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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the year ended December 31, 2004
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal period from_________to_________
Commission file number 2-80070
CASS INFORMATION SYSTEMS, INC.
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(Exact name of registrant as specified in its charter)
Missouri 43-1265338
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
13001 Hollenberg Drive, Bridgeton, Missouri 63044
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (314) 506-5500
Securities registered pursuant to Section 12(b) of the Act:
Title of each Class Name of each exchange on which registered
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None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock par value $.50
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(Title of Class)
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|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes |X| No |_|
As of March 7, 2004, 3,675,757 shares of Common Stock of the registrant
were outstanding; the aggregate market value of the shares of Common Stock of
the registrant held by non-affiliates was approximately $111,636,000 based upon
the Nasdaq Stock Market closing price of $40.86 for March 7, 2004.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Registrant's Proxy Statement for the Annual Meeting of
Shareholders to be held on April 18, 2005 are incorporated by reference in
Part III hereof.
CASS INFORMATION SYSTEMS, INC.
FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I.
Item 1. BUSINESS ......................................................... 1
Item 2. PROPERTIES ....................................................... 3
Item 3. LEGAL PROCEEDINGS ................................................ 4
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .............. 4
PART II.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS .......................................................... 4
Item 6. SELECTED FINANCIAL DATA .......................................... 5
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS ........................................ 5
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK ........ 22
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ...................... 24
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE ......................................... 50
Item 9A. CONTROLS AND PROCEDURES .......................................... 50
Item 9B. OTHER INFORMATION ................................................ 52
PART III.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ............... 52
Item 11. EXECUTIVE COMPENSATION ........................................... 52
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ... 52
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ................... 52
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES ........................... 52
PART IV.
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES ....................... 53
SIGNATURES ....................................................... 54
Forward-looking Statements - Factors That May Affect Future Results
This report may contain or incorporate by reference forward-looking statements
made pursuant to the safe harbor provisions of Section 27A of the Securities Act
of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. Forward-looking statements are not guarantees of future performance and
involve risks, uncertainties, and other factors which may cause future
performance to vary from expected performance summarized in the future-looking
statements, including those set forth in this paragraph. Important factors that
could cause our actual results, performance, or achievements to be materially
different from any future results, performance, or achievements expressed or
implied by those statements include, but are not limited to: the failure to
successfully execute our corporate plan, the loss of key personnel or inability
to attract additional qualified personnel, the loss of key customers, increased
competition, the inability to remain current with rapid technological change,
risks related to acquisitions, risks associated with business cycles and
fluctuations in interest rates, utility and system interruptions or processing
errors, rules and regulations governing financial institutions and changes in
such rules and regulations, credit risk related to borrowers' ability to repay
loans, concentration of loans to certain segments such as commercial
enterprises, churches and borrowers in the St. Louis area which creates risks
associated with adverse factors that may affect these groups and volatility of
the price of our Common Stock. We undertake no obligation to publicly update or
revise any forward-looking statements to reflect changed assumptions, the
occurrence of anticipated or unanticipated events, or changes to future results
over time.
PART I.
ITEM 1. BUSINESS
Description of Business
Cass Information Systems, Inc. ("Cass" or "the Company") is a leading provider
of payment and information processing services to large manufacturing,
distribution and retail enterprises across the United States. The Company
provides freight invoice rating, payment, audit, cost accounting and
transportation information to many of the nation's largest companies. It is also
a leading processor and payer of utility invoices in the United States,
including electricity, gas, water, and refuse collection. The Company also
processes, audits and pays telecommunication invoices and expanded its
capabilities in this market with the purchase of PROFITLAB, Inc. in August,
2004. In addition, the Company, through its wholly-owned bank subsidiary, Cass
Commercial Bank ("the Bank"), provides commercial banking services. Its primary
focus is to support the Company's payment operations and provide banking
services to its target markets, which include privately-owned businesses and
churches and church-related ministries. Services include commercial, real estate
and personal loans; checking, savings and time deposit accounts and other cash
management services. The Company, through its subsidiary, Government
e-Management Solutions, Inc. ("GEMS"), also develops, licenses and installs
integrated financial, property and human resource management systems to the
public sector, primarily cities and counties. The principal offices of the
Company are at 13001 Hollenberg Drive, Bridgeton, Missouri, 63044. Other
operating locations are in Columbus, Ohio, Boston, Massachusetts and Greenville,
South Carolina. The Bank's headquarters are also located at the Bridgeton
location and operates five other branches, four in the St. Louis metropolitan
area and one in southern California. GEMS' offices are located in Ladue,
Missouri.
Company Strategy and Core Competencies
Cass is an information services company with a primary focus on processing
payables and payables-related transactions for large corporations located in the
United States. Cass possesses four core competencies that encompass most of its
processing services.
Data acquisition - This refers to the gathering of data elements from diverse,
heterogeneous sources and the building of complete databases for our customers.
Data is the raw material of the information economy. Cass gathers vital data
from complex and diverse input documents, electronic media, proprietary
databases and data feeds, including data acquired from vendor invoices as well
as customer procurement and sales systems. Through its numerous methods of
obtaining streams and pieces of raw data, Cass is able to assemble vital data
into centralized data management systems and warehouses, thus producing an
engine to create the power of information for managing critical corporate
functions and processing systems.
Data management - Once data is assembled, Cass is able to utilize the power from
derived information to produce significant savings and benefits for its clients.
This information is integrated into customers' unique financial and accounting
systems, eliminating the need for internal accounting processing and to provide
internal and external support for these critical systems. Information is also
used to produce management and exception reporting for operational control,
feedback, planning assistance and performance measurement.
Information delivery - Receiving information in the right place at the right
time and in the required format is paramount for business survival. Cass'
information delivery solutions provide reports, digital images, data files and
retrieval capabilities through the Internet or directly into customer internal
systems. Cass' proprietary Internet management delivery system is the foundation
for driving these critical functions. Transaction, operational, control, status
and processing exception information are all delivered through this system
creating an efficient, accessible and highly reliable asset for Cass customers.
Financial exchange - Since Cass is unique among its competition in that it owns
a commercial bank, it is also able to manage the movement of funds from its
customers to their suppliers. This is a distinguishing factor which clearly
requires the processing capability, operating systems and financial integrity of
a banking organization. Cass provides immediate, accurate, controlled and
protected funds management and transfer system capabilities for all of its
customers. Old and costly check processing and delivery mechanisms are replaced
with more efficient electronic cash management and funds transfer systems. Funds
are managed and protected by our top-rated financial institution.
Cass' core competencies allow it to perform the highest levels of transaction
processing in an integrated, efficient and systematic approach. Not only is Cass
able to process the transaction, it is also able to collect the data defining
the transaction and effect the financial payment governing its terms.
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Cass' shared business processes - Accounting, Human Resources and Technology -
support its core competencies. Cass' accounting function provides the internal
control systems to ensure the highest levels of accountability and protection
for customers. Cass' human resources provide experienced people dedicated to
streamlining business procedures and reducing expenses. Cass' technology is
proven and reliable. The need to safeguard data and secure the efficiency, speed
and timeliness that governs its business is a priority within the organization.
The ability to leverage technology over its strategic units allows Cass the
advantage of deploying technology in a proven and reliable manner without
endangering clients' strategic business and system requirements.
These core competencies, enhanced through shared business processes, drive Cass'
strategic business units. Building upon these foundations, Cass continues to
explore new business opportunities that leverage these competencies and
processes.
Marketing, Customers and Competition
The Company is one of the largest firms in the freight bill processing and
payment industry in the United States based on the total dollars of freight
bills paid and items processed. Competition consists of two primary competitors
and numerous small freight bill audit firms located throughout the United
States. While offering freight payment services, few of these audit firms
compete on a national basis. These competitors compete mainly on price,
functionality and service levels. The Company also competes with other
companies, located throughout the United States, that pay utility bills and
provide management reporting. Available data indicates that the Company is one
of the largest providers of utility information processing and payment services.
Cass is unique among these competitors in that it is not exclusively affiliated
with any one energy service provider ("ESP"). The ESPs market the Company's
services adding value with their unique auditing, consulting and technological
capabilities. Many of Cass' services are customized with the ESPs, providing a
full-featured solution without any development costs to the ESP. There are also
many competitors that process, audit and pay telecommunication invoices located
throughout the United States.
The Bank is organized as a Missouri trust company with banking powers and was
founded in 1906. Due to its ownership of a federally insured commercial bank,
the Company is a bank holding corporation and was originally organized in 1982
as Cass Commercial Corporation under the laws of Missouri. It was approved by
the Board of Governors of the Federal Reserve System in February 1983. The
Company changed its name to Cass Information Systems, Inc. in January 2001. The
Company's bank subsidiary encounters competition from numerous banks and
financial institutions located throughout the St. Louis metropolitan area and
other areas in which the Bank competes. The principal competition however, is
represented by large bank holding companies that are able to offer a wide range
of banking and related services through extensive branch networks.
The governmental software unit, GEMS, was acquired on January 2, 2001 when the
Company's bank subsidiary foreclosed on the operating assets of a software
company in order to protect its financial interests. The Bank sold these assets
to a wholly-owned subsidiary, and invested in and stabilized this business. From
the date of foreclosure through December 31, 2002, these assets were accounted
for as a foreclosed asset held for sale. On January 1, 2003, the Company
reclassified the foreclosed assets relating to its software subsidiary, GEMS,
from held for sale to held and used and consolidated its operations into those
of the Company. GEMS markets its software applications and services to middle
market cities and counties throughout the United States. GEMS competes with
several competitors that market similar products to these governmental units.
These firms compete on price, functionality and support. No one firm appears to
have a dominant position in the marketplace.
The Company holds several trademarks for the payment and rating services it
provides. These include: FreightPay(R), Transdata(R), TransInq(R), Ratemaker(R),
Rate Advice(R), First Rate(R), Best Rate(R) and Rate Exchange(R). The Company
and its subsidiaries are not dependent on any one customer for a significant
portion of their businesses. The Company and its subsidiaries have a varied
client base with no individual client exceeding 10% of total revenue. The Bank
does however, target its services to privately-held businesses located in the
St. Louis, Missouri area and church and church-related institutions located in
St. Louis, Missouri and other selected cities located throughout the United
States.
Employees
The Company and its subsidiaries had 638 full-time and 162 part-time employees
as of December 31, 2004. Of these employees, the bank subsidiary had 64
full-time and 7 part-time employees and the bank's software subsidiary had 65
full-time and 3 part-time employees.
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Supervision and Regulation
The Company and its bank subsidiary are extensively regulated under federal and
state law. These laws and regulations are intended to protect depositors, not
shareholders. The Bank is subject to regulation and supervision by the Missouri
Division of Finance, the Federal Reserve Bank (the "FRB") and the Federal
Deposit Insurance Corporation (the "FDIC"). The Company is a bank holding
company within the meaning of the Bank Holding Company Act of 1956, as amended,
and as such, it is subject to regulation, supervision and examination by the
FRB. The Company is required to file quarterly and annual reports with the FRB
and to provide to the FRB such additional information as the FRB may require,
and it is subject to regular inspections by the FRB. Bank regulatory agencies
use Capital Adequacy Guidelines in their examination and regulation of bank
holding companies and banks. If the capital falls below the minimum levels
established by these guidelines, the agencies may force certain remedial action
to be taken. The Capital Adequacy Guidelines are of several types and include
risk-based capital guidelines, which are designed to make capital requirements
more sensitive to various risk profiles and account for off-balance sheet
exposure; guidelines which consider market risk, which is the risk of loss due
to change in value of assets and liabilities due to changes in interest rates;
and guidelines that use a leverage ratio which places a constraint on the
maximum degree of risk to which a bank holding company may leverage its equity
capital base. For further discussion of the capital adequacy guidelines and
ratios, please refer to Item 7 "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and Item 8, Note 3 of this
report.
The FRB also has extensive enforcement authority over bank holding companies,
including, among other things, the ability to assess civil money penalties, to
issue cease and desist or removal orders and to require that a holding company
divest subsidiaries (including its bank subsidiaries). In general, enforcement
actions may be initiated for violations of law or regulations or for unsafe or
unsound practices. Both the FRB and Missouri Division of Finance also have
restrictions on the amount of dividends that banks and bank holding companies
may pay.
As a bank holding company, the Company must obtain prior approval from the FRB
before acquiring ownership or control of more than 5% of the voting shares of
another bank or bank holding company or acquiring all or substantially all of
the assets of such a company. In many cases, prior approval is also required for
the Company to engage in similar acquisitions involving a non-bank company or to
engage in new non-bank activities. Any change in applicable laws or regulations
may have a material effect on the business and prospects of the Company.
Website Availability of SEC Reports
Cass will, as soon as practicable after they are electronically filed with the
Securities and Exchange Commission (SEC), make available free of charge on its
website each of its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports of Form 8-K, all amendments to those reports, and its definitive
proxy statements. The address of Cass's website is: www.cassinfo.com. All
reports filed with the SEC are available at the SEC's Public Reference Room at
450 Fifth Street, NW, Washington, DC 21549 or for more information call the
Public Reference Room at 1-800-SEC-0330. The SEC also makes all filed reports
available on their website at www.sec.gov.
The reference to our website address does not constitute incorporation by
reference of the information contained on the website and should not be
considered part of this report.
Financial Information about Segments
The revenues from external customers, net income (loss) and total assets by
segment, for the three years ended December 31, 2004 are set forth in Item 8,
Note 19 of this report.
Statistical Disclosure by Bank Holding Companies
For the statistical disclosure by bank holding companies refer to Item 7
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
ITEM 2. PROPERTIES
The Company's headquarters are located at 13001 Hollenberg Drive, Bridgeton,
Missouri. This location is owned by the Company, and includes a building with
approximately 61,500 square feet of office space. The Company also owns a
production facility of approximately 45,500 square feet located at 2675
Corporate Exchange Drive, Columbus, Ohio. The Company operates a production
facility in Lowell, Massachusetts where approximately 25,800 square feet of
office space is leased through October 31, 2005. Through the acquisition of
PROFITLAB, Inc. in
3
August, 2004 the Company now operates a production facility in Greenville, South
Carolina where approximately 5,800 square feet of office space is leased through
December 31, 2005.
The Bank's headquarters are also located at 13001 Hollenberg Drive, Bridgeton,
Missouri, 63044. The Bank occupies approximately 20,500 square feet of the
61,500 square foot building. In addition, the Bank owns a banking facility near
downtown St. Louis that consists of approximately 1,600 square feet with
adjoining drive-up facilities. The Bank has additional leased facilities in
Maryland Heights, Missouri (2,500 square feet); Fenton, Missouri (1,250 square
feet), Chesterfield, Missouri (2,850 square feet) and Santa Ana, California
(3,584 square feet).
GEMS' headquarters are located at 121 Hunter Avenue - Suite 100, St. Louis,
Missouri, 63124. GEMS leases approximately 9,486 square feet.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are not involved in any pending proceedings
other than ordinary routine litigation incidental to their businesses.
Management believes none of these proceedings, if determined adversely, would
have a material effect on the businesses or financial conditions of the Company
or its subsidiaries.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 2004.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
The Company's Common Stock trades on The Nasdaq Stock Market(R) under the symbol
"CASS". As of March 7, 2005 there were 240 holders of record of the Company's
Common Stock. High and low bid prices, as reported by Nasdaq, for each quarter
of 2004 and 2003 were as follows:
2004 2003
---- ----
High Low High Low
---- --- ---- ---
1st Quarter $ 35.000 $ 29.182 $ 25.255 $ 22.183
2nd Quarter 40.700 34.000 30.455 23.364
3rd Quarter 42.000 37.000 30.773 25.782
4th Quarter 38.500 34.950 31.745 26.555
Cash dividends paid per share by the Company during the two most recent fiscal
years were as follows:
2004 2003
March 15 $.191 $.191
June 15 .210 .191
September 15 .210 .191
December 15 .210 .191
The Company also maintains a treasury stock buyback program pursuant to which
the Board of Directors has authorized the repurchase of up to 100,000 shares of
the Company's Common Stock. The Company did not repurchase any shares during
2004 and repurchased 59,237 shares for $1,764,000 in 2003. As of December 31,
2004, 40,763 shares remained available for repurchase under the program.
Repurchases are made in the open market or through negotiated transactions from
time to time depending on market conditions.
Refer to Item 8 Notes 3, 12 and 14 to the consolidated financial statements for
additional shareholder information, including information concerning stock
options and bonus plans.
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ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial information for each of the five
years ended December 31, 2004. The selected financial data should be read in
conjunction with the Company's consolidated financial statements and
accompanying notes included in Item 8 of this report.
(Dollars in thousands, except per share data) 2004 2003 2002 2001 2000
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Fee revenue and other income $ 39,204 $ 40,067 $ 28,030 $ 23,243 $ 21,114
Interest income on loans(1) 27,055 25,601 26,197 29,069 27,716
Interest income on debt and equity securities 2,558 2,033 4,733 4,323 5,264
Other interest income 1,120 609 687 2,790 4,085
Total interest income 30,733 28,243 31,617 36,182 37,065
Interest expense on deposits 3,024 1,847 2,240 3,863 5,165
Interest expense on short-term borrowings 1 14 33 9 20
Interest on subordinated convertible debentures 70 -- -- -- --
Total interest expense 3,095 1,861 2,273 3,872 5,185
Net interest income 27,638 26,382 29,344 32,310 31,880
Provision for loan losses 550 190 500 60 750
Net interest income after provision 27,088 26,192 28,844 32,250 31,130
Operating expense 55,025 54,904 46,575 44,729 41,236
Income before income tax expense 11,267 11,355 10,299 10,764 11,008
Income tax expense 3,262 3,453 2,987 3,739 3,861
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Net income $ 8,005 $ 7,902 $ 7,312 $ 7,025 $ 7,147
===============================================================================================================================
Basic earnings per share $ 2.18 $ 2.15 $ 1.98 $ 1.88 $ 1.78
Diluted earnings per share 2.15 2.13 1.96 1.86 1.75
Dividends per share .821 .764 .710 .693 .693
Dividend payout ratio 37.79% 35.61% 35.94% 36.71% 38.95%
===============================================================================================================================
Average total assets $ 709,518 $ 626,451 $ 602,446 $ 572,724 $ 515,308
Average net loans 471,412 438,072 399,018 371,367 323,515
Average debt and equity securities 78,745 57,729 97,668 72,111 84,949
Average total deposits 292,379 249,951 240,640 214,954 186,684
Average subordinated convertible debentures 1,314 -- -- -- --
Average total shareholders' equity 65,804 61,346 57,300 54,929 54,308
===============================================================================================================================
Return on average total assets 1.13% 1.26% 1.21% 1.23% 1.39%
Return on average total shareholders' equity 12.16 12.88 12.76 12.79 13.16
Average equity to assets ratio 9.27 9.79 9.51 9.59 10.54
Equity to assets ratio at year-end 9.71 10.03 10.59 9.22 9.33
Net interest margin 4.48 4.85 5.60 6.27 6.69
Allowance for loan losses to loans at year-end 1.21 1.17 1.22 1.29 1.32
Nonperforming assets to loans and foreclosed
assets .18 1.12 3.50 1.60 .30
Net loan (recoveries) charge-offs to average
loans outstanding -- (.01) .03 .01 .04
===============================================================================================================================
1. Interest income on loans includes net loan fees.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
Cass Information Systems, Inc. provides payment and information processing
services to national manufacturing, distribution and retail enterprises from its
processing centers in St. Louis, Missouri, Columbus, Ohio, Boston, Massachusetts
and Greenville, South Carolina. The Company's services include freight invoice
rating, payment processing, auditing, and the generation of cost accounting and
transportation information. Cass also processes and pays utility invoices,
including electricity, gas and telecommunications. The Company significantly
enhanced its telecommunication processing and audit capabilities with the
acquisition of PROFITLAB, Inc. located in Greenville, South Carolina during
2004. Cass extracts, stores and presents information from freight, utility and
telecommunication invoices, assisting our customers' transportation, energy and
information technology managers in making decisions that will enable them to
improve operating performance. The Company receives data from multiple
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sources, electronic and otherwise, and processes the data to accomplish the
specific operating requirements of its customers. It then provides the data in a
central repository for access and archiving. The data is finally transformed
into information through the Company's databases that allow client interaction
as required and provide Internet-based tools for analytical processing. The
Company also, through its St Louis, Missouri based bank subsidiary, provides
banking services in the St Louis metropolitan area and other selected cities in
the United States. The Company acquired Franklin Bancorp located in Orange
County, California in November 2004 and merged its subsidiary bank, Franklin
Bank of California into the Bank. This acquisition will allow the company to
establish branches in California to better serve existing customers and expand
the Bank's customer base. In addition to supporting the Company's payment
operations, the Bank also provides banking services to its target markets, which
include privately owned businesses and churches and church-related ministries.
The Company, through the Bank's subsidiary, GEMS, also develops and licenses
integrated financial, property and human resource management systems to the
public sector.
The specific payment and information processing services provided to each
customer are developed individually to meet each customer's specific
requirements. These requirements can vary greatly from customer to customer. In
addition, the degree of automation such as electronic data interchange ("EDI"),
imaging, and web-enhanced solutions varies greatly among customers and
industries. These factors combine so that pricing varies greatly among the
customer base. In general however, Cass is compensated for its processing
services through service fees and account balances that are generated during the
payment process. The amount, type and calculation of service fees vary greatly
by service offering, but generally follow the volume of transactions processed.
Interest income from the balances generated during the payment processing cycle
is affected by the amount of time Cass holds the funds prior to payment and the
dollar volume processed. Both the number of transactions processed and the
dollar volume processed are therefore key metrics followed by management. Other
factors will also influence revenue and profitability, such as changes in the
general level of interest rates which has a significant affect on net interest
income. The funds generated by these processing activities are invested in
overnight investments, investment grade securities and loans generated by the
Bank. The Bank earns most of its revenue from net interest income, or the
difference between the interest earned on its loans and investments and the
interest expense on its deposits. The Bank also assesses fees on other services
such as cash management services. GEMS earns most of its revenue from the
license of its enterprise software solutions and its installation and
maintenance services.
Industry-wide factors that impact the Company include the acceptance by large
corporations of the outsourcing of key business functions such as freight,
utility and telecommunication payment and audit. The benefits that can be
achieved by outsourcing transaction processing and the management information
generated by Cass' systems can be influenced by factors such as the competitive
pressures within industries to improve profitability, the general level of
transportation costs, deregulation of energy costs and consolidation of
telecommunication providers. Economic factors that impact the Company include
the general level of economic activity that can affect the volume and size of
invoices processed, the ability to hire and retain qualified staff and the
growth and quality of our loan portfolio. The general level of interest rates
has a significant effect on the revenue of the Company. Finally, the general
fiscal condition of the counties and municipalities that can benefit from GEMS'
enterprise software can impact licenses sold and related revenue.
Currently, management views Cass' major opportunity and challenge as the
continued expansion of its payment and information processing service offerings
and customer base. Management intends to accomplish this by maintaining the
Company's lead in applied technology, which, when combined with the security and
processing controls of the Bank, makes Cass unique in the industry. This trend
has been positive over the past years and management anticipates that this
should continue in 2005. The low level of interest rates has had a significant
negative impact on net income over the past few years. The general level of
interest rates, particularly short term interest rates, began to increase during
2004 and had a positive effect on the Company's net interest income during the
latter part of the year. If these rates continue to rise, this positive impact
on net interest income and net earnings should continue. Management had been
pleased over the past few years with the growth in revenue generated by GEMS.
However, during 2004, the sales of new systems declined sharply due mainly to a
sluggish marketplace. Despite the decline, the Company continues to invest in
system improvements and product enhancements and anticipates that 2005 should
reflect improved results. Management intends to continue to refine risk
management practices, monitor and manage the quality of the loan portfolio and
maintain a strong financial and liquidity position.
Critical Accounting Policies
The Company has prepared all of the consolidated financial information in this
report in accordance with U.S. generally accepted accounting principles ("U.S.
GAAP"). In preparing the consolidated financial statements in accordance with
U.S. GAAP, management makes estimates and assumptions that affect the reported
amount of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
revenue and expenses during the reporting period. These estimates have been
generally accurate in the
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past, they have been consistent and have not required any material changes.
There can be no assurances that actual results will not differ from those
estimates. Certain accounting policies that require significant management
estimates and are deemed critical to our results of operations or financial
position have been discussed with the Audit Committee of the Board of Directors
and are described below.
Allowance for Loan Losses. The Company performs periodic and systematic detailed
reviews of its loan portfolio to assess overall collectability. The level of the
allowance for loan losses reflects management's estimate of the collectability
of the loan portfolio. Although these estimates are based on established
methodologies for determining allowance requirements, actual results can differ
significantly from estimated results. These policies affect all segments of the
Company with the exception of governmental software services. The impact and
associated risks related to these policies on our business operations are
discussed in the " Allowance and Provision for Loan Losses" section of this
report.
Impairment of Assets. Management periodically evaluates certain long-term assets
such as intangible assets including goodwill, foreclosed assets, internally
developed software and investments in private equity securities for impairment.
Generally, these assets are initially recorded at cost, and recognition of
impairment is required when events and circumstances indicate that the carrying
amounts of these assets will not be recoverable in the future. If impairment
occurs, various methods of measuring impairment may be called for depending on
the circumstances and type of asset, including quoted market prices, estimates
based on similar assets, and estimates based on valuation techniques such as
discounted projected cash flows. Assets held for sale are carried at the lower
of cost or fair value less costs to sell. These policies affect all segments of
the Company and require significant management assumptions and estimates that
could result in materially different results if conditions or underlying
circumstances change.
Results of Operations
The results of 2004 compared to 2003 include the following significant items:
Information services payment and processing revenues increased $2,255,000
or 8% to $30,695,000 as the number of transactions processed increased
747,000 or 3% to 28,724,000. This increase was driven by the expansion of
the Company's customer base and number of services offered.
Net interest income after provision for loan losses increased $896,000 or
3% to $27,088,000 due primarily to the increase in average earning assets
of $80,776,000 or 14% to $643,847,000. This increase included an increase
in total average loans of $33,782,000 or 8% to $477,234,000, an increase
in average investments of $21,016,000 or 36% to $78,745,000 and an
increase in average federal funds sold and other short-term investments of
$25,978,000 or 42% to $87,868,000. The growth in average earning assets
was derived from both increases in deposits and accounts and drafts
payable. Interest income, derived from the increase in earning assets, was
partially offset by an increase in interest paid on deposit liabilities,
due to both an increase in balances and an increase in rates paid. Gains
from the sale of securities decreased $409,000 compared to last year,
$1,045,000 in 2004 and $1,454,000 in 2003.
Revenue generated from the Company's software subsidiary declined
$2,539,000 or 33% to $5,157,000 due primarily to a decrease in license
fees generated from new customers as the market for governmental software
appears to have softened from the previous year.
Bank service fees decreased $87,000 or 5% to $1,719,000 due primarily to
the fact that as the earnings credit rate granted customers on their
account balances increases with the general level of interest rates, the
amount of service fees charged decreases. Other income decreased $83,000
or 12% to $588,000 due mainly to a decrease in revenue generated from the
investment in bank owned life insurance during 2004. Operating expenses
increased a modest $121,000 or less than 1% to $55,025,000 despite the
additional expenses generated from the acquisition of PROFITLAB, Inc.
The results of 2003 compared to 2002 include the following significant items:
Information services payment and processing revenue increased $3,818,000
or 16% to $28,440,000 as the number of transactions processed increased
2,993,000 or 12% to 27,977,000. This increase was driven by the expansion
of the Company's customer base and number of services provided as well as
an increase in national freight activity during the second half of the
year.
Net interest income after provision for loan losses decreased $2,652,000
or 9% to $26,192,000 due to the dramatic decline in interest rates during
the past few years. This decline occurred despite the fact that total
average loans, typically the Company's highest-yielding asset for any
given maturity, grew $39,359,000 or 10%
7
to $443,452,000 and average earning assets grew $19,060,000 or 4% to
$563,071,000. The growth in average earning assets was derived from both
increases in deposits and accounts and drafts payable. Gains from the sale
of securities were comparable to last year, $1,454,000 in 2003 and
$1,477,000 in 2002.
On January 1, 2003, the Company reclassified the foreclosed assets
relating to its software subsidiary, GEMS, from held for sale to held and
used and consolidated its operations into those of the Bank subsidiary. On
January 2, 2001, the Company's bank subsidiary foreclosed on these
operating assets in order to protect its financial interests. The Bank
sold these assets to a wholly owned subsidiary, and invested in and
stabilized this business. From the date of foreclosure through December
31, 2002, these assets were accounted for as a foreclosed asset held for
sale. Statement of Financial Accounting Standards ("SFAS 144"),
"Accounting for the Impairment or Disposal of Long-Lived Assets", adopted
by the Company on January 1, 2002, requires that if certain criteria are
not met for long-lived asset (disposal) groups classified as held for sale
by the end of the fiscal year in which SFAS 144 is initially applied, the
related long-lived assets shall be reclassified as held and used. In 2003
revenues for this segment were $7,696,000 and operating profits were
$107,000.
Bank service fees increased $147,000 or 9% to $1,806,000 due primarily to
the fact that as the earnings credit rate granted customers on their
account balances decreases with the general level of interest rates, the
amount of service fees charged increases. Other income increased $399,000
or 147% to $671,000 due mainly to an investment in bank owned life
insurance during 2002. Operating expenses, excluding the effects of the
GEMS consolidation, increased a modest $996,000 or 2% to $47,571,000 due
mainly to increases in salaries and health and worker's compensation
insurance expenses.
Fee Revenue and Other Income
The Company's fee revenue is derived mainly from freight and utility payment and
processing fees. As the Company provides its processing and payment services, it
is compensated by service fees which are typically calculated on a per-item
basis and by the accounts and drafts payable balances generated in the payment
process which can be used to generate interest income. Processing volumes
related to fees and accounts and drafts payable for the years ended December 31,
2004, 2003 and 2002 are as follows:
December 31, % Change
----------------------------------------- ---------------------------
(In thousands) 2004 2003 2002 2004 v 2003 2003 v 2002
==================================================================================================================
Freight Invoice Transaction Volume 23,526 23,359 21,549 .7% 8.4%
Freight Invoice Dollar Volume $9,752,203 $8,673,993 $7,715,588 12.4% 12.4%
Utility Transaction Volume 5,198 4,618 3,435 12.6% 34.4%
Utility Transaction Dollar Volume $3,700,665 $3,340,375 $2,634,269 10.8% 26.8%
Payment and processing revenue $30,695 $28,440 $24,622 7.9% 15.5%
- ------------------------------------------------------------------------------------------------------------------
Fee revenue and other income in 2004 compared to 2003 include the following
significant pre-tax components:
Transaction volume from the Transportation Information Services increased
slightly due mainly to increased activity from existing clients. There was
also a change in mix from lower priced, simple transactions to higher
priced, complex transactions. Total dollar volume processed from this
division increased during this period due to increased activity from
existing clients and larger average freight charges. Fees for the period
grew due to the increased volume and additional services provided. The
increase in volume and fees from the Utility Information Services division
increased primarily due to new customers as the growth of this segment
continues. The acquisition of PROFITLAB, Inc. contributed $538,000 of
payment and processing fees for 2004.
Software revenue decreased $2,539,000 or 33% to $5,157,000. This decrease
was primarily due to the decrease in license fee revenue generated from
new customer sales. Although revenue generated by GEMS increased in each
of the past three years, sales were off significantly in 2004 as the
market for governmental software appears to have decreased from the prior
years.
Bank service fees decreased $87,000 or 5% to $1,719,000. This decrease was
due primarily to the fact that service fees decrease as the credit
allowance for noninterest bearing deposits increases, due to the general
level of interest rate increases.
During 2004 the Company recorded net gains of $1,045,000 on the sales of
securities with a fair value of $27,195,000. During 2003, net gains of
$1,454,000 were recorded on the sales of securities with a fair value of
$38,454,000. These sales of securities were made to adjust the portfolio
to reflect the changes in the
8
interest rate environment, growth in the loan portfolio during the past
two years and to offset the loss of interest income due to the dramatic
decline in the general level of interest rates.
Other income decreased $83,000 or 12% to $588,000. This decrease was
primarily due to a decrease in income recognized from the increase in the
cash surrender value of bank owned life insurance purchased by the Company
in 2002.
Fee revenue and other income in 2003 compared to 2002 include the following
significant pre-tax components:
Information services payment and processing fee revenue increased
$3,818,000 or 16% to $28,440,000. These increases both relate to new
customers and new product offerings. Utility processing volume and
revenue, which represents a newer market, had higher percentage increases.
Software revenue in 2003 of $7,696,000 represents the revenue of the
Bank's software subsidiary GEMS, which develops and licenses integrated
financial, property and human resource management systems to the public
sector. Prior to December 31, 2002, GEMS was accounted for as an asset
held for sale and its operating results were not consolidated with those
of the Company. SFAS 144, adopted by the company in 2002, now requires
that GEMS be reclassified as an asset held and used. Consequently, Cass
reclassified the entity's net assets and consolidated its operations with
the parent company on January 1, 2003. Although unconsolidated in 2002 and
2001, software revenue was $5,526,000 and $4,187,000, respectively.
Bank service fees increased $147,000 or 9% to $1,806,000. This increase
was due primarily to the fact that service fees increase as the credit
allowance for noninterest bearing deposits decreases, due to the general
level of interest rate decreases.
During 2003 the Company recorded net gains of $1,454,000 on the sales of
securities with a fair value of $38,454,000. During 2002, net gains of
$1,477,000 were recorded on the sales of securities with a fair value of
$63,945,000. These sales of securities were made to adjust the portfolio
to reflect the changes in the interest rate environment, growth in the
loan portfolio during the past two years and to offset the loss of
interest income due to the dramatic decline in the general level of
interest rates.
Other income increased $399,000 or 147% to $671,000. This increase was
primarily due to income recognized from the increase in the cash surrender
value of bank owned life insurance purchased by the Company in 2002.
Net Interest Income
Net interest income is the difference between interest earned on loans,
investments, and other earning assets and interest expense on deposits and other
interest-bearing liabilities. Net interest income is a significant source of the
Company's revenues. The following table summarizes the changes in net interest
income and related factors for the three periods ended December 31, 2004, 2003
and 2002:
% Change % Change
(Dollars In Thousands) 2004 2003 2002 2004 v. 2003 2003 v. 2002
- --------------------------------------------------------------------------------------------------------------
Average earning assets $643,847 $563,071 $544,011 14.3% 3.5%
Net interest income 28,838 27,310 30,466 5.6% (10.4%)
Net interest margin 4.48% 4.85% 5.60% (7.6%) (13.4%)
Yield on earning assets 4.96% 5.18% 6.02% (4.2%) (14.0%)
Rate on interest bearing liabilities 1.64% 1.24% 1.60% 32.3% (22.5%)
- --------------------------------------------------------------------------------------------------------------
Net interest income in 2004 compared to 2003:
The increase in net interest income was caused by the significant increase
in earning assets that exceeded the decline in net interest margin. This
increase in earning assets was funded by both an increase in accounts and
drafts payable due to the increased dollars processed and an increase in
bank deposits due to the expansion of the Banks' customer base. The
Company is negatively affected by decreases in the level of interest rates
due to the fact that its rate sensitive assets significantly exceed its
rate sensitive liabilities. Conversely, the Company is positively affected
by increases in the level of interest rates. This is primarily due to the
noninterest-bearing liabilities generated by the Company in the form of
accounts and drafts payable. Despite the slight increase in interest rates
during the second half of 2004 the net interest margin was lower than in
2003 due to the decreases over the past few years and the fact that
changes in interest rates affect some earning assets such as federal funds
sold and floating rate loans immediately and some earning
9
assets, such as fixed rate loans and municipal bonds, over time. This
decrease in net interest margin was also negatively impacted by an
increase in rates paid on deposits. More information is contained in the
tables below and in Item 7A of this report.
Total average loans increased $33,782,000 or 8% to $477,234,000. This
increase was attributable to new business relationships. Loans have a
positive effect on interest income and the net interest margin due to the
fact that loans are one of the Company's highest yielding earning assets
for any given maturity.
Total average investment in debt and equity securities increased
$21,016,000 or 36% to $78,745,000 as the Company invested part of the
increase in deposits and payables. Total average federal funds sold and
other short-term investments increased $25,978,000 or 42% to $87,868,000.
This increase was also funded by the increase in accounts and drafts
payable and growth in bank deposits and provides the Company with
additional liquidity to take advantage of higher interest rates.
The increase in both interest-bearing liabilities and rates paid on
deposits partially offsets the increases achieved by an increase in
earning assets. Interest-bearing deposits increased $38,638,000 or 25.9%
due to the Bank's marketing efforts to increase its customer base. Rates
paid on the deposits increased 29.8% from 1.24% to 1.61%. This resulted in
an increase of $1,177,000 or 63.7% in interest paid on deposits.
Net interest income in 2003 compared to 2002:
The decrease in net interest income and margin was primarily due to the
dramatic decrease in the general level of interest rates over the past few
years. The prime rate decreased from 9.50% at the beginning of 2001 to
4.00% at the end of 2003 and the 5-year Treasury note rate decreased from
4.80% to 3.22% during this same period. The Company is negatively affected
by decreases in the level of interest rates due to the fact that its rate
sensitive assets significantly exceed its rate sensitive liabilities.
Conversely, the Company is positively affected by increases in the level
of interest rates. This is primarily due to the noninterest-bearing
liabilities generated by the Company in the form of accounts and drafts
payable. Changes in interest rates will affect some earning assets such as
federal funds sold and floating rate loans immediately and some earning
assets, such as fixed rate loans and municipal bonds, over time. More
information is contained in the tables below and Item 7A of this report.
The Company partially offset the decrease in net interest income through
both an increase in earning assets and shift of earning assets to higher
yielding asset classes. Total average earning assets increased $19,060,000
or 4% to $563,071,000. This increase was funded by both an increase in
accounts and drafts payable due to the increase in payments processed and
an increase in bank deposits due to the expansion of the Banks' customer
base.
Total average loans increased $39,359,000 or 10% to $443,452,000. This
increase was attributable to new business relationships and was funded by
the increase in accounts and drafts payable, growth in bank deposits and
reallocation of earning assets from the investment portfolio. Although not
enough to offset the decline in the level of interest rates, this increase
in loans had a positive effect on interest income and the net interest
margin due to the fact that loans are one of the Company's highest
yielding earning assets for any given maturity.
Total average investment in debt and equity securities decreased
$39,939,000 or 41% to $57,729,000. This decrease was used partially to
fund the increase in loans and partially shifted into federal funds sold
and overnight investments. Total average federal funds sold and other
short-term investments increased $19,640,000 or 46% to $61,890,000.
10
Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rate and
Interest Differential
The following table contains condensed average balance sheets for each of the
periods reported, the tax-equivalent interest income and expense on each
category of interest-earning assets and interest-bearing liabilities, and the
average yield on such categories of interest-earning assets and the average
rates paid on such categories of interest-bearing liabilities for each of the
periods reported:
2004 2003 2002
--------------------------- --------------------------- --------------------------
Interest Interest Interest
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
(Dollars in thousands) Balance Expense Rate Balance Expense Rate Balance Expense Rate
====================================================================================================================================
Assets(1)
Earning assets:
Loans(2),(3):
Taxable $471,995 $26,807 5.68% $437,807 $25,319 5.78% $398,060 $25,897 6.51%
Tax-exempt(4) 5,239 376 7.18 5,645 427 7.56 6,033 455 7.54
Debt and equity securities(5):
Taxable 26,603 476 1.79 22,183 499 2.25 55,591 2,839 5.11
Tax-exempt(4) 52,142 3,154 6.05 35,546 2,317 6.52 42,077 2,861 6.80
Federal funds sold and other
short-term investments 87,868 1,120 1.27 61,890 609 .98 42,250 687 1.63
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets 643,847 31,933 4.96 563,071 29,171 5.18 544,011 32,739 6.02
Nonearning assets:
Cash and due from banks 23,035 19,136 24,324
Premises and equipment, net 12,878 14,918 16,281
Bank owned life insurance 10,874 10,419 4,033
Goodwill and other
intangibles, net 6,700 5,232 809
Other assets 18,006 19,055 18,063
Allowance for loan losses (5,822) (5,380) (5,075)
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $709,518 $626,451 $602,446
- ------------------------------------------------------------------------------------------------------------------------------------
Liabilities And Shareholders' Equity(1)
Interest-bearing liabilities:
Interest-bearing demand
deposits $ 73,792 $ 845 1.15% $ 52,630 $ 371 .70% $ 56,705 $ 632 1.11%
Savings deposits 29,712 293 .99 36,192 281 .78 41,837 528 1.26
Time deposits of
$100 or more 49,540 1,160 2.34 44,793 844 1.88 36,158 902 2.49
Other time deposits 34,754 726 2.09 15,545 351 2.26 5,467 178 3.26
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 187,798 3,024 1.61 149,160 1,847 1.24 140,167 2,240 1.60
Short-term borrowings 91 1 1.10 943 14 1.48 1,485 33 2.22
Subordinated convertible
debentures 1,314 70 5.33 -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 189,203 3,095 1.64 150,103 1,861 1.24 141,652 2,273 1.60
Noninterest-bearing liabilities:
Demand deposits 104,581 100,791 100,473
Accounts and drafts payable 341,247 306,227 297,322
Other liabilities 8,683 7,984 5,699
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 643,714 565,105 545,146
Shareholders' equity 65,804 61,346 57,300
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $709,518 $626,451 $602,446
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income $28,838 $27,310 $30,466
Net interest margin 4.48% 4.85% 5.60%
Interest spread 3.32% 3.94% 4.42%
====================================================================================================================================
1. Balances shown are daily averages.
2. For purposes of these computations, nonaccrual loans are included in the
average loan amounts outstanding. Interest on nonaccrual loans is recorded
when received as discussed further in Item 8, Note 1 of this report.
3. Interest income on loans includes net loan fees of $178,000, $90,000 and
$441,000 for 2004, 2003 and 2002, respectively.
4. Interest income is presented on a tax-equivalent basis assuming a tax rate
of 34%. The tax-equivalent adjustment was approximately $1,200,000,
$928,000 and $1,122,000 for 2004, 2003 and 2002, respectively.
5. For purposes of these computations, yields on investment securities are
computed as interest income divided by the average amortized cost of the
investments.
11
Analysis of Net Interest Income Changes
The following table presents the changes in interest income and expense between
years due to changes in volume and interest rates.
2004 Over 2003 2003 Over 2002
------------------------------------ -------------------------------------
(Dollars in thousands) Volume(1) Rate(1) Total Volume(1) Rate(1) Total
===========================================================================================================================
Increase (decrease) in interest income:
Loans(2),(3):
Taxable $ 1,950 $ (462) $ 1,488 $ 2,450 $(3,028) $ (578)
Tax-exempt(4) (30) (21) (51) (29) 1 (28)
Debt and equity securities:
Taxable 90 (113) (23) (1,212) (1,128) (2,340)
Tax-exempt(4) 1,015 (178) 837 (430) (114) (544)
Federal funds sold and other
short-term investments 300 211 511 251 (329) (78)
- --------------------------------------------------------------------------------------------------------------------------
Total interest income 3,325 (563) 2,762 1,030 (4,598) (3,568)
- --------------------------------------------------------------------------------------------------------------------------
Interest expense on:
Interest-bearing demand deposits 186 288 474 (43) (218) (261)
Savings deposits (56) 68 12 (64) (183) (247)
Time deposits of $100 or more 96 220 316 189 (247) (58)
Other time deposits 403 (28) 375 242 (69) 173
Short-term borrowings (10) (3) (13) (10) (9) (19)
Subordinated convertible debenture 35 35 70 -- -- --
- --------------------------------------------------------------------------------------------------------------------------
Total interest expense 654 580 1,234 314 (726) (412)
- --------------------------------------------------------------------------------------------------------------------------
Net interest income $ 2,671 $(1,143) $ 1,528 $ 716 $(3,872) $(3,156)
===========================================================================================================================
1. The change in interest due to the combined rate/volume variance has been
allocated in proportion to the absolute dollar amounts of the change in
each.
2. Average balances include nonaccrual loans.
3. Interest income includes net loan fees.
4. Interest income is presented on a tax-equivalent basis assuming a tax rate
of 34%.
Loan Portfolio
Interest earned on the loan portfolio is a primary source of income for the
Company. The loan portfolio was $500,448,000 and represented 70% of the
Company's total assets as of December 31, 2004 and generated $27,055,000 in
revenue during the year then ended. The following tables shows the composition
of the loan portfolio at the end of the periods indicated and remaining
maturities for loans as of December 31, 2004.
Loans by Type
(At December 31)
(Dollars in thousands) 2004 2003 2002 2001 2000
================================================================================================================
Commercial and industrial $117,777 $103,638 $101,116 $115,316 $136,482
Real estate:
Mortgage 346,711 330,150 282,125 215,504 182,538
Construction 25,838 19,298 39,175 32,715 29,464
Industrial revenue bonds 4,955 5,373 5,773 6,155 15,804
Installment 1,741 1,911 1,918 1,787 2,533
Other 3,426 8,662 4,582 9,975 5,399
- ----------------------------------------------------------------------------------------------------------------
Total loans $500,448 $469,032 $434,689 $381,452 $372,220
================================================================================================================
12
Loans by Maturity
(At December 31, 2004)
Over 1 Year Over
Through 5 Years 5 Years
--------------- -------
One Year Fixed Floating Fixed Floating
(Dollars in thousands) or less Rate Rate(1) Rate Rate(1) Total
=============================================================================================================
Commercial and industrial $ 87,359 $ 17,323 $ 12,911 $ 74 $ 110 $117,777
Real estate:
Mortgage 38,311 257,143 50,636 621 -- 346,711
Construction 23,664 739 1,435 -- -- 25,838
Industrial revenue bonds -- 2,210 -- 2,745 -- 4,955
Installment 1,142 599 -- -- -- 1,741
Other 3,426 -- -- -- -- 3,426
- -------------------------------------------------------------------------------------------------------------
Total loans $153,902 $278,014 $ 64,982 $ 3,440 $ 110 $500,448
=============================================================================================================
(1) Loans have been classified as having "floating" interest rates if the rate
specified in the loan varies with the prime commercial rate of interest.
The Company has no concentrations of loans exceeding 10% of total loans, which
are not otherwise disclosed in the loan portfolio composition table and
discussed in Item 8, Note 5 of this report. As can be seen in the loan
composition table above and discussed in Item 8, Note 5, the Company's primary
market niche for banking services is privately-held businesses and churches and
church-related ministries.
Loans to commercial entities are generally secured by the business assets of the
company, including accounts receivable, inventory, machinery and equipment, and
the real estate from which the company operates. Operating lines of credit to
these companies generally are secured by accounts receivable and inventory, with
specific percentages of each determined on a customer by customer basis based on
various factors including the type of business. Intermediate term credit for
machinery and equipment is generally provided at some percentage of the value of
the equipment purchased, depending on the type of machinery or equipment
purchased by the entity. Loans secured exclusively by real estate to businesses
and churches are generally made with a maximum 80% loan to value ratio,
depending upon the Company's estimate of the resale value and ability of the
property to generate cash. The Company's loan policy requires an independent
appraisal for all loans over $250,000 secured by real estate. Company management
monitors the local economy in an attempt to determine whether it has had a
significant deteriorating effect on such real estate credits. When problems are
identified, appraised values are updated on a continual basis, either internally
or through an updated external appraisal.
Loan portfolio changes from December 31, 2003 to December 31, 2004:
Total loans increased $31,416,000 or 7% to $500,448,000. This increase was
due to both the expansion of church and church-related loans located
throughout the country and commercial and construction loans in the St.
Louis metropolitan area. At year-end, church and church-related real
estate and construction credits totaled $173,379,000, which represents a
7% increase over 2003. Additional details regarding the types and
maturities of loans in the loan portfolio are contained in the tables
above and in Item 8, Note 5.
Loan portfolio changes from December 31, 2002 to December 31, 2003:
Total loans increased $34,343,000 or 8% to $469,032,000. This increase was
due mainly to the expansion of church and church-related loans in the St.
Louis metropolitan area and selected areas across the United States. At
year-end, church and church-related real estate and construction credits
totaled $162,307,000, which represented a 15% increase over 2002.
Additional details regarding the types and maturities of the loan
portfolio are contained in the tables above and in Item 8, Note 5.
Provision and Allowance for Loan Losses
The Company recorded a provision for loan losses of $550,000 in 2004, $190,000
in 2003 and $500,000 in 2002. The amount of the provisions were derived from the
Company's quarterly analysis of the allowance for loan losses in relation to
probable losses in the loan portfolio. The larger provision made in 2004 was
primarily the result of the risks inherent in an expanding loan portfolio and
reserves made for specific problem loans. The larger provision made in 2002
partially resulted from risks inherent with the increase in average loans
outstanding and an increase in nonperforming loans. The amount of the provision
will fluctuate as determined by these quarterly analyses. The Company had net
loan charge-offs of $19,000 in 2004, net loan recoveries of $23,000 in 2003 and
net loan charge-offs of $113,000 in 2002. The allowance for loan losses was
$6,037,000 at December 31, 2004, compared to
13
$5,506,000 at December 31, 2003 and $5,293,000 at December 31, 2002. The
year-end 2004 allowance represented 1.21% of outstanding loans, compared to
1.17% at year-end 2004 and 1.22% at year-end 2002. From December 31, 2003 to
December 31, 2004 the level of nonperforming loans decreased $3,855,000 from
$4,393,000 to $538,000, which represents .11% of outstanding loans.
Nonperforming loans are more fully explained in the section entitled
"Nonperforming Assets".
The allowance for loan losses has been established and is maintained to absorb
probable losses in the loan portfolio. An ongoing assessment of risk of loss is
performed to determine if the current balance of the allowance is adequate to
cover probable losses in the portfolio. A charge or credit is made to expense to
cover any deficiency or reduce any excess. The current methodology employed to
determine the appropriate allowance consists of two components, specific and
general. The Company develops specific valuation allowances on commercial,
commercial real estate, and construction loans based on individual review of
these loans and our estimate of the borrower's ability to repay the loan given
the availability of collateral, other sources of cash flow and collection
options available to us. The general component relates to all other loans, which
are evaluated based on loan grade. The loan grade assigned to each loan is
typically evaluated on an annual basis, unless circumstances require interim
evaluation. The Company assigns a reserve amount consistent with each loan's
rating category. The reserve amount is based on derived loss experience over
prescribed periods. In addition to the amounts derived from the loan grades, a
portion is added to the general reserve to take into account other factors
including national and local economic conditions, downturns in specific
industries including loss in collateral value, trends in credit quality at the
Company and the banking industry, and trends in risk rating changes. As part of
their examination process, federal and state agencies review the Company's
methodology for maintaining the allowance for loan losses and the balance in the
account. These agencies may require the Company to increase the allowance for
loan losses based on their judgments and interpretations about information
available to them at the time of their examination.
Summary of Loan Loss Experience
December 31,
--------------------------------------------------------------------------
(Dollars in thousands) 2004 2003 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------------------
Allowance at beginning of year $ 5,506 $ 5,293 $ 4,906 $ 4,897 $ 4,282
- --------------------------------------------------------------------------------------------------------------------------------
Loans charged-off:
Commercial and industrial loans and
industrial revenue bonds (IRB's) -- -- 152 110 183
Real estate:
Mortgage 48 -- -- -- --
Construction -- -- -- -- --
Installment -- -- -- -- --
Other -- 2 -- -- --
- --------------------------------------------------------------------------------------------------------------------------------
Total loans charged-off 48 2 152 110 183
- --------------------------------------------------------------------------------------------------------------------------------
Recoveries of loans previously charged-off:
Commercial, industrial and IRB's 29 25 39 59 48
Real estate:
Mortgage -- -- -- -- --
Construction -- -- -- -- --
Installment -- -- -- -- --
- --------------------------------------------------------------------------------------------------------------------------------
Total recoveries of loans previously charged-off 29 25 39 59 48
================================================================================================================================
Net loans charged-off (recovered) 19 (23) 113 51 135
Provision charged to expense 550 190 500 60 750
- --------------------------------------------------------------------------------------------------------------------------------
Allowance at end of year $ 6,037 $ 5,506 $ 5,293 $ 4,906 $ 4,897
================================================================================================================================
Loans outstanding:
Average $ 477,234 $ 443,452 $ 404,093 $ 376,275 $ 327,962
December 31 500,448 469,032 434,689 381,452 372,220
Ratio of allowance for loan losses to
loans outstanding:
Average 1.26% 1.24% 1.31% 1.30% 1.49%
December 31 1.21% 1.17% 1.22% 1.29% 1.32%
Ratio of net charge-offs (recoveries) to
average loans outstanding -- (.01)% .03% .01% .04%.
================================================================================================================================
Allocation of allowance for loan losses(1):
Commercial, industrial and IRB's $ 3,066 $ 2,575 $ 2,167 $ 2,129 $ 3,159
Real estate:
Mortgage 2,742 2,761 2,780 2,442 416
Construction 207 152 302 303 1,317
Installment 9 10 10 10 5
Other loans 13 8 34 22 --
- --------------------------------------------------------------------------------------------------------------------------------
Total $ 6,037 $ 5,506 $ 5,293 $ 4,906 $ 4,897
================================================================================================================================
Percent of categories to total loans:
Commercial and industrial and IRB's 24.5% 23.2% 24.6% 31.8% 40.9%
Real estate:
Mortgage 69.3 70.4 64.9 56.5 49.0
Construction 5.2 4.1 9.0 8.6 7.9
Installment .3 .4 .4 .5 .7
Other .7 1.9 1.1 2.6 1.5
- --------------------------------------------------------------------------------------------------------------------------------
Total 100.0% 100.0% 100.0% 100.0% 100.0%
================================================================================================================================
(1) Although specific allocations exist the entire allowance is available to
absorb losses in any particular loan category.
14
Nonperforming Assets
It is the policy of the Company to continually monitor its loan portfolio and to
discontinue the accrual of interest on any loan on which payment of principal or
interest in a timely manner, in the normal course of business, is doubtful.
Subsequent payments received on such loans are applied to principal if there is
any doubt as to the collectibility of such principal; otherwise, these receipts
are recorded as interest income. Interest on nonaccrual and renegotiated loans,
which would have been recorded under the original terms of the loans, was
approximately $38,000 for the year ended December 31, 2004. Of this amount,
approximately $15,000 was actually recorded as interest income on such loans.
The total renegotiated loans of $168,000 at December 31, 2004 relates to one
borrower that is current under the new terms of the loan. Total nonaccrual
commercial loans consists primarily of one loan for $259,000 relating to a
business that is no longer operating, although payments are being made as the
inventory of the business is being sold and a specific reserve has been
established for the potential shortfall. Total nonaccrual real-estate mortgage
loans of $69,000 and the remaining balance of nonaccrual commercial loans of
$38,000 relate to one borrower. The collateral on these loans was sold during
the first quarter of 2005 and the remaining balance of $21,000 was charged-off
against the allowance for loan losses.
Total foreclosed assets of $375,000 at December 31, 2004 consisted of real
estate that was foreclosed on March 2, 2004 and was sold during the first
quarter of 2005 for a net gain of $38,000. The total foreclosed assets of
$859,000 at December 31, 2003 consisted of real estate property that was
foreclosed on August 8, 2001. This property was sold in the fourth quarter of
2004 and the Company recorded a net loss of $59,000. Foreclosed assets
classified as other real estate owned are recorded at what management estimates
to be fair value less cost to sell the property.
At December 31, 2004, approximately $5,008,000 of loans not included in the
table below were identified by management as having potential credit problems.
These loans are excluded from the table due to the fact they are current under
the original terms of the loans, however circumstances have raised doubts as to
the ability of the borrowers to comply with the current loan repayment terms.
Included in this balance is $3,805,000 related to one borrower that was
renegotiated in 2003 and although current under the new terms of the contract
management believes, due to the financial condition of the company, there still
remains risk as to the collectability of all amounts under the loan agreement.
The Company does not have any foreign loans. The Company's loan portfolio does
not include a significant amount of single family real estate mortgage or
installment credits, as the Company does not market its services to retail
customers.
The Company does not have any other interest-earning assets which would have
been included in nonaccrual, past due or restructured loans if such assets were
loans.
15
Summary of Nonperforming Assets
December 31,
-----------------------------------------------------------
(Dollars in thousands) 2004 2003 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------
Commercial, industrial and IRB's:
Nonaccrual $ 297 $ 318 $ 51 $ 157 $ 84
Contractually past due 90 days
or more and still accruing -- -- -- 18 --
Renegotiated loans -- 2,240 -- -- --
Real estate-construction on nonaccrual -- -- -- 265 1,043
Real estate-mortgage:
Nonaccrual 69 1,207 -- 32 --
Contractually past due 90 days
or more and still accruing 4 147 3,388 -- --
Renegotiated loans 168 481 4,252 -- --
Installment loans contractually past due
90 days or more and still accruing -- -- -- -- 4
Other loans contractually past due 90
days and still accruing -- -- 1,503 -- --
- ---------------------------------------------------------------------------------------------------------
Total nonperforming loans 538 4,393 9,194 472 1,131
- ---------------------------------------------------------------------------------------------------------
Total foreclosed assets 375 859 6,241 5,710 --
- ---------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 913 $ 5,252 $15,435 $ 6,182 $ 1,131
=========================================================================================================
Operating Expenses
Operating expenses in 2004 compared to 2003 include the following significant
pre-tax components:
Salaries and employee benefits expense increased $1,046,000 or 3% to
$38,198,000. Of this increase, $616,000 was related to the acquisition of
PROFITLAB, Inc. The remaining increase primarily relates to annual salary
increases and increases in pension and worker's compensation insurance
expense.
Occupancy expense increased $58,000 or 3% to $1,840,000. Of this increase
$28,000 relates to the acquisition of PROFITLAB, Inc. and the remaining
increase is primarily due to an increase in rent expense on leased office
space. Equipment expense decreased $786,000 or 18% to $3,692,000. This
decrease is primarily due to software that was capitalized in 2000 and
2001 that is now fully amortized. Amortization of intangibles increased
$57,000 or 18% to $368,000 due to the software acquired in the acquisition
of PROFITLAB, Inc. Other operating expenses decreased $254,000 or 2% to
$10,927,000. This decrease related to many factors including a decrease of
$544,000 in postage and supply expense related to the increase in
electronic processing in the Information Services Division and a decrease
of $310,000 related to costs associated with the decline in software
sales. These decreases were partially offset by expenses related to the
acquisition of PROFITLAB, Inc. of $171,000 and an increase of $465,000 in
outside service and professional fees, which includes fees of $225,000
related to the additional procedures required under Section 404 of the
Sarbanes-Oxley Act and an increase of $183,000 in outside imaging
expenses. More details on the components of other operating expenses are
contained in Item 8, Note 15 of this report.
Operating expenses in 2003 compared to 2002 include the following significant
pre-tax components:
Salaries and employee benefits expense increased $5,747,000 or 18% to
$37,152,000. Of this increase the consolidation of GEMS amounted to
$4,139,000. The remaining increase primarily relates to annual salary
increases and increases in health and worker's compensation insurance
expense.
Occupancy expense increased $282,000 or 19% to $1,782,000. Of this
increase $237,000 relates to the consolidation of GEMS. Equipment expense
increased $168,000 or 4% to $4,478,000. GEMS contributed $433,000 of
equipment expense. Excluding GEMS, equipment expense decreased $265,000
primarily due to decreases in computer equipment maintenance from the
consolidation of equipment within the transportation processing division.
Other operating expense increased $1,821,000 or 19% to $11,181,000. The
consolidation of GEMS contributed $2,213,000 to other operating expense.
More details on the components of other operating expenses are contained
in Item 8, Note 15 of this report.
16
Income Tax Expense
Income tax expense in 2004 totaled $3,262,000 compared to $3,453,000 in 2003 and
$2,987,000 in 2002. When measured as a percent of income before income taxes,
the Company's effective tax rate was 29% in 2004, 30% in 2003 and 29% in 2002.
The primary reason for the lower effective tax rates in 2004 and 2002 was the
Company's investment in tax-exempt municipal bonds and income recognized on bank
owned life insurance.
Investment Portfolio
Investment portfolio changes from December 31, 2003 to December 31, 2004:
U.S. Treasury securities increased $4,796,000 or 28% to $21,899,000. U.S.
government corporation and agency securities increased $1,404,000 or 30%
to $6,094,000. State and political subdivision securities increased
$1,756,000 or 4% to $48,533,000. The investment portfolio provides the
Company with a significant source of earnings, secondary source of
liquidity, and mechanisms to manage the effects of changes in interest
rates. Therefore, the size, asset allocation and maturity distribution of
the investment portfolio will vary over time depending on management's
assessment of current and future interest rates, changes in loan demand,
changes in the Company's sources of funds and the economic outlook. During
this period the size of the investment portfolio increased as the Company
employed a portion of the increase in deposits and accounts and drafts
payable. The minor changes in asset mix reflects the relative interest
rates of the alternative investments and management's liquidity and
interest rate forecasts at the time funds became available for investment.
Investment portfolio changes from December 31, 2002 to December 31, 2003:
U.S. Treasury securities increased from $0 to $17,103,000. U.S. government
corporation and agency securities decreased $22,557,000 or 83% to
$4,690,000. State and political subdivision securities increased
$5,854,000 or 14% to $46,777,000. During this period, the size of the
investment portfolio remained fairly constant as the Company redeployed
funds from maturing securities and security sales back into the investment
portfolio. The increase in U.S. Treasury securities and decrease in U. S.
government agencies and corporations reflect the relative yields of these
securities at the time of investment.
There was no single issuer of securities in the investment portfolio at December
31, 2004, other than U.S. government corporations and agencies, for which the
aggregate amortized cost exceeded 10% of total shareholders' equity.
Investment by Type
December 31,
-------------------------------------------
(Dollars in thousands) 2004 2003 2002
================================================================================================================
U.S. Treasury securities $ 21,899 $ 17,103 $ --
U.S. government corporations and agencies 6,094 4,690 27,247
State and political subdivisions 48,533 46,777 40,923
Stock of the Federal Home Loan Bank 403 376 1,000
Stock of the Federal Reserve Bank 201 201 201
- ----------------------------------------------------------------------------------------------------------------
Total investments $ 77,130 $ 69,147 $ 69,371
================================================================================================================
Investment in Debt Securities by Maturity
(At December 31, 2004)
Within Over 1 to Over 5 to Over
(Dollars in thousands) 1 Year 5 Years 10 Years 10 Years Yield
================================================================================================================
U.S. Treasury securities $18,934 $2,965 $ -- $ -- 1.91%
U.S. government corporations and
agencies 996 5,098 -- -- 3.27%
State and political subdivisions(1) 149 10,587 25,044 12,753 5.84%
- ----------------------------------------------------------------------------------------------------------------
Total investment in debt securities 20,079 18,650 25,044 12,753 4.49%
- ----------------------------------------------------------------------------------------------------------------
Weighted average yield 1.92% 3.93% 6.10% 6.34%
================================================================================================================
1. Weighted average yield is presented on a tax-equivalent basis assuming a
tax rate of 34%.
17
Equity Investments
During 2003, the Company converted a $2,000,000 investment in a private imaging
company from a convertible debenture into Common Stock. As part of the
conversion, the Company committed to investing an additional $1,100,000 when
certain conditions were met. This additional commitment has funded and the total
investment of the Company in this entity was $3,100,000 at December 31, 2004 and
$2,908,000 at December 31, 2003. At December 31, 2004 the Company had a 19.99%
ownership interest in this entity and the Chairman and CEO of the Company was a
member of the entity's Board of Directors. In addition, the Company has extended
a $2,400,000 line of credit for working capital purposes to this entity, with a
50% interest sold to a new non-affiliated majority owner. As of December 31,
2004 the Company's interest in this line amounted to $1,200,000 and all payments
are current.
This business has performed poorly during the past few years and the new
majority owner is currently in the process of stabilizing the business and
improving its financial performance. However, should this business fail to meet
its objectives, the Company's investment could be subject to future impairment.
The Company accounts for this investment, along with its other non-marketable
equity investments, under the cost method. Under the cost method of accounting,
investments are carried at cost and are adjusted only for other-than-temporary
declines in fair value, distributions of earnings and additional investments.
The Company periodically evaluates whether any declines in fair value of its
investments are other than temporary. In performing this evaluation, the Company
considers various factors including any decline in market price, where
available, the investee's financial condition, results of operations, operating
trends and other financial ratios.
Deposits and Accounts and Drafts Payable
Noninterest-bearing demand deposits decreased $18,272,000 or 16% from December
31, 2003 to $96,362,000 at December 31, 2004. The average balances of these
deposits increased $3,790,000 or 4% from December 31, 2003 to $104,581,000 at
December 31, 2004. The decrease in ending balances relates to normal daily
fluctuations in these accounts.
Interest-bearing deposits increased $21,473,000 or 14% from December 31, 2003 to
$179,267,000 at December 31, 2004. The average balances of these deposits
increased $38,638,000 or 26% from 2003 to $187,798,000 in 2004. These increases
relate mainly to the Bank's increased marketing efforts to attract more
deposits.
Accounts and drafts payable generated by the Company in its payment processing
operations increased $58,484,000 or 20% from December 31, 2003 to $358,473,000
at December 31, 2004. The average balances of these funds increased $35,020,000
or 11% from 2003 to $341,247,000 in 2004. These increases relate to the increase
in dollars processed. Due to the Company's payment processing cycle, average
balances are much more indicative of the underlying activity than period-end
balances since point-in-time comparisons can be misleading if the comparison
dates fall on different days of the week.
The composition of average deposits and the average rates paid on those deposits
is represented in the table entitled "Distribution of Assets, Liabilities and
Stockholders' Equity; Interest Rate and Interest Differential" which is included
earlier in this discussion. The Company does not have any significant deposits
from foreign depositors.
Maturities of Certificates of Deposits of $100,000 or More
(At December 31, 2004)
(Dollars in thousands)
================================================================================
Three months or less $16,296
Three to six months 8,962
Six to twelve months 5,480
Over twelve months 15,379
- --------------------------------------------------------------------------------
Total $46,117
================================================================================
Short-term Borrowings
Short-term borrowings increased $4,000 or 3% from December 31, 2003 to $127,000
at December 31, 2004. Average balances of these funds decreased $852,000 or 90%
from 2003 to $91,000 during 2004. These funds consist primarily of federal funds
purchased and can also include tax deposits of the U.S. Treasury. These balances
can vary significantly from day to day due to the Company's payment cycle and
therefore balances on any particular day are
18
not necessarily reflective of balances throughout the year. For more information
on borrowings please refer to Item 8, Note 10 of this report.
Subordinated Convertible Debentures
Total subordinated convertible debentures at December 31, 2004 were $3,700,000
and average balances of these funds were $1,314,000 for the year. The debentures
were issued on August 24, 2004 as part of the Company purchase of PROFITLAB,
Inc. The Company had no outstanding debentures in 2003. For more information on
these debentures please refer to Item 8, Note 11 of this report.
Liquidity
The discipline of liquidity management as practiced by the Company seeks to
ensure that funds are available to fulfill all payment obligations relating to
the freight and utility invoices processed as they become due, meet depositor
withdrawal requests and borrower credit demands while at the same time
maximizing profitability. This is accomplished by balancing changes in demand
for funds with changes in the supply of funds. Primary liquidity to meet demand
is provided by short-term liquid assets that can be converted to cash, maturing
securities and the ability to obtain funds from external sources. The Company's
Asset/Liability Committee ("ALCO") has direct oversight responsibility for the
Company's liquidity position and profile. Management considers both on-balance
sheet and off-balance sheet items in its evaluation of liquidity.
The balances of liquid assets consists of cash and cash equivalents, which
include cash and due from banks, federal funds sold, and money market funds, and
were $87,543,000 at December 31, 2004, an increase of $25,176,000 or 40% from
December 31, 2003. At December 31, 2004 these assets represented 12% of total
assets. These funds are the Company's and its subsidiaries' primary source of
liquidity to meet future expected and unexpected loan demand, depositor
withdrawals or reductions in accounts and drafts payable.
Secondary sources of liquidity include the investment portfolio and borrowing
lines. Total investment in debt and equity securities was $77,130,000 at
December 31, 2004, an increase of $7,983,000 or 12% from December 31, 2003.
These assets represented 11% of total assets at December 31, 2004. Of this
total, 63% were state and political subdivision securities, 28% were U.S.
Treasury securities, 8% were U.S. government agencies and 1% were other
securities. Of the total portfolio, 26% mature in one year, 24% matures in one
to five years, and 50% matures in five or more years. During the year the
Company sold securities with a market value of $27,195,000 and a portion of
these funds were reinvested in state and political subdivision securities and
the loan portfolio.
The Bank has unsecured lines at correspondent banks to purchase federal funds up
to a maximum of $29,000,000. Additionally, the Bank maintains lines of credit at
unaffiliated financial institutions in the maximum amount of $78,150,000
collateralized by U.S. Treasury and agency securities and commercial and
residential mortgage loans.
The deposits of the Company's banking subsidiary have historically been stable,
consisting of a sizable volume of core deposits related to customers that
utilize many other commercial products of the Bank. The accounts and drafts
payable generated by the Company has also historically been a stable source of
funds.
The Company also maintains a treasury stock buyback program pursuant to which
the Board of Directors has authorized the repurchase of up to 100,000 shares of
the Company's Common Stock. The Company did not repurchase any shares during
2004 and repurchased 59,237 shares for $1,764,000 in 2003. As of December 31,
2004, 40,763 shares remained available for repurchase under the program.
Repurchases are made in the open market or through negotiated transactions from
time to time depending on market conditions.
Net cash flows provided by operating activities for the years 2004, 2003 and
2002 were $10,030,000, $10,181,000 and $8,978,000 respectively. Net income plus
the adjustment for depreciation and amortization accounts for most of the
operating cash provided. Net cash flows from investing and financing activities
fluctuate greatly as the Company actively manages its investment and loan
portfolios and customer activity influences changes in deposit and accounts and
drafts payable balances. Further analysis of the changes in these account
balances is discussed earlier in this report. Due to the daily fluctuations in
these account balances, the analysis of changes in average balances, also
discussed earlier in this report, can be more indicative of underlying activity
than the period-end balances used in the statements of cash flows. Management
anticipates that cash and cash equivalents, maturing investments and cash from
operations will continue to be sufficient to fund the Company's operations and
capital expenditures in 2005.
Capital Resources
One of management's primary objectives is to maintain a strong capital base to
warrant the confidence of customers, shareholders, and bank regulatory agencies.
A strong capital base is needed to take advantage of profitable growth
opportunities that arise and to provide assurance to depositors and creditors.
The Company and its banking subsidiary
19
continue to exceed all regulatory capital requirements, as evidenced by the
capital ratios at December 31, 2004 as shown in Item 8, Note 3 of this report.
In 2004, cash dividends paid were $.821 per share for a total of $3,025,000, a
7% increase over the prior year, which is attributable to an increase in the per
share amount paid and additional shares outstanding. On February 17, 2004 the
Company declared a 10% stock dividend payable to holders of record on March 5,
2004.
Shareholders' equity was $69,589,000, or 10% of total assets, at December 31,
2004, an increase of $4,797,000 over the balance at December 31, 2003. This
increase resulted from net income of $8,005,000, proceeds from the exercise of
stock options of $190,000 and other items of $210,000, which was partially
offset by cash dividends paid of $3,025,000, a decrease in other comprehensive
income of $579,000 and payment of $4,000 related to the stock dividend.
Dividends from the bank subsidiary are a significant source of funds for payment
of dividends by the Company to its shareholders. The only restrictions on
dividends are those dictated by regulatory capital requirements and prudent and
sound banking principles. As of December 31, 2004, unappropriated retained
earnings of $6,714,000 were available at the Bank for the declaration of
dividends to the Company without prior approval from regulatory authorities.
Commitments, Contractual Obligations and Off-Balance Sheet Arrangements
In the normal course of business, the Company is party to activities that
contain credit, market and operational risk that are not reflected in whole or
in part in the Company's consolidated financial statements. Such activities
include traditional off-balance sheet credit-related financial instruments and
commitments under operating and capital leases. These financial instruments
include commitments to extend credit, commercial letters of credit and standby
letters of credit. The Company's maximum potential exposure to credit loss in
the event of nonperformance by the other party to the financial instrument for
commitments to extend credit, commercial letters of credit and standby letters
of credit is represented by the contractual amounts of those instruments. At
December 31, 2004, no amounts have been accrued for any estimated losses for
these instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commercial
and standby letters of credit are conditional commitments issued by the Company
or its subsidiaries to guarantee the performance of a customer to a third party.
These off-balance sheet financial instruments generally have fixed expiration
dates or other termination clauses and may require payment of a fee. At December
31, 2004 the balance of loan commitments, commercial and standby letters of
credit were $20,524,000, $6,097,000 and $1,091,000, respectively. Since some of
the financial instruments may expire without being drawn upon, the total amounts
do not necessarily represent future cash requirements. Commitments to extend
credit and letters of credit are subject to the same underwriting standards as
those financial instruments included on the consolidated balance sheets. The
Company evaluates each customer's credit worthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary upon extension of the credit,
is based on management's credit evaluation of the borrower. Collateral held
varies, but is generally accounts receivable, inventory, residential or
income-producing commercial property or equipment. In the event of
nonperformance, the Company or its subsidiaries may obtain and liquidate the
collateral to recover amounts paid under its guarantees on these financial
instruments.
On August 24, 2004 the Company issued $3,700,000 in subordinated convertible
debentures as part of the Company's acquisition of PROFITLAB, Inc. Interest, at
a rate of 5.33%, is payable annually on the anniversary date of the acquisition.
The holders of the debentures can convert the principal amount into fully paid
and non-assessable shares of the Common Stock of the Company at a rate per share
of $48.20 at various amounts over a 10-year period, at which time the securities
mature. The debentures may be called by the Company without penalty after August
24, 2010. For more information on the acquisition please refer to Item 8, Notes
2 and 11 of this report.
The following table summarizes contractual cash obligations of the Company
related to operating and capital lease commitments and convertible subordinated
debentures at December 31, 2004:
Amount of Commitment Expiration per Period
------------------------------------------
Less than 1-3 3-5 Over 5
(Dollars in thousands at December 31, 2004) Total 1 year Years Years Years
- -------------------------------------------------------------------------------------------------------
Operating lease commitments $2,645 $ 625 $ 357 $ 306 $1,357
Capital lease commitments 25 17 8 -- --
Convertible subordinated debentures* 3,700 -- -- -- 3,700
- -------------------------------------------------------------------------------------------------------
Total $6,370 $ 642 $ 365 $ 206 $5,057
=======================================================================================================
* Includes principal payments only.
20
During 2004, the Company contributed $1,083,000 to its noncontributory defined
benefit pension plan. The contribution had no significant effect on the
Company's overall liquidity. In determining pension expense, the Company makes
several assumptions, including the discount rate and long-term rate of return on
assets. These assumptions are determined at the beginning of the plan year based
on interest rate levels and financial market performance. For 2004 these
assumptions were as follows:
----------------------------------------------------------------
Weighted average discount rate 6.25%
Rate of increase in compensation levels 4.00%
Expected long-term rate of return on assets 8.00%
----------------------------------------------------------------
Effect of Recent and Prospective Accounting Pronouncements
In 2003, the Emerging Issues Task Force ("EITF") reached a consensus on, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments" ("EITF 03-1"), which provides guidance to assess whether there have
been any events or economic circumstances to indicate that a security is
impaired on an other-than-temporary basis. Factors to consider include the
length of time the security has had a market value less than the cost basis, the
intent and ability of the company to hold the security for a period of time
sufficient for a recovery in value, recent events specific to the issuer or
industry and for debt securities, external credit rating and recent downgrades.
Securities on which there is an unrealized loss that is deemed to be
other-than-temporary are written down to fair value with the write-down recorded
as a realized loss. In December 2004, the Financial Accounting Standard