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, 2004
Commission filed number: 811-6268
SBM CERTIFICATE COMPANY
(Exact name of registrant as specified in its charter)
MARYLAND 52-2250397
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5101 RIVER ROAD, SUITE 101
BETHESDA, MD 20816
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 301-656-4200
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
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). |_| Yes |X| No
As of May 14, 2004, 250,000 shares of the registrant's common stock were
outstanding; all of which are privately owned and not traded on a public market.
Table of Contents
Part I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of March 31, 2004
(unaudited) and December 31, 2003................................................3
Condensed Consolidated Statements of Operations for the three months ended
March 31, 2004 (unaudited) and March 31, 2003 (unaudited)........................4
Condensed Consolidated Statements of Cash Flows for the three months ended
March 31, 2004 (unaudited) and March 31, 2003 (unaudited)........................5
Notes to Consolidated Financial Statements ...........................................6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..............................................9
Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...........................15
Item 4 CONTROLS AND PROCEDURES..............................................................16
Part II. OTHER INFORMATION...................................................................16
Item 1. LEGAL PROCEEDINGS ...................................................................16
Item 6. EXHIBITS AND REPORTS ON FORM 8-K REPORTS.............................................16
SIGNATURES ..................................................................................16
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SBM Certificate Company and Subsidiaries
CONSOLIDATED BALANCE SHEETS
March 31, 2004 December 31, 2003
-------------- -----------------
ASSETS (unaudited)
Cash and investments
Available-for-sale securities
(amortized cost: $3,506,636 and $6,705,325) $ 3,565,087 $ 6,900,227
Mortgage notes held for sale 6,434,375 8,195,803
Mortgage notes held for investment 7,801,779 7,795,206
Investments in real estate partnerships 10,348,492 9,736,335
Real estate tax lien certificates 365,682 460,252
Real estate owned 2,300,169 2,285,509
Residual mortgage certificate 2,935,180 2,685,180
Property, net 120,851 121,679
Certificate loans 70,917 69,738
Cash and cash equivalents 901,884 1,392,115
------------ ------------
Total cash and investments 34,844,416 39,642,044
------------ ------------
Dividends and interest receivable 476,105 382,268
------------ ------------
Total qualified assets 35,320,521 40,024,312
Other assets
Related party receivable 218,966 219,371
Fixed assets, net 144,423 108,648
Goodwill 9,032,609 9,032,609
Intangible - registration statement 755,202 755,202
Intangible - client list, net 870,967 893,299
Deferred acquisition costs, net 40,459 802
Other assets 125,638 137,401
------------ ------------
TOTAL ASSETS $ 46,508,785 $ 51,171,644
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Statutory certificate liability 32,522,637 32,912,452
Additional certificate liability 3,183,229 3,029,970
Warehouse line of credit -- 1,222,000
Subscription and note payable 1,980,645 4,902,802
Accounts payable and other liabilities 342,386 614,308
Related party payable 385 49,130
------------ ------------
Total liabilities 38,029,282 42,730,662
------------ ------------
Shareholder's equity (deficit)
Common stock, $1 par value; 10,000,000 shares
authorized; 250,000 shares issued and outstanding 250,000 250,000
Additional paid-in capital 9,270,080 8,615,080
Accumulated comprehensive income (loss), net of taxes 58,451 194,902
Accumulated deficit (1,099,028) (619,000)
------------ ------------
Total shareholder's equity (deficit) 8,479,503 8,440,982
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY (DEFICIT) $ 46,508,785 $ 51,171,644
============ ============
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
-3-
SBM Certificate Company and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
THREE MONTHS ENDED
MARCH 31,
-----------------------------
2004 2003
----------- -----------
Investment income
Interest and dividend income $ 51,511 $ 141,162
Other investment income 15,490 23,261
Loan fee income -- 75,173
Mortgage interest income 411,099 465,983
----------- -----------
Total investment income 478,100 705,579
----------- -----------
Investment and other expenses
Administrative services fee 228,200 113,000
Legal and accounting fees 123,907 --
Deferred acquisition cost amortization and renewal commissions 37,447 66,221
Depreciation and amortization expense 28,131 7,993
Other expenses 95,106 61,107
----------- -----------
Total investment and other expenses 512,791 248,321
----------- -----------
Interest credited on certificate liability 529,772 384,886
----------- -----------
Net investment loss before income taxes
and realized investment gains (losses) (564,463) 72,372
----------- -----------
Realized investment gains (losses) 265,586 (89)
Income tax expense on realized investment gains -- --
----------- -----------
Net investment loss before income taxes (298,877) 72,283
----------- -----------
Other operating income:
Origination fee income 88,144 129,147
Gain on sale to investor 135,181 640,743
Other loan fee income 37,235 131,261
----------- -----------
Total other operating income 260,560 901,151
----------- -----------
Other operating expenses:
Salaries and commissions 300,240 588,945
Other expenses 139,712 173,197
Warehouse interest expense and charges, net 1,759 35,498
----------- -----------
Total other operating expenses 441,711 797,640
----------- -----------
Net other operating income (loss) before income taxes (181,151) 103,511
----------- -----------
Net investment and other operating income (loss) before income taxes (480,028) 175,794
Income tax expense -- --
----------- -----------
Net investment and other operating income (loss) (480,028) 175,794
----------- -----------
Non operating expense:
Reserve for losses - shareholder receivable -- (137,845)
----------- -----------
Net income (loss) $ (480,028) $ 37,949
=========== ===========
SEE ACCOMPANYING NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
-4-
SBM Certificate Company and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, (Unaudited)
2004 2003
------------ ------------
Cash flows provided by (used in) operating activities
Net income (loss) $ (480,028) $ 37,949
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities
Interest credited on certificate liability 529,772 384,886
Reserve for losses - shareholder receivable -- 137,845
Realized investment (gain) loss (265,586) 89
Deferral of revenue -- 359,629
Deferral of acquisition costs (41,627) (13,273)
Amortization of deferred acquisition costs and renewal commissions 1,970 44,954
Depreciation and amortization 28,131 7,993
Decrease in mortgage notes held for sale 1,563,811 2,403,374
Increase in dividends and interest receivable (93,837) (33,742)
Increase in shareholder receivable -- (137,845)
Changes in other assets and liabilities (207,039) (309,180)
------------ ------------
Net cash provided by (used in) operating activities 1,035,567 2,882,679
------------ ------------
Cash flows from investing activities
Purchase of available-for-sale securities (1,000,000) --
Sales and redemptions of available-for-sale securities 4,462,268 10,287
Purchase of mortgage notes receivable -- (937,146)
Principal payments received on mortgage notes receivable 197,617 1,342,317
Cash invested in real estate partnership interest (3,000,000) --
Proceeds from real estate tax lien certificates 94,570 289,482
Purchase of residual mortgage certificate (250,000) --
Principal payments received on residual mortgage certificate -- 65,601
Repayment of certificate loans, net (1,179) (167)
Purchase of fixed assets (40,746) (5,066)
------------ ------------
Net cash provided by (used in) investing activities 462,530 765,308
------------ ------------
Cash flows from financing activities
Amounts paid to face-amount certificate holders (766,328) (572,390)
Warehouse line of credit borrowings, net (1,222,000) (754,600)
------------ ------------
Net cash provided by (used in) financing activities (1,988,328) (1,326,990)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (490,231) 2,320,997
Cash and cash equivalents, beginning 1,392,115 2,230,886
------------ ------------
Cash and cash equivalents, end $ 901,884 $ 4,551,883
============ ============
Supplemental disclosure of significant noncash investing
and financing activities:
Contribution of qualified assets from SBM Financial $ 655,000 $ --
============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-5-
SBM CERTIFICATE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
March 31, 2004
1. ORGANIZATION AND ACQUISITION
SBM Certificate Company and Subsidiaries (the "Company") consists of SBM
Certificate Company, a Maryland Corporation ("SBM"), Atlantic Capital Funding
Corporation, a Maryland Corporation ("ACFC"), and SBM Securities I, LLC, a
Delaware limited liability company ("SBMS I"). SBM was formed on May 24, 2000
under the laws of the State of Maryland. SBM is a wholly-owned subsidiary of SBM
Financial, LLC ("SBM Financial"), formerly known as State Bond and Mortgage
Company, LLC ("State Bond"). Effective December 31, 2003, Geneva Capital
Partners, LLC, a Delaware limited liability company ("Geneva"), became the sole
member of SBM Financial through a dividend to Geneva of the 100% ownership
interest of SBM Financial by 1st Atlantic Guaranty Corporation ("1st Atlantic").
1st Atlantic was previously the sole member of SBM Financial and its
subsidiaries.
SBM is an issuer of face-amount certificates and is registered under the
Investment Company Act of 1940 (the "1940 Act"). ACFC and SBMS I are both wholly
owned subsidiaries of SBM. ACFC was formed on March 27, 1997 under the laws of
the state of Maryland and SBMS I was formed on July 1, 2003 under the laws of
the state of Delaware.
On May 29, 2003, John Lawbaugh, 1st Atlantic's majority shareholder at the
time, filed a petition for relief under Chapter 11 of the United States
Bankruptcy Code in the United States Bankruptcy Court for the District of
Maryland ("Bankruptcy Court").
On November 7, 2003, 1st Atlantic, Geneva and the Chapter 11 Bankruptcy
Trustee (the "Trustee"), as representative of the bankruptcy estate of John J.
Lawbaugh (the "Estate"), agreed to a settlement proposal for the sale of John J.
Lawbaugh's 7,500,000 shares of 1st Atlantic common stock (the "Shares") to
Geneva. An emergency motion was filed in Bankruptcy Court on November 10, 2003
for the approval of the sale of the Shares to Geneva under such proposal. On
December 2, 2003, the Bankruptcy Court granted the motion approving the
settlement proposal for the sale of the Shares free and clear of all liens and
ordered the sale of the Shares to take place immediately. On December 5, 2003,
the sale of the Shares closed pursuant to the terms of the Stock Purchase
Agreement by and between the Trustee and Geneva dated December 2, 2003 (the
"Sale Agreement") (the "Acquisition"). The Trustee sold the Shares to Geneva for
$2,532,981, which was distributed to 1st Atlantic and the Company in the amounts
of $1,175,955 and $1,357,026, respectively, to repay the amounts due from Mr.
Lawbaugh to 1st Atlantic and SBM (See Note 4 of the Notes to the Consolidated
Financial Statements). In addition, Geneva contributed $3,200,000 as additional
paid in capital to 1st Atlantic to resolve the SEC's concerns regarding 1st
Atlantic's compliance with the reserve requirements of Section 28 of the 1940
Act. Further, SBM Financial issued debt instruments secured by the common stock
of SBM totaling $1,616,772 to certain creditors of the Estate. The debt matures
ten years from the date of issuance and has principal and interest payments due
semi-annually with interest accruing at the rate of 1.5% per annum. Cash flows
generated from the operations of the Company may be a source of funds to pay the
interest and principal of the debt as it becomes due. A total of $125,000 was
also paid by Geneva to the Trustee and certain other creditors of the Estate.
Immediately after closing, Geneva made an additional cash and non-cash
contribution to the Company of $1,000,000 cash and a $820,000 partnership
interest in two separate real estate investment funds, which was treated as
additional paid in capital.
Geneva obtained funds to acquire the Shares from the issuance of privately
placed investment notes to unaffiliated investors. The investment notes provide
for a fixed interest rate of 3.75%, payable quarterly, and mature in 2006, three
years from the date of the issuance. The funds obtained to acquire the Shares
and the additional capital contributed by Geneva after the sale of the Shares
may be repaid at their maturity from excess cash flows generated from the
operations of the Company.
The Acquisition was accounted for using the purchase method of accounting
in accordance with Statements of Financial Accounting Standards ("SFAS") 141,
"Accounting for Business Combinations."
-6-
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of the Acquisition and the
significant non-cash investing and financing activities related to the
Acquisition:
At December 5, 2003
Qualified Assets $36,599,242
Other Assets 612,440
Due From Shareholder 1,357,026
Intangible Assets 1,648,501
Goodwill 9,032,609
-----------
Total Assets Acquired $49,249,818
-----------
Certificate Liability $35,796,218
Warehouse Line of Credit 2,068,000
Other Liabilities 4,340,520
-----------
Total Liabilities Assumed $42,204,738
-----------
Net Assets Acquired $ 7,045,080
-----------
Of the $1,648,501 of intangible assets, $755,202 was assigned to SBM's
registration statement to sell face-amount certificates, which is not subject to
amortization, and $893,299 was assigned to SBM's existing client list and will
be amortized over the expected remaining life of the client list of 10 years.
As a result of the Acquisition, goodwill of $9,032,609 was assigned to the
Company, which is not deductible for tax purposes.
2. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
SBM is engaged in the business of issuing and servicing face-amount
certificates. A face-amount certificate is an obligation of the issuer to pay a
face, or principal amount, plus specified interest, to the holder of the
certificate. ACFC is a mortgage broker and lender that originates residential
and commercial loans. SBMS I is an issuer of privately placed investment notes
to accredited investors, but has not yet completed any offerings to investors.
The accompanying unaudited consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q. These principles require management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
contingent assets and liabilities at the date of the financial statements and
the reported amounts of income and expenses during the reporting period. Actual
results could differ from those estimates.
The consolidated financial statements include the accounts of SBM and its
wholly-owned subsidiaries, ACFC and SBMS I. All significant intercompany
balances and transactions have been eliminated.
3. GOODWILL AND PURCHASED INTANGIBLE ASSETS
Goodwill for the year ended December 31, 2003 resulted from the
Acquisition transaction that closed on December 5, 2003 (See Note 1). In
accordance with SFAS No. 142, goodwill and intangible assets that have
indefinite useful lives will not be amortized but rather will be tested at least
annually for impairment.
-7-
4. DUE FROM SHAREHOLDER
Due from shareholder at March 31, 2003 represents amounts paid to John J.
Lawbaugh, the majority shareholder of 1st Atlantic, directly or through
companies affiliated with Mr. Lawbaugh and other costs incurred by the Company
as a result of these payments. As of March 31, 2003, these amounts totaled
$1,356,026 and an allowance for uncollectible amounts due from shareholder was
recorded for the full amount due with a corresponding charge to operations. As
of March 31, 2003, the allowance totaled $1,356,026. In connection with the
Acquisition, the due from shareholder at December 5, 2003 of $1,357,026 was paid
in full by the Trustee of the Estate from funds from the sale of the Shares (see
Note 1). See in "Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations: Significant Events" for further description
of due from shareholder.
5. REGULATORY MATTERS
The Company is subject to restrictions relating to its regulatory capital
requirements under the 1940 Act. The Company is required to establish and
maintain qualified assets (as defined in Section 28(b) of the 1940 Act) having a
value not less than the aggregate of certificate reserves (as calculated under
Section 28(a)) plus $250,000 ($32.7 million and $33.1 million at March 31, 2004
and December 31, 2003, respectively). The Company had qualified assets (at
amortized cost) of $33.1 million and $33.6 million at those respective dates.
For purposes of determining compliance with the foregoing provisions,
qualified assets are valued in accordance with District of Columbia Insurance
Laws (the "D.C. Laws") as required by the 1940 Act. Qualified assets for which
no provision for valuation is made in the D.C. Laws are valued in accordance
with rules, regulations, or orders prescribed by the SEC. These values are the
same as the financial statement carrying values, except that for financial
statement purposes, available-for-sale securities are carried at fair value. For
qualified asset purposes, available-for-sale securities are valued at amortized
cost.
Pursuant to the required calculations of various states, the provisions of
the certificates, depository agreements, and the 1940 Act, qualified assets of
the Company were deposited with independent custodians and invested in certain
investments to meet certificate liability requirements as of March 31, 2004 and
December 31, 2003, as shown in the following table. Certain assets on deposit
are not considered qualified assets for the purposes of this calculation because
they are reserved for the repayment of existing liabilities. Certificate loans,
secured by applicable certificate liabilities, are deducted from certificate
reserves in computing deposit requirements.
-------------- -----------------
March 31, 2004 December 31, 2003
-------------- -----------------
Total qualified assets on deposit $ 35,103,597 $ 39,759,926
Less: Qualified assets reserved by warehouse line $ -- $ (1,222,000)
Less: Qualified assets reserved by subscription and note payable (1,980,645) (4,902,802)
------------ ------------
Total qualified assets $ 33,122,952 $ 33,635,124
------------ ------------
Certificate reserve under Section 28(a) $ 32,522,637 $ 32,912,452
Less: Certificate loans (68,575) (69,738)
Plus: Base capital requirement 250,000 250,000
------------ ------------
Required deposits $ 32,704,062 $ 33,092,714
------------ ------------
-8-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company consists of SBM, ACFC and SBMS I. Unless otherwise indicated
by the context, the terms "Company," "we," "us," or "ours," refers to the
consolidated entities of SBM, ACFC and SBMS I. Our executive offices are located
at 5101 River Road, Suite 101, Bethesda, Maryland, 20816; our telephone number
is 301-656-4200.
SBM is an issuer of face-amount certificates and is registered under the
1940 Act. ACFC and SBMS I are both wholly owned subsidiaries of SBM. ACFC was
formed on March 27, 1997 under the laws of the state of Maryland and SBMS I was
formed on July 1, 2003 under the laws of the state of Delaware.
Business
SBM is a face-amount certificate company registered under the 1940 Act
that issues and services fixed-rate face-amount certificates. A face-amount
certificate is an obligation of the issuer to pay a face, or principal, amount,
plus specified interest, to the holder of the certificate. The face-amount may
be paid at the end of a certificate's "guarantee period" or at its "maturity
date." Lesser amounts are paid at such times if all or part of an investment in
the certificate is withdrawn prior to maturity or the end of any guarantee
period. Interest may be paid quarterly or annually, or may be compounded.
SBM issues various series of single-payment face-amount certificates with
guarantee periods of three, five, seven and ten years, respectively. Unless
otherwise instructed by the holder, a certificate, by its terms, automatically
continues for another guarantee period of the same duration until the
certificate's maturity date. The certificates mature no later than 30 years from
the date they are issued. The face-amount certificate operations include
issuance of single-payment certificates and the servicing of outstanding
single-payment and installment certificates, the investment of related funds,
and other related service activities. As indicated below under "Significant
Events," SBM suspended the sale of its certificates on August 16, 2002. Any use
in this Form 10-Q Quarterly Report of the term "offer," "sale" or "issues" and
any discussion in that context, is qualified by such suspension.
SBM periodically declares the interest rates payable for its certificates,
which are applicable for the entire guarantee period. The prevailing interest
rates available to investors for similar interest-bearing instruments are a
primary consideration in deciding upon the interest rates declared. However, SBM
has complete discretion as to what interest rates it declares for the
certificates. At the end of a guarantee period, the interest rates in effect for
the succeeding guarantee period may be greater or lesser than the rates in
effect for the expiring guarantee period.
SBM's gross income is derived primarily from the margin between earnings
on its investments and amounts paid or credited on its fixed-rate certificate
liability ("investment spread"). The Company's net income is determined by
deducting investment and other expenses and federal income taxes from the
investment spread. The investment spread is affected principally by investment
decisions, general economic conditions, government monetary policy, the policies
of regulatory authorities that influence market interest rates, and SBM's
ability to respond to changes in such rates. Changes in market interest rates
may have a negative impact on earnings.
Following the 2003 Acquisition, the certificate liability is carried at
the account value less an estimate for early surrender charges based on SBM's
history with regard to early surrenders. This method is in accordance with
accounting principles generally accepted in the United States of America.
SBM maintains reserves for its certificate obligations in accordance with
Section 28 of the 1940 Act. Under provisions of the 1940 Act, SBM is permitted
to invest its reserves only in assets that constitute "qualified investments"
and such other assets as the SEC may permit under the 1940 Act.
ACFC is principally a mortgage lender and mortgage broker of single-family
residential mortgages (conventional and FHA), which are sold to investors. ACFC
is approved as a nonsupervised lender under the HUD Title II program, which has
a required net worth based on a prescribed calculation.
-9-
SBMS I is an entity newly formed for the purpose of issuing privately
placed investment notes to accredited investors. The investment notes represent
an obligation of SBMS I to pay the investor its principal investment plus
accrued interest at its maturity date. Proceeds from the issuance of the
investment notes will be invested in real estate, mortgage notes, fixed maturity
and equity securities.
Competition
Our face-amount certificate business competes in general with various
types of individual savings products which offer a fixed-rate of return on
investors' money, especially insurance, bank and thrift products. Some of these
other products are insured by governmental agencies or funds or private third
parties. SBM's certificates are not guaranteed or insured by any governmental
agency or fund or independent third party but are supported by reserves required
by law. Our ability to offer competitive interest rates, attractive terms, and
efficient service is our primary basis for meeting competition.
As disclosed below in " Significant Events", SBM suspended sales of its
face-amount certificates on August 16, 2002 due to the discovery of the
Questioned Transactions. When SBM is selling, certificates are sold directly by
SBM and through broker-dealers who have entered into selling agreements with
SBM. Sales also may be made to members of affinity groups, such as service
organizations, non-profit associations and other types of member organizations.
Significant Events
In 2002, management discovered facts that came to its attention regarding
several transactions (the "Questioned Transactions") involving the Company. The
Questioned Transactions raised concerns that SBM's then Chairman of the Board
and Chief Executive Officer, John J. Lawbaugh, failed to comply with provisions
of the 1940 Act prohibiting transactions with affiliated persons of registered
investment companies, caused us to fail to comply with disclosure requirements
of the Securities Act of 1933 (the "1933 Act") and the Securities Exchange Act
of 1934 (the "Exchange Act"), caused us to improperly report asset balances, and
diverted cash assets of the Company to himself directly or indirectly during
2000, 2001 and 2002 totaling $1,768,917, of which $900,000 was repaid to the
Company by Mr. Lawbaugh in 2002. The balance of $868,917, together with legal
and accounting costs incurred because of these matters constitute the amount due
from shareholder, which was repaid at the closing of the Acquisition on December
5, 2003 (See Note 1 of the Notes to the Consolidated Financial Statements).
As a result of the Questioned Transactions, on August 16, 2002, SBM's
Board of Directors removed Mr. Lawbaugh from his position as Chairman of the
Board and Chief Executive Officer and suspended his authority to act for or bind
the Company with respect to any transactions and authorized an investigation
into the Questioned Transactions. The investigation was performed by our
management under the supervision of two independent directors of the Board (the
"Special Committee") and our independent auditors. Our Form 8-K Current Report
dated October 3, 2002 describes the findings of the Special Committee created by
the Board of Directors to oversee the investigation of Mr. Lawbaugh's
transactions, summarizes the nature of the transactions and discusses various
related matters. SBM also suspended the sale of its face-amount certificates on
August 16, 2002. We restated our financial statements and amended our Form 10-Q
Quarterly Reports and Form 10-K Annual Reports filed with the SEC for the
periods affected to properly reflect the nature and effect of these
transactions. SBM has not yet resumed sales. An amendment to our 1933 Act
registration statement for our face-amount certificates is pending at the SEC.
On November 12, 2002, Mr. Lawbaugh resigned from the Board of Directors
and on November 14, 2002, entered into a Stock Escrow Agreement ("Escrow
Agreement"). The Escrow Agreement placed Mr. Lawbaugh's shares of 1st Atlantic
capital stock, representing majority ownership of 1st Atlantic, into escrow and
removed his voting rights associated with the shares. We filed a Form 8-K
Current Report dated November 12, 2002, with the SEC on November 27, 2002. That
Form 8-K Current Report describes the terms and conditions of the Escrow
Agreement. See Note 1 and Note 4 of the Notes to the Consolidated Financial
Statements or further description of the due from shareholder.
-10-
The following summarizes the impact of the Questioned Transactions on the
Company for the respective periods indicated:
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 2003 DECEMBER 31, 2002 DECEMBER 31, 2001 DECEMEBR 31, 2000 TOTAL
----------------- ----------------- ----------------- ----------------- -----------
Qualified Assets $ (141,392) $ (56,700) $(1,396,907) $ (292,236) $(1,887,235)
Additional Paid in Capital $ -- $ -- $ (707,550) $ -- $ (707,550)
Shareholder's Equity $ (141,392) $ (265,762) $(1,146,957) $ (292,236) $(1,846,347)
Net Loss $ (141,392) $ (365,763) $ (439,407) $ (292,236) $(1,238,798)
On May 29, 2003, John Lawbaugh, 1st Atlantic's majority shareholder at the
time, filed a petition for relief under Chapter 11 of the United States
Bankruptcy Court.
On November 7, 2003, 1st Atlantic, Geneva and the Trustee of the Estate
agreed to a settlement proposal for the sale the Shares to Geneva. An emergency
motion was filed in Bankruptcy Court on November 10, 2003 for the approval of
the sale of the Shares to Geneva under such proposal. On December 2, 2003, the
Bankruptcy Court granted the motion approving the settlement proposal for the
sale of the Shares free and clear of all liens and ordered the sale of the
Shares to take place immediately. On December 5, 2003, the sale of the Shares
closed pursuant to the terms of the Sale Agreement. The Trustee sold the Shares
to Geneva for $2,532,981, which was distributed to 1st Atlantic and SBM in the
amounts of $1,175,955 and $1,357,026, respectively, to repay the amounts due
from Mr. Lawbaugh to 1st Atlantic and SBM (See Note 1 of the Notes to the
Consolidated Financial Statements). In addition, Geneva contributed $3,200,000
as additional paid in capital to 1st Atlantic to resolve the SEC's concerns
regarding 1st Atlantic's compliance with the reserve requirements of Section 28
of the 1940 Act. Further, SBM Financial issued debt instruments secured by the
common stock of SBM totaling $1,616,772 to certain creditors of the Estate. SBM
Financial's debt matures ten years from the date of issuance and has principal
and interest payments due semi-annually with interest accruing at the rate of
1.5% per annum. Cash flows generated from the operations of the Company may be a
source of funds, as a dividend payment to SBM Financial, to pay the interest and
principal of the debt as it becomes due. A total of $125,000 was also paid by
Geneva to the Trustee and certain other creditors of the Estate. Immediately
after closing, Geneva made additional contributions to the Company, consisting
of $1,000,000 cash and partnership interests in two separate real estate
investment funds totaling $820,000. These contributions were treated as
additional paid in capital.
Geneva obtained funds to acquire the Shares through the issuance of
privately placed investment notes to unaffiliated investors. The investment
notes provide for a fixed interest rate of 3.75%, payable quarterly, and mature
in 2006, three years from the date of the issuance. Excess cash flows generated
from the operations of the Company, as dividend payments to SBM Financial and
Geneva, may be used to repay the debt incurred by Geneva to acquire the Shares
and make the additional capital contributions. Geneva is owned 100% by Eric M.
Westbury, Chairman and Chief Executive Officer of SBM.
The following proforma consolidated balance sheet reflects the impact of
the Acquisition on the financial statements of the Company:
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SBM Certificate Company and Subsidiaries
PROFORMA CONDENSED CONSOLIDATED BALANCE SHEET
Pre-Acquisition Acquisition Post-Acquisition
December 5, 2003 Entries December 5, 2003
---------------- ------------- ----------------
Qualified assets
Cash and investments
Available-for-sale securities $ 6,665,571 42,427 1 $ 6,707,998
Mortgage notes held for sale 7,587,230 44,959 1 7,632,189
Mortgage notes held for investment 7,700,738 94,467 1 7,795,205
Warehouse line of credit receivable -- -- --
Investment in real estate partnerships 7,903,001 -- 7,903,001
Real estate tax lien certificates 602,609 -- 602,609
Real estate owned 2,760,509 (475,000) 1 2,285,509
Residual mortgage certificate 2,660,409 24,796 1 2,685,205
Certificate loans 68,575 -- 68,575
Cash and cash equivalents 600,654 1,357,026 2 1,957,680
------------ ------------ ------------
Total cash and investments 36,549,296 1,088,675 37,637,971
------------ ------------ ------------
Dividends and interest receivable 318,297 -- 318,297
------------ ------------ ------------
Total qualified assets 36,867,593 1,088,675 37,956,268
Other assets
Related party receivable 254,385 (4,989) 1 249,396
Fixed assets, net 198,684 -- 198,684
Investment in subsidiary -- -- --
Goodwill and intangible assets 591,463 (591,463) 1
3,636,030 1
7,045,080 3 10,681,110
Deferred acquisition costs, net 442,308 (442,308) 1 --
Due from shareholder 1,359,573 (2,547) 1
(1,357,026) 2 --
Allowance - due from shareholder (1,359,573) 1,359,573 1 --
Other assets 164,360 -- 164,360
------------ ------------ ------------
Total assets $ 38,518,793 10,731,025 $ 49,249,818
============ ============ ============
Liabilities
Statutory certificate liability $ 33,788,203 2,008,015 1 $ 35,796,218
Additional certificate liability -- --
Warehouse line of credit 2,068,000 2,068,000
Deferred revenue 1,295,890 (1,295,890) 1 --
Subscription and note payable 3,902,802 3,902,802
Accounts payable and other liabilities 419,634 419,634
Related party payable 18,084 18,084
------------ ------------ ------------
Total liabilities 41,492,613 712,125 42,204,738
------------ ------------ ------------
Shareholder's equity
Common stock, $1 par value; 10,000,000 shares
authorized; 250,000 shares issued and outstanding 250,000 (250,000) 1
250,000 3 250,000
Common stock, $2 par value; 10,000 shares
authorized; 10,000 shares issued and outstanding -- --
Additional paid-in capital 3,861,818 (3,861,818) 1
6,795,080 3 6,795,080
Accumulated comprehensive loss, net of taxes (246,339) 246,339 1 --
Accumulated deficit (6,839,299) 6,839,299 1 --
------------ ------------ ------------
Total shareholder's equity (2,973,820) 10,018,900 7,045,080
------------ ------------ ------------
Total liabilities and shareholder's equity $ 38,518,793 10,731,025 $ 49,249,818
============ ============ ============
1 - Adjust assets and liabilities to fair value in accordance with SFAS 141
2 - Record receipt of cash for repayment of due from shareholder
3 - To push down unallocated purchase price to reporting unit of value, SBM, in
accordance with SFAS 141
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Financial Condition, Changes in Financial Condition and Results of Operations
For the three months ended March 31, 2004 compared with the three months ended
March 31, 2003
As of March 31, 2004, total qualified assets decreased from 33.6 million
at December 31, 2003 to 33.1 million, while required certificate reserves
decreased approximately $400,000 from $33.1 million as of December 31, 2003 to
$32.7 million as of March 31, 2004.
Our earnings are derived primarily from net investment income and net
other operating income. Net investment income is income earned from invested
assets less investment and other expenses and interest credited on the
certificate liability. Net other operating income is income earned from the
origination of loans in the mortgage lender/broker business less operating
expenses. Changes in net investment income are largely due to changes in the
rate of return on investments. Changes in net other operating income is
attributable to changes in the volume and pricing of loans originated.
We had net income (loss) of $(480,028) and $37,949 for the three months
ended March 31, 2004 and 2003, respectively. The net loss for the three months
ended March 31, 2004 stemmed mainly from the net investment loss before income
tax of $298,877 and the net other operating loss before income taxes of
$181,151. The net investment loss before income taxes for the three months ended
March 31, 2004 was due to the combination of investment and other expenses and
interest credited on certificate liability exceeding the income generated from
the investment portfolio. During the first quarter of 2004, we held several
non-revenue producing assets, which had a negative impact on the income
generated from the investment portfolio. However, the primary reason for the net
losses was the income generated from the investment portfolio was not sufficient
to cover the certificate interest costs and the fixed operational costs related
to the administrative services fee and legal and accounting fees. When
certificate sales resume and the investment portfolio increases, the fixed
operational costs will have less of a negative impact on us as there is a larger
portfolio of assets generating income to cover the fixed costs. We do not expect
a significant increase in fixed costs as the investment portfolio increases. The
net income of $37,949 for the three months ended March 31, 2003 was mainly the
result of net other operating income before income taxes of $103,511, which was
generated from the mortgage company operations.
Investment income (excluding realized investment gains and losses) for the
three months ended March 31, 2004 was $478,100 compared to investment income of
$705,579 for 2003. The decrease in investment income was mainly due to the
investments in real estate partnerships not producing any return on the
investment and one partnership producing a negative return. These partnerships
currently are non-revenue producing since they are in their development stage.
Upon completion of their development, these assets will begin producing revenue.
The development stage for each project varies by project, but ranges from six to
eighteen months. We factored in this development stage into the total expected
return of the investment prior to investing the funds and determined the risk
and return suited our long-term goals. Total investment income plus realized
gains for the three months ended March 31, 2004 and 2003 was $743,686 and
$705,490, respectively. Investment income plus realized investment gains
represents annualized investment yields of 8.91% and 8.53% on average cash and
investments of $33.4 million and $33.1 million for the three months ended March
31, 2004 and 2003, respectively.
Net investment spread, which is the difference between investment income
and interest credited on certificate liability, was ($51,672) for the three
months ended March 31, 2004 compared to $320,693 in 2003. On an annualized yield
basis, these amounts reflect net investment spread of (0.14%) and 3.88%,
respectively.
Interest credited on certificate liability for the three months ended
March 31, 2004 and 2003 was $529,772 and $384,886, respectively. These amounts
represent annualized average rates of interest credited of 5.92% and 4.65% on
average certificate liability of $35.8 million and $33.1 million for 2004 and
2003, respectively. We monitor 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 face-amount certificates
are made periodically by SBM.
Investment and other expenses were $512,791 and $248,321 for the three
months ended March 31, 2004 and 2003, respectively. The increase in investment
and other expenses was mainly the result of an increase in legal and accounting
fees and an increase in the administrative services fee paid to SBM's parent,
SBM Financial. Legal and accounting fees for the first quarter of 2004 were
$123,907 and there was no accrual for legal and accounting fees for the three
months ended March 31, 2003. The increase in legal and accounting fees was due
to accounting costs increasing for the 2003 year end audit, which was performed
and invoiced in first quarter 2004, compared to the 2002 year end audit which
was invoiced in the second quarter 2003. After Mr. Lawbaugh's bankruptcy filing
on May 29, 2003, any legal and accounting costs could not be charged to Mr.
Lawbaugh under Bankruptcy Law. The administrative services fee for 2004
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and 2003 was $228,200 and $113,000, respectively. The increase in the
administrative services fee was due to SBM Financial receiving cash in the first
quarter of 2003 from a subsidiary for an outstanding receivable. The cash
received for this receivable was used to fund SBM Financial operating costs,
which in turn allowed SBM Financial to lower its administrative services fee for
the three months ended March 31, 2003. Other expenses for the three months ended
March 31, 2004 and 2003 were $95,106 and $61,107, respectively.
Net other operating income (loss) before income tax for the three months
ended March 31, 2004 and 2003, was ($181,151) and $103,511, respectively. This
consists of the mortgage lender/broker operations of ACFC. For the three months
ended March 31, 2004 and 2003, other operating income was $260,560 and $901,151,
respectively. This income is derived from loan origination fees, gain on sale to
investor and other processing and underwriting loan fees relating to originating
and brokering loans. The decrease in other operating income for the first
quarter 2004 as compared to the first quarter 2003 was due to a decrease in the
volume of loans originated. This decreased loan origination volume in 2004 was
due to a slight increase in market interest rates from the first quarter 2003,
as well as, the sales division of the mortgage operations was restructured in
late 2003, which resulted in a significant reduction of staff. Both of these
events had a material negative impact on the financial results of ACFC in the
first quarter of 2004, causing the net loss. In the first quarter of 2004, ACFC
had begun replacing a significant portion of the loan sales staff that was lost
in 2003 and intends to continue increasing the sales staff throughout 2004 to
increase revenues. For the three months ended March 31, 2004 and 2003, other
operating expenses were $441,711 and $797,640, respectively. These expenses
consist of salaries and commissions paid in relation to originating and
brokering loans and other costs in operating the mortgage company. The decrease
in other operating expenses for the three months ended March 31, 2004 as
compared to the three months ended March 31, 2003, was mainly due to lower
commissions paid as a result of a decrease in loan revenues.
Realized investment gains (losses) were $265,586 and ($89) for the three
months ended March 31, 2004 and 2003, respectively. The realized investment
gains for the three months ended March 31, 2004 were the result of gains
recognized from the sale of certain available for sale securities, which had
significant increases in their market value from their amortized cost. Realized
investment gains and losses are primarily interest-rate related and attributable
to our asset/liability management strategies. We invest in a mixture of
investments ranging from fixed maturity securities, equity securities, mortgage
notes, real estate, and real estate tax lien certificates. The objective of each
investment is to provide reasonable returns while limiting liquidity and credit
risks.
In the event that SBM experiences higher than historical levels of
certificate surrenders, SBM might need to liquidate investments other than in
accordance with its normal asset/liability management strategy and, as a result,
SBM could experience substantial realized investment losses.
For the three months ended March 31, 2003, reserve for losses -
shareholder receivable was $137,845. See "Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations: Significant Events"
for further descriptions of this item.
Liquidity and Financial Resources
As of March 31, 2004, we had $418,890 of qualified assets in excess of the
minimum amount required by the 1940 Act and the rules and regulations
promulgated thereunder by the SEC, as computed in accordance with the 1940 Act.
The primary liquidity requirement of SBM relates to its payment of
certificate maturities and surrenders and payment of its legal and accounting
costs and administrative services fee. The principal sources of cash to meet
such liquidity requirements are investment income and proceeds from maturities
and redemptions of investments. SBM will have $9.3 million of certificate
principal and interest obligation payments due for the remainder of 2004.
However, in 2003, SBM experienced an 84% renewal rate and management expects
principal and interest payments to certificate holders to be approximately $1.5
million for the remainder of 2004. In connection with the Acquisition, SBM
Financial issued debt instruments totaling $1,616,772 with interest payable
semi-annually, beginning June 2, 2004, at a rate of 1.5% per annum. Cash flows
generated from the Company may be a source of funds for the service of SBM
Financial's debt payments in future years. Principal and interest payments under
such debt total $185,322 annually (See Note 1 of the Notes to the Consolidated
Financial Statements).
At March 31, 2004, cash and cash equivalents totaled $901,884, a decrease
of $490,231 from December 31, 2003. We aim to manage our cash and cash
equivalents position as to satisfy short-term liquidity needs. In connection
with
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this management of cash and cash equivalents, we may invest idle cash in short
duration fixed maturities to capture additional yield when short-term liquidity
requirements permit.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our investments are represented by a mixture of available-for-sale
securities (comprised of government and corporate bonds, mortgage-backed
securities, closed-end mutual funds and equity securities), mortgage notes, real
estate, real estate partnerships and real estate tax lien certificates. Managing
interest rates between those earned on our investments and those paid under the
face-amount certificates is fundamental to our investment decisions. Both rates
are sensitive to changes in the general level of interest rates in the economy,
as well as to competitive factors in the case of the certificates.
We have a portion of our portfolio invested in real estate and real estate
loans, which, at March 31, 2004, includes $14.2 million of mortgage notes and
$2.3 million of real estate owned. Defaults by the borrower on payments due and
fluctuations in the value of the underlying real estate represent the greatest
risk factor for this investment strategy. However, we mitigate the risk
associated with the mortgage notes by investing only in those loans that have a
history of producing income, are of high quality by industry standards or have
underlying properties that represent excellent values and safety relative to the
market. The mortgage notes must have a loan to value ratio no higher than 80%
for the investment to be a qualified asset as defined by the provisions of the
Insurance Code at the District of Columbia.
As of March 31, 2004 we also have investments in real estate partnerships
with a carrying value of $10,348,492 and future funding commitments of
$1,980,645, which are reflected as subscription and notes payable in the
financial statements. These partnerships were formed for the purpose of
acquiring and developing residential and commercial real estate. Acquiring or
developing commercial and residential real estate has risk related to the
construction and the leasing and rental market for the respective properties,
since leasing and rental revenue is the source of cash flows for the properties.
A strong leasing and rental market could have a positive impact on projected
performance, while a weaker leasing and rental market could have a negative
impact on future projected cash flows from the investment. The partnership
guidelines have certain requirements on the type and quality of the real estate
to be acquired or developed. By investing in markets with low leasing vacancy
rates, high quality real estate and partnering with other groups with extensive
building management experience, we are able to moderate the risk for such
investments in relation to the expected return.
We also invest in real estate tax lien certificates, which have a balance
of $365,682 at March 31, 2004. The greatest risk associated with this investment
is the time and costs of the foreclosure process when amounts remain unpaid
beyond the Company's aging policy. The risk is mitigated by our first priority
lien on the property on which the tax is owed, and our general policy of
securing these investments, in most circumstances, only with properties in which
the amount paid by us to acquire the certificates is less than 10% of the market
value of the property that secures the investment.
Our ownership in residual mortgage certificates was $2.9 million at March
31, 2004 and represents a subordinate ownership interest in a trust (the
"Trust") that owns a pool of residential mortgages. We assume the risk of
default on the mortgages held within the Trust. Defaults of principal and
interest by borrowers will adversely affect our return on this investment. A
reserve for defaults was calculated into the original purchase price to account
for the risk of loss on the investment. In addition, risk of loss is lessened by
the weighted average loan to value ratio on the underlying mortgage notes as
compared to the real estate securing the note being approximately 60%.
We regularly analyze interest rate sensitivity and the potential impact of
interest rate fluctuations based on a range of different interest rate models.
These provide "benchmarks" for assessing the impact on our earnings if rates
moved higher or lower than the expected targets set in our investment
guidelines. We will continue to formulate strategies directed at protecting
earnings for the potential negative effects of changes in interest rates.
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ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures.
Our management evaluated, with the participation of our Chief Executive
Officer and our Chief Financial Officer, the effectiveness of our disclosure
controls and procedures as of the end of the period covered by the Quarterly
Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and
our Chief Financial Officer have concluded that our disclosure controls and
procedures are effective to ensure that information we are required to disclose
in reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms.
Changes in internal control over financial reporting.
There was no change in our internal control over financial reporting that
occurred during the period covered by this Quarterly Report on Form 10-Q that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
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
(a) EXHIBITS
(31.1) Certification of Chief Executive Officer
(31.2) Certification of Chief Financial Officer
(32.1) Written Statement of the Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350
(b) REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the three
months ended March 31, 2004.
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, on May 14, 2004.
Date: May 14, 2004 SBM CERTIFICATE COMPANY
/s/ Eric M. Westbury
--------------------------------------
Chief Executive Officer
Date: May 14, 2004 /s/ Trey Stafford
--------------------------------------
Chief Financial and Accounting Officer
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