998.
ILCO's principal source of liquidity consists of the periodic payment of
principal and interest to it by Investors-NA, pursuant to the terms of the two
surplus debentures. The surplus debentures were originally issued by Standard
Life Insurance Company and their terms were previously approved by the
Mississippi Insurance Commissioner. In connection with the 1993 merger of
Standard Life into Investors-NA, the obligations of the surplus debentures were
assumed by Investors-NA. As of September 30, 1998, the outstanding principal
balances of the surplus debentures were $4.4 million and $11.5 million,
respectively. Since Investors-NA is domiciled in the State of Washington, the
Washington insurance law applies to the administration of the terms of the
surplus debentures. Under the provisions of the surplus debentures and current
law, no prior approval of the Washington Insurance Commissioner is required for
Investors-NA to pay interest or principal on the surplus debentures; provided
that, after giving effect to such payments, the statutory surplus of
Investors-NA is in excess of $10 million (the "surplus floor"). However,
Investors-NA has voluntarily agreed with the Washington Insurance Commissioner
that it will provide at least five days advance notice of payments which it will
make under the surplus debenture. As of September 30, 1998, the statutory
capital and surplus of Investors-NA was $66.1 million, an amount substantially
in excess of the surplus floor. The funds required by Investors-NA to meet its
obligations to ILCO under the terms of the surplus debentures are generated from
operating income generated from insurance and investment operations.
In addition to the payments under the terms of the Surplus Debentures, ILCO has
received dividends from Standard Life (now, from Investors-NA). Washington's
insurance code includes the "greater of" standard for payment of dividends to
shareholders, but has a requirement that prior notification of a proposed
dividend be given to the Washington Insurance Commissioner and that cash
dividends may be paid only from earned surplus. Under the "greater of" standard,
an insurer may pay a dividend in an amount equal to the greater of (i) 10% of
policyholder surplus or (ii) the insurer's net gain from operations for the
previous year. As of September 30, 1998, Investors-NA had earned surplus of
$37.5 million. Since the law applies only to dividend payments, the ability of
Investors-NA to make principal and interest payments under the Surplus
Debentures is not affected. ILCO does not anticipate that Investors-NA will have
any difficulty in making principal and interest payments on the Surplus
Debentures for the foreseeable future.
Investors-IN is domiciled in the State of Indiana. Under the Indiana insurance
code, a domestic insurer may make dividend distributions upon proper notice to
the Department of Insurance, as long as the distribution is reasonable in
relation to adequate levels of policyholder surplus and quality of earnings.
Under Indiana law the dividend must be paid from earned surplus. Extraordinary
dividend
- 5 -
<PAGE>
approval would be required where a dividend exceeds the greater of 10% of
surplus or the net gain from operations for the prior fiscal year. Investors-IN
had earned surplus of $17.4 million at September 30, 1998.
The Form 10-Qs of ILCO for the nine-month periods ended September 30, 1998 and
September 30, 1997, set forth the business operations and financial results of
ILCO and its life insurance subsidiaries. Such 10-Q reports of ILCO, including
the discussion by ILCO's management under the caption "Management's Discussion
and Analysis of Financial Conditions and Results of Operations" are incorporated
herein by reference.
Liquidity and Capital Resources
FIC is a holding company whose principal assets consist of the common stock of
Family Life and its equity ownership in ILCO. FIC's primary sources of capital
consists of cash flow from operations of its subsidiaries.
The cash requirements of FIC and its subsidiaries consist primarily of its
service of the indebtedness created in connection with its ownership of Family
Life. As of September 30, 1998, the outstanding balance of such indebtedness was
$49.2 million on the Notes granted by Investors-NA.
The principal source of liquidity for FIC's subsidiaries consists of the
periodic payment of principal and interest by Family Life pursuant to the terms
of a Surplus Debenture. The terms of the Surplus Debenture were previously
approved by the Washington Insurance Commissioner. Under the provisions of the
Surplus Debenture and current law, no prior approval of the Washington Insurance
Department is required for Family Life to pay interest or principal on the
Surplus Debenture; provided that, after giving effect to such payments, the
statutory surplus of Family Life is in excess of 6% of assets (the "surplus
floor"). However, Family Life has voluntarily agreed with the Washington
Insurance Commissioner that it will provide at least five days advance notice of
payments which it will make under the surplus debenture. As of September 30,
1998, the statutory capital and surplus of Family Life was $30.9 million, an
amount substantially in excess of the surplus floor. As of September 30, 1998,
the principal balance of the Surplus Debenture was $25.1 million. The funds
required by Family Life to meet its obligations under the terms of the Surplus
Debenture are generated primarily from premium payments from policyholders,
investment income and the proceeds from the sale and redemption of portfolio
investments.
Washington's insurance code includes the "greater of" standard for dividends but
has requirements that prior notification of a proposed dividend be given to the
Washington Insurance Commissioner and that cash dividends may be paid only from
earned surplus. Family Life does not presently have earned surplus as defined by
the regulations adopted by the Washington Insurance Commissioner and, therefore,
is not permitted to pay cash dividends. However, since the new law applies only
to dividend payments, the ability of Family Life to make principal and interest
payments under the Surplus Debenture is not affected. The Company does not
anticipate that Family Life will have any difficulty
- 6 -
<PAGE>
in making principal and interest payments on the Surplus Debenture in the
amounts necessary to enable Family Life Corporation to service its indebtedness
for the foreseeable future.
The sources of funds for Family Life consist of premium payments from
policyholders, investment income and the proceeds from the sale and redemption
of portfolio investments. These funds are applied primarily to provide for the
payment of claims under insurance and annuity policies, operating expenses,
taxes, investments in portfolio securities, shareholder dividends and payments
under the provisions of the Surplus Debenture.
FIC's net cash flow provided by operating activities was $4.4 million in the
first nine months of 1998, as compared to $7.4 million in the first nine months
of 1997. Net cash flow used in financing activities was $(4.6) million in the
1998 period, as compared to $(4.6) million in the first nine months of 1997.
In connection with the purchase of the Investors Life Companies by ILCO and the
purchase of Family Life by a wholly-owned subsidiary of FIC, FIC guaranteed the
payment of the indebtedness created in connection with such acquisitions. After
giving effect to the refinancing of the ILCO Senior Loan and the repayment of
the ILCO Subordinated Loans, the guaranty commitments of FIC with respect to the
debt obligations of ILCO relate to the ILCO Senior Loan. The outstanding
principal balance of ILCO's senior loan obligations was $3.6 million at June 30,
1998. The final installment on the Senior Loan obligation scheduled for October
1, 1998, was prepaid on September 30, 1998. As a result, the Senior Loan
obligation of ILCO was fully discharged effective September 30, 1998, relieving
FIC of the guaranty commitments with respect to the debt obligations of ILCO.
The guaranty commitments of FIC under the loans incurred in connection with the
acquisition of Family Life (after taking into account the repayments and new
loans which occurred in July, 1993) relate to: (i) the $22.5 million note issued
by Family Life Corporation to Investors Life Insurance Company of North America,
and (ii) the $34.5 million loaned by Investors-NA to two subsidiaries of FIC.
Management believes that its cash, cash equivalents and short term investments
are sufficient to meet the needs of its business and to satisfy debt service.
There are no trends, commitments or capital asset requirements that are expected
to have an adverse effect on the liquidity of FIC.
Investments
As of September 30, 1998, the Company's investment assets totaled $118.9
million, as compared to $119.1 million as of December 31, 1997.
The level of short-term investments at September 30, 1998 was $32.9 million, as
compared to $34.5 million as of December 31, 1997. The fixed maturities
available for sale portion represents $83.0 million of investment assets as of
September 30, 1998, as compared to $81.9 million at December 31,
- 7 -
<PAGE>
1997. The amortized cost of fixed maturities available for sale as of September
30, 1998 was $79.4 million representing a net unrealized gain of $3.6 million.
This unrealized gain principally reflects changes in interest rates from the
date the respective investments were purchased. To reduce the exposure to
interest rate changes, portfolio investments are selected so that diversity,
maturity and liquidity factors approximate the duration of associated
policyholder liabilities.
The assets held by Family Life must comply with applicable state insurance laws
and regulations. In selecting investments for the portfolios of its life
insurance subsidiaries, the Company's emphasis is to obtain targeted profit
margins, while minimizing the exposure to changing interest rates. This
objective is implemented by selecting primarily short- to medium-term,
investment grade fixed income securities. In making such portfolio selections,
the Company generally does not select new investments which are commonly
referred to as "high yield" or "non-investment grade".
The fixed maturities portfolio of Family Life, as of September 30, 1998,
consisted solely of fixed maturities investments which, in the annual statements
of the companies, as filed with state insurance departments, were designated
under the National Association of Insurance Commissioners ("NAIC") rating system
as a "1" (highest quality).
Management believes that the absence of "high-yield" or "non-investment grade"
investments (as defined above) in the portfolios of its life insurance
subsidiary enhances the ability of the Company to service its debt, provide
security to its policyholders and to credit relatively consistent rates of
return to its policyholders.
Year 2000 Compliance
The Company and its subsidiaries utilize a centralized computer system to
process policyholder records and financial information. In addition, the Company
uses non-centralized computer terminals in connection with its operations. The
software programs used in connection with these systems will be affected by what
is referred to as the "Year 2000 problem" or "Y2K problem". This refers to the
limitations of the programming code in certain existing software programs to
recognize date sensitive information as the year 2000 approaches. Unless
modified prior to the year 2000, such systems may not properly recognize such
information and could generate erroneous data or cause a system to fail to
operate properly.
The Company has evaluated its centralized computer systems and has developed a
plan to reach Y2K compliance. A central feature of the plan is to convert most
of the centralized systems to a common system which is already in compliance
with Y2K requirements. The Company is in the process of this systems conversion
and anticipates that the project will be completed in advance of the year 2000.
Based on its initial analysis, the Company expects that the cost of implementing
and completing the Plan will result in a after-tax expense of approximately
$760,000 for the three-year (1997 - 1999) conversion period. For the nine month
period ended September 30, 1998, the Company has incurred an after-tax expense
of approximately $226,000 in connection with the completion of the Plan.
- 8 -
<PAGE>
Between January 1, 1997 and September 30, 1998, the Company has expended
approximately 64% of the three-year expected after-tax cost discussed above.
The Plan calls for an upgrade of the Family Life's administrative systems by
changing individual lines of computer code in order to modify current operating
software such that it will become Y2K compliant. This process includes
approximately 29 sub-systems which provide data input to the main systems. The
administrative systems which are not modified will be converted onto the
Company's CK/4 System, a system designed to be Y2K compliant according to the
representations of the vendor.
The systems which administer a substantial number of Family Life policies will
be modified rather than converted. The modification of the PMS system
(administering approximately 122,000 policies for Family Life) was completed in
March, 1998. The conversion of the Cypros AP system (administering approximately
19,600 active policies for Family Life) is scheduled for completion at the end
of September, 1999.
A small number of Family Life policies are administered by systems which also
administer policies for ILCO and its subsidiaries. With regard to ILCO and its
subsidiaries, the ALIS system (administering approximately 49,280 policies for
Investors-NA at the time of conversion) was converted to CK/4 in January of
1998. The conversion of the Life 70 system (administering approximately 16,120
active policies for Investors-IN) is scheduled for completion in April, 1999.
The modification of the Lifecomm-B system which is responsible for the 19,205
policies assumed after ILCO's acquisition of State Auto Life is also scheduled
for completion in April, 1999. The conversion of the Lifecomm- A system
(administering approximately 62,400 active policies for Investors-NA) is now
scheduled for completion in September of 1999.
The Company also faces the risk that one or more of its external suppliers of
goods or services ("third party providers") will not be in a position to
properly interact with the Company due to the inability of such third party
provider to resolve its own Y2K issues. The Company has completed an inventory
of its third party provider relationships. In order to assess the Y2K readiness
of such third party providers, the Company has developed and forwarded a
detailed questionnaire to such providers. As the responses to the questionnaires
are received, the Company will evaluate the overall Y2K readiness of its third
party provider relationships. However, the Company does not have sufficient
information at the current time to determine whether the computer systems of its
third party providers will be in compliance with the Y2K requirements as the
year 2000 approaches.
In 1997, FIC Computer Services - a subsidiary of FIC which provides data
processing services for the Company and its affiliates - purchased new mainframe
hardware and accompanying operating software, which the vendor has represented
to be Y2K compliant. This hardware and software will be tested in 1998. The
telephone system has been tested by the maintenance provider for that system and
the Company has received assurances that the telephone system is Y2K compliant.
With respect to non-centralized systems (i.e. desktop computers), the Company
anticipates that updated software releases will be commercially available well
in advance of the year 2000.
- 9 -
<PAGE>
Accordingly, to the extent that such systems rely on date sensitive information,
the Company expects that the effort needed to correct for Y2K problems will be
less time intensive than the effort needed to achieve compliance for its
centralized systems.
In the event that a major administrative system fails to operate properly due to
the Y2K problem, or the Company does not complete the necessary systems
conversions prior to January 1, 2000, the Company has developed a plan to
respond to such a contingency. FIC Computer Services has assigned certain
personnel to be members of an emergency response team to resolve Y2K operations
problems. Additionally, insurance policies would be administered manually if the
necessary systems conversions were not completed prior to January 1, 2000, or
subsequent Y2K operations problems persist. Manual policy administration would
require additional personnel. If substantial additional personnel become
necessary for manual policy administration, the training and salary expenses of
such personnel could materially affect the Company's business and results of
operations.
Accounting Developments
In February 1997, the Financial Accounting Standards Board (FASB) issued
Financial Accounting Standard (FAS) No. 128, "Earnings Per Share," which revises
the standards for computing earnings per share previously prescribed by APB
Opinion No. 15, "Earnings Per Share." The Statement establishes two measures of
earnings per share: basic earnings per share and diluted earnings per share.
Basic earnings per share is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding during
the period. Diluted earnings per share reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
converted or exercised. The Statement requires dual presentation of basic and
diluted earnings per share on the face of the income statement for all entities
with potential dilutive securities outstanding. The Statement also requires a
reconciliation of the numerator and denominator of the basic earnings per share
computation to the numerator and denominator of the diluted earnings per share
computation. The Statement is effective for interim and annual periods ending
after December 15, 1997. The Company adopted FAS No. 128 in its annual financial
statements for the year ended December 31, 1997.
In June, 1997, the FASB issued FAS No. 130, "Reporting Comprehensive Income",
which establishes standards for reporting and display of comprehensive income
and its components in a financial statement with the same prominence as other
financial statements. Total comprehensive income is required to be reported in
condensed interim financial statements. Comprehensive income is defined as net
income adjusted for changes in stockholders' equity resulting from events other
than net income or transactions related to an entity's capital instruments. The
Company adopted FAS 130 effective January 1, 1998, with reclassification of
financial statements for earlier years.
In June, 1997, the FASB issued FAS No. 131, "Disclosure About Segments of an
Enterprise and Related Information", which establishes standards for reporting
information about operating segments. Generally, FAS No. 131 requires that
financial information be reported on the basis that
- 10 -
<PAGE>
it is used internally for evaluating performance. The Company adopted FAS 131
effective January 1, 1998 and comparative information for earlier years will be
restated. This statement does not need to be applied to interim financial
statements in the initial year of application. The adoption of FAS No. 131 did
not have a material impact on the Company's results of operations, liquidity or
financial position.
In February, 1998, the FASB issued FAS No. 132, "Employers' Disclosures About
Pensions and Other Postretirement Benefits", which revises current disclosure
requirements for employers' pension and other retiree benefits. FAS No. 132 does
not change the measurement or recognition of pension or other postretirement
benefit plans. The Company adopted FAS No. 132 effective January 1, 1998, with
the effect of such adoption to be reflected in year-end financial statements.
The adoption of FAS No. 132 is not expected to have a material impact on the
Company's results of operations, liquidity or financial position.
In December, 1997, the Accounting Standards Executive Committee issued Statement
of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments", which provides guidance on accounting for
insurance-related assessments. The Company is required to adopt SOP 97-3,
effective January 1, 1999. Previously issued financial statements should not be
restated unless the SOP is adopted prior to the effective date and during an
interim period. The adoption of SOP 97-3 is not expected to have a material
impact on the Company's results of operations, liquidity or financial position.
In June, 1998, the FASB issued FAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives) and for
hedging activities. FAS No. 133 is applicable to financial statements for all
fiscal quarters of fiscal years beginning after June 15, 1999. As the Company
does not have significant investments in derivative financial instruments, the
adoption of FAS 133 does not have a material impact on the Company's results of
operations, liquidity or financial position.
Cautionary Statements for Purposes of the "Safe Harbor" Provisions of the
Private Securities Litigation Reform Act of 1995
Except for historical factual information set forth in this Management's
Discussion and Analysis, certain statements made in this report are forward
looking and contain information about financial results, economic conditions,
Y2K risks and other risks and known uncertainties. The Company cautions the
reader that actual results could differ materially from those anticipated by the
Company, depending upon the eventual outcome of certain factors, including: (1)
heightened competition for new business, (2) significant changes in interest
rates, (3) adverse regulatory changes affecting the business of insurance and
(4) adverse changes in the Y2K readiness of the Company or its significant third
party providers.
- 11 -
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
Part II. Other Information
Item 1. Legal Proceedings
The Company and its subsidiaries are defendants in certain legal actions related
to the normal business operations of the Company. Management believes that the
resolution of such legal actions will not have a material impact upon the
financial statements.
ILCO and Investors-NA are defendants in two lawsuits which were filed in Travis
County, Texas in which the named plaintiffs in the suit, allege that the
universal life insurance policies sold to them by INA Life Insurance Company (a
company which was merged into Investors-NA in 1992) utilized unfair sales
practices. The named plaintiffs seek a class action as to similarly situated
individuals. A more detailed discussion of these two lawsuits is contained in
Part II, Item 1 Legal Proceedings of the Company's Form 10-Q for the three-month
period ended March 31, 1998 and the Company's Form 10-K for the year ended
December 31, 1997.
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
- 12 -
<PAGE>
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Form 10-K Annual Report of Registrant for the year ended
December 31, 1997 heretofore filed by Registrant with the
Securities and Exchange Commission, which is hereby
incorporated by reference.
(b) Reports on Form 8-K:
None
- 13 -
<PAGE>
FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
SIGNATURE
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.
FINANCIAL INDUSTRIES CORPORATION
/s/ James M. Grace
James M. Grace, Treasurer
Date:November 13, 1998
- 14 -
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q FOR
THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<DEBT-HELD-FOR-SALE> 83,019
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 4
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 118,913
<CASH> 1,257
<RECOVER-REINSURE> 12,473
<DEFERRED-ACQUISITION> 47,769
<TOTAL-ASSETS> 309,819
<POLICY-LOSSES> 60,562
<UNEARNED-PREMIUMS> 90
<POLICY-OTHER> 44,693
<POLICY-HOLDER-FUNDS> 4,495
<NOTES-PAYABLE> 49,182
0
0
<COMMON> 1,169
<OTHER-SE> 121,325
<TOTAL-LIABILITY-AND-EQUITY> 309,819
29,350
<INVESTMENT-INCOME> 5,870
<INVESTMENT-GAINS> 0
<OTHER-INCOME> 1,047
<BENEFITS> 12,384
<UNDERWRITING-AMORTIZATION> 3,538
<UNDERWRITING-OTHER> 9,553
<INCOME-PRETAX> 8,531
<INCOME-TAX> 1,552
<INCOME-CONTINUING> 6,979
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,979
<EPS-PRIMARY> 1.29
<EPS-DILUTED> 1.25
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
