UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the quarter ended March 31, 1998
|_| Transition Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Commission file number 33-83524
MERIT SECURITIES CORPORATION
(Exact name of registrant as specified in its charter)
Virginia 54-1736551
(State or other jurisdiction of incorporation((I.R.S.Employer Identification No)
10900 Nuckols Road, 3rd Floor, Glen Allen, Virginia 23060
(Address of principal executive offices) (Zip Code)
(804) 217-5800
(Registrant's telephone number, including area code)
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 ninety days. |X| Yes |_| No
As of April 30, 1998, the latest practicable date, there were 1,000 shares
of Merit Securities Corporation common stock outstanding.
The registrant meets the conditions set forth in General Instructions
H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q with the
reduced disclosure format.
<PAGE>
MERIT SECURITIES CORPORATION
FORM 10-Q
INDEX
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<CAPTION>
Page Number
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Financial Statements
Balance Sheets at March 31, 1998 and
December 31, 1997 3
Statements of Operations for the three months
ended March 31, 1998 and 1997 4
Statement of Shareholder's Equity for the three months
ended March 31, 1998 5
Statements of Cash Flows for the three months ended
March 31, 1998 and 1997 6
Notes to Unaudited Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 9
Item 5. Other Information 9
Item 6. Exhibits and Reports on Form 8-K 9
SIGNATURES 13
</TABLE>
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MERIT SECURITIES CORPORATION
Balance Sheets
(amounts in thousands except share data)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
------------------ ---------------
<S> <C> <C>
ASSETS:
Collateral for collateralized bonds $ 3,279,483 $ 3,835,289
Prepaid shelf registration fees 334 334
Cash 10 10
================== ==================
$ 3,279,827 $ 3,835,633
================== ==================
LIABILITIES AND SHAREHOLDER'S EQUITY
LIABILITIES:
Non-recourse debt - collateralized bonds $ 3,099,015 $ 3,622,877
Due to affiliates 35,583 43,789
------------------ ------------------
3,134,598 3,666,666
------------------ ------------------
SHAREHOLDER'S EQUITY:
Common stock, no par value,
10,000 shares authorized,
1,000 shares issued and outstanding 10 10
Additional paid-in capital 125,952 125,952
Accumulated other comprehensive income 46,887 64,707
Accumulated deficit (27,620 ) (21,702 )
---------------
------------------ ---
145,229 168,967
================== ==================
$ 3,279,827 $ 3,835,633
================== ==================
<FN>
See notes to unaudited financial statements.
</FN>
</TABLE>
<PAGE>
MERIT SECURITIES CORPORATION
Statements of Operations
(amounts in thousands except share data)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------------
1998 1997
-------------- --------------
<S> <C> <C>
Interest Income:
Collateral for collateralized bonds $ 58,145 $ 42,549
--------------- ---------------
Interest and related expense:
Interest expense on collateralized bonds 61,190 38,974
Other collateralized bond expense 1,041 835
--------------- ---------------
62,231 39,809
--------------- ---------------
Net interest margin before provision for losses (4,086) 2,740
Provision for losses (1,178) (600)
--------------- ---------------
Net interest margin (5,264) 2,140
Interest on due to affiliate (654) (646)
--------------- ---------------
Net (loss) income $ (5,918) $ 1,494
=============== ===============
<FN>
See notes to unaudited financial statements.
</FN>
</TABLE>
<PAGE>
MERIT SECURITIES CORPORATION
Statement of Shareholder's Equity
(amounts in thousands except share data)
<TABLE>
<CAPTION>
Additional Accumulated other
Common stock paid-in comprehensive Accumulated
capital income deficit Total
-------------- ------------ -------------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1997 $ 10 $ 125,952 $ 64,707 $ (21,702) 168,967 $
Comprehensive loss:
Net loss - - - (5,918) (5,918)
Change in net unrealized gain
on investments classified as
available-for-sale during
the period - - (17,820) - (17,820)
------------- --------------- ------------------ -------------- --------------
Total comprehensive loss (17,820) (5,918) (23,738)
Balance at March 31, 1998 $ 10 $ 125,952 $ 46,887 $ (27,620) $ 145,229
============= =============== ================== ============== ==============
<FN>
See notes to unaudited financial statements.
</FN>
</TABLE>
<PAGE>
MERIT SECURITIES CORPORATION
Statements of Cash Flows
(amounts in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
------------------- ------------------
<S> <C> <C>
Operating activities:
Net (loss) income $ (5,918) $ 1,494
Adjustments to reconcile net loss to net cash
provided by operating activities:
Provision for losses 1,178 600
Amortization, net 11,212 4,483
Other 104 (43)
------------------- ------------------
Net cash provided by operating activities 6,576 6,534
------------------- ------------------
Investing activities:
Collateral for collateralized bonds:
Principal payments on collateral 523,891 188,825
Decrease in accrued interest receivable 3,562 1,234
------------------- ------------------
Net cash provided by investing activities 527,453 190,059
------------------- ------------------
Financing activities:
Collateralized bonds:
Principal payments on collateralized bonds (524,287) (189,407)
Decrease in accrued interest payable (1,536) (99)
Decrease in due to affiliate (8,206) (7,087)
------------------- ------------------
Net cash used for financing activities (534,029) (196,593)
------------------- ------------------
Cash at beginning of period 10 10
------------------- ------------------
Cash at end of period $ 10 $ 10
=================== ==================
Supplemental disclosure of cash flow information:
Cash paid for interest $ 61,375 $ 39,251
=================== ==================
<FN>
See notes to unaudited financial statements.
</FN>
</TABLE>
<PAGE>
MERIT SECURITIES CORPORATION
Notes to Unaudited Financial Statements
March 31, 1998
(amounts in thousands except share data)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q and do not include all of the
information and notes required by generally accepted accounting principles for
complete financial statements. The financial statements include the accounts of
Merit Securities Corporation (the "Company"). The Company is a wholly-owned,
limited-purpose finance subsidiary of Issuer Holding Corporation ("IHC"). IHC
was formed on September 4, 1996 to acquire all of the outstanding stock of the
Company and certain other affiliates of Dynex Capital, Inc. ("Dynex"). IHC is a
wholly-owned subsidiary of Dynex. The Company was organized to facilitate the
securitization of loans through the issuance and sale of collateralized bonds
(the "Bonds").
In the opinion of management, all material adjustments, consisting of
normal recurring adjustments, considered necessary for a fair presentation of
the financial statements have been included. The Balance Sheet at March 31,
1998, the Statements of Operations for the three months ended March 31, 1998 and
1997, the Statement of Shareholder's Equity for the three months ended March 31,
1998, the Statements of Cash Flows for the three months ended March 31, 1998 and
1997, and the related notes to financial statements are unaudited. Operating
results for the three months ended March 31, 1998 are not necessarily indicative
of the results that may be expected for the year ending December 31, 1998. For
further information, refer to the audited financial statements and footnotes
included in the Company's Form 10-K for the year ended December 31, 1997.
Certain amounts for 1997 have been reclassified to conform with the
presentation for 1998.
NOTE 2-COLLATERAL FOR COLLATERALIZED BONDS
In accordance with the provisions of Statement of Financial Accounting
Standards No. 115, Accounting for Certain Investments in Debt and Equity
Securities, the Company has classified collateral for collateralized bonds as
available-for-sale. The following table summarizes the Company's amortized cost
basis and fair value of collateral for collateralized bonds at March 31, 1998
and December 31, 1997, and the related average effective interest rates
(calculated for the month ended March 31, 1998 and December 31, 1997, and
excluding unrealized gains and losses):
<TABLE>
<CAPTION>
March 31, 1998 December 31, 1997
- -------------------------------------------------------------------------------------------------------------------
Effective Effective
Fair Value Interest Rate Fair Value Interest Rate
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Collateral for collateralized bonds:
Amortized cost $ 3,255,272 6.7% $ 3,795,393 7.2%
Allowance for losses (22,676 ) (24,811 )
Amortized cost, net 3,232,596 3,770,582
Gross unrealized gains 57,744 77,973
Gross unrealized losses (10,857 ) (13,266 )
- -------------------------------------------------------------------------------------------------------------------
$ 3,279,483 $ 3,835,289
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Merit Securities Corporation (the "Company") was incorporated in Virginia
on August 19, 1994 as a wholly-owned, limited-purpose finance subsidiary of
Dynex Capital, Inc. ("Dynex"). On September 4, 1996, Issuer Holding Corporation,
Inc. ("IHC"), a wholly-owned subsidiary of Dynex, acquired all of the
outstanding stock of the Company and certain other affiliates of Dynex.
The Company was organized to facilitate the securitization of loans through
the issuance and sale of collateralized bonds (the "Bonds"). The Bonds will be
secured primarily by: (i) mortgage loans secured by first or second liens on
residential property, (ii) Federal National Mortgage Association Mortgage-Backed
Certificates, (iii) Federal Home Loan Mortgage Corporation Mortgage-Backed
Certificates, (iv) Government National Mortgage Association Mortgage-Backed
Certificates, (v) other mortgage pass-through certificates or
mortgage-collateralized obligations and (vi) consumer installment loans
(collectively, the "Collateral"). In the future, the Company may also securitize
other types of loans.
After payment of the expenses of an offering and certain administrative
expenses, the net proceeds from an offering of Bonds will be used to purchase
Collateral from IHC or various third parties. IHC can be expected to use the
proceeds to reduce indebtedness incurred to obtain such loans or to acquire
additional Collateral. After the issuance of a series of Bonds, the Company may
sell the Collateral securing that series of Bonds, subject to the lien of the
Bonds.
The Company did not issue any Bonds during the three months ended March 31,
1998. As of March 31, 1998, the Company had seven (7) series of collateralized
bonds outstanding totaling approximately $3.1 billion, compared to $3.6 billion
at December 31, 1997, and $2.1 billion at March 31, 1997. Interest income on the
Collateral increased $15.6 million to $58.1 million for the three months ended
March 31, 1998 compared to $42.5 million for the three months ended March 31,
1997, primarily as a result of the increased number of series outstanding.
Interest expense on Bonds increased $22.2 million from $39.0 million for the
three months ended March 31, 1997 to $61.2 million for the three months ended
March 31, 1998, primarily due to the additional series outstanding.
Net interest margin for the three months ended March 31, 1998 decreased to
a negative $5.3 million from a positive $2.1 million for the same period for
1997. This decrease was primarily the result of higher premium amortization
caused by higher prepayments during the three months ended March 31, 1998 than
during the same period in 1997. In addition, the Company securitized lower
coupon collateral, principally A+ quality single-family ARM loans during 1997.
With collateralized bond structures, the Company retains credit risk
relative to the amount of overcollateralization required in conjunction with the
bond insurance. Losses are generally first applied to the overcollateralized
amount, with any losses in excess of that amount borne by the bond insurer or
the holders of the collateralized bonds. The Company only incurs credit losses
to the extent that losses are incurred in the repossession, foreclosure and sale
of the underlying collateral. Such losses generally equal the excess of the
principal amount outstanding, less any proceeds from mortgage or hazard
insurance, over the liquidation value of the collateral. To compensate the
Company for retaining this loss exposure, the Company generally receives an
excess yield on the collateralized securities relative to the yield on the
collateralized bonds. At March 31, 1998, the Company retained $115.5 million in
aggregate principal amount of overcollateralization, and had reserves, or
otherwise had provided coverage on $53 million of this potential credit loss
exposure. $30.3 million of this reserve amount is in the form of a loss
reimbursement guarantee from a third-party rated A by Standards & Poors Ratings
Services, Inc.
At March 31, 1998, the Company had securities of approximately $1.2 billion
remaining for issuance under a registration statement filed with the Securities
and Exchange Commission. The Company anticipates issuing additional Bonds in the
future.
The Company competes in a national market with other private conduits and
various financial firms. Economic conditions, interest rates, regulatory changes
and market dynamics all influence the mortgage securities market.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings:
None
Item 5. Other Information:
None
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
3.1 Articles of Incorporation of the Registrant (Incorporated herein by
reference to the Exhibits to Registrant's Registration Statement No. 33-83524 on
Form S-3 filed August 31, 1994).
3.2 Bylaws of the Registrant (Incorporated herein by reference to the
Exhibits to Registrant's Registration Statement No. 33-83524 on Form S-3 filed
August 31, 1994).
3.3 Amended and Restated Articles of Incorporation of the Registrant,
effective April 19, 1995 (Incorporated herein by reference to Exhibit to the
Registrant's Current Report on Form 8-K, filed April 21, 1995).
4.1 Indenture between Registrant and Trustee, dated as of August 1, 1994
(Incorporated herein by reference to the Exhibits to Registrant's Registration
Statement No. 33-83524 on Form S-3 filed August 31, 1994).
4.2 Form of Supplement Indenture between Registrant and Trustee
(Incorporated herein by reference to the Exhibits to Registrant's Registration
Statement No. 33-83524 on Form S-3 filed August 31, 1994).
4.3 Copy of the Indenture, dated as of November 1, 1994, by and between the
Registrant and Texas Commerce Bank National Association, as Trustee
(Incorporated herein by reference to Exhibit to the Registrant's Current Report
on Form 8-K, filed December 19, 1994).
4.4 Copy of the Series 1 Indenture Supplement, dated as of November 1,
1994, by and between the Registrant and Texas Commerce Bank National
Association, as Trustee (including schedules and exhibits) (Incorporated herein
by reference to Exhibit to the Registrant's Current Report on Form 8-K, filed
December 19, 1994).
4.5 Copy of the Series 2 Indenture Supplement, dated as of February 1,
1995, by and between the Registrant and Texas Commerce Bank National
Association, as Trustee (including schedules and exhibits) (Incorporated herein
by reference to Exhibit to the Registrant's Current Report on Form 8-K, filed
March 8, 1995).
4.6 Copy of the Series 3 Indenture Supplement, dated as of March 1, 1995,
by and between the Registrant and Texas Commerce Bank National Association, as
Trustee (including schedules and exhibits) (Incorporated herein by reference to
Exhibit to the Registrant's Current Report on Form 8-K, filed April 21, 1995).
4.7 Copy of the Series 4 Indenture Supplement, dated as of June 1, 1995, by
and between the Registrant and Texas Commerce Bank National Association, as
Trustee (including schedules and exhibits) (Incorporated herein by reference to
Exhibit to the Registrant's Current Report on Form 8-K, filed July 10, 1995).
4.8 Copy of the Series 5 Indenture Supplement, dated as of October 1, 1995,
to Indenture, dated as of November 1, 1994, by and between the Registrant and
Texas Commerce Bank National Association, as Trustee (related exhibits available
upon request to the Trustee). (Incorporated herein by reference to Exhibit to
the Registrant's Current Report on Form 8-K, filed November 15, 1995).
4.9 Copy of the Series 6 Indenture Supplement, dated as of March 1, 1996,
by and between the Registrant and Texas Commerce Bank National Association, as
Trustee (including schedules and exhibits) (Incorporated herein by reference to
Exhibit to the Registrant's Current Report on Form 8-K, filed March 21, 1996).
4.10 Copy of the Series 7 Indenture Supplement, dated as of May 1, 1996, by
and between the Registrant and Texas Commerce Bank National Association, as
Trustee (related schedules and exhibits available upon request of the Trustee).
(Incorporated herein by reference to Exhibit to Registrant's Current Report on
Form 8-K, filed June 19, 1996).
4.11 Copy of the Series 8 Indenture Supplement, dated as of September 1,
1996, by and between the Registrant and Texas Commerce Bank National
Association, as Trustee (related schedules and exhibits available upon request
of the Trustee). (Incorporates herein by reference to Exhibit of Registrant's
Current Report on Form 8-K, filed October 9, 1996).
4.12 Copy of the Series 9 Indenture Supplement, dated as of June 1, 1997,
by and between the Registrant and Texas Commerce Bank National Association, as
Trustee (related schedules and exhibits available upon request of the Trustee).
(Incorporates herein by reference to Exhibit of Registrant's Current Report on
Form 8-K, filed July 11, 1997).
4.13 Copy of the Series 10 Indenture Supplement, dated as of December 1,
1997, by and between the Registrant and Texas Commerce Bank National
Association, as Trustee (related schedules and exhibits available upon request
of the Trustee). (Incorporates herein by reference to Exhibit of Registrant's
Current Report on Form 8-K, filed January 6, 1998).
99.1 Standard Provisions to Servicing Agreement (Incorporated herein by
reference to the Exhibits to Registrant's Registration Statement No. 33-83524 on
Form S-3 filed August 31, 1994).
99.2 Form of Servicing Agreement (Incorporated herein by reference to the
Exhibits to Registrant's Registration Statement No. 33-83524 on Form S-3 filed
August 31, 1994).
99.3 Standard Terms to Master Servicing Agreement (Incorporated herein by
reference to the Exhibits to Registrant's Registration Statement No. 33-83524 on
Form S-3 filed August 31, 1994).
99.4 Form of Master Servicing Agreement (Incorporated herein by reference
to the Exhibits to Registrant's Registration Statement No. 33-83524 on Form S-3
filed August 31, 1994).
99.5 Form of Prospectus Supplement of Bonds secured by adjustable-rate
mortgage loans (Incorporated herein by reference to Exhibits to Registrant's
Pre-Effective Amendment No. 4 to Registration Statement No. 33-83524 on Form S-3
filed December 5, 1994).
99.6 Form of Financial Guaranty Assurance Policy (Incorporated herein by
reference to the Exhibits to Registrant's Registration Statement No. 33-83524 on
Form S-3 filed August 31, 1994).
99.7 Form of GEMICO Mortgage Pool Insurance Policy (Incorporated herein by
reference to the Exhibits to Registrant's Registration Statement No. 33-83524 on
Form S-3 filed August 31, 1994).
99.8 Form of PMI Mortgage Insurance Co. Pool Insurance Policy (Incorporated
herein by reference to the Exhibits to Registrant's Registration Statement No.
33-83524 on Form S-3 filed August 31, 1994).
99.9 Form of Prospectus Supplement of Bonds secured by fixed-rate mortgage
loans (Incorporated herein by reference to Exhibits to Registrant's
Pre-Effective Amendment No. 4 to Registration Statement No. 33-83524 on Form S-3
filed December 5, 1994).
99.10 Copy of Financial Guaranty Insurance Policy No. 50331-N issued by
Financial Security Assurance Inc., dated December 7, 1994, with respect to the
Series 1 Bonds (Incorporated herein by reference to the Exhibit to Registrant's
1994 Form 10-K, dated and filed March 31, 1995).
99.11 Copy of Financial Guaranty Insurance Policy No. 95010074 issued by
Financial Guaranty Insurance Company, dated February 23, 1995, with respect to
the Series 2 Bonds (Incorporated herein by reference to Exhibit to the
Registrant's Current Report on Form 8-K, filed March 8, 1995).
99.12 Copy of the Saxon Mortgage Funding Corporation Servicing Guide for
Credit Sensitive Loans, February 1, 1995 Edition (Incorporated herein by
reference to Exhibit to the Registrant's Current Report on Form 8-K, filed March
8, 1995).
99.13 Copy of Financial Guaranty Insurance Policy No. 50364-N issued by
Financial Guaranty Assurance Inc., dated April 7, 1995, with respect to the
Series 3 Bonds (Incorporated herein by reference to Exhibit to the Registrant's
Current Report on Form 8-K, filed April 21, 1995).
99.14 Copy of Financial Guaranty Insurance Policy No. 50382-N issued by
Financial Guaranty Assurance Inc., dated June 29, 1995, with respect to the
Series 4 Bonds (Incorporated herein by reference to Exhibit to the Registrant's
Current Report on Form 8-K, filed July 10, 1995).
99.15 Copy of the Standard Terms to Master Servicing Agreement, June 1,
1995 Edition (incorporated herein by reference to Exhibit to the Registrant's
Current Report on Form 8-K, filed July 10, 1995).
99.16 Copy of Financial Guaranty Insurance Policy No. 19804 issued by MBIA
Insurance Corporation (Incorporated herein by reference to Exhibit to the
Registrant's Current Report on Form 8-K, filed November 15, 1995).
99.17 Copy of Financial Guaranty Insurance Policy No. 20596 issued by MBIA
Insurance Corporation (Incorporated herein by reference to Exhibit to the
Registrant's Current Report on Form 8-K, filed March 21, 1996).
99.18 Copy of Financial Guaranty Insurance Policy No. 21296 issued by MBIA
Insurance Corporation (Incorporated herein by reference to Exhibit to the
Registrant's Current Report on Form 8-K, filed June 19, 1996).
(b) Reports on Form 8-K
Current Report on Form 8-K as filed with the Commission on April 3, 1998,
relating to the Registrant's Series 6 Bonds.
Current Report on Form 8-K as filed with the Commission on April 3, 1998,
relating to the Registrant's Series 7 Bonds.
Current Report on Form 8-K as filed with the Commission on April 3, 1998,
relating to the Registrant's Series 8 Bonds.
Current Report on Form 8-K as filed with the Commission on April 3, 1998,
relating to the Registrant's Series 9 Bonds.
Current Report on Form 8-K as filed with the Commission on April 3, 1998,
relating to the Registrant's Series 10 Bonds.
SIGNATURES
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.
MERIT SECURITIES CORPORATION
By: /s/ Lynn K. Geurin
Lynn K. Geurin
(Principal Executive Officer)
/s/ Stephen J. Benedetti
Stephen J. Benedetti
(Principal Financial & Accounting Officer)
Dated: May 15, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-mos
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-START> Jan-01-1998
<PERIOD-END> Mar-31-1998
<CASH> 10
<SECURITIES> 3,279,483
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0 <F1>
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 3,279,827
<CURRENT-LIABILITIES> 0 <F1>
<BONDS> 3,099,015
0
0
<COMMON> 10
<OTHER-SE> 145,129
<TOTAL-LIABILITY-AND-EQUITY> 3,279,827
<SALES> 0
<TOTAL-REVENUES> 58,145
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 1,695
<LOSS-PROVISION> 1,178
<INTEREST-EXPENSE> 61,190
<INCOME-PRETAX> (5,918)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,918)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,918)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<FN>
<F1> The Company's balance sheet is unclassified.
</FN>
</TABLE>
