<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the period ended: March 31, 1999
Commission file number: 811-6268
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 May 3, 1999, 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.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
- -----------------------------------------------------------------------------------------------------------------
(UNAUDITED)
<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:
March 31, 1999--$31,454,166; December 31, 1998--$34,136,751) $ 31,163,441 $ 34,149,196
Equity securities, at fair value (cost: March 31, 1999--$290,688;
December 31, 1998--$290,688) 381,578 390,776
Certificate loans 160,747 164,209
Cash and cash equivalents 6,088,646 3,279,970
----------------------------------
Total cash and investments 37,794,412 37,984,151
Receivables:
Dividends and interest 325,669 296,013
Receivable for investment securities sold 40,464 22,249
----------------------------------
Total receivables 366,133 318,262
----------------------------------
Total qualified assets 38,160,545 38,302,413
Other fixed maturities, available-for-sale, at fair value (amortized
cost: December 31, 1998--$851,978) (unaffiliated issuer) -- 847,835
Deferred acquisition costs 184,292 204,228
Deferred federal income tax asset 80,679 --
----------------------------------
Total assets $ 38,425,516 $ 39,354,476
----------------------------------
----------------------------------
</TABLE>
2
<PAGE>
SBM CERTIFICATE COMPANY
CONDENSED BALANCE SHEETS (CONTINUED)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
- -----------------------------------------------------------------------------------------------------------------
(UNAUDITED)
<S> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Certificate reserves $ 33,339,431 $ 34,067,826
Accounts payable and other liabilities 258,564 231,345
Deferred federal income tax liability -- 27,265
----------------------------------
Total liabilities 33,597,995 34,326,436
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 1,657,419 1,657,592
Accumulated other comprehensive income from
net unrealized gains (losses) on available-for-sale securities (129,898) 70,448
----------------------------------
Total shareholder's equity 4,827,521 5,028,040
----------------------------------
Total liabilities and shareholder's equity $ 38,425,516 $ 39,354,476
----------------------------------
----------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
3
<PAGE>
SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
----------------------------------
<S> <C> <C>
Investment income:
Interest income from securities $ 577,624 $ 817,334
Other investment income 2,597 32,711
----------------------------------
Total investment income 580,221 850,045
Investment and other expenses:
Management and investment advisory fees 53,013 53,596
Deferred acquisition cost amortization and renewal commissions 55,941 76,899
Real estate expenses -- 29,087
Other (income) expenses 4,906 (3,065)
----------------------------------
Total investment and other expenses 113,860 156,517
Interest credited on certificate reserves 432,911 619,002
----------------------------------
Net investment income before federal income taxes 33,450 74,526
Income tax expense (11,725) (26,646)
----------------------------------
Net investment income 21,725 47,880
Realized investment losses (33,689) (130,235)
Income tax benefit on realized investment losses 11,791 50,582
----------------------------------
Net realized investment losses (21,898) (79,653)
----------------------------------
Net loss $ (173) $ (31,773)
----------------------------------
----------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
4
<PAGE>
SBM CERTIFICATE COMPANY
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES $ 489,600 $ 782,873
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments available-for-sale:
Purchases (1,768,704) (17,165,758)
Maturities and redemptions 3,138,684 9,330,719
Sales 2,106,754 5,713,288
Proceeds from sales or maturities of other invested assets -- 75,535
Repayments (issuance) of certificate loans, net 3,462 (980)
-----------------------------------
Cash flows provided by (used in) investing activities 3,480,196 (2,047,196)
CASH FLOWS USED IN FINANCING ACTIVITIES:
Amounts paid to face-amount certificate holders (1,318,817) (4,169,737)
Amounts received from face-amount certificate holders 157,698 36,713
-----------------------------------
Cash flows used in financing activities (1,161,119) (4,133,024)
-----------------------------------
Net change in cash and cash equivalents 2,808,677 (5,397,347)
Cash and cash equivalents at beginning of period 3,279,969 13,054,864
-----------------------------------
Cash and cash equivalents at end of period $ 6,088,646 $ 7,657,517
----------------------------------
----------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
5
<PAGE>
SBM CERTIFICATE COMPANY
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 1999
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 three months ended March 31, 1999, are not necessarily indicative of those
to be expected for the year ending December 31, 1999. 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, 1998.
2. COMPREHENSIVE INCOME
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income," 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 (loss), net of related tax, for the
three months ended March 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------------
1999 1998
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Net loss $ (173) $ (31,773)
Net unrealized gains (losses) on available-for-sale securities (200,346) 43,874
--------------------------------------
Comprehensive income (loss) $ (200,519) $ 12,101
--------------------------------------
--------------------------------------
</TABLE>
6
<PAGE>
ITEM 2. MANAGEMENT'S ANALYSIS OF RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 COMPARED WITH THREE MONTHS ENDED MARCH 31,
1998
Net investment income (net income excluding net realized investment gains
and losses) was $21,727 and $47,880 for the three months ended March 31, 1999
and 1998, 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, was $147,310 during the first
three months of 1999 compared to $231,043 during the same period in 1998. These
amounts reflect net investment spread of 0.92% and 0.91% for the three months
ended March 31, 1999 and 1998, 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
$580,221 from $850,045 for the three months ended March 31, 1999 and 1998,
respectively. These amounts represent annualized investment yields of 6.06% and
6.62% on average cash and investments of $38.3 million and $51.4 million for the
three months ended March 31, 1999 and 1998, respectively. This decrease in
annualized investment yield on cash and investments was primarily attributable
to the Company investing in more corporate and plain vanilla mortgage-backed
securities during 1999 compared to 1998. 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 $432,911 and $619,002 for the
three months ended March 31, 1999 and 1998, respectively. These amounts
represent annualized average rates of interest credited of 5.14% and 5.71% on
average certificate reserves of $33.7 million and $43.4 million for the three
months ended March 31, 1999 and 1998, 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, such as bank certificates of deposit.
Credited interest rate adjustments (up or down) on new 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 $113,860 and $156,517 for the three
months ended March 31, 1999 and 1998, respectively. The decrease in investment
and other expenses is primarily attributable to zero real estate expenses during
the first quarter of 1999 compared to $29,087 during the first quarter of 1998.
The Company sold its investment in real estate during 1998.
Realized investment losses were $33,689 and $130,235 for the three months
ended March 31, 1999 and 1998, respectively. Realized investment losses for 1998
included an estimated loss of $138,042 related to the write-down to fair value
of the Company's real estate investment. Other
7
<PAGE>
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 loss during the first quarter of 1999 and 1998 was $173 and $31,773,
respectively. The decrease in net loss was attributable to a decrease in net
realized investment losses, partially offset by a decrease in net investment
income.
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 97% investment grade
at both March 31, 1999 and December 31, 1998. Investment grade securities are
those classified as 1 or 2 by the National Association of Insurance
Commissioners, or where such classifications are not available, securities are
classified by a nationally recognized statistical rating organization (i.e.,
Standard & Poor's Corporation's rating of BBB- or above). Additionally, the
Company's investment portfolio has no exposure to real estate, mortgage loans
and common equity securities. As of March 31, 1999, the Company held no
securities which had defaulted on principal or interest payments.
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 but
are primarily collateralized mortgage obligations ("CMOs"), totaled $15.2
million at March 31, 1999, representing 40.7% of total qualified assets (48.0%
at December 31, 1998). 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 projects 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.
Certificate reserves decreased $0.7 million or 2.1% during the first
three months of 1999, as maturities and surrenders exceeded sales and
renewals. The Company believes a factor leading to the decrease was the
modest increase in intermediate-term market interest rates in 1999 which
enhanced the attractiveness of competing products, such as money market funds
and bank certificates of deposit.
8
<PAGE>
For face-amount certificates reaching their maturity date during the three
months ended March 31, 1999 and 1998, 63% and 61%, respectively, were renewed.
YEAR 2000
ARM Financial Group, Inc. ("ARM"), the Company's parent company, has
undertaken a Year 2000 project that includes all of its subsidiaries, including
the Company. ARM's Year 2000 compliance project, as it relates to the Company,
is provided for under the Investment Services Agreement and Administrative
Services Agreement between ARM and the Company. Pursuant to the agreements, the
Company's operations are administered and managed by ARM. The cost of ARM's Year
2000 initiatives is not expected to be material to ARM's results of operations
or financial condition. Likewise, any cost to the Company related to Year 2000
compliance is not expected to be material to the Company's results of operations
or financial condition.
ARM has completed the assessment phase of the project for all production
applications, hardware (personal computers and servers), system software,
vendors, facilities and business partners. Although ARM is still receiving
information from a few vendors and business partners and assessing various
logistic concerns with its facilities, ARM's major production systems are
substantially Year 2000 compliant. However, the administrative system which
processes face-amount certificate transactions can not correctly process data in
the Year 2000 due to a two digit year field. Where Year 2000 problems were
found, as in the case of the face-amount certificate administration system, the
necessary upgrades, repairs or conversions are either complete or in progress
and are scheduled for completion no later than September 30, 1999. Specifically,
in regards to the Company, management plans to replace the face-amount
certificate administrative system with an application that is Year 2000
compliant and then convert the business to that application.
The Company is also conducting certification testing. Certification
testing, which serves to verify the results of repairs and assessments, has been
completed for all mission critical production systems and the few problems that
were discovered have been repaired and re-tested.
ARM's Year 2000 project is well underway and management believes that it
will be Year 2000 compliant by September 30, 1999, however, as a precaution ARM
is developing a contingency and business resumption plan. The contingency and
business resumption plan is scheduled for completion no later than September 30,
1999.
Although ARM anticipates no major interruption of business activities, that
will be dependent, in part, upon the activity of third parties. Even though ARM
has assessed and continues to assess third party issues, it has no direct
ability to influence the compliance actions of such parties. Accordingly, while
ARM believes its actions in this regard should have the effect of reducing Year
2000 risks, it is unable to eliminate them or to estimate the ultimate effect
Year 2000 risks will have on ARM's operations.
The estimated date on which ARM believes it will complete its Year 2000
compliance efforts, and the expenses related to ARM's Year 2000 compliance
efforts are based upon management's best
9
<PAGE>
estimates, which were based on assumptions of future events, including the
availability of certain resources, third party modification plans and other
factors. There can be no assurances that these results and estimates will be
achieved and the actual results could materially differ from those anticipated.
10
<PAGE>
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
REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the three months
ended March 31, 1999.
EXHIBITS
No exhibits are filed herewith.
11
<PAGE>
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 May 13, 1999.
SBM CERTIFICATE COMPANY
By: /s/ EDWARD L. ZEMAN
-------------------------------------------
Edward L. Zeman
Executive Vice President-Chief
Financial Officer (Principal Financial
Officer
By: /s/ BARRY G. WARD
-------------------------------------------
Barry G. Ward
Controller (Principal Accounting
Officer)
12
