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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 1998
Commission file number: 811-6268
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SBM CERTIFICATE COMPANY
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1671595
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
C/O ARM FINANCIAL GROUP, INC.
515 WEST MARKET STREET
LOUISVILLE, KENTUCKY 40202
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (502) 582-7900
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. /X/ Yes / / No
As of November 12, 1998, 250,000 shares of the registrant's common stock
were outstanding, all of which are privately owned and not traded on a public
market.
The registrant meets the conditions set forth in General Instruction H(1)
(a) and (b) of Form 10-Q and is therefore filing this Form with the reduced
disclosure format.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998 DECEMBER 31,
(UNAUDITED) 1997
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<S> <C> <C>
ASSETS
Qualified assets:
Cash and investments:
Investments in securities of unaffiliated issuers:
Fixed maturities available-for-sale, at fair value (amortized cost:
September 30, 1998-$36,908,387; December 31, 1997-$45,602,442) $ 37,201,994 $ 45,614,870
Equity securities, at fair value (cost: September 30, 1998-$290,688;
December 31, 1997-$340,473) 406,738 412,234
Certificate loans 165,120 186,292
Other invested assets - 471,992
Cash and cash equivalents 4,432,061 13,054,864
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Total cash and investments 42,205,913 59,740,252
Dividends and interest receivable 369,515 328,516
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Total qualified assets 42,575,428 60,068,768
Deferred acquisition costs 206,101 157,994
Other assets - 42,948
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Total assets $ 42,781,529 $ 60,269,710
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</TABLE>
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SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS (CONTINUED)
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998 DECEMBER 31,
(UNAUDITED) 1997
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<S> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Certificate reserves $34,935,496 $45,127,084
Payable for investment securities purchased 2,205,950 9,731,948
Deferred federal income taxes 152,197 98,320
Accounts payable and other liabilities 268,243 330,686
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Total liabilities 37,561,886 55,288,038
Shareholder's equity:
Common stock, 250,000 shares issued 250,000 250,000
Additional paid-in capital 3,050,000 3,050,000
Retained earnings 1,653,372 1,626,949
Accumulated other comprehensive income from net
unrealized gains on available-for-sale securities 266,271 54,723
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Total shareholder's equity 5,219,643 4,981,672
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Total liabilities and shareholder's equity $42,781,529 $60,269,710
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</TABLE>
SEE ACCOMPANYING NOTES.
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SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
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1998 1997 1998 1997
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<S> <C> <C> <C> <C>
Investment income:
Interest income from securities $ 627,001 $ 994,238 $ 2,096,565 $ 2,989,173
Other investment income 36,734 48,741 115,897 144,145
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Total investment income 663,735 1,042,979 2,212,462 3,133,318
Investment and other expenses:
Management and investment advisory fees 50,925 61,617 157,180 184,851
Deferred acquisition cost amortization and
renewal commissions 68,123 72,356 220,853 213,990
Real estate expenses 14,284 33,284 83,041 116,594
Amortization of goodwill - - - 23,833
Other (income) expenses 309 4,806 (1,337) 16,101
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Total investment and other expenses 133,641 172,063 459,737 555,369
Interest credited on certificate reserves 472,485 697,004 1,615,791 2,122,030
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Net investment income before federal
income taxes 57,609 173,912 136,934 455,919
Income tax benefit (expense) 29,091 (58,529) 203 (154,863)
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Net investment income 86,700 115,383 137,137 301,056
Realized investment gains (losses) (35,012) 9,875 (107,514) 63,479
Federal income tax benefit (expense) on
realized investment gains and losses (33,076) 26,294 (3,200) 5,636
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Net realized investment gains (losses) (68,088) 36,169 (110,714) 69,115
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Net income $ 18,612 $ 151,552 $ 26,423 $ 370,171
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</TABLE>
SEE ACCOMPANYING NOTES.
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SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
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<S> <C> <C>
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES $ 1,670,384 $ 3,168,909
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments and equity securities available-for-sale:
Purchases (39,375,067) (57,489,381)
Maturities and redemptions 19,731,543 4,548,571
Sales 20,875,666 55,967,691
Proceeds from sale or maturity of other invested assets 260,296 2,539
Repayments of certificate loans, net 21,172 86,572
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Cash flows provided by investing activities 1,513,610 3,115,992
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Amounts paid to face-amount certificate holders (11,970,481) (5,187,525)
Amounts received from face-amount certificate holders 163,684 299,478
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Cash flows used in financing activities (11,806,797) (4,888,047)
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Net change in cash and cash equivalents (8,622,803) 1,396,854
Cash and cash equivalents at beginning of period 13,054,864 3,247,192
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Cash and cash equivalents at end of period $ 4,432,061 $ 4,644,046
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</TABLE>
SEE ACCOMPANYING NOTES.
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SBM CERTIFICATE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1998
1. BASIS OF PRESENTATION
The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for SBM Certificate Company (the "Company") for
the nine months ended September 30, 1998, are not necessarily indicative of
those to be expected for the year ending December 31, 1998. For further
information, refer to the financial statements and footnotes thereto included in
the Company's annual report on Form 10-K for the year ended December 31, 1997.
2. COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS
No. 130 establishes new rules for the reporting and display of comprehensive
income and its components; however, the adoption of this Statement had no impact
on the Company's net income or total shareholders' equity. SFAS No. 130 requires
unrealized gains or losses on the Company's available-for-sale securities to be
included in other comprehensive income.
The components of comprehensive income, net of related tax, for the three
and nine months ended September 30, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
Three Months Ended September 30,
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(IN THOUSANDS) 1998 1997
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<S> <C> <C>
Net income $ 18,612 $ 151,552
Net unrealized gains on
available-for-sale securities 227,785 162,773
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Comprehensive income $ 246,397 $ 314,325
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<CAPTION>
Nine Months Ended September 30,
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(IN THOUSANDS) 1998 1997
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<S> <C> <C>
Net income $ 26,423 $ 370,171
Net unrealized gains (losses) on
available-for-sale securities 211,548 (292,250)
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Comprehensive income $ 237,971 $ 77,921
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</TABLE>
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ITEM 2. MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH NINE MONTHS
ENDED SEPTEMBER 30, 1997
Net investment income (net income excluding net realized investment gains
and losses) was $137,137 and $301,056 for the nine months ended September 30,
1998 and 1997, respectively. The decrease in net investment income is primarily
attributable to a decrease in net investment spread, partially offset by lower
investment and other expenses.
Net investment spread, which is the difference between investment income
and interest credited on certificate reserves, decreased to $596,671 during the
first nine months of 1998 from $1,011,288 during the same period in 1997. These
amounts reflect net investment spread of 1.15% and 2.01% for the nine months
ended September 30, 1998 and 1997, respectively, between the Company's
annualized investment yield on average cash and investments and the annualized
average rate credited on certificate reserves. The Company's investment income
decreased to $2.2 million from $3.1 million for the nine months ended September
30, 1998 and 1997, respectively. These amounts represent annualized investment
yields of 6.56% and 7.79% on average cash and investments of $45.0 million and
$53.7 million for the nine months ended September 30, 1998 and 1997,
respectively. This decrease in annualized investment yield on cash and
investments was primarily attributable to the Company selling its
mortgage-backed derivative securities during the last half of 1997 and
reinvesting the proceeds when generally lower reinvestment rates were available.
Further depressing the investment yield, above normal cash balances were held to
provide necessary liquidity for maturing face-amount certificates.
Interest credited on certificate reserves was $1.6 million and $2.1 million
for the nine months ended September 30, 1998 and 1997, respectively. These
amounts represent annualized average rates of interest credited of 5.41% and
5.78% on average certificate reserves of $39.8 million and $48.9 million for the
nine months ended September 30, 1998 and 1997, respectively. The majority of the
Company's outstanding face-amount certificates are fixed-rate three year
contracts. The Company monitors credited interest rates for new and renewal
issues against competitive products, mainly bank certificates of deposit.
Credited interest rate adjustments (up or down) on new and renewal certificates
are made as the Company deems necessary. New and renewal contracts issued during
the past year have crediting rates that are generally lower than contracts that
matured during that period, resulting in the overall decrease in the average
crediting rate.
Investment and other expenses were $459,737 and $555,369 for the nine
months ended September 30, 1998 and 1997, respectively. The decrease in
investment and other expenses is attributable to a decrease in management and
investment advisory fees and real estate expenses for the nine months ended
September 30, 1998 of $27,671 and $33,553, respectively, compared to the same
period in 1997. In addition, there was zero goodwill amortization during the
nine months ended September 30, 1998 compared to $23,833 for the nine months
ended September 30, 1997. The goodwill asset became fully amortized during the
second quarter of 1997.
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Realized investment losses were $107,514 for the nine months ended
September 30, 1998 compared to realized investment gains of $63,479 for the nine
months ended September 30, 1997. Realized investment losses for 1998 include a
loss of $268,960 related to the write-down to fair value and subsequent sale of
the Company's real estate investment. Other realized investment gains and losses
were primarily interest-rate related and attributable to the asset/liability
management strategies of the Company. Fixed maturities and equity securities
(i.e., non-redeemable preferred stock) classified as available-for-sale are sold
during rising and falling interest rate environments which can result in
period-to-period swings in interest-rate related realized investment gains and
losses.
Net income during the nine months ended September 30, 1998 and 1997 was
$26,423 and $370,171, respectively. The decrease in net income was primarily
attributable to the decrease in net investment spread.
The Company primarily invests in securities with fixed maturities with the
objective of providing reasonable returns while limiting liquidity and credit
risks. The Company's investments in fixed maturities were 99% investment grade
as of September 30, 1998 and December 31, 1997. Investment grade securities are
those classified as 1 or 2 by the National Association of Insurance
Commissioners ("NAIC") or, where such classifications are not available, having
a rating on the scale used by Standard & Poor's Corporation ("S&P") of BBB- or
above.
Fixed maturities include mortgage-backed and asset-backed securities,
corporate securities, U.S. Treasury securities, and other government
obligations. Mortgage-backed securities ("MBSs"), which include pass-through
securities and collateralized mortgage obligations ("CMOs"), totaled $19.0
million at September 30, 1998, representing 47.2% of total qualified assets
(54.2% at December 31, 1997). The Company's investments in CMOs, which are
primarily backed by the U.S. Government, U.S. Government agencies or triple-A
rated corporate securities, represented 45.7% of total qualified assets at
September 30, 1998 (52.4% at December 31, 1997). MBSs, including CMOs, are
subject to risks associated with prepayments of the underlying mortgage loans.
Prepayments cause these securities to have actual maturities different from
those expected at the time of purchase. The degree to which a security is
susceptible to either an increase or decrease in yield due to prepayment speed
adjustments is influenced by the difference between its amortized cost and par,
the relative sensitivity of the underlying mortgages backing the assets to
prepayments in a changing interest rate environment and the repayment priority
of the securities in the overall securitization structure. Prepayment
sensitivity is evaluated and monitored, giving full consideration to the
collateral characteristics such as weighted average coupon rate, weighted
average maturity and the prepayment history of the specific loan pool.
Additionally, the Company routinely reprojects three year liability and asset
cash flows with the goal of maintaining an adequate level of liquidity for
maturing face-amount certificates. The Company's asset/liability management
strategies not only allow the Company to monitor its short-term liquidity needs,
but also aim to provide protection to the investment portfolio from adverse
changes in interest rates.
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Certificate reserves decreased $10.2 million or 22.6% during the first nine
months of 1998, as maturities and surrenders exceeded sales and renewals. The
Company believes a significant factor leading to the decrease was the
certificate of deposit marketplace currently being very competitive as many
financial institutions are offering special high rates to induce customers to
open new accounts. For face-amount certificates reaching their maturity date
during the nine months ended September 30, 1998 and 1997, 59% and 65%,
respectively, were renewed.
YEAR 2000
ARM Financial Group, Inc. ("ARM"), the Company's parent company, has a Year
2000 project which includes all of its subsidiaries. ARM has completed the
assessment phase of the project. It was determined that the administration
system which processes face-amount certificate transactions could not accept
Year 2000 data because it uses a two digit year field. The necessary upgrades
and repairs are scheduled for completion no later than March 31, 1999. The Year
2000 project, as it relates to the Company, is provided for under the
Administration Services Agreement between ARM and the Company.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is currently involved in no material legal or administrative
proceedings.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
No exhibits are filed herewith.
REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the three months
ended September 30, 1998.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on November 12, 1998.
SBM CERTIFICATE COMPANY
By: /S/ EDWARD L. ZEMAN
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Edward L. Zeman
Executive Vice President-Chief
Financial Officer
(Principal Financial Officer)
By: /S/ BARRY G. WARD
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Barry G. Ward
Controller (Principal Accounting
Officer)
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