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 March 31, 2002
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:
9,499,629.
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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.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
INDEX
Page No.
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets
March 31, 2002 and December 31, 2001................................ 4
Consolidated Statements of Income
For the three month periods ended
March 31, 2002 and March 31, 2001................................... 6
Consolidated Statements of Cash Flows
For the three month periods ended
March 31, 2002 and March 31, 2001................................... 8
Notes to Consolidated Financial Statements.................................. 10
Item 2. Management's Discussion and Analysis of
Financial Conditions and Results of Operations...................... 13
Item 3. Quantitative and Qualitative Disclosures
About Market Risk .................................................. 22
Part II
Other Information........................................................... 23
Signature Page.............................................................. 25
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, December 31,
2002 2001
(unaudited)
ASSETS
Investments other than investments in affiliate:
Fixed maturities held to maturity, at amortized
cost (market value approximates $1,042 and
$1,028 at March 31, 2002 and December 31, 2001,
respectively) $ 1,035 $ 1,029
Fixed maturities available for sale, at market
value (amortized cost of $492,814 and $496,704
at March 31, 2002 and December 31, 2001,
respectively) 492,471 501,395
Equity securities, at market (cost approximates
$59 at March 31, 2002 and December 31, 2001) 48 56
Policy loans 48,926 49,794
Mortgage loans 4,674 4,715
Invested real estate 64,029 61,049
Short-term investments 128,271 138,291
Total investments 739,454 756,329
Cash and cash equivalents 9,819 7,094
Accrued investment income 10,735 8,483
Agency advances and other receivables 30,072 30,324
Reinsurance receivables 14,976 14,709
Due and deferred premiums 12,861 13,411
Real estate occupied by Company 19,950 20,054
Property and equipment, net 3,576 3,546
Deferred policy acquisition costs 81,191 80,290
Present value of future profits of
acquired businesses 30,590 31,251
Other assets 17,553 14,074
Separate account assets 388,480 399,264
Total Assets $ 1,359,257 $ 1,378,829
The accompanying notes are an integral part of these
consolidated financial statements
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, December 31,
2002 2001
(unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Policy liabilities and contract holder deposit
funds:
Contract holder deposit funds $ 552,851 $ 556,117
Future policy benefits 180,144 180,953
Other policy claims and benefits payable 13,789 13,985
746,784 751,055
Deferred federal income taxes 29,090 31,920
Excess of net assets acquired over cost 0 15,847
Other liabilities 9,283 8,938
Separate account liabilities 380,716 391,593
Total Liabilities 1,165,873 1,199,353
Commitments and Contingencies:
Shareholders' equity:
Common stock, $.20 par value, 25,000 shares
authorized, 11,762 and 11,736 shares issued
at March 31, 2002 and December 31, 2001,
9,499 and 9,499 shares outstanding at March
31, 2002 and December 31, 2001. 2,353 2,348
Additional paid-in capital 65,747 65,558
Accumulated other comprehensive income (441) 2,297
Deferred compensation (263) (292)
Retained earnings 148,345 131,462
215,741 201,373
Common treasury stock, at cost, 2,263 and
2,237 shares at March 31, 2002 and December
31, 2001, respectively. (22,357) (21,897)
Total Shareholders' Equity 193,384 179,476
Total Liabilities and Shareholders' Equity $ 1,359,257 $ 1,378,829
The accompanying notes are an integral part of these
consolidated financial statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Three Months Ended March 31,
2002 2001
(unaudited)
Revenues:
Premiums, net $ 9,914 $ 8,038
Earned insurance charges 10,825 934
Net investment income 11,048 1,631
Other 452 0
32,239 10,603
Benefits and expenses:
Policyholder benefits and expenses 10,284 2,591
Interest expense on contract holders
deposit funds 7,985 570
Amortization of present value of future
profits of acquired businesses 1,070 838
Amortization of deferred policy acquisition
costs 1,923 1,439
Operating expenses 8,887 3,140
Interest expense 0 427
30,149 9,005
Income before federal income tax, equity
in net earnings of affiliates and cumulative
effect of change in accounting principle 2,090 1,598
Provision for federal income taxes 933 360
Income before equity in net earnings of
affiliates and cumulative effect of change
in accounting principle 1,157 1,238
Equity in net earnings of affiliate, net of tax 0 845
Net income before cumulative effect of change
in accounting principle 1,157 2,083
Cumulative effect of change in accounting
principle 15,727 0
Net Income $ 16,884 $ 2,083
The accompanying notes are an integral part of these
consolidated statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands except per share data)
Three Months Ended March 31,
2002 2001
(unaudited)
Net Income Per Share
Basic:
Average weighted shares outstanding $ 9,500 $ 5,055
Basic earnings per share:
Income per share before cumulative effect
of change in accounting principle $ 0.12 $ 0.41
Cumulative effect of change in accounting
principle 1.66 0
Basic earnings per share $ 1.78 $ 0.41
Diluted:
Common stock and common stock equivalents 9,575 5,183
Diluted earnings per share:
Income per share before cumulative effect
of change in accounting principle $ 0.12 $ 0.40
Cumulative effect of change in accounting
principle 1.64 0
Diluted earnings per share $ 1.76 $ 0.40
The accompanying notes are an integral part of these
consolidated financial statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three Months Ended March 31,
2002 2001
(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 16,884 $ 2,083
Adjustments to reconcile net income to
net cash (used in) provided by
operating activities:
Amortization of present value of future
profits of acquired business 1,070 838
Amortization of deferred policy
acquisition costs 1,923 1,439
Cumulative change in accounting principle (15,727) 0
Equity in undistributed earnings of affiliate 0 (1,361)
Changes in assets and liabilities:
Increase in accrued investment income (2,252) (176)
Increase in agent advances and other
receivables (15) (2,920)
Decrease (increase) in due premiums 550 (326)
Increase in deferred policy acquisition costs (2,335) (1,973)
Increase in other assets (3,478) (336)
(Decrease) increase in policy liabilities and
accruals (4,243) 296
Increase in other liabilities 345 1,757
(Decrease) increase in deferred federal income
taxes (1,424) 36
Other, net (36) (661)
Net cash used in operating activities $ (8,738) $ (1,304)
The accompanying notes are an integral part of these
consolidated financial statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(in thousands)
Three Months Ended March 31,
2002 2001
(unaudited)
CASH FLOWS FROM INVESTING ACTIVITIES
Fixed maturities purchased $ (27,395) $ (5,200)
Real estate capitalized (2,980) 0
Change in policy loans 868 (47)
Proceeds from calls and maturities of
fixed maturities 31,276 8,496
Net change in short-term investments 10,020 762
Purchase and retirement of property
and equipment (30) 0
Net cash provided by investing activities 11,759 4,011
CASH FLOW FROM FINANCING ACTIVITIES
Repayment of subordinated notes payable 0 (1,537)
Contract holder fund deposits 12,518 1,063
Contract holder fund withdrawals (12,548) (1,111)
Issuance of capital stock 194 0
Purchase of treasury stock (460) 0
Net cash used in financing activities (296) (1,585)
Net increase in cash 2,725 1,122
Cash and cash equivalents, beginning of year 7,094 2,733
Cash and cash equivalents, end of period $ 9,819 $ 3,855
The accompanying notes are an integral part of these
consolidated financial statements.
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The financial statements included herein have been presented to conform to the
requirements of Form 10-Q. This presentation includes year end balance sheet
data which was derived from audited financial statements. The notes to the
financial statements 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, 2001 previously filed with the Securities
and Exchange Commission for financial statements prepared in accordance with
GAAP. Management believes the financial statements reflect all adjustments
necessary to present a fair statement of interim results. 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. 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, 2001 to March 31, 2002 (in thousands):
<table>
<s> <c> <c> <c> <c>
Net unrealized Total
gain (loss) on Net accumulated
investments appreciation other
in fixed maturities of equity comprehensive
available for sale securities Other income
Balance at December 31, 2001 $ 2,527 $ (2) $ (228) $ 2,297
Current Period Change (2,733) (5) 0 (2,738)
Balance at March 31, 2002 $ (206) $ (7) $ (228) $ (441)
</table>
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FINANCIAL INDUSTRIES CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Dividends Declared
In March, 2001 FIC announced that its board approved the payment of an annual
cash dividend in the amount of $0.41 per share. The dividend was paid on April
12, 2001, to shareholders of record as of the close of business on March 19,
2001.
Related Party Transactions
On January 8, 2001, the Company donated $375,000 to the Roy F. and Joann Cole
Mitte Foundation (the "Foundation"). The Foundation is a charitable entity
exempt from federal income tax under section 501(a) of the Code as an
organization described in section 501(c)(3) of the Code, and owns 16.31% of the
outstanding shares of FIC's common stock. The sole members of the Foundation are
Roy F. Mitte, Chairman, President and Chief Executive Officer of FIC, ILCO and
their insurance subsidiaries, and his wife, Joann Cole Mitte. On January 2,
2002, FIC made a donation of $1,000,000 to the Foundation.
New Accounting Pronouncements
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 all acquisitions of a controlling interest, regardless of the form
of consideration. The most significant changes made by FAS 141 are that it: (1)
requires the purchase method of accounting, rather than the pooling method, be
used for all business combinations initiated after June 30, 2001; (2)
establishes specific criteria for the recognition of intangible assets
separately from goodwill; and (3) requires unallocated negative goodwill (which
is an excess of net assets acquired over cost) to be recognized immediately as
an extraordinary gain (instead of being deferred and amortized).
As of the first quarter of 2002, the amount of any unamortized deferred credit
related to negative goodwill 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, is recognized and reported as
the effect of a change in accounting principle. The effect of the accounting
change and related income tax effects is presented in the income statement
between the captions "extraordinary items" and "net income". The per-share
information presented in the income statement includes the per-share effect of
the accounting change. During the first quarter of 2002, FIC recognized the
unamortized balance of $15,727,000 of negative goodwill. There was no
amortization of negative goodwill recorded during the first quarter of 2002 and
during the first quarter of 2001.
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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 are
effective for FIC's fiscal year beginning January 1, 2002. The most significant
changes made by FAS 142 are: (1) goodwill and indefinite lived intangible assets
will no longer be amortized, but instead will be tested for impairment at least
annually at the reporting unit level, and (2) the amortization period of
intangible assets with finite lives will no longer be limited to forty years.
The adoption of FAS 142 did not materially affect FIC's results of operations,
liquidity or 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 results of operations, liquidity or 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". FAS 144 is effective for fiscal years
beginning after December 15, 2001. The adoption of FAS 144 did not materially
affect FIC's results of operations, liquidity or financial position.
In May 2002, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 145 (FAS 145), "Rescission of FAS Nos. 4,
44, and 64, Amendment of FAS 13, and Technical Corrections as of April 2002."
This Statement rescinds FASB Statement No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and an amendment of that Statement, FASB Statement No.
64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. This
Statement also amends other existing authoritative pronouncements to make
various technical corrections, clarify meanings, or describe their applicability
under changed conditions. FAS 145 is effective for financial statements issued
for fiscal years beginning after May 15, 2002, and is not expected to affect
FIC's results of operations, liquidity or financial position.
The AICPA also recently issued Statement of Position No. 01-06 ("SOP 01-06")
"Accounting by Certain Entities (Including Entities with Trade Receivables) That
Lend to or Finance the Activities of Others." The guidance in SOP 01-06 relating
to financing and lending activities is explicitly applicable to insurance
companies. SOP 01-06 reconciles and conforms the accounting and financial
reporting guidance presently contained in other accounting guidance. SOP 01-06
is effective for financial statements issued for fiscal years beginning after
December 15, 2001. The Company's accounting practices for its lending activities
are already consistent with the guidance contained in SOP 01-06. The adoption of
SOP 01-06 did not have a significant effect on the Company's financial
statements.
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Item 2. Management's Discussion and Analysis of Financial Conditions and Results
of Operation
The following discussion addresses the financial condition of FIC as of March
31, 2002, compared with December 31, 2001, and its results of operations for the
three months ended March 31, 2002, compared with the same period last year. This
discussion should be read in conjunction with Management's Discussion and
Analysis included in FIC's 10-K dated April 1, 2002, to which the reader is
directed for additional information.
Transactions Affecting Comparability of Results of Operations
On May 18, 2001, pursuant to an Agreement and Plan of Merger, as amended (the
"Merger Agreement"), dated as of January 17, 2001, among FIC, InterContinental
Life Corporation ("ILCO"), and ILCO Acquisition Company, a Texas corporation and
wholly-owned subsidiary of FIC ("Merger Sub"), Merger Sub was merged with and
into ILCO (the "Merger"). ILCO was the surviving corporation of the Merger and
became a wholly-owned subsidiary of FIC. In accordance with the Merger
Agreement, FIC issued 1.1 shares of common stock, par value $0.20 per share
("FIC Common Stock"), for each share of common stock, par value $0.22 per share,
of ILCO outstanding at the time of the Merger ("ILCO Common Stock"). In
addition, each share of ILCO Common Stock issuable pursuant to outstanding
options was assumed by FIC and became an option to acquire FIC Common Stock with
the number of shares and exercise price adjusted for the exchange ratio in the
Merger. 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 quarter ending
March 31, 2002, the operations of ILCO are reported on a consolidated basis with
FIC. For the first quarter of 2001, 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.
Results of Operations - Three Months Ended March 31, 2002 and 2001
For the three-month period ended March 31, 2002, Financial Industries
Corporation's ("FIC") net income was $16,884,000 (basic earnings of $1.78 per
common share, or diluted earnings of $1.76 per common share) on revenues of
$32,239,000 as compared to net income of $2,083,000 (basic earnings of $0.41 per
common share, or diluted earnings of $0.40 per common share) on revenues of
$10,603,000 in the first three months of 2001. Net income before the cumulative
effect of change in accounting principle was $1,157,000 (basic earnings of $0.12
per common share, or diluted earnings of $0.12 per common share).
Earnings per share for the three months ended March 31, 2002 were affected by
the increase in the number of FIC's common shares outstanding due to the Merger.
As of March 31, 2002, the number of FIC's common shares outstanding was
9,499,629, as compared to 5,054,661 as of March 31, 2001. Additionally, net
income and earnings per share were affected by a cumulative effect of a change
in accounting principle of $15.7 million. This amount represents the excess of
net assets acquired over cost as of the beginning of 2002 related to the Merger.
The Company recorded this cumulative effect in conjunction with adopting
Statement of Financial Accounting Standards No. 141 (FAS 141), "Business
Combinations," this quarter, as required.
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Revenues.
Premium revenues reported for traditional life insurance products are recognized
when due. Premium income for the first three months of 2002, net of reinsurance
ceded, was $9.9 million, as compared to $8.0 million in the first three months
of 2001. 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 contributed approximately $2.5 million to premium income for the
three month period ended March 31, 2002. At Family Life Insurance Company
("Family Life", which has been a subsidiary of FIC for the periods ending March
31, 2002 and 2001), first year net collected premiums for traditional life
insurance products for the three month period ending March 31, 2002 were $0.8
million as compared to $1.0 million for the same period in 2001. The level of
renewal premiums for traditional life insurance products at Family Life for the
three month period ending March 31, 2002 was $6.3 million, as compared to $6.8
million for the same period in 2001. The decrease in renewal premium is
attributable to the decrease in the traditional life insurance book of business.
Income from universal life and annuity charges for the first three months of
2002 was $10.8 million, as compared to $0.9 million in the same period of 2001.
The consolidation of ILCO's operations contributed approximately $10.0 million
to earned insurance charges for the three month period ended March 31, 2002. At
Family Life, earned insurance charges declined from $0.9 million in the 2001
period ending March 31st to $0.8 million in the 2002 period ending March 31st.
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 $741
million at March 31, 2001 as compared to $602 million at March 31, 2002.
Net investment income for the first three months of 2002 was $11.0 million as
compared to $1.6 million in the same period of 2001. The consolidation of ILCO's
operations contributed approximately $9.6 million to net investment income for
the three month period ended March 31, 2002. FIC and its subsidiaries investment
portfolio were 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.
Net real estate income, included in net investment income, was $1.0 million for
the three month period ended March 31, 2002, as compared to $0 for the same
period in 2001. Real estate income is attributable to the inclusion of ILCO's
investment income with FIC's for the three month period. ILCO's real estate
income was not included in FIC's income statements for the first quarter of
2001. Real estate income is earned from the leases on the buildings at River
Place Pointe, an office complex in Austin, Texas which is owned and being
developed by Investors Life Insurance Company of North America ("Investors
Life").
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Benefits and Expenses.
Policyholder benefits and expenses were $10.3 million in the first three months
of 2002, as compared to $2.6 million in the first three months of 2001. The
consolidation of ILCO's operations for the three month period ending March 31,
2002 contributed approximately $7.6 million to policyholder benefits and
expenses. At Family Life, the level of policyholder benefits and expenses was
$2.6 million for the first three months of 2001 compared to $2.7 million for the
same period in 2002.
Interest expense on contract holders deposit funds was $8.0 million in the first
three months of 2002, as compared to $0.6 million in the same period of the year
2001. This increase is primarily attributable to $7.3 million of interest
expense on contract holders deposit funds resulting from the consolidation of
ILCO's operations.
The expense related to the amortization of deferred policy acquisition costs
increased $0.5 million to $1.9 million in the first three months of 2002, from
$1.4 million in the first three months of 2001. A portion of the increase in
amortization is attributable to the Merger. In the first quarter of 2002,
expenses related to acquiring new business were $3.0 million, of which $2.2
million has been capitalized as a deferred policy acquisition cost. The amount
not capitalized was recorded as an expense in the first quarter.
In the first three months of 2002, the amortization of PVFP was $1.1 million as
compared to $0.8 million in the first three months of 2001. The consolidation of
ILCO's amortization expense with FIC's contributed approximately $0.4 million.
The operating expenses for the first three months of 2002 were $8.9 million, as
compared to $3.1 million in the first three months of 2001. The consolidation of
ILCO's operations contributed approximately $4.6 million to operating expenses
for the three month period ended March 31, 2002. The level of operating expenses
for the three month period ending March 31, 2002 included: (i) expenses related
to acquiring new business; (ii) a donation of $1 million to the Roy F. and Joann
Cole Mitte Foundation which was made in the first quarter of 2002, as compared
to a $375,000 donation in the first quarter of 2001; and (iii) $159,078 related
to the repurchase of James M. Grace's employment contract. For a further
discussion of the donation or repurchase see FIC's 10-K for the year ended
December 31, 2001, dated April 1, 2002.
Interest expense for the first three months of 2002 was $0, as compared to $0.4
million in the first three months of 2001. This interest expense is related to
indebtedness owed to Investors Life by Family Life Corporation (a wholly owned
subsidiary of FIC) and FIC. The consolidation of ILCO's operations with those of
FIC for the three month period ending March 31, 2002 results in the elimination
of this interest expense in the income statements of FIC.
The provision for federal income taxes was $0.9 million in the first three
months of 2002 as compared to $0.4 million in the first three months of 2001.
The inclusion of ILCO's results contributed approximately $1.2 million to the
level of federal income taxes. Because of the Merger and subsequent
consolidation of FIC and ILCO's provision for federal income taxes, FIC was not
able to utilize the small company tax deduction, which provided lower tax rates.
The increase in federal income taxes due to the loss of this deduction was
$69,000. Additionally, due to the Merger, the Company will incur approximately
$200,000 in federal income taxes in the first quarter of 2002 related to excess
compensation.
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Equity in Net Income of InterContinental Life Corporation
For the three-month period ended March 31, 2001, the Company's equity in the net
earnings of InterContinental Life Corporation ("ILCO"), net of federal income
tax, was $845,000. Following the merger of ILCO with FIC on May 18, 2001, the
results of ILCO were consolidated with those of FIC. Accordingly, there is no
equity in net earnings of affiliate results for the period ended March 31, 2002.
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 an insurance
holding company whose principal assets consist of the outstanding capital stock
of its insurance subsidiaries - Family Life Insurance Company ("Family Life"),
Investors Life Insurance Company of North America ("Investors Life"), and prior
to February 19, 2002, Investors Life Insurance Company of Indiana
("Investors-IN"). 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. As a holding
company, FIC's ability to meet its cash requirements, pay interest on any debt,
pay expenses related to its affairs and pay dividends on its common stock
substantially depends upon dividends from its subsidiaries.
Prior to June 2001, the principal source of liquidity for FIC and its
wholly-owned subsidiary, Family Life Corporation, consisted of the periodic
payment of principal and interest by Family Life pursuant to the terms of the
surplus debenture issued in connection with the Family Life acquisition from
Merrill Lynch. For periods subsequent to June 30, 2001, 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 Family Life and Investors Life to pay shareholder dividends is
and will continue to be subject to restrictions set forth in the insurance laws
and regulations of Washington, their domiciliary state. Washington limits how
and when Family Life and Investors Life can pay shareholder dividends by (a)
including the "greater of" standard for payment of dividends to shareholders,
(b) requiring that prior notification of a proposed dividend be given to the
Washington Insurance Commissioner and (c) requiring that cash dividends 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.
Neither Investors Life nor Family Life paid any dividends during the first
quarter of 2002. For the three month period ended March 31, 2002, Investors Life
had earned surplus of $50.7 million and a net gain from operations of $1.8
million, and Family Life had earned surplus of $0.7 million and a net gain from
operations of $0.7 million.
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Prior to the merger of Investors Life and Investors-IN in February 2002,
Investors-IN was 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.
Investors-IN did not make any dividend payments during the first quarter of
2002.
Sources of cash for FIC's insurance subsidiaries consist of premium payments
from policyholders and annuity holders, charges on policies and contracts,
investment income, and proceeds from the sale of investment assets. These funds
are applied primarily to provide for the payment of claims under insurance and
annuity policies, payment of policy withdrawals, surrenders and loans, operating
expenses, taxes, investments in portfolio securities, and shareholder dividends.
FIC's cash and cash equivalents at March 31, 2002 was $9.8 million as compared
to $7.1 million at December 31, 2001. The $2.7 million increase in cash and cash
equivalents at March 31, 2002 from December 31, 2001 was due primarily to the
sale of short-term investments. Cash and cash equivalents at March 31, 2001 was
$3.9 million. The increase in cash from March 31, 2001 to March 31, 2002 was
primarily attributable to the cash obtained by FIC in the Merger.
FIC's net cash flow used in operating activities was ($8.7) million for the
three month period ending March 31, 2002, as compared to ($1.3) million for the
same period in the year 2001. The increase in cash used in operating activities
of $7.4 million from 2001 to 2002 was primarily attributable to an increase in
accrued investment income of $2.1 million, a decrease in policy liabilities of
$4.5 million and a decrease in income from operations of $0.9 million.
Net cash flow provided by investing activities was $11.8 million in the three
month period ending March 31, 2002, as compared to $4.0 million in the same
period of 2001. The increase in cash provided by investing activities from 2001
to 2002 was due to the purchase of ILCO. Further, the cash provided by investing
activity was positively affected by fixed maturity proceeds in excess of
purchases of $3.9 million and a $10.0 million increase in cash from the sale of
short-term investments. These amounts were offset by a ($3.0) million
capitalization of real estate.
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Net cash flow used in financing activities was ($0.3) million in the first three
months of 2002, as compared to ($1.6) million in the first three months of 2001.
The decrease in cash used in financing activities is primarily due to the
elimination on FIC's cash flow statements of principle payments on the
subordinated debt, described in the paragraphs below, due to the Merger.
The cash requirements of FIC, and its holding company subsidiary, Family Life
Corporation, consist primarily of its service of the indebtedness created in
connection with FIC's ownership of Family Life. As of March 31, 2002, the
investment portfolio of Investors Life included $27.7 million of notes
receivable from affiliates, represented by (i) a loan of $30 million by
Investors Life to Family Life Corporation made in July 1993, in connection with
the prepayment 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
Life to Family Life Insurance Investment Company made in July 1993, in
connection with the same transaction described above.
The provisions of the notes owned by Investors Life include the following
provisions: (a) the $30 million note provides for 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 provides for 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%.
Due to the Merger, this indebtedness is not included as a liability on the
consolidated financial statements of FIC. FIC's other liquidity requirements
relate principally to the need for cash flow to meet operating expenses, as well
as the liabilities associated with its insurance subsidiaries' various life
insurance and annuity products.
Given the historical cash flow of our subsidiaries and the current financial
results, management believes that the cash, cash equivalents and short term
investments of FIC and its subsidiaries 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.
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Investments
As of March 31, 2002, FIC's invested assets, excluding separate accounts,
totaled $739.5 million, a decrease of $16.8 million from $756.3 million at
December 31, 2001. The decrease is primarily attributable to a decrease of $8.9
million in fixed maturities, $4.9 million of which resulted from a drop in the
market value of the portfolio, and a decrease of $10 million in short-term
investments, with $3 million of that change reinvested in real estate and $7
million used in operations. There are no significant differences between the
portfolio composition as of March 31, 2002 as compared to December 31, 2001.
The assets held by Family Life and Investors 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". FIC determines
the allocation of our assets primarily on the basis of cash flow and return
requirements of our products and secondarily by the level of investment risk.
A 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 only $40,746 of invested assets
as of March 31, 2002 and $45,479 of invested assets at December 31, 2001.
Our fixed maturity securities portfolio is predominately comprised of low risk,
investment grade, available for sale publicly traded corporate securities,
mortgage-backed securities and United States Government bonds. As of March 31,
2002, the market value of the fixed maturities available for sale segment was
$492.5 million as compared to an amortized cost of $492.8 million or an
unrealized loss of $0.3 million. The decrease reflects unrealized losses on such
investments related to changes in interest rates subsequent to the purchase of
such investments.
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The investments of FIC's insurance subsidiaries in mortgage-backed securities
included collateralized mortgage obligations ("CMOs") of $177.6 million as of
March 31, 2002 as compared to $201.8 million at December 31, 2001, and
mortgage-backed pass-through securities of $26.9 million as of March 31, 2002
and $31.2 million at December 31, 2001. Mortgage-backed pass-through securities,
sequential CMO's and support bonds, which comprised approximately 46.7% of the
book value of FIC's mortgage- backed securities at March 31, 2002, 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 March 31, 2002, PAC and TAC instruments and scheduled bonds represented
approximately 53.3% of the book value of FIC's mortgage-backed securities.
Sequential and support classes represented approximately 31.5% of the book value
of FIC's mortgage-backed securities at March 31, 2002. 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 March 31, 2002. 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 2002, the investment objectives of FIC's
insurance subsidiaries include the making of selected investments in CMOs.
The securities valuation office (SVO) of the National Association of Insurance
Commissioners evaluates all public and private bonds purchased as investments by
insurance companies. The SVO assigns one of six investment categories to each
security it reviews. Category 1 is the highest quality rating, and Category 6 is
the lowest. As of March 31, 2001, the majority of our bonds are investment grade
(Category 1 and 2). The Company's fixed maturities portfolio (including
short-term investments), included only a non-material amount of debt securities
which, in the annual statements of the companies as filed with state insurance
departments, were designated by the SVO as "3" (medium quality) or below. This
number is attributable to mortgage bonds which Investors Life owns in a
California utility, which has been downgraded to a "6" (lowest quality) rating
by the NAIC. As of March 31, 2002, Investors Life owned bonds in Southern
California Edison which were purchased for $0.98 million and had a market value
as of March 31, 2002 of $0.94 million.
FIC's short-term investments consist primarily of U.S. Government bonds. The
level of short-term investments at March 31, 2002 was $128.3 million, as
compared to $138.3 million as of December 31, 2001.
Invested real estate at March 31, 2002 was $64.0 million as compared to $61.0
million at December 31, 2001. The real estate investment is primarily related to
the development of the River Place Pointe project ("River Place Pointe") by
Investors Life. In October 1998, Investors Life 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. Investors Life
obtained a Site Development Permit for the tracts from the City of Austin
allowing 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 during 2000
and 2001. Construction on the second section continued during the first quarter
of 2002, including work on buildings six and seven. Completion of the entire
project is expected by the end of 2002.
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As of March 31, 2002, Investors Life had invested $84.5 million in the
construction of River Place Pointe, of which $20.0 million is recorded on FIC's
balance sheet as real estate occupied by the Company. Investors Life paid $3.0
million during the first quarter of 2002 on construction of the project and
expects to pay an additional $10 million to complete the project.
As of March 31, 2002, $4.7 million was invested in mortgage loans, as compared
to $4.7 million at December 31, 2001. The Company does 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 March 31, 2002, none of the mortgage loans held by the Company had defaulted
as to principal or interest for more than 90 days, and none of the Company's
mortgage loans were in foreclosure.
Policy loans totaled $48.9 million at March 31, 2002, as compared to $49.8
million at December 31, 2001.
Management believes that the absence of "high-yield" or "non-investment grade"
investments (as defined above) in the portfolios of FIC's life insurance
subsidiaries 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.
Critical Accounting Policies
Cumulative Effect of Accounting Changes. During the first quarter of 2002, the
Company adopted Statement of Financial Accounting Standards (SFAS) No. 141,
"Business Combinations." SFAS No. 141 eliminates the practice of amortizing and
deferring excess of net assets acquired over costs and requires unallocated
negative goodwill to be recognized immediately. In accordance with the standard,
FIC ceased negative goodwill amortization on January 1, 2002 and recognized the
unamortized balance of $15.7 million of negative goodwill acquired in the
Merger.
Deferred Policy Acquisition Costs and Present Value of Future Profits of
Acquired Business. The costs of acquiring new business, including certain costs
of issuing policies and certain other variable selling expenses (principally
commissions), are deferred policy acquisition costs ("DAC"). DAC is capitalized
and then amortized to reflect an expense in relation to the projected stream of
profits (for universal life and annuity products) or to the premium revenue (for
traditional life products). Such projections require use of certain assumptions,
including interest margins, product loads, mortality rates, persistency rates,
and maintenance expense levels. Effective with respect to new business issued on
and after January 1, 2002, the Company has capitalized DAC based on an updated
analysis of its cost structure and assumptions as to product performance. For
business written previously, DAC is amortized using previously established
methods and practices. Management periodically reviews the assumptions
associated with the amortization models prospectively.
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Present value of future profits of acquired business ("PVFP") are the costs
associated with acquiring blocks of insurance from other companies or through
the acquisition of other companies. PVFP is capitalized and amortized in a
manner that matches these costs against the associated revenues.
For the quarter ending March 31, 2001, 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.
For a further discussion of accounting standards, see New Accounting
Pronouncements on pages 11-12, herein.
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 "Management's Discussion and Analysis of Financial Condition and Operations -
Investments".
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 that 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 that 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.
Interest Rate Risk. The Company manages the interest rate risk inherent in
our assets relative to the interest rate risk inherent in our liabilities.
Generally, we manage interest rate risk based on the application of a commonly
used model. The model projects the impact of interest rate changes on a range of
factors, including duration and potential prepayment. For example, 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 $26.1 million at March 31, 2002 and
$24.6 million at December 31, 2001. For purposes of the foregoing estimate,
fixed maturities, including fixed maturities available for sale, and short-term
investments were taken into account. The market value of such assets was $621.8
million at March 31, 2002 and $640.7 million at December 31, 2001.
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The fixed income investments of the Company include certain mortgage-backed
securities. The market value of such securities was $186.8 million at March 31,
2002 and $209.9 million at December 31, 2001. 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 $5.9 million
at March 31, 2002 and $6.7 million at December 31, 2001.
Separate account assets have not been included, since gains and losses on those
assets generally accrue to the policyholders.
The Company does not use derivative financial instruments to manager our
exposure to fluctuations in interest rates.
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.
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 on the
financial statements.
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.
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Other Litigation. Additionally, FIC's insurance 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. Management does 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
There were no matters submitted to a vote of security holders during
the first quarter of 2002.
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,
2001 heretofore filed by Registrant with the Securities and Exchange
Commission, which is hereby incorporated by reference.
(b) Reports on Form 8-K:
None.
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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: May 15, 2002
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