SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
For the fiscal year ended December 31, 1994 Commission File No. 811-407
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SBM COMPANY
(Exact name of registrant as specified in its charter)
Minnesota 41-0557530
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
8400 Normandale Lake Blvd., Suite 1150 55437
Minneapolis, Minnesota (Zip Code)
(Address of Principal Executive Offices)
Registrant's Telephone Number (612) 835-0097
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Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate value of the voting stock held by non-affiliates of the registrant
is not available. The common stock of the registrant is not publicly traded;
consequently, there is no definitive available price for the stock.
Number of shares of common stock outstanding at
March 1, 1995 2,179,714
Documents Incorporated By Reference
None
Exhibit Index is on Pages 78-91
PART I
ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS. SBM Company (the "Company") was
incorporated in Minnesota in 1914. The Company's name originally was State Bond
and Mortgage Company. In April of 1992 the Company's name was changed to SBM
Company.
Sale and Liquidation of the Company:
Pursuant to an Amended and Restated Stock and Asset Purchase Agreement dated as
of February 16, 1995, the Company has agreed to sell substantially all of its
business operations to ARM Financial Group, Inc. ("ARM") (the "Proposed
Transaction"). As part of the Proposed Transaction, ARM will acquire all of the
outstanding stock of the Company's wholly-owned subsidiaries and also will
acquire the management arrangements with the Company's affiliated mutual funds.
Subsequent to the completion of the Proposed Transaction, it is anticipated that
the Company will liquidate and dissolve in accordance with Minnesota law. ARM is
a Delaware corporation and a holding company in the business of owning and
managing life insurance companies specializing in the design, marketing and
management of accumulation products. The Morgan Stanley Leveraged Equity Fund
II, L.P. (MSLEF II), an investment fund sponsored by Morgan Stanley & Co.,
Incorporated (Morgan Stanley & Co.), owns approximately 86% of the outstanding
shares of voting stock of ARM. The aggregate purchase price payable by ARM to
acquire the Company's business operations is $38.6 million, subject to
adjustment. The completion of the Proposed Transaction, which is subject to
regulatory and shareholder approvals, currently is anticipated to occur late in
the second quarter of 1995. A meeting of the shareholders of the Company to vote
on the Proposed Transaction and the Company's plan of dissolution will be held
in May of 1995.
In connection with the Proposed Transaction, ARM has entered into agreements
with the holders of the Series A Mandatory Redeemable Voting Convertible
Preferred Stock of the Company to purchase such Preferred Stock and 72,950
shares of Common Stock immediately prior to the closing of the Proposed
Transaction (the "Preferred Agreements"). The Preferred Agreements contain
provisions which, among other things, require (i) the holders of the Preferred
Stock to vote in favor of the Proposed Transaction and a liquidation of the
Company subsequent to the consummation of the Proposed Transaction, (ii) the
holders of the Preferred Stock to refrain from taking various actions which
might interfere with the Proposed Transaction, and (iii) those holders, ARM and
the Company to enter into mutual releases to be effective upon the Proposed
Transaction.
Business Development:
The initial products sold by the Company were securities which subsequent to the
enactment of the Investment Company Act of 1940 were known as face amount
certificates. The Company remained continuously active in that line of business
from the time it originally was founded until January 1, 1991, when it
transferred its face amount certificate business to a newly formed wholly-owned
subsidiary, as is discussed below. The Company received an order from the
Securities and Exchange Commission pursuant to Section 8(f) of the Investment
Company Act de-registering it as an investment company effective January 29,
1991.
In 1952 the Company organized a broker-dealer and began to market the shares of
various mutual funds. In 1962 and later years, seven mutual fund companies were
organized and affiliated with the Company through management contracts. In the
years 1966 through 1969, two wholly-owned subsidiaries were formed and a third
subsidiary acquired. The three subsidiaries consisted of a life insurance
company, a broker-dealer, and a bank.
On June 18, 1990, the Company incorporated a wholly-owned subsidiary to assume
the Company's face amount certificate business. Effective January 1, 1991, the
Company transferred qualified assets to the subsidiary, and the subsidiary
assumed all of the Company's obligations to certificate holders under
outstanding face amount certificates and certain other liabilities associated
with the Company's face amount certificate business. The Company ceased issuing
face amount certificates effective December 31, 1990, and the subsidiary began
issuing face amount certificates on January 8, 1991. The subsidiary is now
primary obligor on all outstanding face amount certificates issued by it or the
Company. The Company continues to remain liable on all certificates that were
issued by it.
In August of 1992, the Company sold the stock of its bank subsidiary.
In June of 1994, all of the assets of one of the Company's affiliated mutual
funds, the State Bond Progress Fund, were acquired by one of the Company's other
affiliated mutual funds, the State Bond Common Stock Fund, in exchange for
shares of Common Stock Fund.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS. See Note P (Industry
Segment Data) to the Company's consolidated financial statements.
(c) NARRATIVE DESCRIPTION OF BUSINESS.
OPERATIONS
The Company classifies its operations into four major industry segments:
(1) Annuities and Life Insurance; (2) Mutual Fund Operations; (3) Face Amount
Certificates; and (4) Brokerage of Securities.
(1) ANNUITIES AND LIFE INSURANCE. The Company formed State Bond and
Mortgage Life Insurance Company ("SBM Life") in 1966. SBM Life is a
stock life insurance company organized under the laws of the State of
Minnesota. The life insurance segment is the largest part of the
Company's business.
SBM Life is presently licensed to sell insurance and annuities in
thirty-one (31) states. The principal states in which SBM Life's
products are sold are California, Minnesota, Iowa, Hawaii, Oregon, and
Washington. Policy sales are made by representatives of the Company's
wholly-owned broker-dealer subsidiary, SBM Financial Services, Inc.
("SBM Financial Services") and associated agents who are licensed and
compensated directly by SBM Financial Services.
Currently, the main emphasis of SBM Life's sales is tax-deferred
annuities. Such annuity sales represented 98.9% of SBM Life's total
sales in 1994. Of the annuity premium received in 1994 by SBM Life,
approximately 51.7% was received from sales of Internal Revenue Code
Section 403(b) tax-sheltered annuities for educational institutions
and certain private non-profit organizations, 16.7% was from other
qualified plans such as IRAs, and 31.6% was from non-qualified
annuities.
SBM Life currently markets eleven different types of annuity policies.
Of these policies five are designed specifically to receive 403(b)
salary reduction payments and seven are eligible for rollovers from
other companies' 403(b) products. Seven of the Company's annuities are
eligible for sale in both the non-qualified and qualified (IRA, SEP,
401(k), and pension and profit sharing) marketplace. SBM Life also
sells Annual Renewable Term Life Insurance, Five-year Renewable and
Convertible Term, Twenty-Year Decreasing Term, Decreasing Term for
Term Stated (Mortgage Cancellation), Preliminary Term Rider,
Guaranteed Insurability Rider, Whole Life Insurance, and Single
Premium Whole Life Insurance.
During 1994, approximately 92% of SBM Life's premium from sales of
individual life insurance policies and annuities was received from
sales made by agents who are under a non-exclusive contract and who
are compensated by commissions. Approximately 72% of the total Company
premium was derived from sales made by agents associated with a single
national independent marketing organization (the "Marketing Agency").
Approximately 50% of the total Company premium was derived from sales
by agents recruited by a single agency (the "Recruiting Agency")
associated with the Marketing Agency. All of these agents are licensed
to and compensated by SBM Life. The Company's total sales are
significantly dependent upon these independent agents, which agents
have the ability to sell for a large number of other companies. SBM
Life also markets its insurance products through its employee agents.
These agents sold approximately 8% of SBM Life's products during 1994.
SBM Life advances a portion of the first-year commissions paid in
connection with salary reduction 403(b) tax-sheltered annuity
premiums. In 1994, SBM Life advanced approximately $180,000 in
commissions.
SBM Life invests its investment portfolio only in socially responsible
investments. Pursuant to this practice, SBM Life screens its
investments using a number of commonly accepted social responsibility
criteria. SBM Life then markets its products as backed by a socially
responsible investment portfolio.
Beginning in the second half of 1992 and continuing into 1994, the
first-year premiums received by SBM Life began to slow appreciably.
The Company believes that there were a variety of reasons for this.
First, the failure of several large insurance companies in 1991 and
1992 and the resultant adverse publicity caused significant consumer
concern about the insurance industry. Second, as interest rates
decreased in 1992 and 1993, the fixed annuity products sold by SBM
Life became less attractive to customers compared to alternative
investments such as mutual funds and variable annuities. Third, new
products brought out by SBM Life in 1992 and 1993, while more
profitable to the Company than earlier products, were not as popular
with agents and customers as the earlier, discontinued products.
Fourth, SBM Life was downgraded by A. M. Best in May of 1992, from A
to A-, which had the effect of reducing sales.
In November of 1994, SBM Life was again downgraded by A.M. Best, from
A- to B+. The apparent reasons for the downgrade by Best included SBM
Life's concentration in CMO investments, the related substantial
unrealized losses in the value of SBM Life's bond portfolio caused by
the dramatic increase in interest rates in 1994, and Best's desire for
additional capital in SBM Life. Also, in the third quarter of 1994,
several adverse newspaper articles were written concerning the
Company's CMO portfolio. (For a discussion of SBM Life's CMO
portfolio, see pages 7-11 hereof). Subsequent to the downgrade and
newspaper articles, SBM Life experienced a falloff in premiums and an
increase in withdrawals. In the fourth quarter of 1994, withdrawals
and surrenders (exclusive of withdrawals and surrenders on ceded
business) totaled approximately $22.9 million. This activity has
continued into 1995, with withdrawals and surrenders through March 31,
1995 totaling approximately $44.2 million. Premiums were $14.8 million
for the fourth quarter of 1994 and $14.6 million for the first quarter
of 1995.
SBM Life has been adversely impacted by state guaranty fund
assessments. As a result of the insolvency of certain non-affiliated
insurance companies, SBM Life was required to recognize guaranty fund
assessments of approximately $1.8 million in 1994, $1.5 million in
1993, and $1.3 million in 1992. SBM Life has no control over these
assessments and assessments in future years are probable.
(2) MUTUAL FUND OPERATIONS. The Company acts as investment adviser for six
mutual funds: State Bond Cash Management Fund; State Bond Common Stock
Fund; State Bond Diversified Fund; State Bond Tax Exempt Fund; State
Bond Minnesota Tax-Free Income Fund; and State Bond U.S. Government
and Agency Securities Fund (the "Funds"). In addition, the Company
acts as transfer agent and dividend disbursing agent for all of the
above-mentioned Funds. Each Fund has a different investment objective.
The Company's subsidiary, SBM Financial Services, Inc., acts as
distributor for the Funds. The Funds are sold primarily in Minnesota,
Iowa, South Dakota, Illinois, and California.
(3) FACE AMOUNT CERTIFICATES. SBM Certificate Company ("SBMCC") is an
issuer of face amount certificates registered under the Investment
Company Act of 1940. A face amount certificate is an obligation of
SBMCC requiring it to pay a certain amount, plus a specified return,
to an investor at a given maturity date, or lesser amounts if the
certificate is redeemed prior to maturity. SBMCC originally was
established as a wholly-owned subsidiary of the Company. Effective
December 31, 1993, the Company transferred ownership of all
outstanding shares of SBMCC to SBM Life. SBMCC currently is offering
to the public one single-payment investment certificate.
The face amount certificate operations include the issuance of
single-payment certificates and the servicing of outstanding
single-payment and installment certificates, the investment of related
funds, and the performance of other service activities. The Company
provides management services to SBMCC pursuant to a Management
Agreement.
SBMCC's face amount certificates are distributed exclusively by SBM
Financial Services, Inc., a wholly-owned subsidiary of the Company.
SBMCC's face amount certificates are sold primarily in Minnesota,
Iowa, South Dakota, California, and Illinois.
In November of 1994, the Minnesota Department of Commerce recommended
that, because of increases in interest rates and decreases in
principal prepayments on CMOs and other mortgage-backed securities in
SBMCC's investment portfolio, SBMCC should increase its capital level.
Subsequently, in March of 1995, SBMCC's parent company, SBM Life,
contributed $1.5 million to SBMCC's capital. See pages 13-14 hereof.
(4) BROKERAGE OF SECURITIES AND INSURANCE. SBM Financial Services, Inc.
("SBM Financial Services") is the principal underwriter and
distributor of the shares of the Company's six affiliated mutual fund
companies and acts as the sole underwriter and distributor of the
SBMCC face amount certificates. It also is the principal distributor
of the products of SBM Life. SBM Financial Services also provides
distribution services for certain unaffiliated investment companies
and limited partnerships. SBM Financial Services is registered as a
broker-dealer with the Securities and Exchange Commission under the
provisions of the Securities Exchange Act of 1934 and also is
registered as a broker-dealer in 25 states.
As of December 31, 1994, the Company and its subsidiaries had approximately 92
employees and an additional approximately 35 employee sales agents. The Company
also had approximately 1,500 independent agents marketing its products and those
of its affiliates. For the year ended December 31, 1994, approximately 27% of
the Company's total product sales were generated by employee salespersons and
approximately 73% were generated by independent agents.
The Company's major product lines are annuities, face amount certificates,
Company-affiliated mutual funds, and brokered products (primarily mutual funds).
The following are product sales/premiums for 1994, 1993, and 1992:
YEAR ENDED DECEMBER 31
----------------------
(In Millions)
1994 1993 1992
---- ---- ----
Annuities $ 71 $98 $98
Face Amount Certificates 5 6 10
SBM-Affiliated
Mutual Funds 17 19 25
Brokered Products,
Primarily Mutual Funds 38 43 39
INTEREST SENSITIVITY OF PRODUCTS
Most of the products issued by SBM Life and SBMCC are interest-sensitive.
Profits recognized on interest-sensitive products are affected by the margin
between interest earned on investments and interest credited to policyholders
and certificate holders and are also affected by mortality, gains and losses on
investments, persistency, and acquisition and policy maintenance expenses. In
the marketing of such products there is significant competition in interest
crediting rates, which can have the effect of reducing investment spreads.
SBM Life has attempted to discourage premature surrenders of interest-sensitive
products prior to recovery of acquisition expenses through the use of
competitive interest rates and surrender charges. As the surrender charges on
policies decrease, SBM Life may experience increased surrenders of policies. If
SBM Life is required to substantially increase interest rates on its
interest-sensitive products in order to discourage surrenders, this could have
an adverse effect on operating income. This could be especially true in a time
of rapidly increasing interest rates.
INVESTMENTS IN MORTGAGE-BACKED SECURITIES AND CMOS
The Company's life insurance subsidiary and face amount certificate subsidiary
invest a substantial portion of their assets in mortgage-backed securities
issued or guaranteed by the U. S. Government or by its agencies or in
obligations backed by such securities. These include Government National
Mortgage Association ("GNMA") Certificates, Federal National Mortgage
Association ("FNMA") Certificates, Federal Home Loan Mortgage Corporation
("FHLMC") Certificates, and Collateralized Mortgage Obligations ("CMOs")
collateralized by GNMA, FNMA, or FHLMC Certificates. At December 31, 1994, the
Company's life insurance subsidiary and face amount certificate subsidiary held
62% and 87% of their investment portfolios, respectively, in these securities.
GNMA Certificates are mortgage-backed securities which represent an undivided
interest in a specific pool of residential mortgages. The payment of principal
and interest on the Certificates is guaranteed by the full faith and credit of
the U. S. Government. The average life of GNMA Certificates varies with the
interest coupon and maturities of the underlying mortgages which can be affected
by prepayments or refinancing of such mortgages or foreclosure. Such prepayments
are passed through to the certificate holder with the regular monthly principal
and interest payments.
The occurrence of mortgage prepayments is affected by factors including the
level of interest rates, general economic conditions, the location and age of
the mortgage and other social and demographic conditions. As prepayment rates
vary widely, it is not possible to accurately predict the average life of a
particular pool. However, statistics have indicated that the average life of the
type of mortgages backing the majority of outstanding GNMA Certificates is
initially approximately 10-12 years. For this reason, in the past it has been
standard practice to treat GNMA Certificates as 30-year mortgaged-backed
securities with principal dollars outstanding an average of twelve years. Pools
of mortgages with other maturities or different characteristics would have
varying assumptions for average life. The assumed average life of pools of
mortgages having maturities of less than 30 years is less than 10-12 years, but
typically not less than three to four years.
As interest rates decrease, prepayments on mortgage-backed securities
accelerate, and the actual average life of the securities shortens. As interest
rates increase, prepayments decrease, which has the effect of increasing the
above average lives of the securities. If this occurs, securities can remain
outstanding for longer than currently anticipated by the companies.
FNMA and FHLMC Certificates also represent an undivided interest in a specific
pool of residential loans formed or guaranteed by FNMA or FHLMC, as applicable.
FNMA and FHLMC Certificates, unlike GNMA Certificates, do not have the full
faith and credit of the U. S. Government expressly pledged to their repayment.
As such, the holders of such securities would look to each U. S. Government
Agency for repayment in the event of a default on the Certificates.
The mortgages underlying FNMA and FHLMC pools typically prepay somewhat more
quickly than the mortgages in GNMA pools. GNMA pools include only loans that are
issued or guaranteed by the Farmers Home Administration, Federal Housing
Administration, or Veteran's Administration. These loans have a maximum value of
$185,000, with the majority of the loans being in a significantly smaller
amount. In contrast, the maximum value of loans contained in FNMA and FHLMC
pools is approximately $203,150. Persons receiving loans that underlie FNMA or
FHLMC securities typically are more affluent and generally are regarded as being
more mobile. In addition, these mortgages are not assumable. This results in a
faster prepayment rate on FNMA and FHLMC loans than on loans underlying GNMA
securities, which typically results in FNMA and FHLMC Certificates paying off at
a faster rate than GNMA Certificates.
The companies have substantial investments in CMOs. CMOs are a discreet pool of
mortgage-backed securities which are generally issued in several classes. Each
such class bears or accrues any interest to which it is entitled at a specified
rate or at a rate calculated in a specified manner. Principal on the mortgage
loans ultimately underlying a series of CMOs may be allocated among the several
classes within such series in a variety of ways, resulting in classes of CMOs
which return principal based on a specified or scheduled order. By varying the
rates or methods of calculating interest on several classes within a series of
CMOs and the allocations of principal among such classes, a CMO issuer can
create "derivative" securities with a wide range of payment characteristics.
These securities include the inverse floaters and the two-tiered index bonds
(TTIBs) held by the Company.
As of December 31, 1994 SBM Life and SBMCC held 51% and 48% of their investment
portfolios, respectively, in CMOs. These CMO portfolio investments consisted of
the following classes:
SBM Life SBMCC
-------- -----
Fixed Rate Planned
Amortization Class ("PAC") 72% 40%
Targeted Amortization
Class ("TAC") 4% 9%
Accrual Bonds 8% 6%
Inverse Floating Rate
Securities 3% 6%
Two-Tiered Index Bonds ("TTIBs") 8% 23%
Companion (Support) Bonds 3% 11%
Sequential Pay 1% -
Floating Rate Securities - 5%
Other 1% -
--- --
100%* 100%*
* Percentages are based on GAAP carrying values.
A PAC CMO is a class that is designed to receive fixed principal payments over a
predetermined time period under a wide range of prepayment scenarios which makes
the average life of the security more predictable. A sequential pay class has a
fixed interest rate and receives principal payments in a prescribed sequence
continuously from the first payment date until the class is paid off. The
average life of this class will shorten or lengthen based on prepayments. A
floating rate security has an interest rate that is based on a known index such
as the Cost of Funds Index ("COFI") or the London Interbank Offered Rate
("LIBOR"), and is adjusted periodically, typically monthly, as such rate
changes. The interest rate paid on the security will move in the same direction
as in the index. A super floating rate security is a CMO the coupon on which
floats in an amount greater than the amount of movement in the related index
rate.
A TAC is similar to a PAC, in that they both have a schedule of principal
repayments. TACs provide more protection against call risk, but offer less
protection against extension risk.
The Companion (Support) Class acts as a shock absorber. It takes excess cash
flow or does not get a payment so that the PAC and TAC classes can be paid. This
is a CMO class that receives principal payments on any payment date only if
scheduled payments have been made on specific PAC and TAC classes.
Inverse floating rate securities are securities with a coupon that moves in the
reverse direction to an applicable index such as COFI. Accordingly, the coupon
rate thereon will increase as interest rates decrease and decrease as rates
increase, in some cases by a greater amount than the amount of change in the
related index rate. Inverse floating rate securities are typically more volatile
than fixed or floating rate securities. Inverse floating securities would be
purchased by the companies to attempt to protect against a reduction in the
income earned on the companies' investments due to a decline in interest rates
and a corresponding increase in prepayments. The companies would be adversely
affected by the purchase of such securities in the event of an increase in
interest rates since the coupon rates thereon will decrease as interest rates
increase, and, like other fixed income securities, the value will decrease as
interest rates increase.
An accrual or zero coupon class of CMOs is a class which does not pay periodic
interest, but rather accumulates interest at a specified rate until the
principal of the class becomes payable. The accumulated interest then is paid
when the principal is repaid. Like other zero coupon securities, a zero coupon
class of CMOs enables the holder to avoid reinvestment risk (i.e., the risk of
having to reinvest interest payments at progressively lower interest rates) in a
period of declining interest rates. However, in a period of increasing interest
rates, a zero coupon class of CMOs is likely to experience a greater decline in
value than a current-interest class with the same interest rate and principal
payment schedule.
A TTIB is a CMO class whose coupon is fixed until the applicable index (e.g.,
COFI) reaches a specified level known as the first strike. When the index is
higher than the first strike, the TTIB becomes an inverse floater whose coupon
declines to its floor at the second strike. The floor at the second strike
typically will be zero. On initial purchase date the first strike on a TTIB is
generally two to three hundred basis points (2-3%) above the current level of
the applicable index. Consequently, it is unlikely at the date of purchase that
the first strike would be reached in the near future. At December 31, 1994, the
weighted average first strike on the TTIBs held by the Company was 2.41% above
the applicable index and, accordingly, none of these securities have become
inverse floaters. The average life of a CMO TTIB can vary greatly, however,
depending upon prepayments, which in a period of rising interest rates can
increase the possibility of reaching the first strike. The companies would
purchase TTIBs in anticipation of an interest rate and prepayment environment in
which prepayments would remain at moderate to high levels, in which event the
TTIBs generally would pay off before the first strike is reached. Nevertheless,
if interest rates increased and prepayments slowed, the value of the TTIB would
be expected to decline, perhaps significantly, even if the first strike were not
reached.
CHANGES IN INTEREST RATES IN 1994
Interest rates increased sharply from February through June of 1994 and
continued to rise through the fourth quarter of 1994. As a result, the economic
value of all fixed-income securities declined significantly. In this generally
declining bond market, mortgage-backed securities and CMOs were dramatically
affected. As interest rates rose, mortgage refinancing activity slowed and
principal prepayments on the mortgages underlying these securities decreased
significantly. This slowdown in principal prepayments resulted in an extension
of the average lives of the securities, resulting in a further decline in the
value of the securities. Securities that had been priced off the short or
intermediate part of the yield curve extended and were priced off the long end
of the curve. In addition, financial problems at certain broker-dealers,
investment companies, hedge funds, and other financial institutions further
eroded the market for these types of securities as large blocks of the
securities were sold into the market at depressed prices and investor confidence
in the securities declined. The effect of the above was a significant decrease
in the overall price level of CMOs, which resulted in substantial unrealized
losses in SBM Life's and SBMCC's CMO portfolios. For unrealized losses as of
December 31, 1994, see Note D of the Company's consolidated financial statements
in Item 8 hereof.
Effective January 1, 1994, the Company and its subsidiaries adopted Financial
Accounting Standards Board Statement of Financial Accounting Standards (SFAS)
115, a new accounting principle applicable to all financial institutions. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Capital Resources" and Note A of the consolidated financial
statements in Item 8 hereof. The principal effect of SFAS 115 is to require
companies to carry certain fixed-income securities ("available-for-sale"
securities) on their balance sheets at current fair value to reflect unrealized
gains or losses on those securities in stockholders' equity, rather than at
amortized cost value, as under previous accounting practice. Upon adoption of
SFAS 115, each of SBM Life and SBMCC analyzed their securities and classified a
significant portion of their investment portfolios (approximately two thirds) as
available-for-sale securities. As such, as of January 1, 1994, approximately
$506 million of the Company's debt securities were classified as
available-for-sale, with $254 million classified as "held to maturity".
The decline in the bond market that occurred in the first six months of 1994 in
conjunction with the implementation of SFAS 115 by the Company and the transfer
of approximately $234 million of debt securities classified as held-to-maturity
to the available-for-sale category with an unrealized loss of $15.9 million due
to the repositioning program described below, resulted in unrealized losses net
of tax savings and other adjustments in the Company's investment portfolio of
$37 million as of June 30, 1994. In addition, stockholders' equity declined from
$32 million at December 31, 1993, to a deficit of $5.3 million at June 30, 1994
(exclusive of Series A Preferred Stock and common stock held by employee benefit
plans).
Based on the above and discussions with A.M. Best Company ("A.M. Best"), a key
insurance industry rating agency, and regulators, the Company determined that it
should reduce the level of CMOs in SBM Life's investment portfolio substantially
in order to diversify its investment portfolio. Through September 30, 1994, SBM
Life sold CMOs with an amortized cost of approximately $186 million and
recognized an after-tax loss of approximately $6.2 million. SBM Life reinvested
the proceeds in U.S. Government and U.S. Government Agency notes and in
intermediate term corporate bonds rated A or above. The repositioning program
reduced the overall yield on SBM Life's portfolio by approximately 25 to 35
basis points, which will have the effect of reducing future investment spreads
and profitability.
At December 31, 1994, the unrealized losses net of tax savings and other
adjustments in SBM Life's and SBM Certificate Company's investment portfolios
aggregated approximately $60 million and the Company's stockholders' equity was
a deficit of $32 million. At February 28, 1995, the unrealized pre-tax loss had
decreased from December 31, 1994 by approximately $26 million.
COMPETITION
All lines of business of the Company and its subsidiaries are highly competitive
and the Company and its subsidiaries compete with many other companies having
greater financial resources, larger sales forces, and greater access to
customers. Many large and long-established insurance companies and investment
companies are engaged in the sale of mutual fund shares, face amount
certificates, and life insurance and annuities in the same geographic area that
the Company markets its products.
In the Company's insurance segment, the Company must compete with a large number
of competitors with similar products. Competition is based largely upon the
crediting rates under the policies, the credit and claims paying ratings of
competing insurers, the commission structures of competing companies, and the
levels of service afforded agents. SBM Life has a claims paying rating from A.M.
Best Company. The rating is used to compare one insurer to other insurers,
particularly with respect to underwriting, expense control, reserves, and
investments. The current rating of SBM Life by A.M. Best Company is B+ (Very
Good). SBM Life's rating was changed to its current rating of B+ from its prior
rating of A- in November of 1994.
A.M. Best defines the rating category of B+ as follows:
Assigned to companies which, in our opinion, have achieved very good
overall performance when compared to the standards established by the A. M.
Best Company. B++ and B+ companies have a good ability to meet their
obligations to policyholders over a long period of time.
REGULATION
The Company and its subsidiaries are subject to significant federal and state
regulation. Such regulation can have a considerable effect upon the Company's
operations and the profitability of its businesses.
INSURANCE COMPANY REGULATION
The insurance industry is highly regulated. Principal regulatory oversight comes
from state insurance departments. The National Association of Insurance
Commissioners (the "NAIC") issues model laws and regulations which are adopted
by the states. The state insurance departments and the NAIC focus primarily on
operations and solvency of insurance companies. Regulation relates generally to
insurer and agent licensing, limitations on insurer investments, valuation of
assets, policy form approval, reserve requirements, solvency standards,
statutory deposit requirements, periodic insurer examination, and trade
practices.
At least once every five years, the Minnesota Department of Commerce conducts a
detailed financial examination of the books, records, and accounts of every
Minnesota domiciled insurance company. These examinations are conducted under
guidelines promulgated by the NAIC and in accordance with applicable Minnesota
law. The most recent financial examination of the Company's life insurance
subsidiary, for the periods 1990-1993, was completed in December of 1994.
The Company has not yet received an examination report.
The State of Minnesota evaluates the sufficiency of a domestic insurance
company's capital by using the NAIC Life Risk-based Capital standard, which
takes into consideration risks associated with the assets and insurance products
of the company. SBM Life has sufficient capital under these requirements.
However, because of SBM Life's significant concentration of CMOs in its
investment portfolio and the related large unrealized losses on the CMOs
resulting from increasing interest rates in 1994, SBM Life anticipates it will
need to raise additional capital. See Items 3 and 7 hereof.
In Minnesota, SBM Life's state of domicile, and in states where SBM Life is
licensed to do business, the Company is required to make annual and quarterly
filings.
Minnesota has an insurance holding company law which applies to an insurer
controlled by another corporation. This law requires periodic disclosure
concerning the corporation and all subsidiaries of the corporation, approval of
changes of control of registered insurers, and prior notice to, or approval by,
the Minnesota Department of Commerce of certain transactions among affiliates
within the holding company system. In addition, the holding company regulations
include restrictions on the payment of dividends by the insurance subsidiary in
excess of specified amounts. See Item 5 hereof. See also Item 3 hereof. SBM Life
is deemed to be "commercially domiciled" in the State of California due to the
volume of business written in that State, and as such also is subject to the
holding company laws of that State. Many other states also have holding company
laws, which may apply to foreign insurers licensed to do business in that state.
In 1992, the Mandatory Securities Valuation Reserve ("MSVR") required by the
NAIC for life insurance companies was replaced by a mandatory Asset Valuation
Reserve ("AVR") which is expanded to cover mortgage loans, real estate, and
other investments. In addition, a new mandatory Interest Maintenance Reserve
("IMR") became effective in 1992. The IMR is designed to defer realized capital
gains and losses due to interest rate changes on fixed income investments and to
amortize those gains and losses into future income. Previously, realized capital
gains attributable to interest rate changes were credited to the MSVR and had
the effect of reducing the company's required MSVR contributions. The
combination of the AVR and IMR over time will affect statutory capital and
surplus and may reduce the dividend-paying ability of SBM Life.
All states have guaranty fund laws and require life insurance companies which
are licensed to do business in that state to participate in guaranty fund
associations. Under these laws, companies are assessable up to a maximum of 1%
to 2% of the average relevant premiums received in that state in the preceding
year or years as defined by each state. The assessments are used to pay claims
of policyholders of insolvent insurance companies. Some states allow premium
taxes otherwise payable to be reduced by some or all of the amounts assessed by
the guaranty fund association. In 1994, 1993, and 1992, guaranty fund
assessments had a significant impact on the Company's profitability. It
currently is anticipated that the Company will be subjected to significant
assessments for the immediately foreseeable future. See Item 7 hereof and Note N
to the Company's consolidated financial statements in Item 8 hereof.
FACE AMOUNT CERTIFICATE COMPANY REGULATION
The Company's face amount certificate subsidiary is subject to significant
regulation and supervision by federal and state regulators. The Investment
Company Act of 1940 and rules issued by the SEC thereunder specify certain terms
for face amount certificates, the method of calculating reserve liabilities on
outstanding certificates, the minimum amounts and types of investments to be
deposited with a qualified custodian to support such reserve liabilities, and a
variety of other restrictions on the operation and governance of a face amount
certificate company. Pursuant to statutory authority, the Minnesota Department
of Commerce (the "MDC") and the Illinois Secretary of State exercise supervisory
powers over the Company's face amount certificate business similar to those
under the Investment Company Act of 1940. In addition, the MDC conducts
examinations of the Company on a periodic basis. The staff of the MDC has taken
the position that the Company's face amount certificate subsidiary should
maintain a minimum capital level, computed based upon amortized cost valuation
of fixed-income securities, of 5%. At December 31, 1994, the face amount
certificate subsidiary's amortized cost capital level was 6.9%.
In November of 1994, the MDC recommended to SBMCC that, because of increases in
interest rates in 1994 and decreasing cash flows on mortgage-backed securities
in SBMCC's investment portfolio, SBMCC should increase its capital. At December
31, 1994, SBMCC's capital level, computed on a GAAP basis (including the effect
of SFAS 115) was .31%. On March 29, 1995, SBM Life, the parent company of SBMCC,
contributed an additional $1.5 million of capital to SBMCC. SBMCC is now in
compliance with the MDC's recommendation. SBMCC's shareholder's equity, computed
on a GAAP basis, as of February 28, 1995, assuming the $1.5 million capital
contribution and the unrealized losses at that date, would have been
approximately $3 million.
The offer and sale of face amount certificates also are subject to federal and
state securities laws.
MUTUAL FUND REGULATION
The Company, which acts as investment adviser to the State Bond group of mutual
funds, is registered under the Investment Advisers Act of 1940, and is subject
to the requirements of such Act. The Company also acts as transfer agent for the
funds, and is registered as a transfer agent under the Securities Exchange Act
of 1934.
In addition, the Company's activities with regard to the funds are subject to
significant regulation under the Investment Company Act of 1940. This regulation
includes restrictions on interlocking directorates between the Company and the
funds, prohibitions on certain types of transactions between the Company and the
funds, and requirements as to the terms of advisory agreements between the
Company and the funds.
BROKER DEALER REGULATION
The Company's broker-dealer subsidiary is registered under the Securities and
Exchange Act of 1934 and also is registered as a broker-dealer in 25 states.
This company is a member of the National Association of Securities Dealers, Inc.
(NASD), and is periodically examined by the NASD. The company is subject to
extensive regulation pertaining to matters including net capital, recordkeeping,
and advertising, and marketing activities.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT
SALES.
The Company and its subsidiaries have no foreign operations.
ITEM 2. PROPERTIES
The administrative offices of the Company and its subsidiaries and affiliates
are located in New Ulm, Minnesota, at 100 North Minnesota Street. The building
has a total office space of approximately 49,000 square feet. All of the
industry segments identified in Item 1 currently use the building for office
purposes. Parts of the building are leased to other persons. The building is
owned by the Company's indirect wholly-owned subsidiary, SBM Certificate
Company.
The Company's corporate offices are at Suite 1150, 8400 Normandale Lake
Boulevard, Minneapolis, Minnesota (the "Minneapolis Corporate Office"). The
Minneapolis Corporate Office is the location of the Company's corporate
executive officers and primary location for the Company's investment,
accounting, legal, marketing, customer service, and mortgage activities, and
various support personnel. This office contains approximately 15,208 square feet
of office space and is subject to a lease that extends through June 30, 1999.
The Company's broker-dealer subsidiary leases a branch office for its sales
representatives in Fresno, California.
ITEM 3. LEGAL PROCEEDINGS
(a) On November 16, 1994, the Commissioner of the Minnesota Department of
Commerce issued a cease and desist order to SBM Life. The order restricts
the following types of material transactions without approval of the
Commissioner: merging or consolidating with another company; paying
dividends; entering into new reinsurance agreements; making material
changes in management; increasing salaries and benefits of officers or
directors or making payment of bonuses; entering into any transactions with
officers and directors, including employment agreements, or making other
payments determined preferential by the Commissioner; disposing of,
conveying, or encumbering its assets or its business in force; or amending
or entering into new contracts with the holding company or other affiliated
companies. The order also restricts the following types of transactions
without approval of the Commissioner other than in the normal course of
business; withdrawing funds from its bank accounts; lending its funds;
incurring debt, obligation, or liability; terminating, surrendering,
forfeiting, converting, or lapsing any insurance policies, certificates or
contracts, except for nonpayment of premiums due; releasing, paying or
refunding premium deposits, accrued cash or loan values, unearned premiums,
or other reserves in an insurance policy, certificate, or contract. The
Company does not believe that the order affects its day to day operations.
(b) Pursuant to the terms of a Stock Agreement between the Company and the
Trustee for the Company's two employee benefit profit sharing plans, under
certain circumstances the Trustee of the Plans is entitled to "put" shares
of Company common stock in the Plans back to the Company at the higher of
fair market value or adjusted book value. In January of 1995, the Trustee
notified the Company of an exercise of a "put" back to the Company of all
shares of Company common stock in the Plans. There are currently 304,693
shares in the Plans. The Trustee argues that the adjusted book value of the
shares in the Plans should be computed based upon a pre-SFAS 115 amortized
cost method of valuing portfolio securities, resulting in a value at
December 31, 1994 of approximately $14 per share. A valuation performed as
of June 30, 1994 for purposes of establishing a fair market valuation of
the stock in the Plans showed a value of $6.29 per share. The adjusted book
value of the stock, computed in accordance with SFAS 115, was negative at
December 31, 1994.
The exercise of the "put" by the Trustee of all stock in the Plans would,
if valid, have a significant effect on the Company's liquidity position.
The Company does not currently have sufficient liquid assets to meet the
put. The exercise of the put at the price being argued by the Trustee also
would affect the Company's capital. The Trustee's valuation is
approximately $2.5 million more than that currently being used by the
Company. See Note M of the consolidated financial statements in Item 8
hereof.
The Company on March 1, 1995 filed a state court declaratory judgment
action in this matter seeking an interpretation of the Stock Agreement. The
Company in its complaint argues that (i) the "put" right that the Trustee
has with regard to the Company common stock in the Plans is a liquidity
put, and cannot be used to put the entire block of stock back to the
Company; (ii) the book value of the stock must be computed in accordance
with SFAS 115; and (iii) the Stock Agreement terminates upon dissolution of
the Company, and the Company is in the process of dissolving. See Sale and
Liquidation of the Company under Item 1 hereof. The action names as
defendants the Trustee of the Plans and the Company's largest common stock
holder, as a representative of the Company's other common stockholders.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
As of March 1, 1995, there were approximately 225 holders of the Company's
common stock and two holders of the Company's Series A Mandatory Redeemable
Voting Convertible Preferred Stock.
MARKET FOR COMMON EQUITY
There is currently no public market or trading in the common stock of SBM
Company. Prior to 1991 it was the Company's informal practice to purchase shares
that shareholders desired to sell at a value established by the Company. The
Company currently is not effecting general repurchases of shares of its common
stock from its shareholders.
In general, most common shares sold by the Company since 1966 (except for common
shares sold by the Company in a 1971 public offering) were sold pursuant to
purchase agreements giving the Company a right of first refusal with respect to
such stock. Before a shareholder may sell to a third party any common shares
subject to such right of first refusal, the shareholder must first offer to sell
common shares to the Company. Depending upon the form of the particular purchase
agreement, such right of first refusal either gives the Company the right to
acquire the common shares at the shareholder's offer price or at adjusted book
value. In recent years, it has not been the Company's practice to exercise its
right of first refusal under such purchase agreements, and the Company has no
present intention to exercise these rights in the future.
In December of 1993, the Company commenced a tender offer for up to 98,296
shares of its outstanding common stock. The tender offer was completed in
January of 1994. In the offer, approximately 530,000 shares were tendered and,
in accordance with the terms of its offer, the Company re-acquired 98,296 shares
or approximately 18.6% of the total tendered shares at a price of $15.26 per
share. The re-acquired stock represented 4.3% of the Company's outstanding
common stock and 2.8% of the Company's total outstanding voting stock.
In February of 1995, the Company entered into an agreement to sell substantially
all of its business operations. See Item 1.a. hereof.
DIVIDENDS
The following table presents dividends per share, and the Company's computation
of its adjusted book value (deficit) per common share for the past five years.
1994 1993 1992 1991 1990
---- ---- ---- ---- ----
Company's adjusted book
value (deficit) per common
share at year end $(13.67)* $15.73 $15.26 $14.15 $13.25
Common Stock
dividends per share $ .10 $ .40 $ .10 $ 0 $ .38
Series A Preferred $ 40.00 $ 80.00 NA NA NA
Stock dividends declared
per share
- -------------------------
* Adjusted book value in 1994 reflects the adoption by the Company of SFAS
115 effective January 1, 1994.
The Company's adjusted book value is calculated by the Company based upon the
consolidated net assets of the Company, as adjusted. In calculating book value,
for 1990 and prior years, the calculation began with the consolidated net assets
of the Company and added to that amount the deferred income taxes of the life
insurance subsidiary, if applicable, and the reserve for loan losses of the bank
subsidiary. Marketable equity securities were valued at cost. The resulting
amount was divided by total shares outstanding. In 1991, the Company entered
into a definitive agreement regarding the sale of its bank subsidiary, and in
1992 the Company sold that subsidiary. See Item 1(a) hereof. For 1991 and 1992,
the calculation of adjusted book value does not add the amount of the reserve
for loan losses of the bank. For 1993, the calculation of adjusted book value
assumes conversion of all outstanding shares of Series A Preferred Stock. For
1994, computation of book value does not include conversion of Series A
Preferred Stock or the warrant (SEE Note L of the consolidated financial
statements included in Item 8 hereof), as they would have been anti-dilutive.
Effective January 1, 1994, the Company adopted SFAS 115, which has a significant
effect on the computation of the Company's book value. See Management's
Discussion and Analysis of Financial Condition and Results of Operations.
The Company declared and paid a dividend on its common stock in each quarter of
1993 and in the first quarter of 1994 in the amount of $.10 per share. The
Company stopped paying dividends in the second quarter of 1994 and has no
current intention of paying dividends on its stock. SEE Items 3 and 7 hereof and
Notes A and M to the Company's consolidated financial statements in Item 8
hereof.
The Company has outstanding a class of preferred stock, its Series A Mandatory
Redeemable Voting Convertible Preferred Stock (the "Series A Preferred Stock").
The Series A Preferred Stock currently pays a cumulative dividend of 8%. The
dividend payable on the Series A Preferred Stock varies depending upon the
rating assigned to the stock by the NAIC Securities Valuation Office. The
dividend payable is 8% if the stock is rated 3 or lower and 6% if it is rated 2
or better. The last dividend paid on the Series A Preferred Stock was on June
15, 1994. The Company at March 31, 1995 was in arrears for three quarterly
Series A Preferred Stock dividends, or $1,140,000.
RESTRICTIONS ON PAYMENT OF DIVIDENDS
The Company's cash flow and its ability to pay dividends is largely dependent
upon management fees and on the receipt of dividends from its subsidiaries. The
payment of dividends and fees by the Company's insurance company subsidiary is
subject to legal restrictions, primarily imposed by applicable insurance laws
and regulations. Payment of dividends by that company also may be affected by
the amount of capital required to be maintained for rating agency purposes. The
Company's life insurance subsidiary currently is prohibited from paying
dividends without the written approval of the Minnesota Department of Commerce.
SEE Item 3. Payment of dividends by the Company's face amount certificate
subsidiary is subject to capital maintenance requirements applicable to that
company that are imposed under the Investment Company Act of 1940 and by the
Minnesota Department of Commerce.
In addition to the foregoing legal restrictions affecting the Company's ability
to pay dividends, the terms of the Company's outstanding Series A Preferred
Stock put substantial restrictions on the Company's ability to pay dividends on
its common stock. The restrictions on the Company's ability to pay dividends is
addressed in further detail in the following paragraphs.
Under the insurance laws of the State of Minnesota, dividend payments must be
paid solely from the adjusted earned surplus of a life insurance company.
Adjusted earned surplus means the earned surplus as determined in accordance
with statutory accounting practices (unassigned funds), less 25% of the amount
of such earned surplus which is attributable to unrealized capital gains.
Further, the life insurance company may not pay in any calendar year any
dividend which, when combined with other dividends paid within the preceding 12
months, exceeds the greater of (i) 10% of the life insurance company's statutory
surplus at the prior year-end or (ii) 100% of the life insurance company's
statutory net gain from operations (not including realized capital gains) for
the prior calendar year. Similar approval is required from the State of
California. SEE Note M of the consolidated financial statements in Item 8
hereof.
The Company's face amount certificate subsidiary has never paid cash dividends
on its common stock and it is anticipated that it will not pay such dividends in
the near future. The face amount certificate subsidiary is subject to two
principal restrictions on its ability to pay dividends. First, under the
Investment Company Act of 1940, this company is required to establish and
maintain minimum capitalization in the amount of certificate reserves plus
$250,000. Second, the Minnesota Department of Commerce has determined that face
amount certificate companies such as the Company's subsidiary should maintain
capital in the minimum amount of 5%. The Company's face amount certificate
company subsidiary had capital of approximately 6.9% at December 31, 1994 on an
amortized cost basis. See pages 13 and 14 hereof and Note M to the consolidated
financial statements in Item 8 hereof. The face amount certificate subsidiary
could not pay dividends if it did not meet both of these two requirements or if
the payment of such dividends would reduce its capital level below the level
required. Because the face amount certificate subsidiary is a subsidiary of the
Company's insurance company subsidiary, dividends from the certificate company
to the Company would be subject to regulatory restrictions both at the level of
the certificate company and at the level of the life insurance company.
SBM Financial Services, Inc. is subject to the Securities and Exchange
Commission's uniform net capital rule (Rule 15c3-1) which requires that the
ratio of aggregate indebtedness to net capital, both as defined, shall not
exceed 15 to 1. In addition, restrictions may be imposed to prohibit the company
from expanding its business or declaring dividends if its ratio of aggregate
indebtedness to net capital is greater that 10 to 1.
The terms of the Company's Series A Preferred Stock provide that, if the Company
is in default with respect to any dividend payable on shares of Series A
Preferred Stock, or if the Company has not effected certain mandatory
redemptions of the Series A Preferred Stock, no dividends may be paid or
declared on shares of common stock, nor may any shares of common stock be
purchased, redeemed or otherwise acquired for value by the Company except from
the Company's or a subsidiary's employee benefit plans as in effect on the issue
date of the Series A Preferred Stock. The terms of the Series A Preferred Stock
also provide that the Company shall not pay any dividends on its common stock or
repurchase any shares of common stock except from the Company's or a
subsidiary's employee benefit plans as in effect on the issue date of the Series
A Preferred Stock if, after giving effect to such dividend payment or stock
repurchase, the aggregate amount expended on such dividends and repurchases
since the issue date of the Series A Preferred Stock would exceed the sum of
$3,000,000 plus 50% of the Company's consolidated net income since January 1,
1993.
The payment of future dividends by the Company may be affected by the foregoing
limitations and by such other factors as the Board of Directors may deem
relevant.
ITEM 6. SELECTED FINANCIAL DATA
FOR THE YEAR ENDED 1994 1993 1992 1991 1990
DECEMBER 31: (in thousands except for per share data)
Total Revenues $59,932 $72,047 $69,027 $65,199 $56,937
Income (Loss) From
Continuing
Operations (1) (3,604) 3,748 3,039 3,043 (419)
Net Income (Loss) (3,604) 3,748 2,778 2,723 225
Per Common Share:
Primary:
Continuing
Operations (2.40) 1.35 1.32 1.32 (.18)
Net Income (Loss) (2.40) 1.35 1.21 1.18 .10
Fully diluted:
Continuing
Operations (2.40) 1.32 1.32 1.32 (.18)
Net Income (Loss) (2.40) 1.32 1.21 1.18 .10
Dividends declared
per share:
Common Stock .10 .40 .10 0 .38
Mandatory
Redeemable
Voting Convertible
Preferred Stock 40.00 80.00
AS OF DECEMBER 31:
Total Assets (1) 969,364 1,024,910 933,367 827,042 682,267
Face Amount Certi-
ficate Reserves 60,355 67,029 66,550 67,159 65,340
Future Policy
Benefits 910,104 891,923 810,963 708,330 556,683
Mandatory Redeemable
Voting Convertible
Preferred Stock 18,486 17,590 3,850
Common Stock Held By
Employee Benefit
Plans 1,917 4,809 4,856 4,496 4,231
Stockholders'
Equity (Deficit)(2)(31,977) 31,959 29,919 27,705 25,198
Total Assets of
Affiliated Mutual
Fund Companies 203,691 209,461 200,088 183,734 153,869
(1) During 1992 the Registrant completed the sale of State Bank & Trust Company
of New Ulm. These operations have been reported as discontinued operations.
See Note C of the consolidated financial --- statements in Item 8 hereof.
(2) Effective January 1, 1994, the Company adopted SFAS 115 which has a
significant effect on stockholders' equity. See Notes A and D of the
consolidated financial statements in Item 8 hereof.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
SALE AND LIQUIDATION OF THE COMPANY
Pursuant to an Amended and Restated Stock and Asset Purchase Agreement dated
February 16, 1995, between the Company and ARM Financial Group, Inc., ("ARM"),
the Company has agreed to sell substantially all of the business operations and
assets of the Company to ARM (the "Proposed Transaction") for a purchase price
of $38.6 million, subject to certain adjustments. As part of the Proposed
Transaction, ARM will acquire all of the outstanding stock of the subsidiaries
and certain other assets of the Company and assume certain liabilities of the
Company. Additionally, the agreement requires ARM to contribute between $15-20
million in additional capital to the subsidiaries. The completion of the
Proposed Transaction is subject to a number of contingencies, including the
obtaining of regulatory and shareholder approvals and is expected to close late
in the second quarter of 1995.
In connection with the Proposed Transaction, ARM had entered into agreements
with the holders of the Series A Mandatory Redeemable Voting Convertible
Preferred Stock of the Company to purchase such Preferred Stock and 72,950
shares of Common Stock immediately prior to the closing of the Proposed
Transaction (the "Preferred Agreements"). The Preferred Agreements contain
provisions which, among other things, require (i) the holders of the Preferred
Stock to vote in favor of the Proposed Transaction and a liquidation of the
Company subsequent to the consummation of the Proposed Transaction, (ii) the
holders of the Preferred Stock to refrain from taking various actions which
might interfere with the Proposed Transaction, and (iii) those holders, ARM, and
the Company to enter into mutual releases to be effective upon the Proposed
Transaction.
As soon as practicable after consummation of the Proposed Transaction, the
Company intends to wind up and liquidate the Company. The Board of Directors of
the Company has adopted a Plan of Dissolution, such Plan to be effective upon
consummation of the Proposed Transaction. The Plan of Dissolution is also
subject to shareholder approval. In the liquidation, distributions to the
holders of the common stock will be subject to the senior rights of the holders
of the Company's Preferred Stock.
The consolidated financial statements have been prepared on an historical basis
of accounting and do not include any purchase accounting, liquidation accounting
or other adjustments which would result upon completion of the Proposed
Transaction and the Plan of Dissolution. See Note B to the consolidated
financial statements in Item 8 hereof.
RESULTS OF OPERATIONS
Pretax results of operations by business segment is as follows:
YEAR ENDED DECEMBER 31,
(Dollars in Thousands) 1994 1993 1992
---- ---- ----
Pretax income (loss):
Annuities and Life Insurance $(4,406) $ 5,832 $ 5,949
Face Amount Certificates 555 56 (235)
Mutual Fund Investment
Advisory 240 302 324
Corporate (1,260) (642) (1,458)
-------- -------- ------
Pretax income (loss) from
continuing operations $(4,871) $ 5,548 $ 4,580
Income tax expense (benefit) (1,267) 1,800 1,541
-------- ------- -------
Income from continuing
operations before
cumulative effect of
change in accounting
principle (3,604) 3,748 3,039
Discontinued operations - - 3
Cumulative effect of change
in accounting principle - - (264)
-------- -------- --------
Net income (loss) $(3,604) $ 3,748 $ 2,778
======== ======= =======
The following discussion of results of operations refers to the above segment
results on amounts before income taxes.
Effective July 31, 1992, the Company completed the sale of its banking
subsidiary, State Bank & Trust Company of New Ulm ("State Bank"). As such, the
results of operations of State Bank have been presented as discontinued
operations. (See Note C to the consolidated financial statements in Item 8
hereof.)
ANNUITIES AND LIFE INSURANCE SEGMENT:
In November 1994, A.M. Best informed SBM Life that its rating was being reduced
from A- (excellent) to B+ (very good). A.M. Best indicated that the reasons for
the rating change were SBM Life's concentration in CMOs even after the
disposition of $186 million of CMOs (discussed in the Bond Portfolio section
below) and its desire that SBM Life increase its capital level. Also, during the
third quarter of 1994, several adverse newspaper articles were written
concerning SBM Life's investment portfolio and the unrealized depreciation
associated with it. The combination of these announcements and the reduction by
A.M. Best of SBM Life's rating has and will continue to negatively impact new
sales, especially in the Tax Sheltered Annuity ("TSA") marketplace. Policy
withdrawals and surrenders have also increased as a result of the above. These
factors should be considered in the review of the following discussion.
The main emphasis of SBM Life's business is the sale of deferred annuities.
Annuity premium for the years ended December 31, 1994, 1993, and 1992 was $71
million, $98 million, and $98 million, respectively. The decrease has mainly
been in both single premium deferred annuities and first year premium on sales
of 403(b) tax sheltered flexible premium deferred annuities. SBM Life believes
this is a result of competition from competitive products such as variable
annuities, changes to SBM Life's TSA product line which have not been fully
accepted by some agents, the goal of SBM Life to increase its investment spread
on annuity products, consumer concern about the soundness of the insurance
industry and the lowering by A.M. Best of its rating of SBM Life in the spring
of 1992 from A to A- (Excellent) and the further reduction of the rating in
November 1994 from A- to B+ (Very Good), along with the adverse newspaper
articles noted above.
During 1993 SBM Life discontinued several annuity products in its TSA product
line and replaced them with several new products. These products were not fully
accepted by some agents as commission levels were decreased and certain policy
liquidity features were reduced in the new products. In the third quarter of
1994, SBM Life restructured the commissions on these products which was
favorably received by the agents. However, the A.M. Best rating reduction and
newspaper articles noted above have significantly reduced SBM Life's sales in
the TSA marketplace. The TSA marketplace is very sensitive to claims paying
ratings and, with SBM Life's rating reduction, all of its major competitors have
higher ratings. As such, until SBM Life is able to improve its rating, new
annuity sales in the TSA marketplace will be significantly reduced from prior
periods. With the reduced rating, SBM Life will continue to market its products
in the non-qualified and the qualified non-TSA marketplaces which are not as
rating sensitive. However, annuity sales will also decrease in these areas.
Direct life insurance sales continue to decline. SBM Life is currently placing
substantially all of its emphasis on the annuity marketplace and direct life
insurance sales will continue to decline.
Return on invested assets excluding realized gains and losses and loan and real
estate losses for the years ended December 31, 1994, 1993, and 1992, were 7.59%,
7.86%, and 8.62%, respectively. The average rate of interest credited on
annuities was 5.48%, 6.18%, and 6.79% for the years ended December 31, 1994,
1993, and 1992, respectively. The interest rate spread increase in 1994 was
mainly the result of management reducing credited rates on January 1, 1994 for
older blocks of annuities. In 1993 the spread was 15 basis points lower than
that in 1992 as a result of significant prepayments in SBM Life's
mortgage-backed security portfolio being reinvested at lower rates as interest
rates declined in 1993. See below for a discussion of SBM Life's investment
portfolio repositioning program and its effect on future spread.
Bond Portfolio of SBM Life:
Over the past several years, SBM Life has invested mainly in U.S. Government
Agency/Instrumentality CMOs. The CMO marketplace was very actively traded during
this period and CMOs were considered a favorable investment for life insurance
companies. These securities have the highest credit rating and no default risk,
though the securities do involve interest rate and extension risk. SBM Life was
able to achieve higher yields with these securities compared to other securities
with comparable default risk.
Beginning toward the end of the first quarter of 1994, the CMO marketplace
became very depressed. This was the result of two main factors. First, interest
rates increased dramatically in the first six months of 1994 and continued to
rise throughout 1994. As such, the economic value of any fixed income security
declined significantly. In this declining bond market, CMOs were dramatically
affected. As interest rates rose, prepayments on mortgages underlying the CMOs
decreased, resulting in reduced principal cash flows and extensions of the
average maturities of these bonds. Such factors had a very negative effect on
the market value of CMOs. Second, combined with the rise in interest rates, the
CMO marketplace was negatively impacted due to the technical/emotional change in
the marketplace as a result of several well-publicized problems in several
broker/dealers, mutual funds and other companies. The effect of these factors
has been a significant decrease in price of CMOs which has resulted in
significant unrealized losses in SBM Life's CMO portfolio.
Toward the end of the second quarter of 1994, SBM Life determined it should
reduce the level of CMOs in its investment portfolio. This was based on its
analysis of the portfolio and discussions with regulators and the A.M. Best
rating service. As such, SBM Life developed an investment portfolio
repositioning program in which, in the third and fourth quarters of 1994, it
would sell a significant level of CMOs from all of the various types of CMOs it
held with emphasis on the more volatile CMOs including accrual bond, TTIB, and
inverse floater tranches.
Through this program, SBM Life sold CMOs with an amortized cost of approximately
$186 million realizing $9.4 million in pre-tax losses. CMOs in the following
tranches were sold: PACs - $91 million; Accrual Bonds - $45 million; TTIBs - $28
million; Sequentials - $15 million; Inverse Floaters - $5 million; Other - $2
million. This reduced the level of CMOs in SBM Life's investment portfolio,
based on amortized cost, from 77% at December 31, 1993 to 54% at December 31,
1994.
As a result of this investment portfolio repositioning program, effective June
30, 1994 SBM Life transferred approximately $234 million of securities
classified as held-to-maturity to the available-for-sale category with an
unrealized loss of $15.9 million. For a discussion of SBM Life's adoption of
SFAS 115 and its investment portfolio see "Capital Resources and Liquidity",
Notes A and D of the consolidated financial statements in Item 8 and pages 7 to
11 hereof.
The following table summarizes the distributions of CMOs held by SBM Life, at
carrying value, as of December 31 of each year:
Type of CMO 1994 1993
----------- -------------------- --------------------
(Dollars in Millions) (Dollars in Millions)
Planned amortization class (PAC) $257.2 72% $361.4 61%
Accrual Bonds 29.5 8% 82.5 14%
Two tiered index bonds (TTIB) 27.0 8% 69.2 12%
Sequential pay 4.3 1% 24.6 4%
Inverse floater 11.9 3% 16.7 3%
Targeted amortization class 14.0 4% 16.9 3%
Other 15.1 4% 19.8 3%
------ ---- ------ ----
$359.0 100% $591.1 100%
At this time SBM Life is not purchasing new CMOs. Proceeds from the sale of CMOs
described above and current cash flows are being invested in commercial paper,
U.S. Government or Agency securities and investment grade debt securities. The
repositioning program initially has reduced the overall yield on SBM Life's
investment portfolio by approximately 25 to 35 basis points which will reduce
future profitability. SBM Life has no investments in interest only or principal
only CMOs. Additionally, SBM Life does not utilize speculative derivative
products, such as swaps, futures or options.
Realized investment gains were a significant source of income to SBM Life in
1993 and 1992 of $3,845,000, and $4,400,000, respectively. Realized investment
gains resulted primarily from the sale of GNMA and FNMA mortgage-backed
securities. SBM Life's investment policy was to hold investments to maturity.
However, market conditions and other factors sometimes dictated changes in
investment portfolios which resulted in realized gains or losses. Effective
January 1, 1994, SBM Life adopted a new accounting standard which established
new criteria for classifying SBM Life's investment portfolio.
See "Capital Resources".
Mortgage and Real Estate Portfolio:
Loss provisions of $320,000, $663,908, and $2,124,952 were recognized for the
years ended December 31, 1994, 1993, 1992, respectively. As a result of the
gradually improving economy and active management of the loan portfolio,
management has been able to reduce non-performing loans and the 1994 and 1993
loss provisions. Management believes the loss reserves provided at this time are
adequate. However, a future downward trend in the real estate market could have
an additional adverse impact on SBM Life's mortgage loan and real estate owned
portfolios. SBM Life's strategy with respect to owned real estate is to lease
the properties to enhance marketability and then sell them in an orderly
fashion. This may require SBM Life to hold the properties for extended periods
of time.
Guaranty Fund Assessments:
SBM Life has been adversely impacted as a result of guaranty fund assessments.
For the years ended December 31, 1994, 1993, and 1992, SBM Life has recognized a
charge to operations of $1,791,617, $1,463,411, and $1,296,293, respectively,
for these assessments. The assessments were made by state guaranty associations
to obtain funds to pay off policy holders of insolvent insurance companies. The
assessments are based on the proportion of SBM Life's premiums in a particular
state to total premiums for all companies in that state. Assessments received by
SBM Life in 1993 and 1992 were mainly for the insolvencies of Executive Life
Insurance Company and Midwest Life Insurance Company and in 1994 for Executive
Life and Investors Equity Life Insurance Company of Hawaii. SBM Life has no
control over these assessments and additional assessments in future years are
probable, but indeterminable in amount, at this time.
FACE AMOUNT CERTIFICATE SEGMENT:
The Company's face amount certificate subsidiary, SBMCC, currently offers one
type of face amount certificate, the Series 503 Certificate.
The following table summarizes face amount certificate activity for the three
years ended December 31, 1994:
REDEMPTIONS Certificate
CERTIFICATES Prior to Reserves
Sold Renewed At Anniversary Anniversary (at End of Period)
---- ------- -------------- ----------- -----------------
Year Ended December 31,
1994 . . . . . . . . . $5,332,840 $16,849,478 $ 8,321,218 $ 7,294,768 $60,355,015
Year Ended December 31,
1993 . . . . . . . . . 5,984,921 7,431,998 3,391,651 6,204,653 67,028,639
Year Ended December 31,
1992 . . . . . . . . . 9,771,496 19,437,653 10,484,137 4,428,308 66,550,117
Face amount certificate sales decreased by $.7 million in 1994 compared to 1993
and decreased by $3.8 million in 1993 compared to 1992. As interest rates in
general decrease, sales of certificates tend to decrease as investors look for
other investments that have a higher yield. The sale of certificates is very
sensitive to interest rates offered on competitive products, mainly bank
certificates of deposit. SBMCC reviews its certificate interest rate structure
to ensure it is competitive in the marketplace while still being profitable. The
changes in sales between years reflects SBMCC's monitoring of competitive rates
and adjusting its rates accordingly.
The increase in renewed certificates in 1994 compared to 1993 was a result of
increased scheduled maturities in 1994. The decrease in renewed certificates in
1993 compared to 1992 is due to there being significantly less certificates with
anniversary dates in 1993 compared to 1992. Overall, the renewal rate has held
fairly steady at an average of 65% to 70%. Scheduled maturities of certificates
in 1995, 1996, and 1997 are approximately $25.7 million, $10.1 million, and
$19.4 million, respectively. In order to maintain SBMCC's historical certificate
renewal rate, it will be necessary for SBMCC to remain competitive in the
marketplace with bank certificates of deposit. If this is not done, both new
sales and renewal rates will decrease.
SBMCC believes that the increase in redemptions prior to anniversary in 1994 and
1993 is due to investors using the certificates for investing cash for short
term periods while they consider alternative investment vehicles. Investors
receive a reduced rate of interest when they redeem their certificates prior to
the anniversary date, but the rate received still tends to be equal to or higher
than typical bank savings rates.
Sales of new certificates for the first two months of 1995 are approximately
one-half the level of sales for the comparable period in 1994. In addition,
during the first two months of 1995, certificate renewal rates have decreased by
approximately 10% from historical renewal levels. SBMCC believes these decreases
are mainly the result of the certificate of deposit marketplace currently being
very competitive as many financial institutions are offering special high rates
to induce customers to open new accounts. SBMCC has increased its rates to
remain as competitive as possible in order to attempt to maintain its historical
certificate renewal rates and generate new certificate sales while still
maintaining adequate operating spreads.
During 1993 and 1994, SBMCC was able to improve its investment spreads by
lowering interest rates in 1993 offered on new and renewed Series 503
Certificates and enhancing its investment yield by adding U. S. Government
Agency CMOs to its investment portfolio. For 1992, operating losses were
incurred due to insufficient spreads between income earned on investment assets
and rates paid on certificate liabilities. This was due primarily to investment
rates decreasing and not maintaining a sufficient spread over rates paid on
certificates. For the years ended December 31, 1994, 1993, and 1992, the average
gross yield on SBMCC's investment portfolio was 7.89%, 7.69%, and 8.16%,
respectively. The average yield paid to certificate holders for the years ended
December 31, 1994, 1993, and 1992 was 5.69%, 6.28%, and 7.05%, respectively. As
can be seen from the above, over the last three years there has been an
increasing spread which resulted in positive investment income in 1993 and 1994.
To improve its investment spreads and as a result of the decreasing interest
rate environment, SBMCC had lowered the interest rates offered on new Series 503
Certificates several times during 1992 and 1993. In 1994, interest rates offered
on new Series 503 Certificates were increased several times to be competitive
with other investment products and the increasing interest rate environment.
SBMCC is closely monitoring these new rates against competitive products, mainly
bank certificates of deposit. Further interest rate adjustments on new
certificates will be made as deemed necessary.
In order to enhance investment yields during 1993 and early 1994, SBMCC added U.
S. Government Agency CMOs to its investment portfolio. SBMCC has been able to
achieve higher yields with these securities without taking on additional credit
risk. However, these securities do have additional interest rate risk in that
volatility in the interest rate market will cause the fair value of these
securities to fluctuate significantly. In addition, the average lives of these
investments can significantly extend. See "Liquidity".
SBMCC believes that, given current market conditions, and assuming relatively
level rates of interest, the net interest margin should decline slightly as
outstanding certificates paying interest at lower rates mature and are renewed
at the slightly higher rates of interest, and as new certificates are sold at
lower rates of interest. In addition, if interest rates continue to rise, it may
be difficult for SBMCC to maintain its current level of interest rate spread.
SBMCC continues to review its asset/liability management strategies to maximize
the spread between investment income and interest expense.
In addition to the spread between investment income and interest expense which
contributed to the operating results discussed above, operating results have
been impacted by provisions for losses on SBMCC's loan and real estate assets.
During the years ended December 31, 1993 and 1992 SBMCC provided a loan loss
provision of $55,000 and $60,000 respectively. No additional provision was
required in 1994.
During 1994, 1993, and 1992 SBMCC realized net investment gain (losses) before
income tax of $29,783, ($3,173), and ($33,397) respectively. This includes
realized net security gains of $3,768, $201,359, and $141,603 in 1994, 1993, and
1992, respectively. SBMCC's investment policy is to hold investments until
maturity. However, market conditions and other factors sometimes will dictate
changes in investment portfolios which may result in realized gains or losses.
During 1993 and 1992, it was SBMCC's decision to liquidate specific
mortgage-backed security pools which were experiencing accelerated principal
paydowns. Also, during 1993 and 1992, SBMCC recognized losses of $175,000 in
each year on its investment in a real estate limited partnership. In 1994, SBMCC
recognized a gain of $26,015 compared to a loss of $29,532 in 1993 on certain
properties held for investment.
MUTUAL FUND INVESTMENT ADVISORY SEGMENT:
Mutual fund assets under management have seen minimal change over the last three
years and were $203 million, $209 million, and $200 million at December 31,
1994, 1993, and 1992, respectively. Advisory and other fees collected from the
funds have remained relatively stable each year as the funds have fluctuated in
size, with total fees being $1,399,000, $1,401,000 and $1,316,000 in 1994, 1993
and 1992, respectively. However, the Company has incurred increased operating
expenses. As such, the Company has shown a decrease in operating income in this
segment in each of the three years ended December 31, 1994. Mutual fund sales
(excluding the State Bond Cash Management Fund) have been $17 million, $19
million and $25 million, for the years ended December 31, 1994, 1993 and 1992,
respectively. Mutual fund sales have slowed during 1994 and 1993 as the
Company's limited distribution system has been unable to maintain and grow
mutual fund sales in today's competitive mutual fund marketplace. Mutual fund
redemptions in 1994, 1993 and 1992 were $19 million, $20 million and $12
million, respectively. The increase in redemptions in 1994 and 1993 over 1992 is
the result of the competitive marketplace described above and the funds aging
shareholder base.
CORPORATE SEGMENT:
The increase in the corporate pretax loss in 1994 relates to a $490,000 loss on
the sale of the Company's aircraft. The decrease in corporate pretax loss in
1993 compared to 1992 was due primarily to a decrease in unrecovered costs from
subsidiaries.
OPERATING EXPENSES:
Operating expenses continue to increase in 1994. The increases in 1993 and 1992
primarily relate to the growth in SBM Life. In 1994, expense increases mainly
relate to consulting, actuarial and other professional fees analyzing various
strategies regarding the capital of the Company including recapitalization,
issuance of shares, tender offer and sale of the Company.
INCOME TAXES:
The effective tax rate for continuing operations for the Company was (26.0%),
32.4% and 33.7% for the years ended December 31, 1994, 1993 and 1992,
respectively. The rate differs from the Federal rate of 35% in 1994 and 1993 and
34% in 1992, mainly due to tax exempt interest in the face amount certificate
segment in 1994 and 1993, the benefit of graduated income tax rates, and in 1994
the change in estimate of the income tax valuation allowance.
Effective January 1, 1992, the Company adopted FASB Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). The
statement changed the practice of recognition and measurement of deferred tax
assets and liabilities. The Company has recorded a decrease in net income of
$264,000 as a cumulative effect of change in accounting principle in 1992. In
addition, the Company began recording the unrealized depreciation on marketable
equity securities net of income tax benefit.
The Internal Revenue Service (the "IRS") has conducted examinations of the
Company's income tax returns for the years 1986 through 1990 and has proposed
several adjustments to increase taxable income relating to the timing of certain
deductions. Based on these adjustments, additional tax due would be
approximately $1.3 million plus interest. However, additional taxes currently
payable would be principally offset by deductions to taxable income in future
periods. The Company has filed a protest with the Appellate Division of the IRS
and is vigorously contesting all of the proposed adjustments. The Company
believes the ultimate resolution of this matter will not have a material adverse
effect on the Company's consolidated results of operations or financial
position.
CAPITAL RESOURCES
Except for the mutual fund adviser operations, each of the Company's business
segments is capital intensive and requires certain levels of capital based on
requirements of regulators or rating agencies.
SFAS 115:
Effective January 1, 1994, the Company adopted Financial Accounting Standards
Board Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for
Certain Investments in Debt and Equity Securities. The primary impact of SFAS
115 is to require the Company to classify its debt securities into categories
based upon the Company's intent relative to the eventual disposition of the
securities. SFAS 115 establishes three categories of securities: (1)
Held-to-maturity securities are comprised of securities which the Company has
the positive intent and ability to hold to maturity. These securities are
carried at amortized cost. SFAS 115 prevents the Company from classifying a
security as held-to-maturity if the security might be sold for liquidity needs
or based on changes in interest rates. (2) Available-for-sale securities may be
sold to address liquidity and other needs of the Company. These securities are
held at "fair value" on the balance sheet with an increase or decrease to
stockholders' equity for unrealized gains or losses after the recording of
deferred income taxes. (3) Trading securities would be securities acquired for
the purpose of selling them in the near term. The Company does not intend to
classify any of its securities as trading securities.
Upon adoption of SFAS 115, the Company analyzed its debt securities and
determined that to maintain flexibility in its investment portfolio it would
classify a significant portion of its investment portfolio as available-for-sale
even though management did not have the intention of selling these securities.
As such, as of January 1, 1994, approximately $505.6 million of its debt
securities were classified as available-for-sale with approximately $254.2
million classified as held-to-maturity. The market value of the
available-for-sale securities created a net unrealized after tax gain of $3.8
million, after adjustment for deferred acquisition costs, at January 1, 1994.
Due to an investment portfolio repositioning program, (see "Results of
Operations - Bond Portfolio"), in mid-1994, SBM Life transferred approximately
$234 million of securities classified as held-to-maturity to the
available-for-sale category with an unrealized loss of $15.9 million. With the
significant increase in interest rates in 1994, the market value of the
available-for-sale securities at December 31, 1994 resulted in a net pre-tax
unrealized loss of $79.1 million and a deferred tax benefit of approximately
$6.5 million. A tax valuation allowance of approximately $20.3 million has been
established for the additional tax benefit that cannot be recognized at this
time. In addition, deferred policy acquisition costs have been increased by
$12.8 million, net of a deferred tax liability of $6.5 million, in conjunction
with SFAS 115. As a result of the implementation of SFAS 115, the Company's
stockholders' equity as of December 31, 1994 was a deficit of $(32) million due
to the reporting of the unrealized losses, net of income tax benefit and
deferred acquisition cost adjustment, on debt securities classified as
available-for-sale of $(59.7) million. During 1994, changes in market interest
rates have caused fluctuations in the value of securities classified as
available-for-sale which has created volatility in the Company's stockholders'
equity (deficit). At February 28, 1995, the unrealized pre-tax loss had
decreased from December 31, 1994 by approximately $26 million.
Capital Issues:
During the period 1992 through 1993, SBM Life has had significant growth and to
support this growth the Company has made capital infusions in SBM Life of
$7,880,000 in 1993 and $8,950,000 in 1992 from the sources described below.
However, in 1994, as a result of the adoption of SFAS 115 and its impact on
stockholders' equity as a result of rising interest rates and the resulting
unrealized losses in the Company's investment portfolios, regulatory concerns
regarding capital, and the reduction in SBM Life's A. M. Best rating, the
Company has had to look to outside sources of capital and as a result has
entered into the pending sale of the Company. (See "Sale and Liquidation of the
Company").
During the past years the Company has recognized its need to raise capital to
support growth. During 1992 the Company retained an investment banker and in
December 1992 the Company entered into a Preferred Stock and Note Purchase
Agreement to raise $19,000,000 of capital. This transaction was completed in
September of 1993. The investors are a group composed of SBM Partners L. P. (of
which Head Insurance Investors L.P. and Jupiter Industries, Inc. are the general
partners), and Georgia International Life Insurance Company. For an additional
description of this transaction and the Series A Preferred Stock, see Items 5
and 11 hereof and Note M to the consolidated financial statements.
The proceeds from the sale of the Series A Preferred Stock were used as follows:
$11,250,000, as a capital infusion into SBM Life, $1,450,000 for Series A
Preferred Stock issuance costs, $3,000,000 to repay the Company's outstanding
line of credit, $1,500,000 for common stock repurchase as described below, and
$1,800,000 for general corporate purposes.
In December of 1993, the Company commenced a tender offer for up to 98,296
shares of its outstanding common stock. The tender offer was completed in
January of 1994. The Company received tenders of approximately 530,000 shares
and, in accordance with the terms of its offer, re-acquired 98,296 shares, or
approximately 18.6% of the total tendered shares, at a price of $15.26 per
share. The re-acquired stock represented 4.3% of the Company's total outstanding
common stock and 2.8% of the Company's total outstanding voting stock.
Effective December 31, 1993 the Company transferred the stock of its
wholly-owned subsidiary, SBMCC, to SBM Life as a capital contribution. As such,
SBMCC is an indirect subsidiary of the Company. The initial effect of the
capital contribution was to increase the capital of SBM Life by $3,880,000.
The Company completed the sale of State Bank in August of 1992. The proceeds
from the sale were used to repay the Company's secured loan ($5 million) and for
additional capital infusions of $1,700,000 and $750,000 to SBM Life and SBMCC,
respectively.
To improve its capital position in previous years, SBM Life entered into an
annuity coinsurance agreement. The total account value ceded in annuity
coinsurance as of December 31, 1994 and 1993 was approximately $105 million and
$117 million, respectively.
Dividends and Regulatory Matters:
The ability of the Company to pay cash dividends to shareholders may be
dependent upon the amount of dividends received from subsidiaries as well as
regulatory and rating agency requirements. See Items 3 and 5 hereof and Note M
of the consolidated financial statements in Item 8 hereof for a summary of
dividend restrictions and capital requirements for each subsidiary.
For regulatory purposes, SBM Life must maintain its financial statements in
accordance with statutory accounting principals. The Company's life insurance
subsidiary has strengthened its reserves on five policy forms in accordance with
Proposed Actuarial Guideline GGG. The Minnesota Department of Commerce and the
California Insurance Department, the Company's domiciliary and commercially
domiciliary states, respectively, have approved the reserve strengthening over a
three-year period beginning in 1994. The strengthening totals $12.3 million and
according to the three year phase-in provision, one-third of this total, or $4.1
million, is included in reserves in the 1994 statutory basis financial
statements of the subsidiary with the remaining two-thirds to be reflected
equally in 1995 and 1996. The NAIC also enacted certain changes to these
principles for 1992, which include the establishment of an Asset Valuation
Reserve ("AVR") and the Interest Maintenance Reserve ("IMR") to replace the
Mandatory Securities Valuation Reserve. The combination of the reserve change,
AVR and IMR will reduce statutory capital and surplus over time, and may reduce
the dividend-paying ability of SBM Life.
The NAIC has developed minimum risk-based capital requirements for life
insurance companies. The formulas for determining the amount of risk-based
capital specify various weighting factors that are applied to financial balances
or various levels of activity based on the perceived degree of risk. Regulatory
compliance is determined by a ratio of a company's regulatory total adjusted
capital, as defined, to its authorized control level risk-based capital, as
defined. Companies below specific trigger points or ratios are classified within
certain levels, each of which requires specified corrective action. As of
December 31, 1994, SBM Life has sufficient capital under these risk-based
capital requirements.
For regulatory matters SEE Regulation under Item 1 hereof and Note M of the
consolidated financial statements in Item 8 hereof.
NEW ACCOUNTING PRONOUNCEMENTS:
In May of 1993, the FASB issued Statement of Financial Accounting Standards No.
114, "Accounting by Creditors for Impairment of a Loan" (SFAS 114). The standard
is effective for fiscal years beginning after December 15, 1994. The primary
effects of SFAS 114 for the Company will be related to the accounting for
impaired commercial loans. The fundamental issue addressed is the utilization of
discounted cash flows in establishing allowances for impaired loans. Adoption of
this standard will result in higher losses in the period the impairment is
recognized with correspondingly higher income in future periods. Although the
Company has not fully evaluated SFAS 114's potential impact, it is not expected
to have a material impact on the Company.
At December 31, 1994, the Company had no material commitments for capital
expenditures or loan commitments.
LIQUIDITY
Liquidity for the Company is measured by the ability of each subsidiary or other
business segment (as described above) to provide adequate cash flows to meet the
needs of the financial instruments it has issued and its operating expenses.
Each of the Company's subsidiaries maintains liquidity based on past history and
expected future cash flow needs.
ANNUITY AND LIFE INSURANCE SEGMENT:
The liquidity requirements of SBM Life are based upon its required ability to
pay scheduled and unscheduled benefit payments (mainly on annuities) and
operating expenses. SBM Life has performed cash flow testing which did not
reveal any significant liquidity inadequacies which could not be handled in the
normal course of business. Sources of liquidity include interest payments on
investments, scheduled and unscheduled principal payments on investments,
premium payments and deposits, and the sale of investments. The changes in the
CMO marketplace (See "Results of Operations - Bond Portfolio" and "Business -
Changes in Interest Rates in 1994"), have extended the lives of SBM Life's CMO
portfolio and have significantly reduced the amount of principal received by SBM
Life from its CMO investments. In addition, the A.M. Best rating reduction and
the adverse newspaper articles (see "Results of Operations - SBM Life"), have
increased surrender and withdrawal requests. All of these items have indicated
the need for additional liquidity for SBM Life. As such, SBM Life has increased
its short term investments including short-term corporate bonds to $57 million
as of December 31, 1994, and as of mid-March 1995 has increased its short term
investments, including short-term corporate bonds, by an additional $22 million.
SBM Life believes this provides it with ample liquidity for payment of
surrenders and withdrawals. However, if liquidity needs exceeded current cash
flow and short term investments, SBM Life's investment portfolio, which includes
corporate bonds, U.S. Government and Agency notes, GNMA and FNMA Certificates
and CMOs, is readily marketable and securities could be sold as necessary. If
SBM Life was required to sell some of the above debt securities, depending on
the interest rate environment at the time of sale, losses may be realized which
would reduce its capital level.
Annuity surrenders and withdrawals for SBM Life for 1994, 1993 and 1992 were $84
million, $64 million and $40 million, respectively. During the past seven years
SBM Life has had significant growth with its annuity reserves increasing from
$143 million at December 31, 1987 to $787 million (net of ceded reserves) at
December 31, 1994. With this increasing level of reserves, a corresponding
increase in surrenders and withdrawals is expected. Many of the annuities sold
by SBM Life allow the annuitant a 10% per year free withdrawal privilege. As the
number of outstanding policies increases, a certain percentage of annuities will
elect to use this feature. Also, each year a larger number of policies have the
surrender charge period expire, which allows annuitants to surrender their
policies without any penalty. On one particular product a significant number of
policies are reaching this point and surrenders on this product have increased.
In addition, the higher interest rates during 1994 have caused some increase in
withdrawals as annuity holders look for other investments which have higher
rates of return. As mentioned previously, the change in SBM Life's A.M. Best
rating and the adverse newspaper articles also caused an increase in withdrawals
and will have a negative effect in 1995. In the fourth quarter of 1994,
withdrawals and surrenders (exclusive of withdrawals and surrenders on ceded
business) totaled approximately $22.9 million. This activity has continued into
1995, with withdrawals and surrenders through March 31, 1995 totaling
approximately $44.2 million.
FACE AMOUNT CERTIFICATE SEGMENT:
The asset/liability strategy of SBMCC has been to use a combination of
longer-term assets (mainly GNMA and FNMA securities, GNMA and U.S. Government
Agency CMOs, and mortgages) and short-term commercial paper to match against its
face amount certificate liabilities. While GNMA and FNMA securities have a
stated maturity of 30 years, the typical average life of such securities is
seven to twelve years due to prepayments. However, due to the increasing
interest rate environment in 1994 the remaining average life of SBMCC's GNMA and
FNMA Certificates currently is approximately nine to ten years.
During 1993 and early 1994 SBMCC increased the portion of the portfolio invested
in U.S. Government Agency CMOs backed by U.S. Government Agency securities to
approximately 43% at December 31, 1994. SBMCC purchased these CMOs with a
weighted average life of 4.5 years and currently the CMO portfolio has a
weighted average life of seven to eight years.
The average lives of the GNMAs, FNMAs, and CMOs have, in the past, provided a
relatively good match with the certificates, which have an initial term of three
years, but historically have had a high level of retention by certificate
holders (approximately 65- 70% of all matured certificates have been renewed).
As such, the certificate's average life (6-7 years based on the historical
renewal rates above) is considerably longer than the initial stated term of
three years, and approached the GNMA, FNMA and CMO average lives. In 1994,
however, the interest rate environment extended the average lives of these
securities, as noted above, beyond the average life of the certificates and
principal prepayments on the securities slowed considerably. As a result, to
assure adequate liquidity, in the first quarter of 1995, SBMCC sold $5.4 million
of available-for-sale portfolio securities and recognized pre-tax losses on the
sales of $314,000. SBMCC believes that it currently has sufficient resources to
meet its liquidity needs. If prepayments on SBMCC's GNMAs, FNMAs, and CMOs
decrease or if the renewal rate on the certificates decreases or there is an
increase in certificate surrender rates, SBMCC could have additional liquidity
needs. Management is monitoring this situation closely and will adjust its
investment portfolio, if necessary.
The residential and commercial mortgages held by SBMCC, which, at December 31,
1994, made up approximately 6.7% of SBMCC's qualified investments, have an
average weighted maturity of approximately six years.
The GNMA and FNMA certificates, CMOs, bonds, and other securities invested in by
SBMCC are readily marketable, and in most instances provide monthly principal
and interest payments as a source of liquidity. It should be noted, however,
that in connection with certain types of investments in which SBMCC does or may
invest, depending upon the terms of such amount of prepayments of principal may
not begin until a certain date, or may be affected in timing and amount by
prepayments of underlying obligations. In 1993, prepayments increased
significantly as many higher interest rate mortgages were refinanced as a result
of the low interest rate environment. However, in 1994 prepayments decreased due
to generally increasing interest rates in 1994 which dramatically slowed down
mortgage refinancing and the related prepayments on the CMOs and GNMA and FNMA
certificates.
While there may currently be a mismatch in duration between the investments and
the liabilities to face amount certificate holders, and a slowdown in
prepayments, as discussed above, SBMCC believes it has adequate liquidity with
which to meet payment needs on SBMCC's face amount certificate obligations with
the use of funds from interest and principal payments, current levels of
commercial paper and from the sale of available-for-sale debt securities, if
necessary. However, if liquidity needs required SBMCC to sell debt securities,
depending on the interest rate environment at time of sale, losses may be
realized. Any losses incurred by SBMCC would reduce its capital level and future
resources for making payments on certificates.
INFLATION:
The primary effect of inflation on the Company has been increases in operating
expenses of which salaries are a significant portion. In addition, government
economic policy results in changes in interest rates which affect the Company's
sales of products, investment income, stockholders' equity and overall interest
spread.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
SBM COMPANY AND SUBSIDIARIES
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
SBM Company and Subsidiaries
Minneapolis, Minnesota
We have audited the accompanying consolidated balance sheets of SBM Company and
subsidiaries as of December 31, 1994 and 1993 and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 1994. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of SBM Company and
subsidiaries as of December 31, 1994 and 1993 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1994 in conformity with generally accepted accounting principles.
As discussed in Note A to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 109, "Accounting for
Income Taxes," in 1992, and Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", in 1994.
As discussed in Note B to the consolidated financial statements, the Company has
agreed to sell substantially all of the business operations and assets of the
Company, subject to a number of contingencies, including the obtaining of
regulatory and shareholder approvals. As soon as practicable after the
consummation of the sale, the Company intends to wind up and liquidate the
Company. The accompanying financial statements have been prepared on a
historical basis of accounting and do not include any purchase accounting,
liquidation accounting or other adjustments which would result upon completion
of the proposed sale and resulting liquidation.
DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
March 29, 1995
F-1
SBM COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
Assets
December 31
-----------------------------
1994 1993
------------ ----------
Investments:
Debt securities available-for-sale at market - Note D.......................... $653,207,076 $ -
Debt securities held-to-maturity at amortized cost - Note D.................... 13,944,234 742,940,222
Debt securities held for sale - Note D......................................... - 16,674,496
Marketable equity securities at market - Note D................................ 683,089 962,268
Mortgage loans - Note E........................................................ 36,257,214 44,255,353
Policy loans................................................................... 22,153,936 20,401,812
Other invested assets.......................................................... 1,694,506 2,188,327
Short-term investments......................................................... 37,602,490 8,762,806
----------- ------------
Total investments........................................................... 765,542,545 836,185,284
Cash............................................................................. 3,565,693 898,726
Accrued investment income........................................................ 8,470,103 5,705,199
Receivable from reinsurer - Notes A and J........................................ 105,806,093 117,493,980
Deferred policy acquisition costs, less accumulated amortization - Note F........ 76,950,470 56,720,069
Land, building and equipment, at cost less accumulated
depreciation of $2,470,302 and $2,625,527, respectively - Note I............... 1,417,796 3,891,259
Deferred income taxes - Note K................................................... 3,091,000 2,305,000
Refundable income taxes.......................................................... 3,003,386 354,818
Other assets..................................................................... 1,517,067 1,356,114
------------- --------------
$ 969,364,153 $1,024,910,449
============= ==============
Liabilities and Stockholders' Equity (Deficit)
Future policy benefits........................................................... $910,104,179 $ 891,923,036
Face amount certificate reserves - Note H........................................ 60,355,015 67,028,639
Accounts payable and other liabilities........................................... 9,252,047 8,352,811
Notes payable - Note I........................................................... - 2,012,210
Deferred compensation and retirement benefits for officers - Note L.............. 1,227,284 1,236,048
------------- --------------
Total liabilities.............................................................. 980,938,525 970,552,744
-------------- --------------
Mandatory redeemable voting convertible preferred stock,
par value $1,000 (1994 includes $760,000 dividends in arrears). Authorized
19,000 shares, issued 19,000 shares, liquidation value $19,000,000 plus
dividends in arrears - Note M.................................................. 18,485,868 17,589,680
Common stock held by employee benefit plans; 304,693 and
305,693 shares, respectively - Note M.......................................... 1,916,519 4,808,551
Commitments and contingencies - Notes J, L, M and N
Common stock, no par value. Authorized 20,000,000 shares;
issued and outstanding 2,179,714 and 2,279,755 shares, respectively,
less 304,693 and 305,693 shares held by employee benefit plans, respectively... 2,945,606 3,101,197
Unrealized losses on marketable equity securities - Notes D and K................ (254,388) (165,742)
Unrealized losses on debt securities - Notes A, D and K.......................... (59,691,765) -
Retained earnings................................................................ 25,023,788 29,024,019
---------- ----------
Total stockholders' equity (deficit) - Note M............................... (31,976,759) 31,959,474
----------- ----------
$969,364,153 $1,024,910,449
============= ==============
See notes to consolidated financial statements.
F-2
SBM COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31
-------------------------------------------
1994 1993 1992
----------- ----------- ------------
Revenues:
Net investment income............................................ $62,887,722 $ 60,884,031 $ 58,090,436
Underwriting, sales service and distribution fees................ 3,124,299 3,618,848 3,124,309
Life insurance premiums.......................................... 392,801 415,141 441,921
Advisory and other fees from affiliated mutual funds............. 1,481,074 1,486,052 1,391,679
Realized investment (losses) gains, net.......................... (9,799,377) 3,828,598 4,366,646
Other income..................................................... 1,845,231 1,814,676 1,612,317
---------- ----------- ----------
Total revenues................................................ 59,931,750 72,047,346 69,027,308
---------- ----------- ----------
Benefits and expenses:
Provisions for benefits:
Annuities and life insurance................................... 42,466,335 44,659,544 42,868,428
Face amount certificate reserves (interest) - Note H........... 3,575,075 4,089,905 4,531,992
Loan and real estate losses - Notes D and E...................... 320,000 718,908 2,184,952
Death and other benefits......................................... 471,419 489,768 533,766
Commissions, wages and benefits.................................. 7,148,918 6,795,909 6,320,839
Interest expense................................................. 124,363 598,450 540,982
Amortization of deferred policy acquisition costs - Note F....... 4,275,361 4,076,736 2,934,718
Occupancy and equipment.......................................... 1,370,685 1,433,732 1,426,801
State guaranty association assessments........................... 1,791,617 1,463,441 1,296,293
Other expenses................................................... 3,259,408 2,173,256 1,808,463
---------- ---------- ---------
Total benefits and expenses................................... 64,803,181 66,499,649 64,447,234
---------- ---------- ----------
Income (loss) from continuing operations before income taxes... (4,871,431) 5,547,697 4,580,074
Income taxes (benefit) - Note K.................................. (1,267,000) 1,800,000 1,541,000
---------- --------- ---------
Income (loss) from continuing operations......................... (3,604,431) 3,747,697 3,039,074
Income from discontinued operations, less income taxes of
$45,409 in 1992 - Note C....................................... - - 183,295
Loss on disposal of discontinued operations, including income taxes (benefit)
of ($65,000) in 1992 - Note C.................................. - - (180,000)
---------- --------- --------
Income (loss) before cumulative effect of change in accounting (3,604,431) 3,747,697 3,042,369
principle
Cumulative effect of change in accounting principle - Note A..... - - (264,000)
---------- ---------- --------
Net income (loss)............................................. $(3,604,431) $ 3,747,697 $ 2,778,369
============ ============ ============
Discount accretion on preferred stock............................ $ 136,188 $ - $ -
Mandatory redeemable voting convertible preferred stock dividends $1,520,000 $ 657,802 $ -
=========== ============ ============
Net income (loss) applicable to common stock..................... $(5,260,619) $ 3,089,895 $ 2,778,369
============ ============ ============
Earnings per common share:
Primary:
Income (loss) from continuing operations....................... $ (2.40) $ 1.35 $ 1.32
Cumulative effect of change in accounting principle............ - - (.11)
------------ ------------ -------------
Net income (loss)............................................. $ (2.40) $ 1.35 $ 1.21
============ ============ =============
Fully diluted:
Income (loss) from continuing operations....................... $ (2.40) $ 1.32 $ 1.32
Cumulative effect of change in accounting principle............ - - (.11)
------------ ------------ -------------
Net income (loss)............................................. $ (2.40) $ 1.32 $ 1.21
============ ============ =============
Weighted average common shares outstanding (primary)............. 2,187,481 2,281,673 2,295,932
Weighted average common shares outstanding (fully diluted)....... 2,187,481 2,971,923 2,295,932
See notes to consolidated financial statements.
F-3
SBM COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Unrealized
losses
on marketable Unrealized Total
Common equity losses on debt Retained stockholders'
stock securities securities earnings equity (deficit)
---------- ----------- ----------- ----------- ---------------
Balances at December 31, 1991.............................. $3,210,461 $ (342,021) $ - $24,836,590 $27,705,030
Net income............................................ - - - 2,778,369 2,778,369
Common stock dividends declared, $.10 per share....... - - - (229,226) (229,226)
Allocation of net income in excess of dividends to
common stock held by employee benefit plans....... - - - (354,515) (354,515)
Income tax effect relating to marketable equity
securities for adoption of SFAS No. 109 - Note A.. - 116,000 - - 116,000
Decrease in unrealized loss on marketable
equity securities, net of income tax benefit...... - 12,997 - - 12,997
Purchase of 7,700 shares.............................. (109,264) - - - (109,264)
--------- --------- -------- ---------- ----------
Balances at December 31, 1992.............................. 3,101,197 (213,024) - 27,031,218 29,919,391
Net income............................................ - - - 3,747,697 3,747,697
Dividends declared:
Common stock, $.40 per share...................... - - - (911,925) (911,925)
Mandatory redeemable voting convertible preferred .. - - - (657,802) (657,802)
stock, 8%
Decrease in unrealized loss on marketable
equity securities, net of income tax benefit...... - 47,282 - - 47,282
Accretion of discount on mandatory redeemable
voting convertible preferred stock................ - - - (38,994) (38,994)
Allocation of net income in excess of dividends to
common stock held by employee benefit plans....... - - - (146,175) (146,175)
--------- --------- -------- ---------- -----------
Balances at December 31, 1993.............................. 3,101,197 (165,742) - 29,024,019 31,959,474
Net loss.............................................. - - - (3,604,431) (3,604,431)
Dividends declared:
Common stock, $.10 per share...................... - - - (217,971) (217,971)
Mandatory redeemable voting convertible preferred .. - - - (760,000) (760,000)
stock, 8%
Dividends in arrears on mandatory redeemable
voting convertible preferred stock, 8%............ - - - (760,000) (760,000)
Adoption of SFAS No. 115 - Note A..................... - - 3,800,000 - 3,800,000
Increase in unrealized loss on marketable
equity securities, net of income tax benefit...... - (88,646) - - (88,646)
Accretion of discount on mandatory redeemable
voting convertible preferred stock................ - - - (136,188) (136,188)
Allocation of net loss, dividends and carrying value to
common stock held by employee benefit plans....... - - - 2,876,307 2,876,307
Increase in unrealized loss on debt securities........ - - (63,491,765) - (63,491,765)
Purchase of 100,041 shares including acquisition costs
of $42,193........................................ (155,591) - - (1,397,948) (1,553,539)
----------- ---------- ------------ ----------- -----------
Balances at December 31, 1994.............................. $2,945,606 $ (254,388) $(59,691,765) $25,023,788 $(31,976,759)
========== ========== ============ =========== =============
See notes to consolidated financial statements.
F-4
SBM COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31
-------------------------------------------
1994 1993 1992
------------ ------------ ------------
Cash flows from operating activities:
Net income (loss)................................................ $(3,604,431) $ 3,747,697 $ 2,778,369
------------ ------------ ------------
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating activities:
Provisions for losses and benefits:
Annuities and life insurance................................ 42,466,335 44,659,544 42,868,428
Face amount certificate reserves (interest)................. 3,575,075 4,089,905 4,531,992
Loan and real estate losses................................. 320,000 718,908 2,184,952
Depreciation.................................................. 302,491 318,025 311,633
Amortization of deferred policy acquisition costs............. 4,275,361 4,076,736 2,934,718
Deferred income taxes......................................... (786,000) (252,000) (180,850)
Premium amortization, net..................................... (4,537,537) (4,396,269) (5,117,106)
Realized investment (gains) losses, net....................... 9,799,377 (3,828,598) (4,366,646)
Decrease (increase) in operating assets:
Accrued investment income...................................... (2,764,904) (120,792) (434,472)
Receivable from reinsurer...................................... (300,934) 363,943 115,346
Deferred policy acquisition costs capitalized.................. (5,205,762) (7,932,570) (9,789,170)
Refundable income taxes........................................ (2,648,568) 282,256 (637,074)
Other assets................................................... (160,953) 991,081 126,602
Increase (decrease) in operating liabilities:
Accounts payable and other liabilities......................... 899,236 1,388,655 (125,758)
Deferred compensation and retirement benefits for officers..... (8,764) (68,268) 12,760
Income taxes payable........................................... - - (1,699,180)
------------ ------------ -----------
Net cash provided by operating activities........................ 41,620,022 44,038,253 33,514,544
------------ ------------ -----------
Cash flows from investing activities:
Proceeds from maturities and repayments of debt securities:
Available -for-sale........................................... 67,792,568
Held-to-maturity.............................................. 22,833,787 311,637,232 164,812,308
Proceeds from other investments sold............................. 314,979 -
Proceeds from sales of debt securities:
Available-for-sale............................................ 176,422,655 - -
Held-to-maturity.............................................. 11,983 103,871,141 110,139,335
Cost of debt securities acquired:
Available-for-sale............................................ (242,280,515) - -
Held-to-maturity.............................................. (16,678,534) (513,801,212) (414,625,769)
Cost of other investments purchased.............................. (2,880) - -
Sales (purchases) of short-term investments, net................. (28,729,158) 6,710,632 34,583,053
Loan principal repayments........................................ 17,472,582 22,503,776 19,193,176
Loans funded..................................................... (11,142,529) (10,654,812) (11,957,427)
Proceeds from (additions to) land, building and equipment, net... 2,170,973 (203,697) (163,922)
Proceeds from disposal of discontinued operations................ - - 7,591,174
----------- ----------- ------------
Net cash used in investing activities......................... (11,814,089) (79,936,940) (90,428,072)
----------- ----------- ------------
Cash flows from financing activities:
Payments to face amount certificate holders...................... (15,615,986) (9,596,304) (14,912,445)
Reserve payments from face amount certificate holders............ 5,332,840 5,984,921 9,771,496
Deposits received from annuitants, net........................... 73,987,946 99,636,112 98,844,866
Payments to annuitants........................................... (86,284,317) (65,545,851) (41,417,119)
Sale of preferred stock.......................................... - 11,000,000 4,000,000
Expenses on issuance of preferred stock.......................... - (1,299,314) (150,000)
Purchase of common stock......................................... (1,569,268) (193,375) (153,835)
Dividends on common stock........................................ (217,971) (683,925) (229,226)
Dividends on preferred stock..................................... (760,000) (657,802) -
Principal payments on notes payable.............................. (2,012,210) (3,175,575) (6,533,976)
Proceeds from notes payable...................................... - - 6,222,853
Sale of common stock............................................. - - 50,000
------------ ----------- ----------
Net cash provided by financing activities..................... (27,138,966) 35,468,887 55,492,614
------------ ----------- ----------
Net increase (decrease) in cash..................................... 2,666,967 (429,800) (1,420,914)
Cash at beginning of year........................................... 898,726 1,328,526 2,749,440
------------ ----------- ----------
Cash at end of year................................................. $ 3,565,693 $ 898,726 $ 1,328,526
=========== ============ ============
See notes to consolidated financial statements.
F-5
SBM COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of SBM Company (the
"Company") and all wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
See Note B for reclassifications regarding discontinued operations. In addition,
for comparability, certain prior year amounts have been reclassified to conform
with the current year presentation.
INVESTMENTS
Effective January 1, 1994, the Company adopted Financial Accounting Standards
Board Statement of Financial Accounting Standards (SFAS) No. 115, ACCOUNTING FOR
CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. The primary impact of SFAS
115 is to require the Company to classify its debt securities into categories
based upon the Company's intent relative to the eventual disposition of the
securities. SFAS 115 establishes three categories of securities: (1)
Held-to-maturity securities are comprised of securities which the Company has
the positive intent and ability to hold to maturity. These securities are
carried at amortized cost. SFAS 115 prevents the Company from classifying a
security as held-to-maturity if the security might be sold for liquidity needs
or based on changes in interest rates. (2) Available-for-sale securities may be
sold to address liquidity and other needs of the Company. These securities are
held at "fair value" on the balance sheet with an increase or decrease to
stockholders' equity for unrealized gains or losses after the recording of
deferred income taxes. (3) Trading securities would be securities acquired for
the purpose of selling them in the near term. The Company does not intend to
classify any of its securities as trading securities.
Upon adoption of SFAS 115, the Company analyzed its debt securities and
determined that to maintain flexibility in its investment portfolio it would
classify a significant portion of its investment portfolio as available-for-sale
even though management did not have the intention of selling these securities.
As such, as of January 1, 1994, approximately $505.6 million of its debt
securities were classified as available-for-sale with approximately $254.2
million classified as held-to-maturity. The fair value of the available-for-sale
securities created a net unrealized after tax gain of $3.8 million, after
adjustment for deferred acquisition costs, at January 1, 1994. Due to an
investment portfolio repositioning program in mid 1994, the Company's life
insurance subsidiary transferred approximately $234 million of securities
classified as held-to-maturity in to the available-for-sale category with an
unrealized loss of $15.9 million. With the significant increase in interest
rates in 1994, the market value of the available-for-sale securities at December
31, 1994 resulted in a net pretax unrealized loss of $79.1 million and a
deferred tax benefit of approximately $6.6 million. A tax valuation allowance of
approximately $20.3 million has been established for the additional tax benefit
that cannot be recognized at this time. In addition, deferred policy acquisition
costs have been increased by $12.8 million, net of a deferred tax liability of
$6.5 million, in conjunction with SFAS 115. This amount is included in the
stockholders' equity section for unrealized losses on debt securities
available-for-sale. During 1994, changes in market interest rates and other
factors have caused fluctuations in the value of securities classified as
available-for-sale which has created volatility in the Company's stockholders'
equity.
Marketable equity securities are carried at fair value, and any change in
unrealized losses, net of deferred income taxes, is recorded directly against
stockholders' equity (deficit).
The fair values for actively traded bonds, such as GNMA and FNMA Certificates,
are based on quoted market prices. The fair values of collateralized mortgage
obligations (CMOs) are based on quotes from independent brokers. Considerable
judgment is required in interpreting market data to develop estimates of fair
value for CMOs; accordingly, these quotes are not necessarily indicative of the
amounts that could be realized or would be paid in a current sale of the
security. The fair values of equity securities are based on closing market
quotations or on estimates from independent broker-dealers and pricing services.
When evidence indicates there is an other than
F-6
temporary decline in the underlying value of individual investments, such
investments are written down to reflect such impairment by a charge to realized
gains (losses) in the consolidated statements of income. Realized gains or
losses on the sale of investments are computed on the basis of specific
identification of investment costs.
Mortgage loans on real estate are carried at amortized cost less an allowance
for loan losses.
Real estate acquired in satisfaction of loans is stated at the lower of cost or
fair value, less cost of disposition, at the date acquired. If there are
subsequent declines in market value, the property is adjusted to fair value
through current earnings. Foreclosed real estate is included as a component of
other invested assets.
Securities held-for-sale were carried at the lower of amortized cost or market.
As of December 31, 1993, these securities consisted of FNMA and GNMA
certificates with a market value of $17,514,330.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses provides for potential losses when other than
temporary declines have occurred in the value of the real estate and other
assets securing the loans. The allowance is based upon management's evaluation
of a number of factors, including loan loss experience, a continuing review of
problem loans and current and anticipated economic conditions that may affect
the borrower's ability to repay the loan. The allowance is increased by
provisions charged to operating expense and reduced by net chargeoffs. Loans are
placed on non-accrual status when management believes the collection of interest
is uncertain, generally when payments are past due more than three months.
DEFERRED POLICY ACQUISITION COSTS
The costs of acquiring and issuing new life insurance policies, annuity
contracts and face amount certificates, principally commissions, expenses of
issuance and underwriting and certain sales expenses have been deferred.
Deferred policy acquisition costs applicable to annuity contracts are amortized
over the lives of the policies in relation to the present value of estimated
gross profits from investment and expense margins. The deferred policy
acquisition costs applicable to traditional life insurance policies are
amortized to income over the premium-paying periods of the related policies in
proportion to the ratio of the expected annual premium revenues to total
anticipated premium revenues from the life insurance policies. Expected premium
revenue was estimated using the same actuarial assumptions as were used in
calculating the liabilities for future policy benefits. Deferred acquisition
costs applicable to face amount certificates are amortized on a straight-line
basis over three years.
LAND, BUILDING AND EQUIPMENT
Depreciation is computed using the straight-line method over estimated useful
lives of thirty-three years for the building and related improvements and from
three to twenty years for equipment.
FUTURE POLICY BENEFITS
The liability for future policy benefits for traditional life insurance has been
computed by a net level premium method based on assumptions as to investment
yields, mortality, withdrawals and dividends. The assumptions are based on
projections of past experience and include provisions for possible unfavorable
deviation. These assumptions are made at the time the contract is issued.
The liability for future policy benefits for flexible premium and single premium
deferred annuities represents accumulated account values with interest currently
at 4.50% to 8.0%.
The Company records ceded reinsurance receivables, including amounts related to
paid and unpaid benefits and amounts related to liabilities for future policy
benefits, as assets and liabilities on the Company's consolidated balance sheet.
As of December 31, 1994 and 1993, receivable from reinsurer and future policy
benefits on the consolidated balance sheet include reinsurance receivables of
$105,428,796 and $117,417,617, respectively.
F-7
FACE AMOUNT CERTIFICATE RESERVES
Face amount certificates issued by the Company's subsidiary entitle certificate
holders, who have made either single or installment payments, to receive a
definite sum of money at maturity. Certificate reserves earn interest and cash
surrender values are less than accumulated certificate reserves prior to
maturity dates. Certificate reserves are maintained for advance payments by
certificate holders and accrued interest thereon, and for interest earned and
accrued due to additional interest rates declared. The reserve accumulation
rates, cash surrender values and certificate reserves, among other matters, are
governed by the Investment Company Act of 1940.
INCOME TAXES
Effective January 1, 1992, the Company adopted FASB Statement of Financial
Accounting Standards No. 109, ACCOUNTING FOR INCOME TAXES (SFAS 109). The
statement changed the practice of recognition and measurement of deferred tax
assets and liabilities. The Company has recorded a decrease in net income of
$264,000 as a cumulative effect of change in accounting principle in 1992. In
addition, the Company began recording the unrealized loss on marketable equity
securities net of income tax benefit. The effect of the adoption of SFAS 109 on
the results of 1992 was not material.
EARNINGS PER SHARE
Primary earnings per share were computed by dividing net income (loss) less
dividends on mandatory redeemable voting convertible preferred stock by the
weighted average number of common shares outstanding during each year. The
mandatory redeemable voting convertible preferred stock is not considered to be
a common stock equivalent. Fully diluted earnings per share for 1993 assumes
conversion of the mandatory redeemable voting convertible preferred stock into
690,250 weighted average common shares and a $180,000 adjustment for interest,
net of tax, paid on the convertible promissory note. For 1994, the warrant (Note
L) and the assumed conversion of the mandatory redeemable voting convertible
preferred stock would have been anti-dilutive and are not considered in primary
or fully diluted common shares, respectively.
MANDATORY REDEEMABLE VOTING CONVERTIBLE PREFERRED STOCK
The discount on the mandatory redeemable voting convertible preferred stock is
being accreted through a charge against retained earnings over ten years using
the effective interest method.
UNDERWRITING, SALES SERVICE AND DISTRIBUTION FEES
Sales service fees for selling and servicing life insurance policies and annuity
contracts are recognized at the time a new policy or contract is written and as
premiums are collected from policy and contract holders thereafter. Underwriting
fees for sale of mutual fund shares and other products are recognized at the
time of sale. All significant intercompany transactions have been eliminated
with no effect on net income since fees received by the Company's sales
subsidiary approximate the costs incurred by the Company and its other
subsidiaries.
PREMIUM REVENUE
Life insurance premiums are reported as earned when due. Benefits and expenses
are associated with earned premiums in a manner that results in recognition of
policy profits over the lives of the related policies.
Annuity contracts which do not subject the Company to significant risks arising
from policyholder mortality or morbidity are considered interest-sensitive
insurance contracts. Amounts received as payments for such contracts are not
reported as revenues. Revenues for investment products consist of investment
income and policy administration charges. Contract benefits that are charged to
expense include benefit claims incurred in the period in excess of related
contract values and interest credited to contract values.
F-8
CONSOLIDATED STATEMENTS OF CASH FLOWS
Supplemental Cash Flow Information:
Cash paid for interest during the years ended December 31, 1994, 1993 and 1992,
was $4,062,114, $4,784,118 and $5,715,562, respectively. Cash paid for income
taxes, net of refunds received, for the years ended December 31, 1994, 1993 and
1992, were $2,062,899, $2,057,832 and $4,827,637, respectively.
Noncash Investing and Financing Activities:
At December 31, 1994, the Company was $760,000 in arrears for dividends on the
mandatory redeemable voting convertible preferred stock.
During 1993 and 1992, the Company sold real estate owned properties and financed
$2,235,000, and $2,265,750 of the purchase prices, respectively. During 1993 and
1992, the Company foreclosed on certain mortgage loans and acquired the
underlying real estate collateral. This real estate was then transferred to
other invested assets at the lower of cost or fair value less cost of
disposition of $2,374,951 and $1,296,163 in 1993 and 1992, respectively.
During 1993, the Company's $4,000,000 Convertible Promissory Note was converted
into 4,000 shares of the Company's Series A Mandatory Redeemable Voting
Convertible Preferred Stock.
IMPACT OF ACCOUNTING PRONOUNCEMENTS TO BE ADOPTED IN THE FUTURE
In May 1993, the Financial Accounting Standards Board issued SFAS No. 114 (SFAS
114), ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN. SFAS 114 is effective
for fiscal years beginning after December 15, 1994. The primary effect of the
statement for the Company will be related to the accounting for impaired
commercial mortgage loans. The significant issue addressed is the utilization of
fair value in establishing allowances for impaired loans. The Company estimates
that the effect of adoption of SFAS 114 will not be material.
B. SALE AND LIQUIDATION OF THE COMPANY
Pursuant to a Stock and Asset Purchase Agreement dated February 16, 1995,
between the Company and ARM Financial Group, Inc., (ARM), the Company has agreed
to sell substantially all of the business operations and assets of the Company
to ARM (the Proposed Transaction) for a purchase price of $38.6 million, subject
to certain adjustments. As part of the Proposed Transaction, ARM will acquire
all of the outstanding stock of the subsidiaries and certain assets of the
Company and assume certain liabilities of the Company. Additionally, the
agreement requires ARM to contribute between $15-20 million in additional
capital to the subsidiaries (See Note M regarding Stockholders' Equity and
Regulatory Matters). The completion of the Proposed Transaction is subject to a
number of contingencies, including the obtaining of regulatory and shareholder
approvals.
As soon as practicable after consummation of the Proposed Transaction, the
Company intends to wind up and liquidate the Company. The Company anticipates
adopting a Plan of Dissolution, such Plan to be effective upon consummation of
the Proposed Transaction. In the liquidation, distributions to the holders of
common stock will be subject to the senior rights of the holders of the Series A
Preferred Stock (Note M) and the Series B Preferred Stock (no Series B shares
are outstanding as of December 31, 1994).
At the Company's regular meeting of shareholders, expected to be held in April
or May 1995, the Company's shareholders will vote on the above matters. A proxy
statement will be sent to all shareholders with detailed information concerning
the Proposed Transaction and the Plan of Dissolution.
The Proposed Transaction and the Plan of Dissolution each require the
affirmative vote of the holders of a majority of the voting power of all shares
entitled to vote, voting together as a single class. Approval of the Proposed
Transaction also requires the affirmative vote of the holders of 66 2/3% of the
outstanding shares of Series A Preferred Stock, voting separately as a class.
The accompanying consolidated financial statements have been prepared on an
historical basis of accounting and do not include any purchase accounting,
liquidation accounting or other adjustments which would result upon completion
of the Proposed Transaction and the Plan of Dissolution.
C. DISCONTINUED OPERATIONS
Effective July 31, 1992, the Company completed the sale of its banking
subsidiary, State Bank and Trust Company of New Ulm (State Bank). During 1991,
the Company had entered into the definitive sales agreement and recorded a loss
of $550,000 including income taxes. During 1992, the selling price for State
Bank was adjusted and an additional loss of $180,000 including income taxes was
recognized. The results of operations for State Bank are presented as
discontinued operations. Total revenue for State Bank was $5,107,000 for the
seven months ended July 31, 1992.
F-9
D. INVESTMENTS
Investment securities by type and gross unrealized gains and losses at December
31 are presented below:
1994 1993
---------------------------------------------- ----------------------------------------------------
Amortized Gross Unrealized Fair Amortized Gross Unrealized Fair
Cost Gains Losses Value Cost Gains Losses Value
----------------------------------------------- ----------------------------------------------------
Debt securities
available-for-sale:
CMOs $ 444,647,746 $ - $(70,647,798) $373,999,948
GNMA certificates 88,584,779 224,202 (2,399,982) 86,408,999
FNMA certificates 19,483,095 11,277 (958,581) 18,535,791
Corporate bond
obligations 78,968,327 77,713 (1,580,342) 77,465,698
U.S. Government
obligations 100,578,894 - (3,782,254) 96,796,640
-------------- ----------- ----------- -----------
$ 732,262,841 $ 313,192 $(79,368,957) $653,207,076
============= =========== ============ =============
Debt securities
held-to-maturity:
CMOs $ 13,108,720 $ - $ (1,987,005) $ 11,121,715 $621,734,824 $6,257,066 $(2,246,751) $625,745,139
GNMA certificates - - - - 98,391,554 5,269,320 - 103,660,874
FNMA certificates - - - - 13,121,007 483,603 - 13,604,610
Corporate bond obligations - - - - 8,496,298 742,342 - 9,238,640
State and municipal 667,053 5,601 (34,254) 638,400 676,380 30,848 (21,007) 686,221
obligations
U.S. Government 168,461 - (15,248) 153,213 520,159 14,697 - 534,856
obligations
--------------- ---------- ------------ ------------ ------------- ----------- ------------ -------------
$ 13,944,234 $ 5,601 $ (2,036,507) $ 11,913,328 $742,940,222 $12,797,876 $(2,267,758) $753,470,340
============== ========== ============== ============= ============= =========== ============ =============
Marketable equity securities:
Preferred stocks $ 1,065,645 $ 6,932 $ (392,368) $ 680,209 $ 1,114,010 $ 35,840 $ (287,582) $ 862,268
Common stocks.... 2,880 - - 2,880 - - - -
Affiliated mutual funds - - - - 100,000 - - 100,000
------------- ---------- ------------ ------------- ------------ ------------ ------------ -------------
$ 1,068,525 $ 6,932 $ (392,368) $ 683,089 $ 1,214,010 $ 35,840 $ (287,582) $ 962,268
============== ========== ============== ============= ============= =========== ============= =============
CMOs are a discreet pool of mortgage-backed securities which are generally
issued in several classes. Each such class bears or accrues any interest to
which it is entitled at a specified rate or at a rate calculated in a
specified manner. Principal on the mortgage loans ultimately underlying a
series of CMOs may be allocated among the several classes within such
series in a variety of ways, resulting in classes of CMOs which return
principal based on a specified or scheduled order. By varying the rates or
methods of calculating interest on several classes within a series of CMOs
and the allocations of principal among such classes, a CMO issuer can
create "derivative" securities with a wide range of payment
characteristics. These securities include the inverse floaters and the
two-tier index bonds held by the Company. All of the CMOs held by the
Company are collateralized by mortgage pass-through certificates which are
guaranteed by either FNMA or FHLMC.
As of December 31, 1994 the Company's CMO portfolio consisted of the
following classes based on carrying value:
Available- Held-to-
for-Sale Maturity
Planned amortization class (PACs) 70.5% 38.1%
Two-tiered index bonds (TTIBs) 8.3 20.4
Accrual bond (Z bond) 7.9 12.3
Targeted amortization class (TACs) 3.8 19.1
Inverse floating rate 3.6 .6
Companion bonds (SUPs) 3.5 9.5
Sequential 1.1 -
Very acccurately determined maturity (VADMs) .8 -
Floating rate .5 -
----- ------
100.0% 100.0%
====== ======
A PAC CMO has a fixed interest rate and is a class that is designed to
receive fixed principal payments using a predetermined schedule over a
predetermined time period under a wide range of prepayment scenarios which
makes the average life of the security more predictable. A sequential pay
class ("Sequential") has a fixed interest rate and receives principal
payments in a prescribed sequence continuously from the first payment date
until the class is paid off. The average life of the class will shorten or
lengthen based on prepayments.
F-10
A TTIB is a CMO class whose coupon is fixed until the applicable index such as
the Cost of Funds Index ("COFI") reaches a specified level known as the first
strike. When the index is higher than a first strike, the TTIB becomes an
inverse floater whose coupon declines to its floor at the second strike. The
floor at the second strike typically will be zero. On initial purchase date the
first strike on a TTIB is generally two to three hundred basis points (2-3%)
above the current level of the applicable index. Consequently, it is unlikely at
the date of purchase that the first strike would be reached in the near future.
At December 31, 1994, the weighted average first strike on the TTIBs held by the
Company was 2.41% above the applicable index and, accordingly, none of these
securities have become inverse floaters. The Company would purchase TTIBs in
anticipation of an interest rate and prepayment environment in which prepayments
would remain at moderate to high levels, in which event the TTIBs generally
would pay off before the first strike is reached. Nevertheless, if the index
applicable to a TTIB reaches its first strike, the value of the TTIB would be
expected to decline. The average life of a CMO TTIB can vary greatly, depending
upon prepayments.
An accrual bond class of CMOs, also known as Z bond, does not pay periodic
interest, but rather accumulates interest at a specified rate until the
principal of the class becomes payable. The accumulated interest then is paid
when the principal is repaid. An accrual bond class of CMOs enables the holder
to avoid reinvestment risk. However, in a period of increasing interest rates,
an accrual bond class of CMOs is likely to experience a greater decline in value
than a current-interest class with the same interest rate and principal payment
schedule.
A TAC is similar to a PAC, in that they both have a schedule of principal
repayments. TACs provide more protection against call risk, but offer less
protection against extension risk.
A floating rate security has an interest rate that is based on a known index
such as COFI and is adjusted periodically, typically monthly, as such index rate
changes. The interest rate of the security moves in the same direction as the
index. Inverse floating rate classes are securities with a coupon that moves in
the reverse direction to an applicable index such as COFI. Accordingly, the
coupon rate thereon will increase as interest rates decrease and decrease as
rates increase, in some cases by a greater amount than the amount of change in
the related index rate. Inverse floating rate securities are typically more
volatile than fixed or floating rate securities. The current yield on the
Company's inverse floating rate securities was approximately 10.4% at December
31, 1994. Inverse floating securities would be purchased by the Company to
attempt to protect against a reduction in the income earned on the Company's
investments due to a decline in interest rates and a corresponding increase in
prepayments. The Company would be adversely affected by the purchase of such
securities in the event of an increase in interest rates since the coupon rates
thereon will decrease as interest rates increase, and, like other fixed income
securities, the value will decrease as interest rates increase.
The Companion (Support) Class acts as a shock absorber. It takes excess cash
flow or does not get a payment so that the PAC and TAC classes can be paid. This
is a CMO class that receives principal payments on any payment date only if
scheduled payments have been made on specific PAC and TAC classes.
VADMs or Accretion Directed class pays principal from specified accretions of
accrual bonds. VADM's may, in addition, receive principal from the collateral
paydowns. This class is a CMO that has a very stable average life because the
cashflows are directed from the Z bonds, which receive no principal payments.
The amortized cost and fair value of debt securities at December 31, 1994, by
contractual maturity are shown below. Actual maturities may differ from
contractual maturities because the borrower may have the right to call or prepay
with or without call or prepayment penalties.
Amortized Fair
Debt securities available-for-sale: Cost Value
------------ ------------
Due in one year or less..................................................... $33,491,503 $ 33,111,737
Due after one year through five years....................................... 141,053,572 136,436,774
Due after five years through ten years...................................... 4,950,702 4,665,156
Due after ten years......................................................... 51,444 48,671
------------ -----------
179,547,221 174,262,338
Mortgage-backed securities.................................................. 552,715,620 478,944,738
----------- -----------
$732,262,841 $653,207,076
============= ============
Amortized Fair
Debt securities held-to- maturity: Cost Value
---------- ------------
Due in one year or less..................................................... $ 50,000 $ 50,000
Due after one year through five years....................................... 110,000 109,153
Due after five years through ten years...................................... 217,228 214,576
Due after ten years......................................................... 458,286 417,884
------- -------
835,514 791,613
Mortgage-backed securities.................................................. 13,108,720 11,121,715
---------- ----------
$13,944,234 $ 11,913,328
=========== ============
F-11
The weighted average stated maturity of mortgage-backed securities was in excess
of 20 years as of December 31, 1994. However, after factoring in estimated
prepayments of the underlying loans, the weighted average duration of the
Company's GNMA and FNMA Certificates and CMO portfolio, in the aggregate, is 8.5
years. Changes in interest rates would effect the prepayment speed of the
underlying mortgages and the average lives of the securities. If interest rates
increased, it would be expected that the average life of these securities would
increase and correspondingly, if interest rates decreased, the average life
would decrease.
Gross gains and (losses) in 1994 from debt securities available-for-sale were
$852,201 and $(10,193,636), respectively. Gross gains from debt securities
held-to-maturity in 1994 were $1,864. Gross gains of $3,976,052 and $4,506,501
and gross losses of $0 and $28,078 were recognized in 1993 and 1992,
respectively.
At December 31, 1994 and 1993, debt securities of the life insurance subsidiary
carried at $14,845,594 and $13,273,964, respectively, were on deposit with
various states pursuant to legal deposit requirements.
Investments in affiliated mutual funds include shares of the Company's
affiliated tax-free income fund. This investment primarily represents "seed"
money for the start-up of the fund. Under regulations of the Investment Company
Act of 1940, the investments may not be liquidated until all organization costs
of the fund are amortized, unless the fund is reimbursed for unamortized
organization costs at the time of sale. This investment was liquidated in 1994
after organization costs were fully amortized.
Short-term investments consist of commercial paper with maturities of less than
35 days.
Real estate acquired in satisfaction of loans included in other invested assets
was $1,462,149 and $1,910,004 at December 31, 1994 and 1993, respectively.
During 1994, 1993 and 1992, the Company recognized losses on real estate owned
of $320,000, $258,908 and $759,216, respectively.
Net investment income summarized by investment category for the three years
ended December 31, is as follows:
1994 1993 1992
----------- ------------ ------------
Debt securities available-for-sale.................................. $54,509,734 $ - $ -
Debt securities held-to-maturity.................................... 953,519 55,147,353 50,160,174
Marketable equity securities........................................ 60,154 66,328 92,835
Mortgage loans...................................................... 4,586,675 5,019,123 7,109,735
Policy loans........................................................ 851,780 717,164 605,219
Short-term investments.............................................. 2,412,970 654,426 903,870
----------- ------------ -------------
Total investment income.......................................... 63,374,832 61,604,394 58,871,833
Less investment expenses............................................ (487,110) (720,363) (781,397)
----------- ------------ -------------
$62,887,722 $ 60,884,031 $ 58,090,436
=========== ============ ============
E. MORTGAGE LOANS
A summary of the changes in the allowance for loan losses as of December 31 is
as follows:
1994 1993 1992
----------- ------------ -----------
Balance at beginning of year........................................ $ 1,609,000 $ 1,617,000 $ 1,154,000
Provision for loan losses......................................... - 460,000 1,425,000
Less loans charged off............................................ (18,000) (468,000) (962,000)
----------- ------------ -------------
Balance at end of year.............................................. $ 1,591,000 $ 1,609,000 $ 1,617,000
=========== ============ ============
At December 31, 1994 and 1993, nonperforming loans (past due three months or
more) totaled $0 and $1,836,890 and restructured loans totaled $6,380,264 and
$4,621,475, respectively. Had such loans been accruing interest in accordance
with the original terms, interest income would have been $706,129 and $770,554
for the years ended December 31, 1994 and 1993, respectively. Interest income
received on restructured and nonperforming loans was $595,296 and $501,154 for
the years ended December 31, 1994 and 1993, respectively.
As of December 31, 1994 and 1993, approximately 51% and 53% of the mortgage loan
property was in Minnesota and 12% and 12% was located in Arizona, respectively,
with the remainder in various geographic areas of the United States. Mortgage
loans by significant types as of December 31, 1994 and 1993, were as follows:
industrial/warehouse - 41% and 39%; office/warehouse - 35% and 32%; office - 12%
and 10%; multifamily housing - 5% and 8%, respectively.
F-12
F. DEFERRED POLICY ACQUISITION COSTS
The changes in deferred acquisition costs for the three years ended December 31
are summarized as follows:
1994 1993 1992
--------------------------- --------------------------- ---------------------------
ANNUITIES FACE- ANNUITIES FACE- ANNUITIES FACE-
AND LIFE AMOUNT AND LIFE AMOUNT AND LIFE AMOUNT
INSURANCE CERTIFICATES INSURANCE CERTIFICATES INSURANCE CERTIFICATES
---------------------------- --------------------------- ---------------------------
Balance at beginning of year......$ 56,399,696 $ 320,373 $ 52,419,951 $ 444,284 $ 45,634,086 $ 375,697
Acquisition costs deferred during
the year (primarily commissions) 4,697,766 507,996 7,555,104 377,466 9,226,663 562,507
Acquisition costs amortized during
the year....................... 3,756,579 518,782 3,575,359 501,377 2,440,798 493,920
SFAS 115 adjustment............... 19,300,000 - - - - -
------------ --------- ------------- ---------- ------------- ---------
Balance at end of year............$ 76,640,883 $ 309,587 $ 56,399,696 $ 320,373 $ 52,419,951 $ 444,284
============ ========= ============= ========== ============== =========
G. DEPOSITS OF ASSETS AND MAINTENANCE OF QUALIFIED ASSETS
Under the provisions of its face amount certificates and the Investment Company
Act of 1940 (the "Act"), the Company's face amount certificate subsidiary was
required to have qualified assets (as defined in Section 28(b) of the Act) of
$60,605,015 and $67,278,639 at December 31, 1994 and 1993, respectively. The
Company had qualified assets of $64,729,182 and $70,940,763 at those respective
dates (such amounts are before reduction of $385,437 and $251,742 for net
unrealized pretax losses on marketable equity securities and net unrealized
pretax losses on debt securities of $4,890,270 in 1994).
For purposes of determining compliance with the foregoing provisions, qualified
assets are valued in accordance with such provisions of the Code of the District
of Columbia (the "Code") as are applicable to life insurance companies as
required by the Act. Qualified assets for which no provision for valuation is
made in such Code are valued in accordance with rules, regulations or orders
prescribed by the Securities and Exchange Commission. These values are the same
as the financial statement carrying value, except that for financial statement
purposes, marketable equity securities and debt securities classified as
available-for-sale are carried at fair value. For qualified asset purposes,
marketable equity securities are carried at cost and debt securities classified
as available-for sale are carried at amortized cost.
Pursuant to the requirements of various states, the provisions of the
certificates, depository agreements and the Act, qualified assets were deposited
with custodians to meet certificate liability requirements as follows at
December 31:
1994 1993
--------- -----------
Assets on deposit with:
State governmental authority................................................... $ 170,435 $ 174,867
Bank - central depository...................................................... 64,092,848 70,009,967
---------- -----------
Total deposits................................................................ $64,263,283 $ 70,184,834
=========== ============
Required deposits.............................................................. $60,266,136 $ 66,928,266
=========== ============
Certificate loans, secured by applicable certificate reserves, are deducted from
certificate reserves in computing deposit requirements.
Assets on deposit consisted of the following at December 31:
1994 1993
--------- -----------
Investment securities, at cost plus accrued interest............................. $58,871,273 $ 64,420,896
Mortgage loans, at cost less allowances for loan losses.......................... 4,281,089 4,415,364
Other assets on deposit, at cost................................................. 1,110,921 1,348,574
---------- ----------
$64,263,283 $ 70,184,834
=========== ============
Investment securities consist mainly of GNMA and FNMA certificates, CMOs, and
commercial paper.
F-13
H. FACE AMOUNT CERTIFICATE RESERVES
Total Reserves at Minimum
December 31 Interest
--------------------
1994 1993 (a)
----------- --------- ----------
Installment certificates:
Reserves to mature, by series:
120, 215 and 220................................................. $ 554,466 $ 557,941 3.25(b)(c)
315.............................................................. 425,412 492,716 3.50(c)
----------- ------------
979,878 1,050,657
Advance payments.................................................... 384,282 371,446 (d)
Fully-paid certificates:
Installment....................................................... 2,311,547 2,277,106 2.50 - 3.50(c)(e)
Optional settlement............................................... 615,811 711,253 2.50 - 3.00(c)
Single-payment series 503......................................... 56,056,890 62,600,112 2.50(f)
Due to unlocated certificate holders................................ 6,607 18,065 None
----------- ------------
$60,355,015 $ 67,028,639
=========== ============
(a) The amount of interest accrued on installment certificates is reduced by
delays in certificate holders making specified payments. After a nonpayment
period of six months, the certificate is converted to an optional settlement
certificate.
(b) Series 120 certificates provide for additional interest at a rate dependent
upon the Company earning in excess of rates specified in the certificates. Such
additional interest is credited to the certificate holder's account upon
attainment of the annual anniversary date.
(c) As of December 31, 1994, the Board of Directors has declared additional
interest to be credited on anniversary dates through 1995 and 1996 as follows:
1995 1996
------- -------
Series 215 and 220:
Installment certificates.................................................................. 2.25% 2.75%
Optional settlements elected at maturity.................................................. 2.25% 2.75%
Unapplied advance payments................................................................ 2.25% 2.75%
Series 315:
Installment certificates.................................................................. 1.75% 2.25%
Optional settlements elected at maturity.................................................. 1.75% 2.25%
Unapplied advance payments................................................................ 1.75% 2.25%
(d) Minimum interest rates on advance payments are generally the same as the
rates on scheduled installment payments. Interest on advance payments, however,
is accruing at 5.25% and will continue at this rate through 1995.
(e) Effective July 1, 1980, the rate of reserve accumulation on fully paid
installment certificates having loans outstanding is limited to the greater of
the minimum interest, as set forth in the certificate, or the interest rate
applicable to the loan.
(f) The Company's Executive Committee declares interest rates for Series 503
certificates purchased during the designated time periods. Additional interest
rates are assigned based on the three-year life of the certificate and vary
between first, second and third anniversary dates. Since 503 certificates were
first issued on July 17, 1986, the combined minimum and additional interest
rates have ranged from 4.20% to 9.50%.
I. NOTES PAYABLE
The Company had a note payable secured by an airplane with interest at 8.5%
through December 2000. The airplane was sold at a loss of approximately $490,000
and the related note was retired in 1994. As of December 31, 1993, the amount
outstanding on the note was $2,007,325. Also, as of December 31, 1993, the
Company had an outstanding automobile loan of $4,885.
During 1993, the Company entered into a $1,000,000 committed line of credit,
none of which was outstanding as of December 31, 1994 or 1993. The line of
credit expired on December 31, 1994 and was not renewed.
F-14
J. REINSURANCE
The Company retains up to $50,000 of life insurance and waiver of premium
benefits on any one life, depending on age and classification of the risk. The
excess over the maximum retention is reinsured with other life insurance
companies. Reinsurance ceded could become a liability in the event that the
reinsurers became unable to meet the obligations assumed under the reinsurance
agreements. Life insurance in force on direct business aggregated approximately
$105,929,000 and $109,718,000 at December 31, 1994 and 1993, respectively, of
which $25,284,000 and $24,931,000, respectively, was ceded.
In a prior year, the Company entered into an annuity coinsurance agreement in
which it ceded a 90% interest in a block of annuity contracts to a reinsurer. As
of December 31, 1994 and 1993, the account value and statutory value of the
ceded annuities was $105,428,796 and $103,586,535 and $117,417,617 and
$112,767,409, respectively. Provision for benefits for annuities excludes
interest credited on coinsured annuities of approximately $6.4 million, $7.2
million and $7.8 million for the years ended December 31, 1994, 1993 and 1992,
respectively.
Under the coinsurance agreement, the reinsurer is required to maintain assets
with a statutory value equal to or greater than the statutory value of the
annuities in a trust with the Company as the beneficiary to secure the
obligations of the reinsurer under the coinsurance agreement. As of December 31,
1994 and 1993, the statutory value of the assets securing the coinsurance
agreement was $103,487,006 and $113,263,800, respectively.
K. INCOME TAXES
The provision for income taxes (benefit) for the years ended December 31 was as
follows:
1994 1993 1992
------------ ----------- ------------
Current:
Federal........................................................... $ (675,000) $ 2,069,000 $ 2,150,000
State............................................................. 86,000 29,000 (10,000)
Deferred federal and state.......................................... (678,000) (298,000) (599,000)
-------- -------- --------
$(1,267,000) $ 1,800,000 $ 1,541,000
=========== ============= =============
The components of deferred income taxes as of December 31 are summarized as
follows:
1994 1993
---------------------------------------- -------------------------------------------
Assets Liabilities Total Assets Liabilities Total
----------- ------------ ----------- ----------- ------------ -----------
Future policy benefits...................$21,002,000 $ (590,000) $20,412,000 $20,973,000 $ (694,000) $20,279,000
Unrealized losses on debt securities
available-for-sale......................26,879,000 - 26,879,000 - - -
Deferred acquisition costs (DAC).......... - (19,496,000) (19,496,000) - (19,352,000) (19,352,000)
DAC recovery on SFAS 115 unrealized losses - (6,500,000) (6,500,000) - -
Depreciation on building and equipment.... - (98,000) (98,000) 5,000 (848,000) (843,000)
Write down of investments not currently
deductible for taxes.................... 625,000 - 625,000 569,000 - 569,000
Guaranty fund assessments accrual......... 1,088,000 - 1,088,000 690,000 - 690,000
Deferred compensation..................... 444,000 - 444,000 463,000 - 463,000
Real estate limited partnership........... - (189,000) (189,000) - (180,000) (180,000)
Premium capitalization.................... 464,000 - 464,000 445,000 - 445,000
Unrealized losses on marketable equity.... 131,000 - 131,000 86,000 - 86,000
securities
Other..................................... 260,000 (214,000) 46,000 116,000 (167,000) (51,000)
Income tax loss carryforward............. - - - 199,000 - 199,000
----------- ------------- ----------- ----------- ------------- -----------
Total....................................50,893,000 (27,087,000) 23,806,000 23,546,000 (21,241,000) 2,305,000
Valuation allowance.....................(20,715,000) - (20,715,000) - - -
----------- ------------- ----------- ----------- ------------- -----------
$30,178,000 $(27,087,000) $ 3,091,000 23,546,000 $(21,241,000) $2,305,000
============ ============= =========== =========== ============ ===========
Federal income tax expense (benefit) in the consolidated financial statements is
different than the federal statutory rate of 35% in 1994 and 1993 and 34% in
1992 applied to pretax income. The reasons for these differences are summarized
as follows:
F-15
1994 1993 1992
----------- ------------ ------------
Federal income tax expense (benefit) at statutory rate.............. $(1,705,000) $ 1,942,000 $ 1,557,000
Change in estimate of valuation allowance........................... 400,000 - -
Tax-exempt interest................................................. (10,000) (46,000) (50,000)
State income taxes, net of federal benefit.......................... 22,000 17,000 41,000
Benefit of graduated income tax rates............................... 37,000 (56,000) -
Other, net.......................................................... (11,000) (57,000) (7,000)
----------- ------------ ------------
$(1,267,000) $ 1,800,000 $ 1,541,000
=========== ============ ============
Prior to January 1, 1984, the life insurance subsidiary was entitled to exclude
certain amounts from taxable income and accumulate such amounts in a
"policyholder surplus" account. The balance in this account at December 31, 1994
of approximately $1,738,000 will be taxed if distributed to SBM Company (the
"Parent"). The life insurance subsidiary has no plans to distribute amounts from
the "policyholder surplus" account and no further additions to the account are
allowed by the Tax Reform Act of 1984.
L. PROFIT SHARING PLANS, COMPENSATION AND COMMITMENTS FOR FUTURE RETIREMENT
BENEFITS
The Company has a non-contributory employee profit sharing plan whereby
contributions are made to a trust based on percentages of participants' annual
compensation. The Company also has a non-contributory profit sharing stock plan
whereby employees can participate in the ownership of the Company. Under this
plan, the contributions are used by the trustee primarily to purchase common
shares of the Company. During 1994, 1993 and 1992, the Company purchased 1,000,
12,500 and 3,000 respectively from the plan and during 1992, the Company sold
3,477 shares to the plan.
The two plans generally cover all full-time employees age twenty-one and over
with six months of service. Total employer contributions to the two plans cannot
exceed 15% of the total compensation of the participants. Profit sharing expense
for these plans aggregated $197,851 in 1994, $270,587 in 1993 and $261,942 in
1992.
Directors' fees were $200,367, $79,957 and $55,197 in 1994, 1993 and 1992,
respectively, and aggregate salaries of executive officers for the respective
years was $1,187,087, $1,043,870 and $848,414 excluding amounts under the
agreements described in the following paragraphs.
Under employment agreements with two retired officers, the Company is required
to make payments after retirement to each individual until death and,
thereafter, reduced payments during the lifetimes of their spouses. The required
payments are adjusted for the annual change in the Consumer Price Index.
Required payments by the Company for the two retired officers for 1995 will be
$144,288. The estimated present value, using a 6% discount rate, of the
retirement benefits of the retired officers at December 31, 1994 and 1993 was
$913,865 and $921,269, respectively. The Company has been accruing the liability
for such deferred retirement benefits over remaining active employment periods
by annual charges to expense. In addition, deferred compensation related to
other agreements for certain officers is $313,419 and $314,779 at December 31,
1994 and 1993, respectively. One of the employment agreements also contains
provisions for consultation and non-compete restrictions for an aggregate
compensation of $66,000 annually through December 31, 1999.
Total expense provisions for deferred compensation and future retirement
benefits under these agreements aggregated $83,772 in 1994, $93,252 in 1993 and
$130,316 in 1992.
During 1994, the Company entered into an employment agreement with the Company's
Chief Executive Officer (CEO). The agreement requires the Company to make a
bonus payment of $135,000 if the CEO is terminated for other than cause or
$270,000 if for constructive termination or due to a change in control of the
Company. In addition, the agreement provides for a bonus of 1% of the net amount
of value received by the Company in any new capital financing which includes
substantial sale of assets by the Company or any subsidiary, issuance of shares
or securities by the Company or any tender offer for shares of the Company, if
such transaction is commenced during the CEO's tenure.
In connection with execution of the employment agreement, the Company issued the
CEO a warrant to purchase five percent of the fully-diluted outstanding stock of
the Company at $6.29 per share. The warrant provides that the CEO may require
the Company to repurchase the warrant if employment is terminated prior to
December 31, 1996 other than for cause at a redemption price of $300,000 if
notice is given before a change in control and $500,000 if the notice is given
subsequent to a change in control. The Company may also repurchase the warrant
subsequent to the termination of employment at the same terms as described
above.
F-16
M. STOCKHOLDERS' EQUITY AND REGULATORY MATTERS
MANDATORY REDEEMABLE VOTING CONVERTIBLE PREFERRED STOCK AND CONVERTIBLE
PROMISSORY NOTE
On December 20, 1992, the Company entered into a Preferred Stock and Note
Purchase Agreement (the "Agreement") with SBM Partners L.P. (of which Head
Insurance Investors L.P. and Jupiter Industries, Inc. are general partners)
("SBM Partners") and Integon Life Insurance Corporation ("Integon") (SBM
Partners and Integon are referred to herein as the "Purchasers") regarding a
sale to the Purchasers of an aggregate of 19,000 shares of the Company's Series
A Mandatory Redeemable Voting Convertible Preferred Stock (the "Preferred
Stock") at a purchase price of $19,000,000.
The closing of the transaction occurred in two stages. At the first closing,
which occurred on December 23, 1992, the Company issued 4,000 shares of its
Preferred Stock to SBM Partners at a purchase price of $4,000,000. In addition,
the Company issued to Integon a $4,000,000 Convertible Promissory Note (the
"Note"). At the second closing, which occurred on September 21, 1993, the Note
was converted into 4,000 shares of Preferred Stock, and the Company sold an
additional 11,000 shares of Preferred Stock to the Purchasers for $11,000,000.
The Preferred Stock will initially pay a cumulative preferred dividend of 8%;
however, if the National Association of Insurance Commissioners (NAIC) rating
assigned to the Preferred Stock is increased to a two, the dividend rate will be
lowered to 6%. Each share of Preferred Stock is convertible at the option of the
holder into 62.5 shares of the Company's common stock, which represents a
conversion price of $16.00 per common share.
The terms of the Preferred Stock prohibit the payment of common stock dividends
or redemptions of common stock by the Company at any time when a dividend on the
Preferred Stock is in arrears. As of December 31, 1994, the Company was $760,000
in arrears on its Preferred Stock dividends. In addition, common stock dividends
and redemptions of common stock are restricted to a maximum amount equal to the
sum of $3 million plus 50% of the Company's consolidated net income subsequent
to January 1, 1993. As of December 31, 1994, the aggregate amount available for
common stock dividends and redemptions was $219,257.
The Preferred Stock provides that the shares will be redeemed by the Company on
January 1, 2004, unless the shares are converted earlier into shares of the
Company's common stock. Starting in 1998, the Company has the option to redeem
the Preferred Stock at a price of 105% decreasing to 100% in 2003. The Preferred
Stock also gives the holders of the Preferred Stock the right to have such
shares redeemed prior to such date upon the occurrence of certain events of
default at a price of 105% until 1998 decreasing to 100% in 2003.
The Purchasers own shares representing approximately 34% (assuming conversion to
common stock) of the voting power of all outstanding shares of the Company's
voting stock and are entitled as a class to elect at least 34% of the Company's
directors or four of the ten member Board of Directors. The holders of Preferred
Stock have voting rights on matters other than election of directors that are
based upon the number of shares of the Company's common stock into which the
Preferred Stock is convertible. In addition, upon the occurrence of certain
significant defaults by the Company, the Preferred Stockholders would be
permitted to elect a majority of the Board Directors of the Company.
The Company and the Purchasers also have entered into a Registration Rights
Agreement and an Exchange Right Agreement. Under the terms of the Registration
Rights Agreement, the Purchasers have been given the right to require the
Company to publicly register the Preferred Stock and any shares of the
Registrant's common stock issued upon conversion of such Preferred Stock. The
Exchange Right Agreement gives the Purchasers the right to exchange shares of
common stock of the Company held or acquired by them for shares of the Company's
Series B Voting Convertible Participating Preferred Stock (the "Series B
Preferred Stock"). Unless and until any shares of the Preferred Stock are
redeemed, repurchased or converted, the Series B Preferred Stock will vote as a
class with the Preferred Stock for purposes of election of directors, and
together with the Preferred Stock, will elect a number of directors of the
Company proportionate to the aggregate ownership interest of the holders of the
Preferred Stock and Series B Preferred Stock in the Company.
COMMON STOCK HELD BY EMPLOYEE BENEFIT PLANS
The Company's two employee benefit plans own 304,693 and 305,693 shares of
Company common stock at December 31, 1994 and 1993, respectively (see Note L).
The Company has entered into a written trustee agreement whereby the Company has
agreed to purchase common shares tendered to it by the trustee from either
benefit plan at a price equal to the higher of adjusted book value or fair
market value. Adjusted book value is defined as the consolidated net assets of
the Company plus unrealized losses on marketable equity securities plus the
deferred income tax liability (if any) of the Company's life insurance
subsidiary. Historically, adjusted book value of Company common stock in the two
plans has been computed based upon amortized cost value of debt securities.
However, as is discussed in Note A, effective January 1, 1994, SFAS 115 requires
that debt securities classified as available-for-sale be valued on a
mark-to-market basis rather than at amortized cost. Accordingly, with the
required adoption of SFAS 115, common stockholders' equity is in a deficit
position. The Company has determined that in connection with the adoption of
SFAS 115 the adjusted book value of Company common stock held by employee
benefit plans for purposes of the trustee agreement must be computed based upon
market value of available-for-sale debt securities. As such, the adjusted book
value for the common stock held by the plans is currently negative.
F-17
However, as is discussed above, under the terms of the trustee agreement the
Company is required to repurchase Company common stock from the plans at a price
equal to the higher of adjusted book value or fair market value. In the past,
for purposes of the trustee agreement, the Company has regarded adjusted book
value of Company stock as being equivalent to the fair market value of such
stock. With the adoption of SFAS 115, adjusted book value of Company stock
frequently will be greater or less than the fair market value of such stock.
Accordingly, the Company has obtained an independent determination of the fair
market value of its common stock as of June 30, 1994, for purposes of valuing
the Company's stock pursuant to the trustee agreement. The fair market value of
the Company stock held by the plans was determined by the valuation to be $6.29
per common share. As this amount exceeds the adjusted book value of Company
stock, it has been used by management to determine the value of the stock in the
plans as of December 31, 1994. Because the valuation was performed as of June
30, 1994, it may not precisely reflect the value of SBM common stock held by the
plans as of December 31, 1994. Further, the value determined by the independent
valuation does not reflect the value of the Company's common stock held by the
Company's other shareholders. In as much as interest rates have continued to
rise in the third and fourth quarters of 1994, it is possible that the value of
the Company stock held by the plans has decreased.
Subsequent to year-end, the trustee of the plans notified the Company that it
was tendering all shares held by the plans to the Company under the trustee
agreement. The tender indicated that the value of the stock should be based on
amortized cost adjusted book value in that it was the trustee's interpretation
that this was the appropriate method of valuing the stock under the trustee
agreement. The Company believes the trustee's tender of all shares is not
consistent with the trustee agreement and the valuation of the common stock held
by the Plans should not be based upon amortized cost but rather based on the
methodology described above. The Company has subsequently commenced a lawsuit
against the trustee to obtain a declaratory judgment as to the appropriate
interpretation of the trustee agreement.
While the Company believes its interpretation of the trustee agreement is
appropriate, if it were determined that, for the limited purpose of establishing
the adjusted book value of the Company common stock in the two plans under the
trustee agreement, the plans should use amortized cost value of portfolio
securities rather than market value, this would have the effect at December 31,
1994 of increasing the value of the stock held by the plans by approximately
$2.5 million or $1.33 per share and reducing stockholders' equity by an equal
amount.
As the common stock held by employee benefit plans is subject to the trustee
agreement as described above, the Company has classified those shares of common
stock held by the Company's employee benefit plans outside of Stockholders'
Equity on the consolidated balance sheet.
COMMON STOCK AND STOCK OPTIONS
The Company has a stock option plan which allows for incentive stock options,
nonstatutory options and stock appreciation rights. The Company has reserved
350,000 shares for issuance under the plan. No options have been granted under
the plan.
TENDER OFFER
During January 1994, the Company purchased 98,296 shares of its common stock for
approximately $1.5 million, $15.26 per share, pursuant to a cash tender offer
initiated by the Company during December 1993.
DIVIDENDS
The ability of the Company to pay cash dividends to shareholders may be
dependent upon the amount of dividends received from subsidiaries. The following
is a summary of dividend restrictions and capital requirements for each
subsidiary.
As of December 31, 1994 the life insurance subsidiary is required to obtain
written approval prior to payment of all dividends in accordance with an
administrative order issued by the Minnesota Department of Commerce ("MDC") -
see REGULATORY MATTERS below. Exclusive of the administrative order, pursuant
to Minnesota legal requirements, dividend payments must be paid solely from the
adjusted earned surplus of the life insurance subsidiary. Adjusted earned
surplus means the earned surplus as determined in accordance with statutory
accounting practices (unassigned funds), less 25% of the amount of such earned
surplus which is attributable to unrealized capital gains. Further, the life
insurance subsidiary may not pay in any calendar year any dividend which, when
combined with other dividends paid within the preceding 12 months, exceeds the
greater of (i) 10% of the life insurance subsidiary's statutory surplus at the
prior year-end or (ii) 100% of the life insurance subsidiary's statutory net
gain from operations (not including realized capital gains) for the prior
calendar year. The limitation for 1995 would be $3,262,671. Furthermore,
distributions to the Parent by the life insurance subsidiary in excess of
$26,896,170 as of December 31, 1994, would result in an additional income tax
liability to the subsidiary.
F-18
The Company's life insurance subsidiary prepares its statutory basis financial
statements in accordance with accounting practices prescribed or permitted by
the MDC. Prescribed statutory accounting practices include a variety of
publications of the NAIC, as well as state laws, regulations and general
administrative rules. The Company's life insurance subsidiary has strengthened
its reserves on five policy forms in accordance with Proposed Actuarial
Guideline GGG. The Minnesota Department of Commerce and the California Insurance
Department, the Company's domiciliary and commercially domiciliary states,
respectively, have approved the reserve strengthening over a three-year period
beginning in 1994. The strengthening totals $12.3 million and according to the
three year phase-in provision, one-third of this total, or $4.1 million, is
included in reserves in the 1994 statutory basis financial statements of the
subsidiary with the remaining two-thirds to be reflected equally in 1995 and
1996. The life insurance subsidiary's statutory capital and surplus as of
December 31, 1994 and 1993 was $32,626,711 and $41,863,603, respectively.
Statutory operating income was $3,102,341, $1,460,216 and $191,670 for 1994,
1993 and 1992, respectively.
The Company's sales subsidiary is subject to the Securities and Exchange
Commission's uniform net capital rule (Rule 15c3-1) which requires that the
ratio of aggregate indebtedness to net capital, both as defined, shall not
exceed 15 to 1. In addition, restrictions may be imposed to prohibit the Company
from expanding its business or declaring dividends if its ratio of aggregate
indebtedness to net capital is greater than 10 to 1. Net capital and the related
net capital ratio fluctuate on a daily basis; however, at December 31, 1994, the
net capital ratio was .78 to 1 and net capital was $562,500, which exceeded the
minimum capital requirement by $533,053.
The Company's face amount certificate subsidiary is subject to two principal
restrictions relating to its regulatory capital requirements. First, under the
Investment Company Act of 1940, the subsidiary is required to establish and
maintain minimum capital in an amount of certificate reserves plus $250,000.
Second, the MDC has historically recommended to the Company that face amount
certificate companies should maintain a ratio of stockholder's equity to total
assets at a minimum of 5% based upon a valuation of available-for-sale
securities reflected at amortized cost. Under this formula, the subsidiary's
capital level was 6.9% at December 31, 1994. In November 1994, the MDC notified
the subsidiary that, based on the decline in the value of the subsidiary's
investment portfolio resulting from increasing interest rates in 1994 and the
subsidiary's decreasing liquidity resulting from reduced principal prepayments
on the subsidiary's CMO portfolio, the MDC recommended that the subsidiary
increase its capital level. The MDC's concern was influenced by the subsidiary's
capital ratio, calculated including the effects of SFAS 115 (see Note D), which
would have been 0.31% at December 31, 1994. On March 29, 1995, the life
insurance subsidiary, parent of the face amount certificate subsidiary,
contributed $1.5 million to the capital of the certificate subsidiary. The
certificate subsidiary is now in compliance with the MDC's recommendation. The
certificate subsidiary's shareholder's equity on a proforma basis at December
31, 1994, adjusted to reflect the $1.5 million capital contribution and the
change in unrealized losses through February 28, 1995, would have been
approximately $3 million. SBM Company is guarantor of approximately 65% of the
certificates issued by the certificate company. The subsidiary has not paid
dividends in the past and has no present intention to pay dividends in the near
future, in order to increase capital resources.
REGULATORY MATTERS
On November 16, 1994, the Commissioner of the MDC issued an administrative order
to the Company's life insurance subsidiary (SBM Life). The order restricts the
following types of material transactions without approval of the Commissioner:
merging or consolidating with another company; paying dividends; entering into
new reinsurance agreements; making material changes in management; increasing
salaries and benefits of officers or directors or making payment of bonuses;
entering into any transactions with officers and directors, including employment
agreements, or making other payments determined preferential by the
commissioner; disposing of, conveying, or encumbering its assets or its business
in force; or amending or entering into new contracts with the holding company or
other affiliated companies.
The issuance of the order was influenced by the SBM Life's A.M. Best rating
reduction and the significant unrealized depreciation in its investment
portfolio (Note D). An additional capital infusion to SBM Life will be necessary
to address the issues of the MDC and for possible re-evaluation of its rating.
N. COMMITMENTS AND CONTINGENCIES
The Company leases office space under two noncancelable operating leases
expiring on July 14, 1998, and on June 30, 1999. In addition to the minimum
rental payments, the Company is required to pay as additional rent its pro-rata
share of all operating costs as defined. Rent expense under these and former
leases was $443,209, $425,285 and $399,126, for 1994, 1993 and 1992,
respectively. The leases require minimum annual rental payments as follows:
1995....................... 305,785
1996....................... 320,993
1997....................... 336,201
1998....................... 321,169
1999....................... 145,465
----------
Total................... $1,429,613
==========
F-19
The Company's life insurance subsidiary is subject to state guaranty association
assessments. The assessments are made by the associations to obtain funds to pay
off policyholders of insolvent insurance companies. In 1994, 1993 and 1992, the
Company recorded approximately $1.8 million, $1.5 million and $1.3 million of
assessments, respectively. At December 31, 1994 and 1993, accounts payable and
other liabilities includes accrued guaranty fund assessments of $3.2 million and
$2.0 million, respectively, which are reflected at present value using a
discount rate of 8%. The Company has no control over these assessments and
additional assessments in future years are probable, but undeterminable at this
time.
The Company and its subsidiaries are involved in various litigation in the
ordinary course of business. In the opinion of management, the ultimate
resolution of such litigation will not have a material adverse effect upon the
financial condition or results of operations of the Company.
The Internal Revenue Service (the "IRS") has conducted examinations of the
Company's income tax returns for the years 1986 through 1990 and has proposed
several adjustments to increase taxable income relating to the timing of certain
deductions. Based on these adjustments, additional tax due would be
approximately $1.3 million plus interest. However, additional taxes currently
payable would be principally offset by deductions to taxable income in future
periods. The Company has filed a protest with the Appellate Division of the IRS
and is vigorously contesting all of the proposed adjustments. The Company
believes the ultimate resolution of this matter will not have a material adverse
effect on the Company's consolidated results of operations or financial
position.
O. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosures are made in accordance with the requirements of SFAS
107, DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS and SFAS 119,
DISCLOSURES ABOUT DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE OF FINANCIAL
INSTRUMENTS. SFAS 107 requires disclosure of fair value information about
financial instruments, whether or not recognized in the balance sheet, for which
it is practicable to estimate that value. In cases where quoted market prices
are not available, fair values are based on estimates using present value or
other valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument.
SFAS 107 excludes certain financial instruments and all nonfinancial instruments
from its disclosure requirements. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Company.
SFAS 119 requires fair value disclosures to be presented together with the
related carrying amount in a summary table. The fair value estimates presented
herein are based on pertinent information available to the Company as of
December 31, 1994 and 1993. Although the Company is not aware of any factors
that would significantly affect the estimated fair value amounts, such amounts
have not been comprehensively revalued for purposes of these financial
statements since that date; therefore, current estimates of fair value may
differ significantly from the amounts presented herein.
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
Debt Securities: The estimated market value disclosures for debt securities
satisfy the fair value disclosure requirements of SFAS 107. (See Note D -
Investments.)
Marketable Equity Securities: Fair value equals carrying value as these
securities are carried at quoted market value.
Mortgage Loans: The fair values for mortgage loans are estimated using
discounted cash flow analyses, using interest rates currently being offered in
the marketplace for similar loans to borrowers with similar credit ratings.
Loans with similar characteristics are aggregated for purposes of the
calculations.
Policy Loans, Other Invested Assets, Cash and Short-Term Investments: The
carrying amounts for these assets approximate the assets' fair values.
Other Financial Instruments Reported as Assets: The carrying amounts for these
financial instruments (receivable from reinsurer and accrued investment income)
approximate those assets' fair values.
Future Policy Benefits: The fair value of future policy benefits, principally
deferred annuities, was determined to be the customers' account balance as
management has the ability to reprice the deferred annuities on an annual basis.
Face Amount Certificate Reserves: The fair value for face amount certificate
reserves was determined from discounted cash flow analyses of the certificates
included in the reserve. The interest rates used in the analyses were based on
interest rates currently being offered on the Company's certificates.
F-20
Other Financial Instruments Reported as Liabilities: The carrying amounts for
other financial instruments (normal payables of a short-term nature, notes
payable and deferred compensation and retirement benefits) approximate those
liabilities' fair values.
Mandatory Redeemable Voting Convertible Preferred Stock: The fair value for
mandatory redeemable voting convertible preferred stock equals the liquidation
value plus any dividends in arrears.
Common Stock Held by Employee Benefit Plans: The fair value equals the most
recent appraised value for 1994. For 1993 the fair value approximated the
carrying value.
The carrying amounts and estimated fair values of the Company's financial
instruments are as follows:
December 31
-------------------------------------------------------------------
1994 1993
-------------------------------- --------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------------- --------------- -------------- ---------------
Financial Instruments Recorded as Assets:
Debt securities available-for-sale $ 653,207,076 $ 653,207,076 $ - $ -
Debt securities held-to-maturity 13,944,234 11,913,328 742,940,222 753,470,340
Debt securities held-for-sale - - 16,674,496 17,514,330
Equity securities 683,089 683,089 962,268 962,268
Mortgage loans 36,257,214 37,373,864 44,255,353 49,310,908
Policy loans 22,153,936 22,153,936 20,401,812 20,401,812
Other invested assets 1,694,506 1,694,506 2,188,327 2,188,327
Cash and short-term investments 41,168,183 41,168,183 9,661,532 9,661,532
Other financial instruments reported
as assets 114,276,196 114,276,196 123,199,179 123,199,179
Financial Instruments Recorded as Liabilities:
Future policy benefits 899,709,020 899,709,020 883,180,188 883,180,186
Face amount certificate reserves 60,355,015 60,050,268 67,028,639 68,069,645
Other financial instruments reported
as liabilities 10,479,331 10,479,331 11,601,069 11,601,069
Mandatory Redeemable Voting
Convertible Preferred Stock 18,485,868 19,760,000 17,589,680 19,000,000
Common Stock Held by Employee
Benefit Plans 1,916,519 1,916,519 4,808,551 4,808,551
Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These
estimates do not reflect any premium or discount that could result from offering
for sale at one time the Company's holdings of a particular financial
instrument. These estimates are subjective in nature and involve uncertainties
and matters of significant judgment and, therefore, cannot be determined with
precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing financial instruments without
attempting to estimate the value of anticipated future business and the value of
assets and liabilities that are not considered financial instruments. In
addition, the tax ramifications related to the realization of the unrealized
gains and losses can have a significant effect on fair value estimates and have
not been considered in the estimates.
P. INDUSTRY SEGMENT DATA
The Company's principal business activities consist of four distinct business
segments. SBM Company (the "Parent") manages six mutual fund companies. SBM
Certificate Company currently issues single payment face amount certificates.
SBM Financial Services, Inc. is registered as a broker and dealer in securities
under the Securities and Exchange Act of 1934 and performs sales functions for
SBM Certificate Company, affiliated mutual funds and State Bond and Mortgage
Life Insurance Company. State Bond and Mortgage Life Insurance Company is
licensed as a life insurer and issues a variety of ordinary life insurance
policies and flexible premium and single premium deferred annuities. SBM Company
segment data is as follows:
F-21
(Dollar amounts SBM COMPANY STATE BOND
in thousands) MUTUAL SBM AND MORTGAGE ADJUSTMENTS
FUND GENERAL CERTIFICATE SBM FINANCIAL LIFE INSURANCE AND
OPERATIONS CORPORATE COMPANY SERVICES, INC. COMPANY ELIMINATIONS CONSOLIDATED
---------- --------- ----------- --------------- --------------- ------------ ------------
1994:
Total revenues $1,399 $ (258) $ 5,336 $ 9,191 $ 55,598 $ (11,334) $ 59,932
Pretax income 240 (1,260) 555 - 4,406) - (4,871)
(loss)2
Income (loss)2 158 (1,208) 383 - (2,937) - (3,604)
Identifiable assets - (8,085) 60,563 1,004 906,449 9,433 969,364
Liabilities - 3,235 60,376 441 917,486 (599) 980,939
1993:
Total revenues $1,401 $ 337 $ 5,413 $11,797 60,642 $ (7,543) 72,047
Pretax income 302 (642) 56 - 5,832 - - 5,548
(loss)2
Income (loss)2 199 (415) 101 - 3,863 - - 3,748
Identifiable assets - 60,198 70,939 992 949,800 (57,019) - 1,024,910
Liabilities - 5,675 67,058 495 897,852 (527) - 970,553
1992:
Total revenues $1,316 $ 265 $ 5,596 $12,928 $ 58,319 $ (9,397) $ 69,027
Pretax income 324 (810) (235) - 5,949 (648) 4,580
(loss)2
Income (loss)2 214 (749) (85) - 3,874 (215) 3,039
Identifiable assets - 51,980 70,308 1,268 856,945 (47,134) 933,367
Liabilities - 13,142 66,576 1,116 814,886 (978) 894,742
1 The operations of State Bank and Trust Company of New Ulm were sold in 1992
and have been classified as discontinued operations. See Note B.
2 Before discontinued operations and cumulative effect of change in accounting
principle in 1992.
The Company's capital expenditures and related depreciation expenses are
incurred by the Parent and SBM Certificate Company. For the three years ended
December 31, 1994, total capital expenditures for the Parent were $161,330,
$266,284 and $209,872, respectively, and depreciation expense for the Parent and
SBM Certificate Company was $248,474 and $54,017; $259,347 and $58,678; and
$252,371 and $59,262, respectively.
Income (loss) of each industry segment includes a provision for income taxes
calculated on a separate return basis, (except for the Parent's segments, which
are allocated taxes (credits) based on the segments' percentage of pretax income
(loss) to the Parent's total) modified to the extent that benefits from
operating losses are recognizable for SBM Company on a consolidated basis.
The adjustments and eliminations required to determine consolidated amounts
shown above consist principally of elimination of intersegment financial income,
investments in consolidated subsidiaries and intersegment receivables or
payables. Intersegment income is related primarily to commissions earned by SBM
Financial Services, Inc. on the sale of the other subsidiaries' products to
outside customers.
The Parent received dividends from its life insurance subsidiary of $650,000 in
1994, $1,855,000 in 1993 and $1,000,000 in 1992. The Parent received dividends
of $83,720 from its broker-dealer subsidiary during 1992.
F-22
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There were no disagreements on accounting and financial disclosure and no change
of accountants during the last two years.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following persons are the directors, nominees, and executive officers of the
Company at March 15, 1995.
Name
Year First Became
Director or Officer Position with Business
(Age) Company Experience
- ------------------- ------------- ----------
Richard M. Evjen Director President, The Evjen Asso-
1993 (Common Stock ciates, Inc., architects/
(62) Class II) engineers/planners
Kennon V. Rothchild Director Chairman and Chief
1992 (Common Stock Executive Officer,
(66) Class I) RCN Associates, Inc.,
mortgage banking con-
sultants, since 1989;
prior thereto, Chief
Executive Officer and
Chairman of the Board,
H. & Val J. Rothchild,
Inc., mortgage banking.
Robert M. Winslow Director Professor of Medicine,
1992 (Common Stock University of California
(53) Class I) at San Diego
Charles A. Geer President & President and Chief
1993 Chief Executive Executive Officer,
(54) Officer SBM Company, SBM Certi-
ficate Company, a subsid- ary of SBM
Company and an issuer of face amount
certificates registered under the
Investment Company Act of 1940, and
the State Bond Group of Mutual Funds,
a group of six affiliated open-end
management investment companies
registered under the Investment
Company Act of 1940; President, State
Bond and Mortgage Life Insurance
Company, a subsidiary of SBM Company
and a life insurance company;
Director, SBM Financial Services,
Inc., a subsidiary of SBM Company and
a registered broker-dealer. Owner,
Charles Geer Associates, a private
merchant banking firm and consulting
attorney.
Edward L. Zeman Vice President, Vice President, Treasurer,
1990 Treasurer, Chief Chief Operating Officer,
(40) Operating Officer, and Chief Financial Offi-
and Chief cer, SBM Company, SBM Cer-
Financial Officer tificate Company, and State
Bond and Mortgage Life In-
surance Company; Vice
President, Chief Financial Officer,
and Treasurer, the State Bond Group
of Mutual Funds; Vice President,
Chief Financial Officer, Treasurer,
and Director, SBM Financial
Services, Inc.
Walter W. Balek Senior Vice Senior Vice President, SBM
1965 President Company; Vice President,
(74) SBM Certificate Company,
State Bond Group of Mutual
Funds, State Bond and
Mortgage Life Insurance
Company, and SBM Financial
Services, Inc.
Richard M. Carlblom Vice President Vice President, SBM Com-
1991 pany, SBM Certificate
(45) Company, and State Bond
and Mortgage Life
Insurance Company;
President and Director,
SBM Financial Services,
Inc.
Darell R. Evers Vice President Vice President, SBM Compa-
1989 ny, SBM Certificate Compa-
(52) ny, State Bond and Mort-
gage Life Insurance Compa-
ny, and SBM Financial Ser-
vices, Inc.
Stewart D. Gregg Vice President, Vice President, Gen-
1990 General Counsel, eral Counsel, and
(40) and Secretary Secetary, SBM Com-
pany, SBM Certificate Company, the
State Bond Group of Mutual Funds,
State Bond and Mortgage Life
Insurance Company, and SBM Financial
Services, Inc.
Keith O. Martens Executive Vice Executive Vice President -
1972 President - Investments, SBM Company;
(55) Investments Vice President, SBM
(principal Certificate Company, the
portfolio State Bond Group of
manager) Mutual Funds, and State
Bond and Mortgage Life
Insurance Company
Louis J. Knippenberg Vice President Vice President - SBM
1992 Company and State Bond and
(56) Mortgage Life Insurance
Company; Assistant Vice
President - SBM Financial
Services, Inc.
Ann M. Schmid Vice President - Vice President -
1988 Investments Investments, SBM Com-
(30) (fixed - income pany, SBM Certificate Com-
portfolio pany, the State Bond Group
manager for of Mutual Funds, State
SBM Life and Bond and Mortgage Life In-
SBM Certificate surance Company, and SBM
Company) Financial Services, Inc.
The members of the Company's Board of Directors are elected separately by either
the holders of the Company's outstanding common stock or the holders of the
Company's outstanding Series A Mandatory Redeemable Voting Convertible Preferred
Stock (the "Series A Preferred Stock"). Of the current three members of the
Board, all were elected by the holders of the Company's outstanding common
stock. The members of the Company's Board of Directors elected by the holders of
the Company's common stock are elected in three classes and serve staggered
three-year terms. They hold their positions for the term of their class until
the applicable regular meeting of the shareholders and until their successors
are elected and qualified. The members of the Board elected by the holders of
the Company's Series A Preferred Stock are elected for one-year terms and until
their successors are elected and qualified.
The Company's Series A Preferred Stock currently gives the holders of such stock
the right to elect a total of forty percent(but at least three) of the Board of
Directors of the Company. There are no current directors elected by the holders
of the Company's Series A Preferred Stock. The Preferred Stock directors
resigned in 1994.
Messrs. Evjen and Rothchild, are also directors of the State Bond group of
mutual funds, which consists of State Bond Cash Management Fund, State Bond
Common Stock Fund, State Bond Diversified Fund, State Bond Tax Exempt Fund,
State Bond Minnesota Tax-Free Income Fund, and State Bond U.S. Government and
Agency Securities Fund. These funds are open-end management investment companies
registered under the Investment Company Act of 1940. The Company acts as
investment adviser to the funds. Messrs. Evjen, Rothchild, and Winslow also act
as directors of SBM Certificate Company. SBM Certificate Company is an indirect
wholly-owned subsidiary of the Company and is an issuer of face amount
certificates registered under the Investment Company Act of 1940. The Company
provides certain management services to SBM Certificate Company pursuant to a
Management Agreement. Mr. Zeman is a director of Dotronix, Inc.
There were twelve meetings of the Board of Directors of the Company during its
last fiscal year. All current members of the Board attended 75% or more of the
meetings of the Board during such year.
The Company's Board of Directors has an audit committee, which met twice during
1994. The audit committee is comprised of Messrs. Richard M. Evjen and Robert M.
Winslow. The function of the audit committee is generally to review with the
Company's outside, independent auditors the scope and standards of such
auditor's annual audit as well as review the results of their audit with them.
The Company's directors also have a compensation committee. This committee met
or conferred on numerous occasions in 1994. The function of this committee is to
set executive compensation. The compensation committee consists of Messrs.
Rothchild and Winslow.
The terms of office for executive officers are for one year. With the exception
of Charles A. Geer, Edward L. Zeman, Stewart D. Gregg and Louis J. Knippenberg,
all of the Company's executive officers have been employed by the Company or its
subsidiaries for more than five years. Prior to joining the Company and
currently, Mr. Geer was the owner of a private merchant banking firm and
consulting attorney. Prior to joining the Company in June of 1990, Mr. Zeman was
associated with the Deloitte & Touche LLP accounting firm, where he most
recently had held the position of Senior Manager. Mr. Gregg was associated with
Oppenheimer Wolff & Donnelly, a private law firm. Mr. Knippenberg was Regional
Marketing Director of Minnesota Protective Life Insurance Company.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The compensation paid by the Company to its Chief Executive Officer and each of
its most highly compensated executive officers whose salary and bonus exceeded
$100,000 during 1994 is set forth in the table below.
Other
Annual All Other
Name & Principal Compensation Options/ Compensation
Position Year Salary(1) Bonus (2)(3)(4) SARs (5)(6)
- ---------------- ---- --------- ----- --------- ---- ------
Charles A. Geer(7) 1994 $225,000(8) -0- -0- 168,361(10) -0-
President and (9) shares
Chief Executive
Officer
Roman G. Schmid(11) 1994 $323,217(12) -0- $ 276 -0- $ 94,863
Former Chairman of 1993 294,859 $ 68,850 3,382 -0- 113,908
Board, President, 1992 265,534 55,300 7,500 -0- 113,796
and Chief Execu-
tive Officer
Keith O. Martens 1994 $105,460 $ 5,250 -0- -0- $ 7,146
Executive Vice 1993 100,464 13,000 -0- -0- 7,829
President - 1992 95,695 11,900 -0- -0- 7,412
Investments
Edward L. Zeman 1994 $149,375 $ 57,500 -0- -0- 10,118
Vice President, 1993 133,792 44,050 -0- -0- 10,426
Chief Operating 1992 105,333 37,120 -0- -0- 8,159
Officer, Chief
Financial Officer,
and Treasurer
Stewart D. Gregg 1994 $105,031 $25,294 -0- -0- $7,099
Vice President and 1993 89,792 14,700 -0- -0- 6,998
General Counsel 1992 84,792 11,700 -0- -0- 6,384
(1) This amount includes sales commissions paid in 1994, 1993, and 1992 to Mr.
Schmid in the amounts of $927, $1,109, and $1,159, respectively, and to Mr.
Martens in the amounts of $668, $672, and $1,112 respectively.
(2) The aggregate amount of "perquisites" received during 1994 by those
individuals listed in the table above did not exceed the lesser of $50,000
or 10% of their respective listed salary and bonus received during the
year.
(3) This includes $1,915 of "above-market earnings" accrued for the benefit of
Mr. Schmid in 1993 pursuant to a Deferred Compensation Plan maintained by
the Company. The earnings on the Plan for 1994 and 1992 did not constitute
"above-market earnings" and are not reflected in the above Summary
Compensation Table.
(4) The Company accrued $276, $1,467, and $7,500, in 1994, 1993, and 1992,
respectively, for the benefit of Mr. Schmid for post-retirement benefits
payable to Mr. Schmid pursuant to the terms of an employment agreement. The
employment agreement, which was dated March 20, 1975 and was amended on
February 16, 1978, and October 26, 1987, and was amended and restated on
April 8, 1994. The agreement provides for consulting fees and
non-competition payments through December 31, 1994. The agreement provides,
commencing on January 1, 1995, for Mr. Schmid to receive an aggregate of
$11,512 per month until December 31, 1999, at which time he shall receive a
monthly salary until his death of $6,012. Also, under the agreement, if Mr.
Schmid's wife survives him, upon his death she is to receive $3,006 per
month until her death. Of the monthly payments, $6,012 is subject to
escalation or de-escalation pursuant to an index described in the contract.
See Note L to the Company's consolidated financial statements.
(5) The Company paid insurance premiums of $99,263 in each of 1994, 1993, and
1992, for the benefit of Mr. Schmid pursuant to a split-dollar arrangement.
The Company has entered into an agreement with an irrevocable trust
established by Roman G. Schmid and Helen M. Schmid to pay the annual
premium on a life insurance policy on their joint lives. Under the
arrangement, a split-dollar life insurance plan, Mr. and Mrs. Schmid will
reimburse the Company for the insurance protection element of the premium
and the Company will receive a return of premiums paid by it upon the
maturity of the life insurance policy. The net premium paid by the Company
in 1994 was $94,863.
(6) This represents amounts paid to the benefit of the named officers under the
Company's employee benefit plans.
The Company has two profit-sharing plans, an employee's Thrift Plan that
went into effect in 1954 and an employee's Profit Sharing Stock Plan that
went into effect in 1975. The following amounts were allocated to the
Thrift Plan in 1994 as a Company contribution or as a forfeiture for the
benefit of the persons listed in the above table: Stewart D. Gregg, -
$6,866; Keith O. Martens - $6,912; and Edward L. Zeman - $9,787. The
Company did not make a contribution to the Profit Sharing Stock Plan in
1994. The following amounts were allocated to the Profit Sharing Stock Plan
in 1994 as forfeitures for the benefit of the persons listed in the above
table: Stewart D. Gregg - $233; Keith O. Martens - $234; and Edward L.
Zeman - $331.
(7) Mr. Geer commenced his engagement with the Company pursuant to the letter
agreement between Mr. Geer and the Company in July of 1994. He acted as an
independent contractor for the Company through December 31, 1994. He now is
an employee of the Company.
(8) This represents $195,000 paid to Mr. Geer pursuant to the terms of his
letter agreement with the Company, plus fees in the amount of $30,000 paid
to Mr. Geer for acting as a director and as a member of the Special
Committee of Independent Directors from January 1, 1994 through July of
1994. Mr. Geer was a director of the Company through July of 1994.
(9) Excludes $90,000 which was advanced to Mr. Geer as a deposit under his
letter agreement with the Company.
(10) In 1994, Mr. Geer was issued a warrant to acquire common stock equal to 5%
of the Company's outstanding shares, which at March 1, 1995 equaled 168,361
shares, at a price of $6.29 per share. The warrant and the underlying
shares are not publicly traded and, as such, there is no definitive value
for the warrant. The warrant is subject to optional and mandatory
redemption by the Company upon the occurrence of certain events. See
"Employment Agreements" on pages 47 to 48.
(11) Mr. Schmid retired from active management of the Company in June of 1994.
(12) This amount includes $147,498 paid to Mr. Schmid pursuant to the terms of
his Amended and Restated Employment Agreement subsequent to his retirement
from active management.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with a number of its
executive officers.
LETTER AGREEMENT WITH CHARLES A. GEER. In August of 1994 the Company and Charles
Geer entered into a letter agreement effective as of July 15, 1994 ("Initial
Agreement") under which Mr. Geer agreed to serve as interim Chief Executive
Officer of the Company and providing, under different circumstances, for $30,000
to $15,000 per month payment. Under the Letter Agreement, Mr. Geer served as an
independent contractor and was permitted to continue his other consulting
activities. The initial term under the Letter Agreement extended to June 30,
1996 and was terminable by the Company on 30 days' notice. The Initial Agreement
provided, among other things, that Mr. Geer would receive a termination payment
of $90,000 in the event of termination of his engagement by the Company before
June 30, 1996, other than for cause, and of $180,000 if terminated before June
30, 1996 upon a change of control of the Company. Mr. Geer was advanced $90,000
as a deposit against such termination payment. In addition, Mr. Geer was
entitled to receive a transaction bonus of 1% of the value of any new capital
financing or the proceeds of the sale of substantial assets by the Company
during the term of his engagement.
In November of 1994, the Company and SBM Life entered into a letter agreement
with Mr. Geer (the "Letter Agreement") superseding the Initial Agreement and
providing the terms of Mr. Geer's full-time employment as Chief Executive
Officer of the Company and of SBM Life and affiliated mutual funds and providing
for a monthly salary under different circumstances, of $30,000 to $22,500, less
the value of any employee benefits received. The initial term under the Letter
Agreement extends to June 30, 1996 although employment is terminable by the
Company on 30 days' notice. The Letter Agreement provides, among other things,
for a termination bonus, in lieu of severance pay, of $135,000 in the event of
Mr. Geer's termination by the Company before June 30, 1996, other than for
cause, and of $270,000 if terminated before June 30, 1996 upon a change of
control of the Company. The termination deposit to Mr. Geer was increased to
$135,000.
The Letter Agreement also provides for a transaction bonus of 1% of the net
amount of the consideration received by the Company in the following
transactions during the term of Mr. Geer's employment: (i) of the proceeds of a
substantial new capital financing for the Company, or subsidiary, (ii) of the
proceeds of a substantial sale of assets by the Company, or subsidiary, (iii) of
the proceeds of the sale of securities by the Company or subsidiary; or (iv) of
the proceeds of the sale of shares by stockholders in a tender offer.
WARRANT ISSUED TO CHARLES GEER. In connection with the execution of the Letter
Agreement, the Company issued Mr. Geer a warrant to purchase five percent of the
Company's common stock outstanding on a fully-diluted basis (assuming for
purposes of calculating the percentage that all options and convertible
securities have been exercised or converted) at a price of $6.29 per share (the
"Warrant"). The Warrant contains standard anti-dilution protections such that
the Warrant purchase price will be approximately adjusted in the event of a
stock split, stock combination or reorganization and also contains price
protection such that if the Company were to issue, or enter into a binding
commitment to issue, 100,000 or more shares of common stock on or before March
31, 1995 at a price less than the Warrant purchase price, the Warrant purchase
price would be reduced to such lesser price.
The Warrant gives the Company the right to redeem and Mr. Geer the right to
require the Company to repurchase the Warrant if at any time prior to December
31, 1996 his employment is terminated by the Company or by Mr. Geer, without
cause. The redemption price is $300,000 before the occurrence of a change of
control of the Company and $500,000 after such an event. The Warrant will expire
and may not be exercised if the Company terminates Mr. Geer's employment for
cause.
Mr. Geer anticipates requiring redemption of the Warrant as a part of the
closing of the sale referred to in Item 1.a. which, because it involves a change
of control, will entitle Mr. Geer to receive $500,000.
OTHER EXECUTIVE EMPLOYMENT AGREEMENTS. In November 1994, the Company and SBM
Life entered into employment agreements with each of Edward Zeman, Stewart
Gregg, Richard Carlblom, Keith Martens and Dale Bauman which provide for
payments to such individuals in the event of a change in control or a
termination of employment other than for cause.
The agreements with Messrs. Zeman and Gregg provide for, among other things,
bonus payments upon execution of a definitive agreement to refinance and/or sell
the Company or a controlling interest in the Company (an "Agreement Bonus") in
an amount not greater than specified percentages of annualized 1995 compensation
(40% for Mr. Zeman and 20% for Mr. Gregg), as determined by the Chief Executive
Officer in his sole discretion, and bonus payments upon the closing of the
transaction contemplated by the definitive agreement (a "Closing Bonus") in an
amount not greater than specified percentages of annualized 1995 compensation
(75% for Mr. Zeman and 50% for Mr. Gregg), as determined by the Chief Executive
Officer in his sole discretion, provided that they are employed by the Company
at the relevant times. The agreements also provide for payments upon termination
of employment by the Company, including constructive termination of employment,
other than for cause, in varying amounts, not greater than twelve months' base
salary, depending upon the circumstances surrounding the termination.
In determining the actual amount of the bonuses to be paid to Messrs. Zeman and
Gregg, the employment agreements require the Chief Executive Officer to consider
various performance factors. The amounts of the Agreement bonuses have been
determined by the Chief Executive Officer and 15% of the Agreement bonuses was
paid subsequent to execution of the Agreement and the balance will be paid at
closing. The aggregate amount of the Agreement Bonuses is $75,000.
Each of the agreements provides that if it is assumed by an acquiror of the
Company's business such entity shall, prior to December 31, 1995, either
terminate the agreement or state its intentions with respect to continuation of
employment and, if long-term employment is offered, where such employment will
be located and what its terms will be.
The agreement with each of Messrs. Carlblom, Martens and Bauman provides for,
among other things, a change of control bonus in an amount not less than 5% and
not greater than 20% of 1995 base compensation, as determined by the Chief
Executive Officer, and a termination fee upon termination of employment by the
Company, for other than substantial cause, of varying amounts, not greater than
six months' base salary, depending upon the circumstances surrounding the
termination. In determining the actual amount of the bonuses to be paid, the
employment agreements require the Chief Executive Officer to consider various
performance factors.
Pursuant to the Agreement between the Company and ARM discussed in Item 1.a.
hereof, ARM has agreed to assume all of the Company's obligations, except the
bonus obligations, under the aforementioned agreements. The Agreement requires
ARM to offer as of the closing date transitional or regular employment to each
current employee of the Company in good standing. In the event any of Messrs.
Zeman, Gregg, Carlblom, Martens, or Bauman accepts such employment, ARM shall no
later than December 31, 1995 offer regular employment to such person or inform
them that no such offer will be made. If no offer of regular employment is made
or if such offer relates to a location outside of the Minneapolis - St. Paul
metropolitan area and is not accepted by such person, ARM will pay the change of
control payments set forth above.
OPTION/SAR GRANTS IN 1994
The Company did not grant any options or SARs in 1994, other than the Warrant
issued to Charles A. Geer, as described in the preceding section.
- -------------------------------------------------------------------------------------------------------------------
Percent of
total
options/SARs
Number of granted to em-
Securities ployees in Exercise or Expira-
Underlying Option/ fiscal year purchase tion
Name Sars Granted price date 5% 10%
- -------- ------------ -------- -------- -------- ---------- ------------
Charles A. Geer 168,361(1) 100% $6.29 N/A $52,950(2) $105,899 (2)
(1) Based on 5% of the outstanding shares of Common Stock as of March 1, 1995.
(2) There is no public market for the Company's common stock or definitive
price for the stock. In addition, the warrant listed in the above chart has
no term. Therefore, projected appreciation is portrayed for a one-year
period and is based upon the exercise price of the warrant of $6.29 per
share.
- --------------------------------------------------------------------------------------------------------------------
AGGREGATED OPTION/SAR EXERCISES IN 1994 AND YEAR-END
OPTION/SAR VALUES
There were no options or SARs exercised in 1994 or outstanding at December 31,
1994 other than the warrant as described in Item 11 Note 9 and Item 11
"Employment Agreements."
COMPENSATION OF DIRECTORS
Members of the Board of Directors of the Company who are also officers and/or
employees of the Company are not compensated by the Company for their services
as directors. Other directors receive an annual fee of $3,600 plus an additional
sum equal to (1)(a) $2,700 if the director attends 75% or more of the regular
meetings of the Board of Directors during the year, or (b) if the director
attends less than 75% of such meetings of the Board of Directors during the
year, an amount equal to $675 multiplied by the total number of regular meetings
of the Board of Directors the director did attend, and (2) $675 for each special
meeting. In addition, directors who are members of the Compensation Committee,
the Executive Committee, the Audit Committee, or the Special Committee of
Independent Directors are paid a per-meeting fee for each meeting. The Company's
life insurance subsidiary also pays director fees in accordance with the above
fee schedule. The Company and its life insurance subsidiary in the aggregate
paid or accrued $104,500 in Director fees in 1994 and $90,250 for Committee
meetings. Directors also are reimbursed for reasonable travel expenses incurred
in attending Board meetings. Such reimbursement totaled $50,346 in 1994.
Members of the Board of Directors who are not officers or employees of the
Company and who serve as directors of the Company's insurance company subsidiary
or the State Bond group of mutual funds are separately compensated by those
companies for acting as directors of such companies.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER
PARTICIPATION IN COMPENSATION DECISIONS
The three members of the Company's Compensation Committee in 1994 were John C
Head III, Kennon V. Rothchild, and Robert M. Winslow. Mr. Head resigned as a
director in November of 1994.
As is discussed in Item 1.a. hereof, the Company has entered into an agreement
to sell substantially all of its business operations and, in connection with
such sale, the Company and Mr. Head will provide mutual releases.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information with respect to the ownership of the
issued and outstanding shares of the stock of the Company as of March 1, 1995,
by all persons who owned 5% or more of a class of such shares, by directors, by
the executive officers listed in Item 11 hereof, and by all executive officers
and directors of the Company as a group.
Amount and
Nature of
Beneficial Title of Percent
Name and Address Ownership Class of Class
- ---------------- --------- -------- --------
Roman G. Schmid -0- (1) ---- ----
8400 Normandale Lake Blvd. Record and
Suite 1150 Beneficial
Minneapolis, MN 55437
Clara K. Schonlau 354,400 (2) Common 16.26%
300 South State Street Beneficial Stock
New Ulm, MN 56073
Henry Somsen 120,000 Common 5.51%
211 2nd Street Record and Stock
New Ulm, MN 55901 Beneficial
Firstar Trust Company 304,693 (3) Common 13.98%
of Minnesota Record Stock
601 Marquette Avenue
Minneapolis, MN 55402
State Bank & Trust Co. 249,835 (4) Common 11.46%
of New Ulm Record Stock
100 North Minnesota St.
New Ulm, MN 56073
SBM Company 257,413 (5) Common 11.81%
Profit Sharing Beneficial Stock
Stock Plan
SBM Partners L.P. 15,000 (6) Series A 78.95%
545 Madison, 6th Floor Record and Preferred
New York, NY 10022 Beneficial Stock
145,900 Common 6.69%
Record and Stock
Beneficial
Georgia International 4,000 (7) Series A 21.05%
Life Insurance Company Record and Preferred
500 W. 5th Street Beneficial Stock
Winston-Salem, NC 27152
Charles A. Geer -0- (8) ---- ----
4440 IDS Center
Minneapolis, MN 55402
Richard M. Evjen -0- ---- ----
P.O. box 225
Hudson, WI 54016
Stewart D. Gregg 290 (1) Common (9)
8400 Normandale Record and Stock
Lake Boulevard Beneficial
Suite 1150
Minneapolis, MN 55437
John C Head III 19,000 (10) Series A 100%
545 Madison Beneficial Preferred
6th Floor Stock
New York, NY 10022
145,900 (11) Common 6.69%
Beneficial Stock
Keith O. Martens 7,800 (1) Common (9)
8400 Normandale Lake Blvd. Record and Stock
Suite 1150 Beneficial
Minneapolis, MN 55437
Kennon V. Rothchild 2,200 Common (9)
2300 American National Beneficial Stock
Bank Building
St. Paul, MN 55101
Robert M. Winslow 1,000 Common (9)
Dept. of Medicine Record and Stock
Univ. of California - Beneficial
Veterans Affairs Medical Cntr.
3350 LaJolla Village
Drive (111-E)
San Diego, CA 92161
Edward L. Zeman 400 (1) Common (9)
8400 Normandale Lake Blvd. Record and Stock
Suite 1150 Beneficial
Minneapolis, MN 55437
All current executive 56,648 (1)(12) Common 2.60%
officers and directors Record and Stock
as a group (11 persons) Beneficial
(1) This figure does not include shares of Company common stock allocated to
the account of current and former officers of the Company under the
Company's Thrift Plan and Profit Sharing Stock Plan. At March 1, 1995,
under these two Plans, 68,286.223 common shares, or 3.13% of the common
shares outstanding, had been allocated to current and former executive
officers of the Company, including Messrs. Gregg, Martens, Schmid, and
Zeman. Mr. Schmid had been allocated 31,703.923 shares, or 1.45% of the
common shares outstanding, under the two Plans. Mr. Gregg had been
allocated 1,011.931 shares, or less than 1% of the common shares
outstanding, under the two Plans. Mr. Martens had been allocated 6,144.219
shares, or less than 1% of the common shares outstanding, under the two
Plans. Mr. Zeman had been allocated 1,501.218 shares, or less than 1% of
the common shares outstanding, under the two Plans. Persons who have been
allocated shares under either of the Plans have voting power over these
shares. See Note 3.
(2) Of these shares, 352,800 are held of record by Robert Struyk and First Bank
National Association of Minneapolis as Trustees of the Trust under the will
of T. H. Schonlau, and 1,600 are held of record by State Bank & Trust
Company of New Ulm as Trustee of the Clara Schonlau Revocable Trust, of
which trusts Mrs. Schonlau is the life beneficiary.
(3) These shares are held by the record holder as trustee of the Company's
Thrift Plan and Profit Sharing Stock Plan. Pursuant to the terms of these
Plans, the trustee votes the shares held by the Plans unless, pursuant
action of the Plan Administrative Committee, voting rights have been passed
through to Plan Participants. The Administrative Committee for the Plans
has passed through the right to vote shares held by the Plans. Shares in
the Plans as to which the officers of the Company exercise investment power
are not included as beneficially owned by the named officer or all officers
and directors as a group solely by reason of possession of such investment
power.
(4) The Bank holds these shares as trustee of a number of trusts. All shares as
to which the Bank exercises investment power, either sole or shared, are
reflected in the foregoing table as beneficially owned by the Bank,
including the 1,600 shares held as trustee of the Clara Schonlau Revocable
Trust referred to in Note 2. The Bank exercises sole (222,478 shares) or
shared (27,357 shares) investment power with respect to all such shares
through its Trust Investment Committee.
In addition to the shares listed in the foregoing table, the Bank holds
15,868 shares as to which the Bank exercises no investment power.
(5) These shares are held of record by Firstar Trust Company of Minnesota. See
Note 3.
(6) SBM Partners L.P. is a Delaware limited partnership of which Jupiter
Industries, Inc. and Head Insurance Investors L.P. are the sole general
partners.
(7) Georgia International is a wholly-owned subsidiary of Integon Life
Insurance Corporation and an affiliate of SBM Partners L.P. See Note 6
hereof.
(8) In 1994, Mr. Geer was issued a warrant to acquire common stock equal to 5%
of the Company's outstanding shares, at a price of $6.29 per share. The
warrant and the underlying shares are not publicly traded and, as such,
there is no definitive value for the warrant. The warrant is subject to
optional and mandatory redemption by the Company upon the occurrence of
certain events. See "Employment Agreements" on pages 47 to 48.
(9) Less than 1%.
(10) These shares are held of record by SBM Partners L.P. and Georgia
International Life Insurance Company. Mr. Head is a controlling person of
both entities. See Notes 6 - 7 hereof.
(11) These shares are held of record by SBM Partners L. P. See Note 9.
(12) Includes shares held by or for spouses and minor children.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company has entered into an employment agreement and a split-dollar
arrangement with Roman G. Schmid, the former Chairman, Chief Executive
Officer, and President of the Company. See Notes 4 and 5 to Item 11 hereof.
In 1994, Charles A. Geer, President and Chief Executive Officer of the
Company, entered into a Letter Agreement with the Company, and was issued a
warrant by the Company. See Item 11 Note 10 and Item 11 "Employment
Agreements". Mr. Geer received a prepayment of $90,000 pursuant to his
Letter Agreement with the Company. No other officer or director of the
Company was directly indebted to the Company in 1994.
The Company has entered into an agreement to sell its business to a third
party. See Item 1.a. hereof. Pursuant to employment agreements between the
Company and Executive Officers of the Company, such Officers may receive
special payments in connection with such transaction. See "Employment
Agreements" at pages 47 to 48.
As is discussed in Section 1.a. hereof, in connection with the proposed
sale of the Company's business, the Company and Mr. John C Head III, a
former director of the Company and a principal beneficial owner of the
Company's stock, will provide mutual releases.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements of SBM Company and Subsidiaries for year ended
December 31, 1994 included in Item 8.
10-K Page
---------
Independent Auditors' Report F-1 (39)
Consolidated Balance Sheets - F-2 (40)
December 31, 1994, and 1993
Consolidated Statements of Income F-3 (41)
- Three years ended December 31, 1994
Consolidated Statements of
Stockholders' Equity - Three Years F-4 (42)
ended December 31, 1994
Consolidated Statements of Cash Flows - Three F-5 (43)
Years ended December 31, 1994
Notes to Consolidated Financial
Statements - Three years ended
December 31, 1994 F-6-F-22(44-60)
(a) 2. The following Financial Statement Schedules and Independent
Auditors' Report are included herein:
10-K Page
---------
Independent Auditors' Report on Financial
Statement Schedules ................................... S-1 (96)
SBM Company - Consolidated Financial Statement Schedules:
Schedule I - Summary of Investments - Other than
Investments in Related Parties- December 31, 1994
.............................................. S-2 (97)
Schedule II - Condensed Financial
Information of Registrant
- Three Years Ended December 31, 1994 ...S-3 - S-6 (98-101)
Schedule III - Supplementary
Insurance Information
- Three Years Ended December 31, 1994....S-7 - S-8 (102-103)
Schedule IV - Reinsurance
Three Years Ended December 31, 1994......S-9 (104)
Schedule I - Marketable Securities - Other
Security Investments - December 31, 1993*
Schedule IX - Short-Term Borrowings - Three
Years Ended December 31, 1993*
* Filed as pages S-2 (63) and S-7 (68) to Form 10-K filed March 31, 1994
(File No. 811-407), and incorporated herein by reference.
SBM Certificate Company-Schedules for Registered
Investment Companies:
Independent Auditors' Report on Financial Statement Schedules*
Schedule I - Investments in Securities of
Unaffiliated Issuers - December 31, 1994*
Schedule III - Mortgage Loans on Real Estate
and Interest Earned on Mortgages - Year Ended
December 31, 1994*
Schedule IV - Real Estate Owned and Rental Income -
Year Ended December 31, 1994*
Schedule V - Qualified Assets on Deposit
December 31, 1994*
Schedule VI - Certificate Reserves - Year Ended
December 31, 1994*
Schedule VII - Valuation and Qualifying Accounts Years Ended December
31, 1994 and 1993*
* Financial Statement Schedules for Registrant are incorporated herein
by reference and were previously filed as pages 45 to 74 to Post
Effective Amendment No. 6 to Registration Statement on Form S-1 of SBM
Certificate Company filed March 31, 1995 (File No. 33-38066).
Independent Auditor's Report on Financial Statement Schedules **
Schedule I - Investments in Securities of Unaffiliated Issuers
- December 31, 1993.**
Schedule III - Mortgage Loans on Real Estate and Interest Earned on
Mortgages - Year ended December 31, 1993**
Schedule IV- Real Estate Owned and Rental Income - Year ended
December 31, 1993**
Schedule V - Qualified Assets on Deposit - December 31, 1993**
Schedule IX - Supplementary Profit and Loss Information - Three years
ended December 31, 1993.**
Schedule XI - Certificate Reserves - Year ended December 31, 1993**
** Filed as pages 52-80 to Post-Effective Amendment No. 5 to
Registration Statement No. 33-38066 on Form S-1 of SBM Certificate
Company, filed on February 25, 1994, and incorporated herein by
reference.
Independent Auditor's Report on Financial Statement Schedules ***
Schedule III - Mortgage Loans on Real Estate and Interest Earned on
Mortgages - Year ended December 31, 1992. ***
Schedule IV - Real Estate Owned and Rental Income - Year ended
December 31, 1992. ***
*** Filed as pages 50-78 to Post-Effective Amendment No. 3 to Registration
Statement No. 33-38066 on Form S-1 of SBM Certificate Company, filed
on March 5, 1993, and incorporated herein by reference.
All other schedules have been omitted as the required
information is inapplicable or information is presented in the
notes to the financial statements.
3. List of required exhibits:
(3) Amended and Restated Articles of Incorporation filed as Exhibit
3B to Form 10-K filed April 1, 1991 (File No. 811-407).*
Amendment to Amended and Restated Articles of Incorporation filed
as Exhibit 3A hereto.
Restated By-laws, as amended, filed as Exhibit 3 to Form 10-K
filed March 31, 1993 (File No.811-407).*
(4) Instruments defining the rights of security holders - filed as
exhibits 4A through 4K to Registration Statement No. 2-61993
dated June 27, 1978; Exhibit 4 to Registration Statement No.
2-76706 dated March 26, 1982; and Exhibit 4 to Registration
Statement No. 33-6131 dated May 28, 1986.*
Certificate of Designation of Series A Mandatory Redeemable
Voting Convertible Preferred Stock filed as Exhibit 4A to Form
10-K filed March 31, 1993 (File No. 811-407).*
Certificate of Designation of Series B Voting Convertible
Participating Preferred Stock filed as Exhibit 4A to Form 10-K
dated December 31, 1993 (File No. 811-407).*
Exchange Right to Acquire Series B Voting Convertible
Participating Preferred Stock of the registrant filed as Exhibit
4B to Form 10-K dated December 31, 1993 (File No. 811-407).*
(9) Voting trust agreement - None
(10) Material Contracts.
The following documents were filed as the designated exhibits to
Registration Statement No. 2-61993 dated June 27, 1978.*
Employment Agreement between registrant and Ford H. Winslow dated
January 23, 1975 - filed as Exhibit 11E.
Management Agreement between registrant and State Bond and
Mortgage Life Insurance Company dated May 26, 1967 - filed as
Exhibit 13B.
Agreement between registrant and SBM Financial Services, Inc.
(formerly State Bond Sales Corporation) dated August 11, 1969 and
amendment dated December 5, 1969 - filed as Exhibit 13C.
Agreement between State Bond and Mortgage Life Insurance Company
and SBM Financial Services, Inc. (formerly State Bond Sales
Corporation) dated January 1, 1976 - filed as Exhibit 13D.
* Previously filed as indicated and incorporated herein by reference.
List of required exhibits (Continued)
Agency Agreement between registrant and Common Stock Fund of
State Bond and Mortgage Company dated June 26, 1972 - filed as
Exhibit 13L.
Agency Agreement between registrant and Diversified Fund of State
Bond and Mortgage Company dated June 26, 1972 - filed as Exhibit
13M.
Reinsurance Agreement between State Bond and Mortgage Life
Insurance Company and Continental Assurance Company dated July 3,
1974 - filed as Exhibit 130.
Reinsurance Agreement between State Bond and Mortgage Life
Insurance Company and North American Life and Casualty Company
dated August 6, 1973 - filed as Exhibit 13P.
Reinsurance Agreement between State Bond and Mortgage Life
Insurance Company and Lincoln National Life Insurance Company,
undated and amendments thereto dated May 1, 1975, August 1, 1977
and August 9, 1977 - filed as exhibit 13Q.
* Previously filed as indicated and incorporated herein by reference.
List of required exhibits (Continued)
The following documents were filed as the designated exhibits to Form
10-K or registration statements filed as indicated.
Agency Agreement between the registrant and State Bond Tax Exempt
Fund, Inc. dated May 22, 1984, filed as Exhibit 9 to Registration
Statement No. 2-77156 dated May, 1984.*
Administration Agreement between registrant and State Bond U.S.
Government Securities Fund, Inc., dated November 21, 1985, filed
as Exhibit 10B to Form 10K filed March 26, 1986 (File No.
811-407).*
Accounting Services Agreement between the registrant and State
Bond U.S. Government Securities Fund, Inc., dated November 21,
1985, filed as Exhibit 10D to Form 10K filed March 26, 1986 (File
No. 811-407).*
Administration Agreement between the registrant and State Bond
Cash Management Fund, Inc. dated June 1, 1986 and filed as
Exhibit 10F for Form 10K filed March 27, 1987 (File No.
811-407).*
Accounting Services Agreement between the registrant and State
Bond Government Securities Fund, Inc. (subsequently renamed State
Bond Tax Exempt Fund, Inc.) dated July 6, 1982 and filed as
Exhibit 10G for Form 10K filed March 27, 1987 (File No.
811-407).*
Reinsurance Agreement between State Bond and Mortgage Life
Insurance Company and American United Life Insurance Company
dated November 1, 1987 and filed as Exhibit 10H to Form 10K filed
March 27, 1987 (File No. 811-407).*
Reinsurance Agreement between State Bond and Mortgage Life
Insurance Company and Old Fort Life Insurance Co. LTD. dated
December 1987 and filed as Exhibit 10A to Form 10K filed March
28, 1988 (Filed No. 811-407).*
Transfer Agreement, between the registrant and State Bond
Tax-Free Income Fund, Inc., dated December 17, 1987, filed as
Exhibit 9(ii), to Registration Statement No. 33-18934 dated
December 7, 1987.*
* Previously filed as indicated and incorporated herein by reference.
List of required exhibits (Continued)
Reinsurance Agreement, Automatic Coinsurance, between registrant
and Frankona America Life Reassurance Company dated October 1,
1988 filed as Exhibit 10C to Form 10K filed March 28, 1989 (File
No. 811-407).*
Reinsurance Agreement, Automatic YRT, between registrant and
Frankona America Life Reassurance Company dated October 1, 1988,
filed as Exhibit 10D to Form 10K filed March 28, 1989 (File No.
811-407).*
Reinsurance Agreement, Bulk Accidental Death and Dismemberment
Benefit, between registrant and Frankona America Life Reassurance
Company dated January 1, 1989, filed as Exhibit 10E to Form 10K
filed March 28, 1989 (File No. 811-407).*
Amendment to Reinsurance Agreement between State Bond and
Mortgage Life Insurance Company (SBM) and Old Fort Life Insurance
Co. LTD. dated December 1989 - filed as Exhibit 10A to Form 10K
filed March 28, 1990 (File No. 811-407).*
Custody Agreement, as amended and supplemented, between
registrant, SBM Certificate Company, and First Bank National
Association dated December 20, 1990, filed as Exhibit 10(b) to
Amendment No. 1 to Registration Statement No. 33-38066 of SBM
Certificate Company dated January 2, 1991.*
Assumption, Assignment Agreement and Bill of Sale between
registrant and SBM Certificate Company dated December 31, 1990
filed as Exhibit 18(b) to Form N-8B-4 No. 811-6268 of SBM
Certificate Company filed April 1, 1991.*
Lease Agreement between registrant and Connecticut General Life
Insurance Company dated May 11, 1990, filed as Exhibit 10C to
Form 10K filed April 1, 1991 (File No. 811-407).*
Reinsurance Agreement between registrant and NRG American Life
Reassurance Corporation dated December 31, 1990, filed as Exhibit
10E to Form 10K field April 1, 1991 (File No. 811-407).*
* Previously filed as indicated and incorporated herein by reference.
List of required exhibits (Continued)
Lease between registrant and Minnesota ND Properties, Inc. dated
March 28, 1991, revised May 7, 1991 and revised May 13, 1991
filed as Exhibit 10D to Form 10K filed March 30, 1992 (File No.
811-407).*
Amendment to Reinsurance Agreement between registrant and NRG
American Life Reassurance Corporation dated June 30, 1991 filed
as Exhibit 10E to Form 10K filed March 30, 1992 (File No.
811-407).*
Trust Agreement between State Bond and Mortgage Life Insurance
Company and NRG American Life Reassurance Corporation and Mellon
Bank N.A. dated January 18, 1991 filed as Exhibit 10F to Form 10K
filed March 30, 1992 (File No. 811-407).*
Stock Purchase Agreement between registrant and Taylor
Bancshares, Inc. dated November 29, 1991 filed as Exhibit 10J to
Form 10K filed March 30, 1992 (File No. 811-407).*
Lease between registrant and SBM Certificate Company dated
January 1, 1992 filed as Exhibit 10K to Form 10K filed March 30,
1992 (File No. 811-407).* First Amendment to Lease dated June 30,
1993, filed as Exhibit 10A to Form 10-K dated December 31, 1993
(File No. 811-407).*
Lease between SBM Certificate Company and State Bank & Trust
Company of New Ulm dated August 13, 1992 filed as Exhibit 10A to
Form 10-K filed March 31, 1993 (File No. 811-407).*
Data Processing Agreement between the registrant and State Bank &
Trust Company of New Ulm dated August 13, 1992 filed as Exhibit
10B to Form 10-K filed March 31, 1993 (File No. 811-407).*
Non-Competition Agreement between the registrant and Taylor
Bancshares, Inc. dated August 13, 1992 filed as Exhibit 10C to
Form 10-K filed March 31, 1993 (File No. 811-407).*
Asset Purchase Agreement and Non-Competition Agreement between
the registrant and ML Agency, Inc. filed as Exhibit 10D to Form
10-K filed March 31, 1993 (File No. 811-407).*
Agreement between the registrant and Multico Marketing
Corporation dated July 14, 1983, as amended, filed as Exhibit 10F
to Form 10-K filed March 31, 1993 (File No. 811-407).*
* Previously filed as indicated and incorporated herein by reference.
List of required exhibits (Continued)
Agreement between the registrant and Tri-Mark Insurance Services,
Inc. dated March 23, 1989, as amended, filed as Exhibit 10G to
Form 10-K filed March 31, 1993 (File No. 811-407).*
Preferred Stock and Note Purchase Agreement by and among the
registrant, SBM Partners L.P., and Integon Life Insurance
Corporation dated December 20, 1992 filed as Exhibit 10H to Form
10-K filed March 31, 1993 (File No. 811-407).*
Registration Rights Agreement by and among the registrant, SBM
Partners L.P., and Integon Life Insurance Corporation dated
December 23, 1992 filed as Exhibit 10I to Form 10-K filed March
31, 1993 (File No. 811-407).*
Secured Promissory Note to BOT Financial Corporation dated
December 8, 1992 filed herewith as Exhibit 10J to Form 10-K filed
March 31, 1993 (File No. 811-407).*
Security Agreement between the registrant and BOT Financial
Corporation dated December 8, 1992 filed as Exhibit 10K to Form
10-K filed March 31, 1993 (File No. 811-407).*
Management Agreement between registrant and SBM Certificate
Company dated September 21, 1993 filed as Exhibit 10(a) to
Amendment No. 5 to Registration Statement No. 33-38066 of SBM
Certificate Company dated February 24, 1994*
Underwriting Agreement between SBM Financial Services, Inc. and
SBM Certificate Company dated September 21, 1993 filed as Exhibit
1 to Amendment No. 5 to Registration Statement No. 33-38066 of
SBM Certificate Company dated February 24, 1994.*
Investment Advisory and Management Agreement between the
registrant and State Bond Equity Funds, Inc. dated September 21,
1993, filed as Exhibit 5 to Registration Statement No. 2-19600 of
State Bond Equity Funds, Inc. dated February 24, 1994. *
Investment Advisory and Management Agreement between the
registrant and State Bond Income Funds, Inc. dated September 21,
1993, filed as Exhibit 5 to Registration Statement No. 33-1176 of
State Bond Income Funds, Inc. dated December 29, 1993. *
* Previously filed as indicated and incorporated herein by reference.
List of required exhibits (Continued)
Investment Advisory and Management Agreement between the
registrant and State Bond Investment Funds, Inc. dated September
21, 1993, filed as Exhibit 5 to Registration Statement No.
2-22365 of State Bond Investment Funds, Inc. dated February 24,
1994. *
Investment Advisory and Management Agreement between the
registrant and State Bond Money Funds, Inc. dated September 21,
1993, filed as Exhibit 5 to Registration Statement No. 2-74561 of
State Bond Money Funds, Inc. dated September 27, 1993. *
Investment Advisory and Management Agreement between the
registrant and State Bond Municipal Funds, Inc. dated September
21, 1993, filed as Exhibit 5 to Registration Statement No.
2-77156 of State Bond Municipal Funds, Inc. dated October 20,
1993. *
Investment Advisory and Management Agreement between the
registrant and State Bond Tax-Free Income Funds, Inc. dated
September 21, 1993, filed as Exhibit 5 to Registration Statement
No. 33-18934 of State Bond Tax-Free Income Funds, Inc. dated
October 20, 1993. *
Underwriting Agreement between the registrant and State Bond
Equity Funds, Inc. dated September 21, 1993 filed as Exhibit 6 to
Registration Statement No. 2-19600 of State Bond Equity Funds,
Inc. dated February 24, 1994.*
* Previously filed as indicated and incorporated herein by reference.
List of required exhibits (Continued)
Underwriting Agreement between the registrant and State Bond
Income Funds, Inc. dated September 21, 1993 filed as Exhibit 6 to
Registration Statement No. 33-1176 of State Bond Income Funds,
Inc. dated December 29, 1993.*
Underwriting Agreement between the registrant and State Bond
Investment Funds, Inc. dated September 21, 1993 filed as Exhibit
6 to Registration Statement No. 2-22365 of State Bond Investment
Funds, Inc. dated February 24, 1994.*
Underwriting Agreement between the registrant and State Bond
Money Funds, Inc. dated September 21, 1993 filed as Exhibit 6 to
Registration Statement No. 2-74561 of State Bond Money Funds,
Inc. dated September 27, 1993.*
Underwriting Agreement between the registrant and State Bond
Municipal Funds, Inc. dated September 21, 1993 filed as Exhibit 6
to Registration Statement No. 2-77156 of State Bond Municipal
Funds, Inc. dated October 20, 1993.*
Underwriting Agreement between the registrant and State Bond
Tax-Free Income Funds, Inc. dated September 21, 1993 filed as
Exhibit 6 to Registration Statement No. 33-18934 of State Bond
Tax-Free Income Funds, Inc. dated October 20, 1993.*
SBM Company Thrift Plan Trust Agreement dated November 1, 1993,
filed as Exhibit 10B to Form 10-K dated December 31, 1993 (File
No. 811-407)*. First Amendment to Thrift Plan dated December 22,
1994 filed as Exhibit 10A hereto.
SBM Company Profit Sharing Stock Plan Trust Agreement dated
November 1, 1993, filed as Exhibit 10C to Form 10-K dated
December 31, 1993 (File No. 811-407)*. First Amendment to Stock
Plan dated December 22, 1994 filed as Exhibit 10B hereto.
Amended and Restated Employment Agreement between registrant and
Roman G. Schmid dated April 8, 1994 - filed as an Exhibit to Form
8-K dated April 8, 1994 (File No. 811-407).*
Engagement Agreement between registrant and Charles A. Geer dated
November 22, 1994 and Warrant issued to Charles A. Geer filed as
Exhibit 10C hereto.
Employment Agreement between registrant and Edward L. Zeman dated
November 22, 1994 filed as Exhibit 10D hereto.
Employment Agreement between registrant and Stewart D. Gregg
dated November 22, 1994 filed as Exhibit 10E hereto.
Employment Agreement between registrant and Richard M. Carlblom
dated November 30, 1994 filed as Exhibit 10F hereto.
Employment Agreement between registrant and Keith O. Martens
dated November 30, 1994 filed as Exhibit 10G hereto.
Employment Agreement between registrant and Dale C. Bauman dated
November 30, 1994 filed as Exhibit 10H hereto.
Amended and Restated Stock and Asset Purchase Agreement between
the registrant and ARM Financial Group, Inc., dated as of
February 16, 1995, filed as an Exhibit to a Form 8-K of the
registrant dated February 16, 1995.*
* Previously filed as indicated and incorporated herein by reference.
EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS
Amended and Restated Employment Agreement between registrant and
Roman G. Schmid dated April 8, 1994 - filed as an Exhibit to Form
8-K dated April 8, 1994 (File No. 811-407).*
Deferred Compensation Plan of registrant filed as Exhibit 10C to
Form 10K filed March 27, 1987 (File No. 811-407).*
Deferred Compensation Plan for Non-Employee Directors of State
Bond and Mortgage Life Insurance Company filed as Exhibit 10D to
Form 10K filed March 27, 1987 (File No. 811-407).*
Deferred Compensation Plan for Non-Employee Directors of
registrant filed as Exhibit 10E to Form 10K filed March 27, 1987
(File No. 811-407).*
SBM Company Amended and Restated 1990 Stock Option Plan filed as
Exhibit 10L to Form 10-K filed March 31, 1993 (File No.
811-407).*
Split-dollar Agreement between the registrant, Roman G. Schmid,
and Helen M. Schmid dated December 20, 1989 filed as Exhibit 10N
to Form 10-K filed March 31, 1993 (File No. 811-407).*
SBM Company Thrift Plan Trust Agreement dated November 1, 1993,
filed as Exhibit 10B to Form 10-K dated December 31, 1993 (File
No. 811-407)*. First Amendment to SBM Company Thrift Plan Trust
Agreement filed as Exhibit 10A hereto.
SBM Company Profit Sharing Stock Plan Trust Agreement dated
November 1, 1993, filed as Exhibit 10C to Form 10-K dated
December 31, 1993 (File No. 811-407)*. First Amendment to SBM
Company Profit Sharing Stock Plan Trust Agreement filed as
Exhibit 10B hereto.
Engagement Agreement between registrant and Charles A. Geer dated
November 22, 1994 and Warrant issued to Charles A. Geer filed as
Exhibit 10C hereto.
Employment Agreement between registrant and Edward L. Zeman dated
November 22, 1994 filed as Exhibit 10D hereto.
Employment Agreement between registrant and Stewart D. Gregg
dated November 22, 1994 filed as Exhibit 10E hereto.
Employment Agreement between registrant and Richard M. Carlblom
dated November 30, 1994 filed as Exhibit 10F hereto.
* Previously filed as indicated and incorporated herein by reference.
Employment Agreement between registrant and Keith O. Martens
dated November 30, 1994 filed as Exhibit 10G hereto.
Employment Agreement between registrant and Dale C. Bauman dated
November 30, 1994 filed as Exhibit 10H hereto.
(11) Statement regarding computation of per share earnings. See
Statements of Income - Three years ended December 31, 1994, in
Item 8 hereof.
(12) Statements regarding computation of ratios - None.
List of required exhibits (Continued)
(18) Letters regarding change in accounting principles - None.
(19) Previously unfiled documents - None.
(21) Subsidiaries of the registrant - filed herewith as Exhibit 22.
(23) Published report regarding matters submitted to vote of security
holders - None.
(24) Consent of Deloitte & Touche LLP, filed herewith.
(25) Power of Attorney - None.
(27) Article 7 Financial Data Schedule as required for electronic
submissions.
(28) Additional Exhibits - None.
(29) Information from reports furnished to state insurance regulatory
authorities - None.
(b) Reports on Form 8-K.
Report dated December 29, 1994, Items 5 and 7 regarding signing of
Letter of Intent with ARM Financial Group, Inc.
INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Directors
SBM Company
Minneapolis, Minnesota
We have audited the consolidated financial statements of SBM Company as of
December 31, 1994 and 1993 and for each of the three years in the period ended
December 31, 1994, and have issued our report thereon dated March 29, 1995; such
report is included elsewhere in this Form 10-K. Our audits also included the
consolidated financial statement schedules of SBM Company, listed in Item 14.
These consolidated financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits. In our opinion, such consolidated financial statement schedules, when
considered in relation to the basic consolidated financial statements taken as a
whole, present fairly, in all material respects, the information set forth
therein.
DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
March 29, 1995
S-1
Schedule I
SBM COMPANY AND SUBSIDIARIES
Summary of Investments - Other than Investments in Related Parties
December 31, 1994
Amount at
Which Shown on
AMORTIZED MARKET THE BALANCE
TYPE OF INVESTMENT COST VALUE SHEET
- ------------------ ---------------- --------------- ----------------
Debt securities:
Available-for-sale:
U.S. Government obligations $ 100,578,894 $ 96,796,640 $ 96,796,640
GNMA certificates 88,584,779 86,408,999 86,408,999
FNMA certificates 19,483,095 18,535,791 18,535,791
Corporate Medium Term Notes 28,130,588 27,620,368 27,620,368
Corporate Bond Obligations 50,837,739 49,845,330 49,845,330
Collateralized Mortgage Obligations
(FNMA and FHLMC) 444,647,746 373,999,948 373,999,948
-------------- ---------------- ---------------
732,262,841 653,207,076 653,207,076
Held-to-maturity:
U.S. Government obligations 168,461 153,213 168,461
State and Municipal Obligations 667,053 638,400 667,053
Collateralized Mortgage Obligations
(FNMA and FHLMC) 13,108,720 11,121,715 13,108,720
-------------- ---------------- --------------
13,944,234 11,913,328 13,944,234
Marketable equity securities:
Common stocks 2,880 2,880 2,880
Preferred stocks 1,065,645 680,209 680,209
-------------- ----------------- -------------
1,068,525 683,089 683,089
Mortgage loans 36,257,214 37,373,864 36,257,214
Policy loans 22,153,936 22,153,936 22,153,936
Other invested assets:
Property acquired in satisfaction of debt 1,462,149 1,462,149 1,462,149
Other 232,357 232,357 232,357
-------------- ---------------- ------------
1,694,506 1,694,506 1,694,506
Short-term investments:
Commercial Paper 37,023,203 37,023,203 37,023,203
U.S. Treasury Bill, 2/23/95 567,353 567,353 567,353
Money market mutual funds 11,934 11,934 11,934
-------------- ---------------- -------------
37,602,490 37,602,490 37,602,490
Total: $ 844,983,746 $ 764,628,289 $ 765,542,545
================ ================= ==============
See notes to consolidated financial statements.
S-2
Schedule II
SBM COMPANY
Condensed Financial Information of Registrant
Balance Sheets
ASSETS
December 31
----------------------------
1994 1993
------------ ------------
Cash............................................................................. $ 105,913 $ 128,131
Money market fund................................................................ 11,935 3,454,570
Investment in wholly owned subsidiaries.......................................... (10,474,080) 52,509,823
Furniture and equipment, at cost less accumulated depreciation
of $1,649,302 and $1,782,174, respectively.................................... 822,228 3,059,206
Receivable from subsidiaries and affiliates...................................... 230,349 140,317
Deferred income taxes............................................................ 81,785 -
Other assets..................................................................... 1,300,515 1,197,965
----------- ------------
Total assets $(7,921,355) $ 60,490,012
=========== ============
Liabilities and Stockholders' Equity (Deficit)
Accounts payable and other liabilities........................................... $ 1,883,207 $ 2,270,699
Payable to subsidiaries and affiliates........................................... 124,381 155,822
Deferred income taxes............................................................ - 188,215
Demand loans and notes payable................................................... - 2,012,210
Income taxes payable............................................................. 418,145 269,313
Deferred compensation and retirement benefits for officers....................... 1,227,284 1,236,048
------------ ----------
Total liabilities........................................................... 3,653,017 6,132,307
------------ ----------
Mandatory redeemable voting convertible preferred
stock, par value $1,000 (1994 includes $760,000 dividends in arrears).
Authorized 19,000 shares; issued 19,000 shares, liquidation value
$19,000,000 plus dividends in arrears......................................... 18,485,868 17,589,680
Common stock held by employee benefit plans;
304,693 and 305,693 shares, respectively...................................... 1,916,519 4,808,551
Stockholders' equity (deficit):
Common stock no par value. Authorized 20,000,000 shares;
issued and outstanding 2,179,714 and 2,279,755 shares,
less 304,693 and 305,693 shares held by employee benefit plans, respectively 2,945,606 3,101,197
Unrealized losses on marketable equity securities net
of income tax benefit of $131,000 and $86,000, respectively................. (254,388) (165,742)
Unrealized losses on debt securities, net of
income tax benefit of $6.5 million.......................................... (59,691,765) -
Retained earnings............................................................. 25,023,788 29,024,019
----------- ----------
Total stockholders' equity (deficit).................................... (31,976,759) 31,959,474
------------ ----------
$(7,921,355) $ 60,490,012
=========== ============
See notes to consolidated financial statements.
S-3
Schedule II, Continued
SBM COMPANY
Condensed Financial Information of Registrant
Statements of Income
Year ended December 31
-------------------------------------------
1994 1993 1992
------------ ------------ ------------
Investment and service fee income:
Advisory and other fees from affiliated mutual funds.............. $ 1,481,075 $ 1,486,052 $ 1,391,679
Interest and dividends............................................ 29,789 54,949 10,530
Realized capital gains (losses)................................... (487,726) (13,448) 8,197
Other income - net................................................ 117,609 210,704 170,126
------------ ------------ ------------
Total investment and service fee income......................... 1,140,747 1,738,257 1,580,532
General and administrative expenses............................... 2,161,686 2,078,732 2,714,751
------------ ------------ ------------
Loss before income tax credit and equity in net earnings (loss)
of subsidiaries............................................... (1,020,939) (340,475) (1,134,219)
Income tax expense (credit)....................................... 30,000 (124,000) (385,000)
------------ ------------ ------------
Loss before equity in net earnings (loss) of subsidiaries..... (1,050,939) (216,475) (749,219)
Equity in net earnings (loss) of continuing subsidiaries:
State Bond and Mortgage Life Insurance Company.................. (2,936,695) 3,862,963 3,873,861
SBM Certificate Company......................................... 383,203 101,209 (85,568)
------------ ------------ ------------
Income (loss) before equity in net earnings of discontinued
subsidiary.................................................... (3,604,431) 3,747,697 3,039,074
Equity in net earnings of discontinued subsidiary:
State Bank & Trust Company of New Ulm, less income taxes of
$45,409 in 1992............................................... - - 183,295
Loss on disposal of State Bank & Trust Company of New Ulm,
including income taxes (benefit) of ($65,000) in 1992......... - - (180,000)
------------ ------------ ------------
Income (loss) before cumulative effect of change in .......... (3,604,431) 3,747,697 3,042,369
accounting principle
Cumulative effect of change in accounting principle............... - - (264,000)
------------ ------------ ------------
Net income (loss)............................................... $(3,604,431) $ 3,747,697 $ 2,778,369
============ ============ ============
Discount accretion on preferred stock............................... $ 136,188 $ - $ -
Mandatory redeemable voting convertible preferred stock dividends... $ 1,520,000 $ 657,802 $ -
============ ============ ============
Net income (loss) applicable to common stock........................ $(5,260,619) $ 3,089,895 $ 2,778,369
============ ============ ============
Earnings per common share:
Primary:
Income (loss) from continuing operations.......................... $ (2.40) $ 1.35 $ 1.32
Cumulative effect of change in accounting principle............... - - (.11)
------------ ------------ ------------
Net income (loss)............................................... $ (2.40) $ 1.35 $ 1.21
============ ============ ============
Fully diluted:
Income (loss) from continuing operations.......................... $ (2.40) $ 1.32 $ 1.32
Cumulative effect of change in accounting principle............... - - (.11)
------------ ------------ ------------
Net income (loss)............................................... $ (2.40) $ 1.32 $ 1.21
============ ============ ============
Weighted average common shares outstanding (primary)................ 2,187,481 2,281,673 2,295,932
Weighted average common shares outstanding (fully diluted).......... 2,187,481 2,971,923 2,295,932
See notes to consolidated financial statements.
S-4
Schedule II, Continued
SBM COMPANY
Condensed Financial Information of Registrant
Statements of Stockholders' Equity (Deficit)
UNREALIZED
LOSSES ON UNREALIZED
MARKETABLE LOSSES TOTAL
COMMON EQUITY ON DEBT RETAINED STOCKHOLDERS'
STOCK SECURITIES SECURITIES EARNINGS EQUITY (DEFICIT)
----------- ----------- ------------ ----------- ----------------
Balances at December 31, 1991.......................... $ 3,210,461 $ (342,021) $ - $24,836,590 $ 27,705,030
Net income.......................................... - - - 2,778,369 2,778,369
Common stock dividends declared, $.10 per share..... - - - (229,226) (229,226)
Allocation of net income in excess of dividends to
common stock held by employee benefit plans....... - - - (354,515) (354,515)
Income tax effect relating to marketable equity
securities for adoption of SFAS No. 109 - Note A.. - 116,000 - - 116,000
Decrease in unrealized loss on marketable
equity securities, net of income tax benefit...... - 12,997 - - 12,997
Purchase of 7,700 shares............................ (109,264) - - - (109,264)
----------- ----------- ------------ ----------- ------------
Balances at December 31, 1992.......................... 3,101,197 (213,024) - 27,031,218 29,919,391
Net income.......................................... - - 3,747,697 3,747,697
Dividends declared:
Common stock, $.40 per share...................... - - - (911,925) (911,925)
Mandatory redeemable voting convertible preferred stock, 8% - - (657,802) (657,802)
Decrease in unrealized loss on marketable
equity securities, net of income tax benefit...... - 47,282 - - 47,282
Accretion of discount on mandatory redeemable
voting convertible preferred stock................ - - - (38,994) (38,994)
Allocation of net income in excess of dividends to
common stock held by employee benefit plans....... - - - (146,175) (146,175)
----------- ----------- ------------ ----------- ------------
Balances at December 31, 1993.......................... 3,101,197 (165,742) - 29,024,019 31,959,474
Net loss............................................ - - - (3,604,431) (3,604,431)
Dividends declared:
Common stock, $.10 per share...................... - - - (217,971) (217,971)
Mandatory redeemable voting convertible preferred stock, 8% - - - (760,000) (760,000)
Dividends in arrears on mandatory redeemable
voting convertible preferred stock, 8%........... - - - (760,000) (760,000)
Adoption of SFAS No. 115, net of
income tax expense of $2.2 million............... - - 3,800,000 - 3,800,000
Increase in unrealized loss on marketable
equity securities, net of income tax benefit..... - (88,646) - - (88,646)
Accretion of discount on mandatory redeemable
voting convertible preferred stock............... - - - (136,188) (136,188)
Allocation of net loss, dividends and carrying value to
common stock held by employee benefit plans...... - - - 2,876,307 2,876,307
Increase in unrealized loss on debt securities, net of
income tax benefit of $9.4 million............... - - (63,491,765) - (63,491,765)
Purchase of 100,041 shares including acquisition costs
of $42,193....................................... (155,591) - - (1,397,948) (1,553,539)
----------- ----------- ------------ ----------- ------------
Balances at December 31, 1994......................... $ 2,945,606 $ (254,388) $(59,691,765) $25,023,788 $(31,976,759)
=========== =========== ============ =========== ============
See notes to consolidated financial statements.
S-5
Schedule II, Continued
SBM COMPANY
Condensed Financial Information of Registrant
Statements of Cash Flows
Year ended December 31
-------------------------------------------
1994 1993 1992
----------- ------------ ------------
Cash flows from operating activities:
Net income (loss)................................................. $(3,604,431) $ 3,747,697 $ 2,778,369
----------- ------------ ------------
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation.................................................... 248,474 259,347 252,370
Deferred income taxes........................................... (270,000) (8,000) (12,651)
Equity in net (earnings) loss of subsidiaries, less dividends received
of $650,000, $1,855,000 and $1,083,720, respectively.......... 3,203,492 (2,109,172) (2,713,868)
Decrease (increase) in operating assets:
Other assets.................................................... (102,550) 816,904 (439,012)
Refundable income taxes......................................... - - 84,559
Increase (decrease) in operating liabilities:
Income tax payable.............................................. 148,832 (62,646) 331,959
Accounts payable and other liabilities.......................... (142,710) (326,231) (902,179)
Deferred compensation........................................... (8,764) (60,761) 135,095
Net receivable/payable to subsidiaries and affiliates........... 121,473 (154,272) (689,352)
----------- ------------ ------------
Net cash (used in) provided by operating activities............. (406,184) 2,102,866 (1,174,710)
----------- ------------ ------------
Cash flows from investing activities:
Sales (purchases) of short-term investments, net.................. 3,442,635 (2,984,949) 525,682
Investments in subsidiaries....................................... - (4,000,000) (10,700,000)
Proceeds from (additions to) furniture and equipment, net......... 1,500,780 (226,665) (163,922)
Proceeds from disposal of net assets of discontinued operations... - - 8,310,012
----------- ------------ ------------
Net cash provided by (used in) investing activities............. 4,943,415 (7,211,614) (2,028,228)
----------- ------------ ------------
Cash flows from financing activities:
Purchase of common stock.......................................... (1,569,268) (193,375) (153,835)
Sale of common stock.............................................. - - 50,000
Dividends on common stock......................................... (217,971) (683,925) (229,226)
Dividends on preferred stock...................................... (760,000) (657,802) -
Sale of preferred stock........................................... - 11,000,000 4,000,000
Expenses on issuance of preferred stock........................... - (1,299,314) (150,000)
Principal payments on notes payable............................... (2,012,210) (3,175,575) (6,533,976)
Proceeds from notes payable....................................... - - 6,222,853
----------- ------------ ------------
Net cash (used in) provided by financing activities............. (4,559,449) 4,990,009 3,205,816
----------- ------------ ------------
Net (decrease) increase in cash..................................... (22,218) (118,739) 2,878
Cash at beginning of year........................................... 128,131 246,870 243,992
----------- ------------ ------------
Cash at end of year................................................. $ 105,913 $ 128,131 $ 246,870
=========== ============ ============
Supplemental disclosure of cash flow information: Cash paid (received) during
the year for:
Interest........................................................ $ 124,339 $ 606,970 $ 532,105
Income taxes, net of refunds received........................... $ 151,168 $ 11,646 $ (429,182)
Non-cash financing activity - At December 31, 1994, the Company was $760,000 in
arrears for dividends on the mandatory redeemable voting convertible preferred
stock. During 1993, the Company's $4,000,000 convertible promissory note was
converted into 4,000 shares of the Company's Series A Mandatory Redeemable
Voting Convertible Preferred Stock.
Non-cash investing activity - Effective January 1, 1991, SBM Company transferred
its face amount certificate business to a wholly owned subsidiary, SBM
Certificate Company. The net assets transferred were $1,307,732, of which
$1,057,732 were non-cash net assets. SBMC remains liable, as issuer, for the
certificate obligations on all certificates issued and outstanding prior to
January 1, 1991.
Effective December 31, 1993, SBM Company transferred the stock of its
wholly-owned subsidiary, SBM Certificate Company, with a book value of
$3,880,637, to Stock Bond and Mortgage Life Insurance Company as a capital
contribution.
See notes to consolidated financial statements.
S-6
Schedule III
SBM COMPANY
STATE BOND AND MORTGAGE LIFE INSURANCE COMPANY
Supplementary Insurance Information
(Part 1)
FUTURE POLICY
DEFERRED BENEFITS, OTHER
POLICY LOSSES, CLAIMS, POLICY CLAIMS
ACQUISITION AND LOSS UNEARNED AND BENEFITS
COSTS EXPENSES PREMIUMS PAYABLE
------------ ------------ ------------- ------------
Year Ended December 31, 1994:
State Bond and Mortgage
Life Insurance Company $ 76,640,883 $910,104,179 - -
Non-insurance segments 309,587 - - -
------------ ------------ ------------- ------------
Total $ 76,950,470 $910,104,179 $ - $ -
============ ============ ============= ============
Year Ended December 31, 1993:
State Bond and Mortgage
Life Insurance Company $ 56,399,696 $891,923,036 - -
Non-insurance segments 320,373 - - -
------------ ------------ ------------- ------------
Total $ 56,720,069 $891,923,036 $ - $ -
============ ============ ============= ============
Year Ended December 31, 1992:
State Bond and Mortgage
Life Insurance Company $ 52,419,951 $810,963,373 - -
Non-insurance segments 444,284 - - -
------------ ------------ ------------- ------------
Total $ 52,864,235 $810,963,373 $ - $ -
============ ============ ============= ============
See notes to consolidated financial statements.
S-7
Schedule III (Continued)
(Part 2)
BENEFITS, AMORTIZATION
CLAIMS, OF DEFERRED
NET LOSSES AND POLICY OTHER
PREMIUM INVESTMENT SETTLEMENT ACQUISITION OPERATING PREMIUMS
REVENUE INCOME EXPENSES COSTS EXPENSES WRITTEN
------------ ----------- ------------ ------------ ------------ ----------
$ 392,801 $56,845,103 $ 42,937,755 $ 3,756,579 $ 5,077,889 N/A
- 6,042,619 - 518,782 6,701,122
------------ ----------- ------------ ------------ ------------
$ 392,801 $62,887,722 $ 42,937,755 $ 4,275,361 $ 11,779,011
============ =========== ============ ============ ============
$ 415,141 $54,905,631 $ 45,149,312 $ 3,575,359 $ 3,958,862 N/A
- 5,978,400 - 501,377 6,444,035
------------ ----------- ------------ ------------ ------------
$ 415,141 $60,884,031 $ 45,149,312 $ 4,076,736 $ 10,402,897
============ =========== ============ ============ ============
$ 441,921 $52,148,149 $ 43,402,194 $ 2,440,798 $ 3,105,931 N/A
- 5,942,287 - 493,920 6,450,172
------------ ----------- ------------ ------------ ------------
$ 441,921 $58,090,436 $ 43,402,194 $ 2,934,718 $ 9,556,103
============ =========== ============ ============ ============
S-8
Schedule IV
SBM COMPANY
STATE BOND AND MORTGAGE LIFE INSURANCE COMPANY
Reinsurance
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
GROSS OTHER FROM OTHER NET ASSUMED TO
AMOUNT COMPANIES COMPANIES AMOUNT NET
------------ ------------ ------------- ------------ ---------
Year Ended December 31, 1994:
Life insurance in force $105,929,254 $ 25,284,130 $ - $ 80,645,124 $ -
Premiums:
Life insurance 484,322 94,228 (a) - 390,094 -
Accident and health insurance 5,110 2,403 - 2,707 -
------------ ------------ ------------- ------------ ---------
Total premiums $ 489,432 $ 96,631 $ - $ 392,801 $ -
============ ============ ============= ============ =========
Year Ended December 31, 1993:
Life insurance in force $109,717,548 $ 24,931,384 $ - $ 84,786,164 $ -
Premiums:
Life insurance 512,579 100,007 (a) - 412,572 -
Accident and health insurance 5,864 3,295 - 2,569 -
------------ ------------ ------------- ------------ ---------
Total premiums $ 518,443 $ 103,302 $ - $ 415,141 $ -
============ ============ ============= ============ =========
Year Ended December 31, 1992:
Life insurance in force $108,664,397 $ 24,110,765 $ - $ 84,553,632 $ -
Premiums:
Life insurance 540,103 100,938 (a) - 439,165 -
Accident and health insurance 6,494 3,738 - 2,756 -
------------ ------------ ------------- ------------ ---------
Total premiums $ 546,597 $ 104,676 $ - $ 441,921 $ -
============ ============ ============= ============ =========
(a)Life insurance premiums ceded to other companies are net of reinsurance
commissions of $11,457, $13,089 and $13,104 for the years ended December 31,
1994, 1993 and 1992, respectively.
See notes to consolidated financial statements.
S-9
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
SBM COMPANY
Registrant
Date April 12, 1995 By /s/CHARLES A. GEER
Charles A. Geer, President and Chief
Executive Officer
Date April 12, 1995 By /s/EDWARD L. ZEMAN
Edward L. Zeman, Vice President,
Chief Operating Officer,
Chief Financial Officer, and Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Date April 12, 1995 By /s/RICHARD M. EVJEN
Richard M. Evjen Director
Date April 12, 1995 By /s/KENNON V. ROTHCHILD
Kennon V. Rothchild Director
Date April 12, 1995 By /s/ROBERT M. WINSLOW
Robert M. Winslow Director
------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------
EXHIBITS
TO
FORM 10-K
ANNUAL REPORT
PURSUANT TO
SECTION 13
OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
-----------------------
SBM COMPANY
------------------------------------------------------------
(a) EXHIBIT INDEX *
(1) Financial Statements. See Item 8 of the Registrant's Form 10-K.
(2) Financial Statement Schedules. See the Registrant's Form 10-K Item 14.
(3) (A) Amendment to Amended and Restated Articles of Incorporation
(10)
A. First Amendment to SBM Company Thrift Plan Trust Agreement**
B. First Amendment to SBM Company Profit Sharing Stock Plan Trust
Agreement**
C. Engagement Agreement and Warrant - Charles A. Geer**
D. Employment Agreement - Edward L. Zeman**
E. Employment Agreement - Stewart D. Gregg**
F. Employment Agreement - Richard M. Carlblom
G. Employment Agreement - Keith O. Martens**
H. Employment Agreement - Dale C. Bauman**
(21) Subsidiaries of SBM Company.
(23) Consent of Deloitte & Touche LLP.
(27) Article 7 Financial Data Schedule as required for electronic
submissions.
* A complete list of Exhibits filed and incorporated by reference is
found at pages 78-91 of the Registrant's Form 10-K.
** Management contract or compensatory plan or arrangement.