10-Q 1 fic3q01.txt FIC 10Q 2001 3RD QUARTER 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, 2001 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) 6500 River Place Blvd., Building One Austin, Texas 78730 (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: 9,487,516. - 1 - Forward-Looking Statements Except for historical factual information set forth in this Form 10-Q, the statements, analyses, and other information contained in this report relating to trends in the Company's operations and financial results, the markets for the Company's products, the future development of the Company's business, and the contingencies and uncertainties to which the Company may be subject, as well as other statements including words such as "anticipate," "believe," "path," "estimate," "expect," "intend" and other similar expressions constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Such statements are made based upon management's current expectations and beliefs concerning the financial results, economic conditions and are subject to known and unknown risks, uncertainties and other factors contemplated by the forward-looking statements. Such factors include, among other things: (1) general economic conditions and other factors, including prevailing interest rate levels and stock market performance, which may affect the ability of FIC to sell its products, the market value of FIC's investments and the lapse rate and profitability of policies; (2) FIC's ability to achieve anticipated levels of operational efficiencies and cost-saving initiatives; (3) customer response to new products, distribution channels and marketing initiatives; (4) mortality, morbidity and other factors which may affect the profitability of FIC's insurance products; (5) changes in the Federal income tax laws and regulations which may affect the relative tax advantages of some of FIC's products; (6) increasing competition in the sale of insurance and annuities; (7) regulatory changes or actions, including those relating to regulation of insurance products and insurance companies; (8) ratings assigned to FIC's insurance subsidiaries by independent rating organizations such as A.M. Best Company, which FIC believes are particularly important to the sale of annuity and other accumulation products; and (9) unanticipated litigation. There can be no assurance that other factors not currently anticipated by management will not also materially and adversely affect FIC. - 2 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES INDEX Page No. Part I - Financial Information Item 1. Financial Statements Consolidated Balance Sheets September 30, 2001 and December 31, 2000...........................4 Consolidated Statements of Income For the three and nine month periods ended September 30, 2001 and September 30, 2000..........................7 Consolidated Statements of Cash Flows For the three and nine month periods ended September 30, 2001 and September 30, 2000.........................11 Notes to Consolidated Financial Statements.................................15 Item 2. Management's Discussion and Analysis of Financial Conditions and Results of Operations....................18 Item 3. Quantitative and Qualitative Disclosures About Market Risk ................................................28 Part II Other Information.........................................................29 Signature Page............................................................32 - 3 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands) September 30, December 31, 2001 2000 (unaudited) ASSETS Investments other than investments in affiliate: Fixed maturities available for sale at market value (amortized cost of $454,491 and $78,249 at September 30, 2001 and December 31, 2000, respectively) $ 470,067 $ 79,786 Fixed maturities at amortized cost (market approximates $1,450 at September 30, 2001) 1,450 0 Equity securities at market (cost approximates $40 at September 30, 2001 and $11 at December 31, 2000) 46 4 Policy loans 49,828 3,699 Mortgage loans and other investments 4,758 0 Invested real estate and other invested assets 56,113 0 Short-term investments 179,840 15,624 Total investments 762,102 99,113 Cash 12,922 2,733 Investment in affiliate 0 79,105 Accrued investment income 9,487 1,172 Agency advances and other receivables 23,112 7,604 Reinsurance receivables 34,588 17,466 Due and deferred premiums 18,707 12,537 Real estate occupied by the Company 20,135 0 Property and equipment, net 3,805 1,318 Deferred policy acquisition costs 77,252 56,161 Present value of future profits of acquired businesses 33,002 19,440 Other assets 15,976 4,117 Separate account assets 389,432 0 Total Assets $ 1,400,520 $ 300,766
The accompanying notes are an integral part of these consolidated financial statements. - 4 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands) September 30, December 31, 2001 2000 (unaudited) LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Policy liabilities and contract holder deposit funds: Future policy benefits $ 194,668 $ 62,462 Contract holder deposit funds 559,122 43,301 Unearned premiums 0 0 Other policy claims and benefits payable 15,849 2,931 769,639 108,694 Subordinated notes payable to affiliate 0 35,349 Deferred federal income taxes 36,989 24,437 Excess of net assets acquired over cost 13,381 0 Other liabilities 12,335 3,734 Separate account liabilities 381,998 0 Total Liabilities 1,214,342 172,214
The accompanying notes are an integral part of these consolidated financial statements. - 5 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS, Continued (in thousands) September 30, December 31, 2001 2000 (unaudited) Commitments and Contingencies Shareholders' equity: Common stock, $.20 par value, 25,000,000 shares authorized; 11,727,860 and 5,845,300 shares issued, 9,487,516 and 5,054,661 shares outstanding in 2001 and 2000, respectively. 2,345 1,169 Additional paid-in capital 68,025 7,225 Accumulated other comprehensive income 8,174 2,107 Retained earnings 130,100 125,426 208,644 135,927 Common treasury stock, at cost, 2,240,344 at 2001 and 790,639 at 2000. (22,466) (7,375) Total Shareholders' Equity 186,178 128,552 Total Liabilities and Shareholders' Equity $ 1,400,520 $ 300,766
The accompanying notes are an integral part of these consolidated financial statements. - 6 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands except per share data) Three Months Ended September 30, 2001 2000 (unaudited) Revenues: Premiums $ 10,225 $ 8,503 Net investment income 12,694 1,780 Earned insurance charges 10,361 824 Other 685 3 33,965 11,110 Benefits and expenses: Policyholder benefits and expenses 10,321 3,528 Interest expense on contract holders deposit funds 7,439 496 Amortization of present value of future profits of acquired businesses 875 1,112 Amortization of deferred policy acquisition costs 1,745 1,417 Operating expenses 8,042 2,674 Interest expense 0 501 28,422 9,728 Income before federal income tax and equity in net earnings of affiliates 5,543 1,382 Provision for federal income taxes 1,737 256 Income before equity in net earnings of affiliates 3,806 1,126 Equity in net earnings of affiliate, net of tax 0 1,041 Net Income $ 3,806 $ 2,167
The accompanying notes are an integral part of these consolidated statements. - 7 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands except per share data) Three Months Ended September 30, 2001 2000 (unaudited) Net Income Per Share Basic: Average weighted shares outstanding 9,483 5,055 Basic earnings per share $ 0.40 $ 0.43 Diluted: Common stock and common stock equivalents 9,536 5,160 Diluted earnings per share $ 0.40 $ 0.42
The accompanying notes are an integral part of these consolidated financial statements. - 8 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands except per share data) Nine Months Ended September 30, 2001 2000 (unaudited) Revenues: Premiums $ 27,324 $ 25,347 Net investment income 21,466 5,220 Earned insurance charges 16,953 3,196 Other 939 6 66,682 33,769 Benefits and expenses: Policyholder benefits and expenses 19,615 10,749 Interest expense on contract holders deposit funds 12,135 1,555 Amortization of present value of future profits of acquired businesses 2,651 2,984 Amortization of deferred policy acquisition costs 4,678 3,860 Operating expenses 16,558 8,612 Interest expense 616 1,513 Total 56,253 29,273 Income before federal income tax and equity in net earnings of affiliates 10,429 4,496 Provision for federal income taxes 3,091 834 Income before equity in net earnings of affiliates 7,338 3,662 Equity in net earnings of affiliate, net of tax 1,317 2,924 Net Income $ 8,655 $ 6,586
The accompanying notes are an integral part of these consolidated statements. - 9 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (in thousands except per share data) Nine Months Ended September 30, 2001 2000 (unaudited) Net Income Per Share Basic: Average weighted shares outstanding 7,261 5,055 Basic earnings per share $ 1.19 $ 1.30 Diluted: Common stock and common stock equivalents 7,292 5,163 Diluted earnings per share $ 1.18 $ 1.28
The accompanying notes are an integral part of these consolidated financial statements. - 10 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Three Months Ended September 30, 2001 2000 (unaudited) CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 3,806 $ 2,167 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of present value of future profits of acquired business 875 1,112 Amortization of deferred policy acquisition costs 1,745 1,417 Equity in undistributed earnings of affiliate 0 (1,534) Changes in assets and liabilities: Decrease in accrued investment income 1 62 Decrease (Increase) in agent advances and other receivables 3,006 (73) Decrease (Increase) in due and deferred premiums 3,494 (26) Increase in deferred policy acquisition costs (3,324) (2,624) Decrease in other assets 184 13 Decrease in policy liabilities and accruals (4,503) (308) (Decrease) Increase in other liabilities (937) 281 Increase in deferred federal income taxes 162 102 Other, net 1,484 (246) Net cash provided by operating activities $ 5,993 $ 343
The accompanying notes are an integral part of these consolidated financial statements. - 11 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued (in thousands) Three Months Ended September 30, 2001 2000 (unaudited) CASH FLOWS FROM INVESTING ACTIVITIES Fixed maturities purchased $ (6,063) $ (500) Proceeds from sales and maturities of fixed maturities 27,841 3,279 Real estate development (10,861) 0 Decrease (Increase) in policy loans 1,933 (73) Net change in short-term investments (16,234) (1,080) Purchase of property and equipment (43) 0 Net cash (used in) provided by investing activities $ (3,427) $ 1,626 CASH FLOW FROM FINANCING ACTIVITIES Dividends Paid (2,051) 0 Issuance of common capital stock 271 0 Issuance of treasury stock 57 0 Repayment of subordinated notes payable 0 (1,537) Net cash used in financing activities (1,723) (1,537) Net Increase (Decrease) in cash 843 432 Cash, beginning of period 12,079 1,181 Cash, end of period $ 12,922 $ 1,613
The accompanying notes are an integral part of these consolidated financial statements. - 12 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Nine Months Ended September 30, 2001 2000 (unaudited) CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 8,655 $ 6,586 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of present value of future profits of acquired business 2,931 2,984 Amortization of deferred policy acquisition costs 4,662 3,860 Equity in undistributed earnings of affiliate (2,137) (4,565) Changes in assets and liabilities: Increase in accrued investment income (103) (2) Decrease (Increase) in agent advances and other receivables 3,003 (1,582) Decrease (Increase) in due and deferred premiums 3,067 (149) Increase in deferred policy acquisition costs (7,864) (6,817) Decrease (Increase) in other assets 229 (20) Decrease in policy liabilities and accruals (5,208) (399) Decrease in other liabilities (800) (48) Increase (Decrease) in deferred federal income taxes 12 (22) Other, net 2,212 59 Net cash provided by (used in) operating activities $ 8,659 $ (115)
The accompanying notes are an integral part of these consolidated statements. - 13 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued (in thousands) Nine Months Ended September 30, 2001 2000 (unaudited) CASH FLOWS FROM INVESTING ACTIVITIES Fixed maturities purchased $ (37,253) $ (10,788) Proceeds from sales and maturities of fixed maturities 70,406 9,917 Real estate development (13,656) 0 Decrease (Increase) in policy loans 1,825 (81) Net change in short-term investments (19,229) 7,469 Purchase & retirement of property and equipment (53) 37 Net cash provided by investing activities 2,040 6,554 CASH FLOW FROM FINANCING ACTIVITIES Dividends Paid (3,982) (907) Issuance of common capital stock 271 0 Purchase of insurance holding company 6,979 0 Purchase of treasury stock (2,241) 0 Repayment of subordinated notes payable (1,537) (4,611) Net cash used in financing activities $ (510) $ (5,518) Net Increase (Decrease) in cash 10,189 921 Cash, beginning of year 2,733 692 Cash, end of period $ 12,922 $ 1,613
The accompanying notes are an integral part of these consolidated financial statements. - 14 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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, 2000, 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 which FIC held in InterContinental Life Corporation ("ILCO") prior to the May 18, 2001 merger of ILCO with a subsidiary of FIC (see Acquisition of InterContinental Life Corporation, below), is presented using the equity method. All significant intercompany items and transactions have been eliminated. Other Comprehensive Income The following is a reconciliation of accumulated other comprehensive income from December 31, 2000 to September 30, 2001 (in thousands): 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, 2000 $ 2,107 $ 0 $ 2,107 Current Period Change 6,063 4 6,067 Balance at September 30, 2001 $ 8,170 $ 4 $ 8,174
Acquisition of InterContinental Life Corporation On May 18, 2001, Financial Industries Corporation ("FIC") completed the merger of a subsidiary of FIC with and into ILCO, with ILCO surviving the merger as a wholly-owned subsidiary of FIC. In connection with the transaction, FIC issued 1.1 shares of its common stock for each share of ILCO common stock outstanding at the time of the merger and not held directly by FIC or ILCO. In addition, each option to purchase ILCO common stock was assumed by FIC and became an option to purchase FIC common stock with the number of shares and the exercise price adjusted for the exchange ratio in the merger. The consideration for the transaction was $50.536 million represented by the issuance of 4.7 million shares of FIC stock, at $10 per share, to ILCO shareholders. The $10 per share price was calculated based on the average price of FIC common stock on the two days immediately preceding and following the date of the merger agreement between FIC and ILCO. Prior to the merger, FIC owned approximately 48.1% of ILCO's common stock. The acquisition of ILCO was accounted for as a purchase; accordingly, the results of ILCO's operations are included in the consolidated result of operations from the date of the acquisition to June 30, 2001. The allocation of the purchase price to the net assets acquired resulted in excess of net assets acquired which have been estimated to be approximately $14.1 million. This estimate is based on an analysis, as of May 18, 2001, of the acquired book of business, which estimate is subject to adjustment based on actuarial and other analysis of the assets and liabilities acquired. For the period from January 1, 2001 to May 17, 2001, and for the first nine months of 2000, FIC;s net income includes its equity interest in the net income of ILCO, with such equity interest being based on FIC's percentage ownership of ILCO. - -15 - The pro forma unaudited results of operations for the nine months ended September 30, 2001 and 2000, assuming the ILCO acquisition had been consummated as of the beginning of the respective periods, are as follows: Nine Months Ended September 30 (In thousands, except per share data) 2001 2000 Total Revenues $104,337 $109,366 Net Income $ 10,959 $ 13,079 Net Income per share: Basic $ 1.14 $ 1.34 Diluted $ 1.13 $ 1.32 New Accounting Pronouncements In June 1998, the Financial Accounting Standard Board ("FASB") issued Statement of Financial Accounting Standards No. 133 (FAS 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, 2000, as amended by FAS 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FAS 133." As the Company does not have significant investments in derivative financial instruments, the adoption of FAS 133 did not have a material impact on the Company's results of operations,liquidity or financial position. - 16 - During 2001, the FASB issued Statement of Financial Accounting Standards No. 141 (FAS 141), "Business Combinations," which supersedes Accounting Principles Board Opinion No. 16 (APB 16), "Business Combinations," and establishes guidelines to account for business combinations under one method, the purchase method. The most significant changes made by FAS 141 are: (1) requiring that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, (2) establishing specific criteria for the recognition of intangible assets separately from goodwill, and (3) requiring unallocated negative goodwill to be written off immediately as an extraordinary gain (instead of being deferred and amortized). As of the earlier of the first day of the fiscal year beginning after December 15, 2001, or the date Financial Accounting Standards Statement No. 142 (FAS 142) is initially applied in its entirety, the amount of any unamortized deferred credit related to an excess of net assets acquired over cost arising from (a) a business combination for which the acquisition date was before July 1, 2001, or (b) an investment accounted for by the equity method acquired before July 1, 2001, shall be written off and recognized as the effect of a change in accounting principle. The effect of the accounting change and related income tax effects shall be presented in the income statement between the captions extraordinary items and net income. The per-share information presented in the income statement shall include the per-share effect of the accounting change. Upon adoption of FAS 141 in the first quarter of 2002, FIC will allocate the unamortized balance of excess of net assets acquired over cost to net income. This amount will be recorded as a change in accounting principle. During 2001, the FASB issued Financial Accounting Standards No. 142 (FAS 142), "Goodwill and Other Intangible Assets," which supersedes Accounting Principles Board Opinion No. 17 (APB 17), "Intangible Assets," and which addresses financial accounting and reporting for acquired goodwill and other intangible assets upon and subsequent to their acquisition. The provisions of FAS 142 will be effective for fiscal years beginning after December 15, 2001. The most significant changes made by FAS 142 are: (1) goodwill and indefinite lived intangible assets will no longer be amortized, (2) goodwill will be tested for impairment at least annually at the reporting unit level, (3) intangible assets deemed to have an indefinite life will be tested for impairment at least annually, and (4) the amortization period of intangible assets with finite lives will no longer be limited to forty years. The adoption of FAS 142 is not expected to materially affect FIC's financial position. During 2001, the FASB issued Statement of Financial Accounting Standard No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" (FAS 144). FAS 144 supersedes Statement of Financial Accounting Standard No. 121, "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" (FAS 121) and amends Accounting Principles Bulletin Opinion No. 30, "Reporting Results of Operations-Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" (APB 30) and Accounting Research Bulletin No. 51 (ARB 51) "Consolidated Financial Statements". The adoption of FAS 144 did not materially affect FIC's financial position. During 2001, the FASB issued Statement of Financial Accounting Standards No. 143 (FAS 143), "Accounting for Asset Retirement Obligations", which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. FAS 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002, the adoption of which is not expected to materially affect FIC's financial position. Dividend Paid In May, 2001, FIC announced that its Board of Directors has approved the payment of a semi-annual cash dividend in the amount of $.25 per common share. The dividend was paid on July 2, 2001, to record holders as of the close of business on June 18, 2001. - 17 - Item 2. Management's Discussion and Analysis of Financial Conditions and Results of Operation Results of Operations - Nine Months Ended September 30, 2001 and 2000 For the nine-month period ended September 30, 2001, Financial Industries Corporation's ("FIC") net income was $8,655,000 (basic earnings of $1.19 per common share, or diluted earnings of $1.18 per common share) as compared to $6,586,000 (basic earnings of $1.30 per common share, or diluted earnings of $1.28 per common share) in the first nine months of 2000. 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. Earnings per share for the nine months ended September 30, 2001, were affected by the increase in the number of FIC's common shares outstanding. The increase is attributable to the shares issued to InterContinental Life Corporation ("ILCO") shareholders in connection with the merger described in the following paragraph. As of September 30, 2001, the number of FIC's common shares outstanding was 9,487,516, as compared to 5,054,661 as of September 30, 2000. On May 18, 2001, FIC completed the merger of a subsidiary of FIC with and into ILCO. In connection with the merger, FIC issued 1.1 shares of its common stock for each share of ILCO common stock outstanding at the time of the merger and not held directly by FIC or ILCO. As a result of the merger, ILCO became a wholly-owned subsidiary of FIC. Prior to the merger, FIC owned approximately 48.1% of ILCO's common stock. Since ILCO was a wholly-owned subsidiary of FIC for the period from May 18, 2001 to September 30, 2001, the operations of ILCO are reported on a consolidated basis with FIC. For the period from January 1, 2001 to May 17, 2001, and for the first nine months of 2000, FIC's net income included its equity interest in the net income of ILCO, with such equity interest being based on FIC's percentage ownership of ILCO. 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, 2001, was $10,429,000 (on revenues of $66,682,000), as compared to $4,496,000 (on revenues of $33,769,000), in the first nine months of 2000. The consolidation of ILCO's operations for the period from May 18, 2001 to September 30, 2001 contributed approximately $5,509,000 to income from operations and approximately $35,935,000 to revenues for the nine-month period ended September 30, 2001. - 18 - Revenues Premium income for the first nine months of 2001, net of reinsurance ceded, was $27.32 million, as compared to $25.35 million in the first nine months of 2000. This source of revenues is related to the traditional life insurance book of business of FIC's insurance subsidiaries. The consolidation of ILCO's operations following the May 18th merger contributed approximately $3.4 million to premium income for the nine-month period ended September 30, 2001. Net investment income for the first nine months of 2001 was $21.47 million as compared to $5.22 million in the same period of 2000. The consolidation of ILCO's operations for the period from May 18, 2001 to September 30, 2001 contributed approximately $17.4 million to net investment income for the nine-month period ended September 30, 2001. The level of investment income contributed by the investment portfolio of Family Life Insurance Company (which has been a subsidiary of FIC for both of the nine-month periods covered by this report) during the current period was adversely affected by the decline in the level of interest income received from fixed income and short-term investments. This decline is attributable to lower interest rates during the period. Earned insurance charges for the first nine months of 2001 were $16.95 million, as compared to $3.20 million in the same period of 2000. This source of revenue is related to the universal life insurance and annuity book of business of FIC's insurance subsidiaries. The consolidation of ILCO's operations following the May 18th merger contributed approximately $14.1 million to earned insurance charges for the nine-month period ended September 30, 2001. At Family Life, earned insurance charges declined from $3.2 million in the 2000 period to $2.6 million in the 2001 period. This change is attributable to a decrease in Family Life's universal life and annuity business. The face amount of in force universal life policies was $859.1 million at September 30, 2000 as compared to $737.6 million at September 30, 2001. Benefits and Expenses Policyholder benefits and expenses were $19.62 million in the first nine months of 2001, as compared to $10.75 million in the first nine months of 2000. The consolidation of ILCO's operations for the period from May 18, 2001 to September 30, 2001 contributed approximately $10.6 million to policyholder benefits and expenses for the nine-month period ended September 30, 2001. At Family Life, the level of policyholder benefits and expenses decreased from $10.7 million for the first nine months of 2000 to $8.8 million for the same period in 2001, which decrease is attributable to a decrease in death benefit claims. Interest expense on contract holders deposit funds was $12.14 million in the first nine months of 2001, as compared to $1.56 million in the same period of the year 2000. This increase is primarily attributable to $10.2 million of interest expense on contract holders deposit funds resulting from the consolidation of ILCO's operations following the May 18th merger transaction. - 19 - In the first nine months of 2001, the amortization of present value of future profits of acquired business was $2.65 million as compared to $2.98 million in the first nine months of 2000. The decreases in amortization was expected and should continue to decrease as the underlying asset, present value of future profits, decreases. The amortization of deferred policy acquisition costs was $4.68 million in the first nine months of 2001, as compared to $3.86 million in the first nine months of 2000. The increase in amortization is attributable to the capitalization of expenses incurred in connection with the writing of new business. The amortization of deferred policy acquisition costs for the current period includes costs associated with Investors-NA and Investors-IN only for the period from May 18, 2001 to September 30, 2001, in the amount of $0.47 million. The operating expenses for the first nine months of 2001 were $16.56 million, as compared to $8.61 million in the first nine months of 2000. The consolidation of ILCO's operations for the period from May 18, 2001 to September 30, 2001 contributed approximately $7.53 million to operating expenses for the nine-month period ended September 30, 2001. Interest expense for the first nine months of 2001 was $0.62 million, as compared to $1.51 million in the first nine months of 2000. The decrease in the amount of interest expenses from the first nine months of 2000 to the first nine months of 2001 is attributable to the scheduled reduction in the amount of outstanding indebtedness. This interest expense is related to the indebtedness owed to Investors- NA by Family Life Corporation and FIC and includes the amount of interest for the period from January 1, 2001 to May 18, 2001. The consolidation of ILCO's operations with those of FIC for periods following the May 18th merger results in the elimination of this interest expense in the income statements of FIC and thus the interest expense amount for the three month period ended September 20, 2001 is $0. The provision for federal income taxes was $3.09 million in the first nine months of 2001 as compared to $0.83 million in the first nine months of 2000. The inclusion of ILCO's results for the period from May 18, 2001 to September 30, 2001 contributed approximately $1.67 million to the level of federal income taxes. Results of Operations - Three Months Ended September 30, 2001 as compared to the Three Months Ended September 30, 2000 For the three-month period ended September 30, 2001, FIC's net income was $3.81 million (basic and diluted earnings of $0.40 per common share) on revenues of $33.97 million as compared to net income of $2.17 million (basic earnings of $0.43 per common share and diluted earnings of $0.42 per common share) on total revenues of $11.11 million in the same three month period of 2000. The increase in net income and total revenues from 2000 to 2001 is primarily attributable to the consolidation of ILCO's operations into FIC's Statements of Income for the third quarter of 2001. - 20 - Equity in Net Income of InterContinental Life Corporation For the period from January 1, 2001 to May 17, 2001, FIC's equity in the net earnings of InterContinental Life Corporation ("ILCO"), net of federal income tax, was $1.32 million, as compared to $2.92 million for the first nine months of 2000. Following the merger of ILCO with FIC on May 18, 2001, the results of ILCO were consolidated with those of FIC. Accordingly, the equity in net earnings of affiliate results for the 2001 period are not fully comparable with the 2000 period. Prior to the merger with ILCO, FIC owned 3,591,534 shares of ILCO's common stock. In addition, Family Life owned 342,400 shares of ILCO common stock. As a result, FIC owned, directly and indirectly through Family Life, 3,933,934 shares (approximately 48.1%) of ILCO's common stock. Upon completion of the merger, ILCO became a wholly-owned subsidiary of FIC. Liquidity and Capital Resources Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of business operations. FIC is a holding company whose principal assets currently consists of the common stock of its insurance subsidiaries - Investors Life Insurance Company of North America ("Investors-NA"), Investors Life Insurance Company of Indiana ("Investors-IN") and Family Life Insurance Company ("Family Life"). Prior to the merger of FIC and ILCO on May 18, 2001, the principal assets of FIC consisted of the common stock of its insurance subsidiary, Family Life - and its equity ownership in ILCO. FIC's primary source of capital consists of dividends from its subsidiaries. Prior to the May 18th merger of ILCO with FIC, the principal source of liquidity for FIC's subsidiaries consisted of the periodic payment of principal and interest by Family Life pursuant to the terms of a Surplus Debenture. In June, 2001, the outstanding principal balance of the Surplus Debenture was completely paid off. For future periods, FIC's available source of liquidity will be dividends paid to it from its subsidiaries. Applicable state insurance laws generally restrict the ability of insurance companies to pay cash dividends in excess of prescribed limitations without prior approval. The ability of Investors-NA to pay shareholder dividends is and will continue to be subject to restrictions set forth in the insurance laws and regulations of Washington, its domiciliary state. The Washington insurance law limits how and when Investors-NA can pay shareholder dividends by including the "greater of" standard for payment of dividends to shareholders, and requiring 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 the policyholder surplus or (ii) the insurer's net gain from operations for the previous year. As of September 30, 2001, Investors-NA had earned surplus of $77.8 million. 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 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 $28.0 million at September 30, 2001. - 21 - Family Life is domiciled in the State of Washington and its ability to pay dividends to FIC is subject to the insurance regulatory requirements described above. 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. The sources of funds for the insurance subsidiaries of FIC consist of premium payments from policyholders, earned insurance charges, 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 and shareholder dividends. FIC's net cash flow provided by (used in) operating activities was $8.66 million in the first nine months of 2001, as compared to $(0.12) million in the first nine months of 2000. Net cash used in financing activities was $(0.51) million in the first nine months of 2001, as compared to $(5.52) million in the first nine months of 2000. Net cash flow provided by investing activities was $2.04 million for the nine months ended September 30, 2001, as compared to $6.55 million for the same period in 2000. The cash requirements of FIC, and its subsidiary, Family Life Corporation ("FLC"), consist primarily of its service of the indebtedness created in connection with FIC's ownership of Family Life. As of September 30, 2001, the outstanding balance of such indebtedness was $30.74 million on the Subordinated Notes granted by Investors-NA. FIC believes that the resources available to it within the holding company group are sufficient to provide for FLC's service of its indebtedness to Investors- NA. The guaranty commitments of FIC under the loans incurred in connection with the acquisition of Family Life relate to the $34.5 million loaned by Investors-NA to a subsidiary of FIC. Prior to September 12, 2001, FIC's guaranty commitments also consisted of a $22.5 million note issued by Family Life Corporation to Investors Life Insurance Company of North America. That loan was fully paid off as of September 12, 2001. 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. - 22 - Investments As of September 30, 2001, FIC's investment assets totaled $762.10 million, as compared to $99.11 million as of December 31, 2000. The increase is primarily attributable to the inclusion of the assets of ILCO in the consolidated financial statements of FIC. As of September 30, 2001, the market value of the fixed maturities available for sale segment was $470.07 million as compared to an amortized cost of $454.49 million or an unrealized gain of $15.58 million. The increase reflects unrealized gains on such investments related to changes in interest rates subsequent to the purchase of such investments. A portion ($1.96 million) of the unrealized gain has been recorded as a decrease in deferred policy acquisition costs on the consolidated balance sheet. The net of tax effect of the remainder of this increase ($8.17 million) has been recorded as an increase in shareholders' equity. The level of short-term investments at September 30, 2001 was $179.84 million, as compared to $15.62 million as of December 31, 2000. This increase is also primarily attributable to the inclusion of the assets of ILCO in the consolidated financial statements of FIC. Invested real estate and other invested assets at September 30, 2001 were $56.11 million. At December 31, 2000, FIC did not have any assets invested in real estate. The change is attributable to the consolidation of ILCO's financial results with FIC following the May 18th merger of the two companies. The real estate investment is related to the development of the River Place Pointe project ("River Place Pointe") by Investors-NA, a subsidiary of ILCO. In October, 1998, Investors-NA purchased River Place Pointe, two adjoining tracts of land located in Austin, Texas totaling 47.995 acres. The aggregate purchase price for these tracts was $8.1 million. Prior to the closing of the transaction, Investors-NA obtained a Site Development Permit for the tracts from the City of Austin. The Site Development Permit allows for the construction of seven office buildings totaling 600,000 square feet, with associated parking, drives and related improvements. Construction on the first section of the Project, which consists of four office buildings, an associated parking garage, and related infrastructure was completed in the second quarter of 2001. Construction on the second section continued during the third quarter of 2001, including work on buildings six and seven. The assets held by the life insurance subsidiaries of FIC 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". - 23 - The Company's fixed maturities portfolio (including short-term investments), as of September 30, 2001, included a non-material amount (0.3% of total fixed maturities and short-term investments) of debt securities 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 "3" (medium quality) or below. This number is primarily attributable to mortgage bonds which one of the Company's insurance subsidiaries owns in California utilities, which have been downgraded to a "6" (lowest quality) rating by the NAIC. As of September 30, 2001, Investors-NA owned mortgage bonds in Pacific Gas & Electric which were purchased for $515,000 and had a market value as of September 30, 2001 of $450,000 and Investors-NA and Investors-IN owned bonds in Southern California Edison which were purchased for $1.47 million and had a market value as of September 30, 2001 of $1.30 million. The investment objective of the Company's insurance subsidiaries emphasizes the selection of short to medium term high quality fixed income securities, rated Baa-3 (investment grade) or better by Moody's Investors Service, Inc. As of September 30, 2001, only 5.8% of the Company's total assets were invested in mortgage loans or real estate. Non-affiliated corporate debt securities that were non-investment grade represented only 0.1% of the Company's total assets at September 30, 2001. The investments of FIC's insurance subsidiaries in mortgage-backed securities included collateralized mortgage obligations ("CMOs") of $182.0 million, and mortgage-backed pass-through securities of $34.6 million, at September 30, 2001. Mortgage-backed pass-through securities, sequential CMO's and support bonds, which comprised approximately 51.5% of the book value of FIC's mortgage- backed securities at September 30, 2001, are sensitive to prepayment and extension risks. FIC's insurance subsidiaries have reduced the risk of prepayment associated with mortgage-backed securities by investing in planned amortization class ("PAC"), target amortization class ("TAC") instruments and scheduled bonds. These investments are designed to amortize in a predictable manner by shifting the risk of prepayment of the underlying collateral to other investors in other tranches ("support classes") of the CMO. At September 30, 2001, PAC and TAC instruments and scheduled bonds represented approximately 48.5% of the book value of FIC's mortgage-backed securities. Sequential and support classes represented approximately 35.5% of the book value of FIC's mortgage-backed securities at September 30, 2001. In addition, FIC's insurance subsidiaries limit the risk of prepayment of CMOs by not paying a premium for any CMOs. FIC's insurance subsidiaries do not invest in mortgage- backed securities with increased prepayment risk, such as interest-only stripped pass-through securities and inverse floater bonds. FIC's insurance subsidiaries did not have any z-accrual bonds as of September 30, 2001. The prepayment risk that certain mortgage-backed securities are subject to is prevalent in periods of declining interest rates, when mortgages may be repaid more rapidly than scheduled as individuals refinance higher rate mortgages to take advantage of the lower current rates. As a result, holders of mortgage-backed securities may receive large prepayments on their investments which cannot be reinvested at an interest rate comparable to the rate on the prepaying mortgages. For the year 2001, the investment objectives of FIC's insurance subsidiaries include the making of selected investments in CMOs. - 24 - FIC's insurance subsidiaries do not make new mortgage loans on commercial properties. Substantially all of the Company's mortgage loans were made by its subsidiaries prior to their acquisition by the Company. At September 30, 2001, none of the mortgage loans held by the subsidiaries had defaulted as to principal or interest for more than 90 days, and none of the Company's mortgage loans were in foreclosure. Another key element of the Company's investment strategy is to avoid large exposure in other investment categories which the Company believes carry higher credit or liquidity risks, including private placements, partnerships and bank participations. These categories accounted for approximately 0.2% of the Company's invested assets at September 30, 2001. The investment portfolio of Investors-NA includes $30.74 million of notes , represented by (i) a loan of $30 million by Investors-NA to Family Life Corporation made in July, 1993, in connection with the prepayment by the FIC subsidiaries of indebtedness which had been previously issued to Merrill Lynch as part of the 1991 acquisition of Family Life Insurance Company by a wholly-owned subsidiary of FIC and (ii) a loan of $4.5 million by Investors-NA to Family Life Insurance Investment Company made in July, 1993, in connection with the same transaction described above. Prior to September 12, 2001, the investment portfolio also included a $22.5 million loan from Investors-NA to Family Life Corporation and a $2.5 million loan from Investors-CA to Financial Industries Corporation (which is now owned by Investors-NA as a result of the merger of Investors-CA into Investors-NA) and $2.0 million of additions to the $2.5 million note made in accordance with the terms of such note. These loans were fully paid on September 12, 2001. As of June 12, 1996, the provisions of the notes from Investors-NA to FLC and FLIIC were modified as follows: (a) the $30 million note was amended to provide for forty quarterly principal payments, in the amount of $163,540 each for the period December 12, 1996 to September 12, 2001; beginning with the principal payment due on December 12, 2001, the amount of the principal payment increases to $1,336,458; the final quarterly principal payment is due on September 12, 2006; the interest rate on the note remains at 9%, and (b) the $4.5 million note was amended to provide for forty quarterly principal payments, in the amount of $24,531 each for the period December 12, 1996 to September 12, 2001; beginning with the principal payment due on December 12, 2001, the amount of the principal payment increases to $200,469; the final quarterly principal payment is due on September 12, 2006; the interest rate on the note remains at 9%. In December, 1998, FLIIC was dissolved. In connection with the dissolution, all of the assets and liabilities of FLIIC became the obligations of FLIIC's sole shareholder (FIC). Accordingly, the obligations under the provisions of the $4.5 million note described above are now the obligations of FIC. The NAIC continued its rating of "3" to the "Notes receivable from affiliates", as amended. These loans have not been included in the preceding description of NAIC rating percentages. - 25 - 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, to provide security to its policyholders and to credit relatively consistent rates of return to its policyholders. Accounting Developments In June 1998, the Financial Accounting Standard Board ("FASB") issued Statement of Financial Accounting Standards No. 133 (FAS 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, 2000, as amended by FAS 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FAS 133." As the Company does not have significant investments in derivative financial instruments, the adoption of FAS 133 did not have a material impact on the Company's results of operations, liquidity or financial position. During 2001, the FASB issued Statement of Financial Accounting Standards No. 141 (FAS 141), "Business Combinations," which supersedes Accounting Principles Board Opinion No. 16 (APB 16), "Business Combinations," and establishes guidelines to account for business combinations under one method, the purchase method. The most significant changes made by FAS 141 are: (1) requiring that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, (2) establishing specific criteria for the recognition of intangible assets separately from goodwill, and (3) requiring unallocated negative goodwill to be written off immediately as an extraordinary gain (instead of being deferred and amortized). As of the earlier of the first day of the fiscal year beginning after December 15, 2001, or the date Financial Accounting Standards Statement No. 142 (FAS 142) is initially applied in its entirety, the amount of any unamortized deferred credit related to an excess of net assets acquired over cost arising from (a) a business combination for which the acquisition date was before July 1, 2001, or (b) an investment accounted for by the equity method acquired before July 1, 2001, shall be written off and recognized as the effect of a change in accounting principle. The effect of the accounting change and related income tax effects shall be presented in the income statement between the captions extraordinary items and net income. The per-share information presented in the income statement shall include the per-share effect of the accounting change. Upon adoption of FAS 141 in the first quarter of 2002, FIC will allocate the unamortized balance of excess of net assets acquired over cost to net income. This amount will be recorded as a change in accounting principle. - 26 - During 2001, the FASB issued Financial Accounting Standards No. 142 (FAS 142), "Goodwill and Other Intangible Assets," which supersedes Accounting Principles Board Opinion No. 17 (APB 17), "Intangible Assets," and which addresses financial accounting and reporting for acquired goodwill and other intangible assets upon and subsequent to their acquisition. The provisions of FAS 142 will be effective for fiscal years beginning after December 15, 2001. The most significant changes made by FAS 142 are: (1) goodwill and indefinite lived intangible assets will no longer be amortized, (2) goodwill will be tested for impairment at least annually at the reporting unit level, (3) intangible assets deemed to have an indefinite life will be tested for impairment at least annually, and (4) the amortization period of intangible assets with finite lives will no longer be limited to forty years. The adoption of FAS 142 is not expected to materially affect FIC's financial position. During 2001, the FASB issued Statement of Financial Accounting Standard No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets" (FAS 144). FAS 144 supersedes Statement of Financial Accounting Standard No. 121, "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" (FAS 121) and amends Accounting Principles Bulletin Opinion No. 30, "Reporting Results of Operations-Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" (APB 30) and Accounting Research Bulletin No. 51 (ARB 51) "Consolidated Financial Statements". The adoption of FAS 144 did not materially affect FIC's financial position. During 2001, the FASB issued Statement of Financial Accounting Standards No. 143 (FAS 143), "Accounting for Asset Retirement Obligations", which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. FAS 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002, the adoption of which is not expected to materially affect FIC's financial position. Other Developments Dividend Paid In May, 2001, FIC announced that its Board of Directors has approved the payment of a semi-annual cash dividend in the amount of $.25 per common share. The dividend was paid on July 2, 2001, to record holders as of the close of business on June 18, 2001. Events of September 11, 2001 As of the date of this report, FIC's subsidiaries have only received one claim arising from the events of September 11, 2001. As a result, claims resulting from September 11th did not have a material effect on results of operations, liquidity or financial condition during the third quarter. - 27 - Item 3. Quantitative and Qualitative Disclosures About Market Risk General FIC's principal assets are financial instruments, which are subject to market risks. Market risk is the risk of loss arising from adverse changes in market rates, principally interest rates on fixed rate investments. For a discussion of the Company's investment portfolio and the management of that portfolio to reflect the nature of the underlying insurance obligations of the Company's insurance subsidiaries, please refer to the information set forth in Item 2 "Management's Discussion and Analysis of Financial Conditions and Results of Operation - Investments" of this report. The following is a discussion of the Company's primary market risk sensitive instruments. It should be noted that this discussion has been developed using estimates and assumptions. Actual results may differ materially from those described below. Further, the following discussion does not take into account actions which could be taken by management in response to the assumed changes in market rates. In addition, the discussion does not take into account other types of risks which may be involved in the business operations of the Company, such as the reinsurance recoveries on reinsurance treaties with third party insurers. The primary market risk to the Company's investment portfolio is interest rate risk. The Company does not use derivative financial instruments. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical loss in fair market value related to the financial instruments segment of the Company's balance sheet is estimated to be $16.1 million at September 30, 2001 and $22.0 million at December 31, 2000. For purposes of the foregoing estimate, the following categories of the Company's fixed income investments were taken into account: (i) fixed maturities, including fixed maturities available for sale and (ii) short-term investments. The market value of such assets was $646.7 million at September 30, 2001 and $702.7 million at December 31, 2000. The fixed income investments of the Company include certain mortgage-backed securities. The market value of such securities was $228.0 million at September 30, 2001 and $251.0 million at December 31, 2000. Assuming an immediate increase of 100 basis points in interest rates, the net hypothetical loss in the fair market value related to such mortgage-backed securities is estimated to be $4.2 million at September 30, 2001 and $12.6 million at December 31, 2000. The hypothetical effect of the interest rate risk on fair values was estimated by applying a commonly used model. The model projects the impact of interest rate changes on a range of factors, including duration and potential prepayment. - 28 - 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. Universal Life Litigation: ILCO and Investors-NA are defendants in a lawsuit which was filed in October, 1996, in Travis County, Texas. CIGNA Corporation, an unrelated Company, is also a named defendant in the lawsuit. The named plaintiffs in the suit (a husband and wife), 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 reformation of the life insurance contracts and an unspecified amount of damages. The named plaintiffs also seek a class action as to similarly situated individuals. In April, 2001, the named plaintiffs filed an amended complaint, so as to include various post-sale allegations, including allegations related to the manner in which increases in the cost of insurance were applied, the allocation of portfolio yields to the universal life policies and changes in the spread between the earned rate and the credited rate. The Company has filed a Motion for Summary Judgment to dismiss the lawsuit, which will be heard by the court on November 20, 2001. The plaintiffs have filed a motion with the court for certification, which motion will be heard by the court in December, 2001. The Company believes that the suit is without merit and intends to vigorously defend this matter. Litigation Relating to the FIC/ ILCO Merger: On the day that FIC and ILCO each publicly announced the formation of a special committee to evaluate a potential merger, two class action lawsuits were filed against ILCO, FIC and the officers and directors of ILCO. The actions allege that a cash consideration in the proposed merger is unfair to the shareholders of ILCO, that it would prevent the ILCO shareholders from realizing the true value of ILCO, and that FIC and the named officers and directors had material conflicts of interest in approving the transaction. In their initial pleadings, the plaintiffs sought certification of the cases as class actions and the named plaintiffs as class representatives, and among other relief, requested that the merger be enjoined (or, if consummated, rescinded and set aside) and that the defendants account to the class members for their damages. The defendants believe that the lawsuits are without merit and intend to vigorously contest the lawsuits. Management is unable to determine the impact, if any, that the lawsuits may have on the results of operations of the Company. - 29 - Other Litigation: Additionally, FIC and its subsidiaries are regularly involved in litigation, both as a defendant and as plaintiff. The litigation naming the insurance subsidiaries as defendant ordinarily involves our activities as a provider of insurance protection products. We do not believe that such litigation, either individually or in the aggregate, will have a material adverse effect on the Company's business, financial condition or results of operations. Item 2. Changes in Securities None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders The Annual Meeting of the Shareholders was held on August 24, 2001. The only matter submitted at the meeting to a vote of the Shareholders was the election of directors. All of the nominees had previously served as directors of the Company, and all were reelected as directors. The voting tabulation as to each nominee was as follows: Name In Favor Withheld John D. Barnett 6,214,861 602,493 S. Tim Casey 6,194,199 623,155 Joseph F. Crowe 6,214,911 602,443 Jeffrey H. Demgen 6,194,434 622,920 Theodore A. Fleron 6,194,549 622,805 W. Lewis Gilcrease 6,199,161 618,193 James M. Grace 6,194,844 622,510 Roy F. Mitte 6,201,044 616,310 M. Scott Mitte 6,220,261 597,093 Elizabeth T. Nash 6,193,256 624,098 Frank Parker 6,217,511 599,843 Thomas C. Richmond 6,214,461 602,893 Steven P. Schmitt 6,194,974 622,380 - 30 - 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, 2000 heretofore filed by Registrant with the Securities and Exchange Commission, which is hereby incorporated by reference. (b) Reports on Form 8-K: None - 31 - 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/ Jeffrey Demgen Jeffrey Demgen Vice-President /s/ David Hopkins David Hopkins Chief Accounting Officer Date: November 14, 2001 - 32 -