-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IqjquTVd4kHoTggT9c5A7yhihB5yfokPUXIddfFo+gQyT9l2O/EUzCXmwSfShyF3 qizzTngERbbdpUYb9iBjpA== 0000050982-98-000017.txt : 19981116 0000050982-98-000017.hdr.sgml : 19981116 ACCESSION NUMBER: 0000050982-98-000017 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FINANCIAL INDUSTRIES CORP CENTRAL INDEX KEY: 0000035733 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 742126975 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-04690 FILM NUMBER: 98748693 BUSINESS ADDRESS: STREET 1: THE AUSTIN CENTER STREET 2: 701 BRAZOS 12TH FL CITY: AUSTIN STATE: TX ZIP: 78701 BUSINESS PHONE: 5124045050 MAIL ADDRESS: STREET 1: 701 BRAZOS 12TH FL CITY: AUSTIN STATE: TX ZIP: 78701 FORMER COMPANY: FORMER CONFORMED NAME: GOLDEN UNITED INVESTMENT CO STOCK PLAN DATE OF NAME CHANGE: 19731128 FORMER COMPANY: FORMER CONFORMED NAME: ILEX CORP DATE OF NAME CHANGE: 19730801 FORMER COMPANY: FORMER CONFORMED NAME: GOLDEN UNITED INVESTMENT CO DATE OF NAME CHANGE: 19730801 10-Q 1 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 - 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 - FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands of dollars) 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 ======== ========
The accompanying notes are an integral part of the consolidated financial statements. FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands of dollars) 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 ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 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) 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 ======= =======
The accompanying notes are an integral part of the consolidated financial statements. 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) 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 ======= =======
The accompanying notes are an integral part of the consolidated financial statements. 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) 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 ------- -------
The accompanying notes are an integral part of the consolidated financial statements. 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) 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 ======= =======
The accompanying notes are an integral part of the consolidated financial statements. 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) 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 ------- -------
The accompanying notes are an integral part of the consolidated financial statements. 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) 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 ======= =======
The accompanying notes are an integral part of the consolidated financial statements. 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): 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 ======== ======== ========
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. 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 - 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 - 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 - 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 - 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 - 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 - 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 - 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 - 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 - 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 - 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 - 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 - EX-27 2
7 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 1,000 9-MOS DEC-31-1998 JUN-30-1998 83,019 0 0 4 0 0 118,913 1,257 12,473 47,769 309,819 60,562 90 44,693 4,495 49,182 0 0 1,169 121,325 309,819 29,350 5,870 0 1,047 12,384 3,538 9,553 8,531 1,552 6,979 0 0 0 6,979 1.29 1.25 0 0 0 0 0 0 0
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