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 fiscal year ended December 31, 2006
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition 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 checkmark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes |_| No |X|
Indicate by checkmark if the registrant is not required to file reports pursuant
to Section 13 or Section 15(d) of the Act.
Yes |_| No |X|
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, 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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer: |_| Accelerated filer: |X|
Non-accelerated filer: |_|
Indicate by checkmark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes |_| No |X|
The aggregate market value of the common stock held by non-affiliates of the
Registrant was approximately $218,020,000 based on the closing price of the
common stock of $32.46 on June 30, 2006, as reported by the Nasdaq Global
National Market.
As of March 9, 2007, the Registrant had 8,367,489 shares outstanding of common
stock.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required for Part III of this report is incorporated by
reference to the Registrant's Proxy Statement for the 2007 Annual Meeting of
Shareholders.
CASS INFORMATION SYSTEMS, INC.
FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I.
Item 1. BUSINESS 1
Item 1A. RISK FACTORS 3
Item 1B. UNRESOLVED STAFF COMMENTS 7
Item 2. PROPERTIES 7
Item 3. LEGAL PROCEEDINGS 7
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 7
PART II.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 8
Item 6. SELECTED FINANCIAL DATA 10
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 10
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 28
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 30
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE 58
Item 9A. CONTROLS AND PROCEDURES 58
Item 9B. OTHER INFORMATION 59
PART III.
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE 59
Item 11. EXECUTIVE COMPENSATION 59
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS 60
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 60
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES 60
PART IV.
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 60
SIGNATURES 62
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 forward-looking
statements, including those set forth in this paragraph and in the "Risk
Factors" section of this report. 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, accounting and transportation
information to many of the nation's largest companies. It is also a processor
and payer of utility invoices, including electricity, gas, and other facility
related expenses. Additionally, Cass competes in the telecommunications expense
management market which includes bill processing and payment services for
telephone, data line, cellular and communication equipment expense. Also 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 principal offices of the Company are at 13001 Hollenberg Drive,
Bridgeton, Missouri 63044. Other operating locations are in Columbus, Ohio,
Boston, Massachusetts, Greenville, South Carolina and Wellington, Kansas. 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.
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.
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.
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 department provides 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 govern its business is a priority within
the organization. The ability to
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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 a few 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 for 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, Missouri metropolitan
area and other areas in which the Bank competes. The Bank's principal
competitors, however, are large bank holding companies that are able to offer a
wide range of banking and related services through extensive branch networks.
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), Rate Exchange(R) and CassPort(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, Orange County, California and other selected cities
located throughout the United States.
Employees
The Company and its subsidiaries had 659 full-time and 231 part-time employees
as of December 31, 2006. Of these employees, the Bank had 64 full-time and 12
part-time employees.
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
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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 files annual, quarterly and current reports with the Securities and
Exchange Commission (the "SEC"). Cass will, as soon as reasonably practicable
after they are electronically filed with or furnished to the 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' website is:
www.cassinfo.com. All reports filed with the SEC are available for reading and
copying at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC
20549-0213 or for more information call the Public Reference Room at
1-800-SEC-0330. The SEC also makes all filed reports, proxy statements and
information statements available on its 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, 2006, 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 1A. RISK FACTORS
This section highlights specific risks that could affect the Company's business.
Although this section attempts to highlight key factors, please be aware that
other risks may prove to be important in the future. New risks may emerge at any
time and Cass cannot predict such risks or estimate the extent to which they may
affect the Company's financial performance. In addition to the factors discussed
elsewhere or incorporated by reference in this report, the identified risks that
could cause actual results to differ materially include the following:
Unfavorable developments concerning customer credit quality could affect Cass'
financial results.
Although the Company regularly reviews credit exposure related to its customers
and various industry sectors in which it has business relationships, default
risk may arise from events or circumstances that are difficult to detect or
foresee. Under such circumstances, the Company could experience an increase in
the level of provision for credit losses, nonperforming assets, net charge-offs
and allowance for credit losses.
The Company has lending concentrations, including, but not limited to, churches
and church-related entities located in selected cities and privately-held
businesses located in or near St. Louis, Missouri, that could suffer a
significant decline which could adversely affect the Company.
Cass' customer base consists, in part, of lending concentrations in several
segments and geographical areas. In the event of a downturn in the economy or
general decline in any one of these segments or areas, the Company could
experience increased credit losses, and its business could be adversely
affected.
Fluctuations in interest rates could affect Cass' net interest income and
balance sheet.
The operations of financial institutions such as the Company are dependent to a
large degree on net interest income, which is the difference between interest
income from loans and investments and interest expense on deposits and
borrowings. Prevailing economic conditions, the fiscal and monetary policies of
the federal government and the policies of various regulatory agencies all
affect market rates of interest, which in turn significantly affect financial
3
institutions' net interest income. Fluctuations in interest rates affect Cass'
balance sheet, as they do for all financial institutions. Volatility in interest
rates can also result in disintermediation, which is the flow of funds away from
financial institutions into direct investments, such as federal government and
corporate securities and other investment vehicles, which, because of the
absence of federal insurance premiums and reserve requirements, generally pay
higher rates of return than financial institutions.
Customer borrowing, repayment, investment and deposit practices generally may be
different than anticipated.
The Company uses a variety of financial tools, models and other methods to
anticipate customer behavior as a part of its strategic planning and to meet
certain regulatory requirements. Individual, economic, political,
industry-specific conditions and other factors outside of Cass' control could
alter predicted customer borrowing, repayment, investment and deposit practices.
Such a change in these practices could adversely affect Cass' ability to
anticipate business needs and meet regulatory requirements.
Operational difficulties or security problems could damage Cass' reputation and
business.
The Company depends on the reliable operation of its computer operations and
network connections from its clients to its systems. Any operational problems or
outages in these systems would cause Cass to be unable to process transactions
for its clients, resulting in decreased revenues. In addition, any system
delays, failures or loss of data, whatever the cause, could reduce client
satisfaction with the Company's products and services and harm Cass' financial
results. Cass also depends on the security of its systems. Company networks may
be vulnerable to unauthorized access, computer viruses and other disruptive
problems. A material security problem affecting Cass could damage its
reputation, deter prospects from purchasing its products, deter customers from
using its products or result in liability to Cass.
Cass must respond to rapid technological changes and these changes may be more
difficult or expensive than anticipated.
If competitors introduce new products and services embodying new technologies,
or if new industry standards and practices emerge, the Company's existing
product and service offerings, technology and systems may become obsolete.
Further, if Cass fails to adopt or develop new technologies or to adapt its
products and services to emerging industry standards, Cass may lose current and
future customers, which could have a material adverse effect on its business,
financial condition and results of operations. The payment processing and
financial services industries are changing rapidly and in order to remain
competitive, Cass must continue to enhance and improve the functionality and
features of its products, services and technologies. These changes may be more
difficult or expensive than the Company anticipates.
Competitive product and pricing pressure within Cass' markets may change.
The Company operates in a very competitive environment, which is characterized
by competition from a number of other vendors and financial institutions in each
market in which it operates. The Company competes with large payment processors
and national and regional financial institutions and also smaller auditing
companies and banks in terms of products and pricing. If the Company is unable
to compete effectively in products and pricing in its markets, business could
decline.
Management's ability to maintain and expand customer relationships may differ
from expectations.
The industries in which the Company operates are very competitive. The Company
not only competes for business opportunities with new customers, but also
competes to maintain and expand the relationships it has with its existing
customers. While management believes that it can continue to grow many of these
relationships, the Company will continue to experience pressures to maintain
these relationships as its competitors attempt to capture its customers.
The introductions, withdrawal, success and timing of business initiatives and
strategies, including, but not limited to, the expansion of payment and
processing activities to new markets, the expansion of products and services to
existing markets and opening of new bank branches, may be less successful or may
be different than anticipated. Such a result could adversely affect Cass'
business.
The Company makes certain projections and develops plans and strategies for its
payment processing and banking products. If the Company does not accurately
determine demand for its products and services, it could result in the Company
incurring significant expenses without the anticipated increases in revenue,
which could result in an adverse effect on its earnings.
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Management's ability to retain key officers and employees may change.
Cass' future operating results depend substantially upon the continued service
of Cass' executive officers and key personnel. Cass' future operating results
also depend in significant part upon Cass' ability to attract and retain
qualified management, financial, technical, marketing, sales and support
personnel. Competition for qualified personnel is intense, and the Company
cannot ensure success in attracting or retaining qualified personnel. There may
be only a limited number of persons with the requisite skills to serve in these
positions, and it may be increasingly difficult for the Company to hire
personnel over time. Cass' business, financial condition and results of
operations could be materially adversely affected by the loss of any of its key
employees, by the failure of any key employee to perform in his or her current
position, or by Cass' inability to attract and retain skilled employees.
Methods of reducing risk exposures might not be effective.
Instruments, systems and strategies used to hedge or otherwise manage exposure
to various types of credit, interest rate, market and liquidity, operational,
compliance, business risks and enterprise-wide risks could be less effective
than anticipated. As a result, the Company may not be able to effectively
mitigate its risk exposures in particular market environments or against
particular types of risk.
Changes in regulation or oversight may have a material adverse impact on Cass'
operations.
The Company is subject to extensive regulation, supervision and examination by
the Missouri Division of Finance, the Federal Deposit Insurance Corporation, the
Board of Governors of the Federal Reserve System, the Securities and Exchange
Commission and other regulatory bodies. Such regulation and supervision governs
the activities in which the Company may engage. Regulatory authorities have
extensive discretion in their supervisory and enforcement activities, including
the imposition of restrictions on Cass' operations, investigations and
limitations related to Cass' securities, the classification of Cass' assets and
determination of the level of Cass' allowance for loan losses. Any change in
such regulation and oversight, whether in the form of regulatory policy,
regulations, legislation or supervisory action, may have a material adverse
impact on Cass' operations.
The Company's accounting policies and methods are the basis of how Cass reports
its financial condition and results of operations, and they may require
management to make estimates about matters that are inherently uncertain. In
addition, changes in accounting policies and practices, as may be adopted by the
regulatory agencies, the Financial Accounting Standards Board, or other
authoritative bodies, could materially impact Cass' financial statements.
The Company's accounting policies and methods are fundamental to how Cass
records and reports its financial condition and results of operations.
Management must exercise judgment in selecting and applying many of these
accounting policies and methods in order to ensure that they comply with
generally accepted accounting principles and reflect management's judgment as to
the most appropriate manner in which to record and report Cass' financial
condition and results of operations. In some cases, management must select the
accounting policy or method to apply from two or more alternatives, any of which
might be reasonable under the circumstances yet might result in the Company
reporting materially different amounts than would have been reported under a
different alternative.
Cass has identified four accounting policies as being "critical" to the
presentation of its financial condition and results of operations because they
require management to make particularly subjective and/or complex judgments
about matters that are inherently uncertain and because of the likelihood that
materially different amounts would be reported under different conditions or
using different assumptions. More information on Cass' critical accounting
policies is contained in Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
From time to time, the regulatory agencies, the Financial Accounting Standards
Board, and other authoritative bodies change the financial accounting and
reporting standards that govern the preparation of the Company's financial
statements. These changes can be hard to predict and can materially impact how
management records and reports the Company's financial condition and results of
operations.
Legal and regulatory proceedings and related matters with respect to the
financial services industry, including those directly involving the Company and
its subsidiaries, could adversely affect Cass or the financial services industry
in general.
The Company has been, and may in the future be, subject to various legal and
regulatory proceedings. It is inherently difficult to assess the outcome of
these matters, and there can be no assurance that the Company will prevail in
any proceeding or litigation. Any such matter could result in substantial cost
and diversion of Cass' efforts, which by itself could have a material adverse
effect on Cass' financial condition and operating results. Further, adverse
determinations
5
in such matters could result in actions by Cass' regulators that could
materially adversely affect Cass' business, financial condition or results of
operations.
Cass is subject to examinations and challenges by tax authorities, which, if not
resolved in the Company's favor, could adversely affect the Company's financial
condition and results of operations.
In the normal course of business, Cass and its affiliates are routinely subject
to examinations and challenges from federal and state tax authorities regarding
the amount of taxes due in connection with investments it has made and the
businesses in which it is engaged. Recently, federal and state taxing
authorities have become increasingly aggressive in challenging tax positions
taken by financial institutions. These tax positions may relate to tax
compliance, sales and use, franchise, gross receipts, payroll, property and
income tax issues, including tax base, apportionment and tax credit planning.
The challenges made by tax authorities may result in adjustments to the timing
or amount of taxable income or deductions or the allocation of income among tax
jurisdictions. If any such challenges are made and are not resolved in the
Company's favor, they could have an adverse effect on Cass' financial condition
and results of operations.
Cass' stock price can become volatile and fluctuate widely in response to a
variety of factors.
These factors can include actual or anticipated variations in Cass' quarterly
results; new technology or services by competitors; unanticipated losses or
gains due to unexpected events, including losses or gains on securities held for
investment purposes; significant acquisitions or business combinations,
strategic partnerships, joint ventures or capital commitments by or involving
the Company or its competitors; changes in accounting policies or practices;
failure to integrate acquisitions or realize anticipated benefits from
acquisitions; or changes in government regulations.
General market fluctuations, industry factors and general economic and political
conditions, such as economic slowdowns or recessions, interest rate changes,
credit loss trends, low trading volume or currency fluctuations also could cause
Cass' stock price to decrease regardless of the Company's operating results.
There could be terrorist activities or other hostilities, which may adversely
affect the general economy, financial and capital markets, specific industries,
and the Company.
The terrorist attacks in September 2001 in the United States and ensuing events,
as well as the resulting decline in consumer confidence, has had a material
adverse effect on the economy. Any similar future events may disrupt Cass'
operations or those of its customers. In addition, these events have had and may
continue to have an adverse impact on the U.S. and world economy in general and
consumer confidence and spending in particular, which could harm Cass'
operations. Any of these events could increase volatility in the U.S. and world
financial markets, which could harm Cass' stock price and may limit the capital
resources available to its customers and the Company. This could have a
significant impact on Cass' operating results, revenues and costs and may result
in increased volatility in the market price of Cass' common stock.
There could be natural disasters, including, but not limited to, hurricanes,
tornadoes, earthquakes, fires and floods, which may adversely affect the general
economy, financial and capital markets, specific industries, and the Company.
The Company has significant operations and customer base in Missouri,
California, Ohio, Massachusetts, S. Carolina, and other regions where natural
disasters may occur. These regions are known for being vulnerable to natural
disasters and other risks, such as tornadoes, hurricanes, earthquakes, fires and
floods. These types of natural disasters at times have disrupted the local
economy, Cass' business and customers and have posed physical risks to Cass'
property. A significant natural disaster could materially affect Cass' operating
results.
General political, economic or industry conditions may be less favorable than
expected.
Local, domestic, and international economic, political and industry-specific
conditions and governmental monetary and fiscal policies affect the industries
in which the Company competes, directly and indirectly. Conditions such as
inflation, recession, unemployment, volatile interest rates, tight money supply,
real estate values, international conflicts and other factors outside of Cass'
control may adversely affect the Company. Economic downturns could result in the
delinquency of outstanding loans, which could have a material adverse impact on
Cass' earnings.
6
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
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. Additional production facilities are
located in Lowell, Massachusetts where approximately 25,800 square feet of
office space is leased through March 2009, Greenville, South Carolina where
approximately 8,500 square feet of office space is leased through November 2013
and Wellington, Kansas where approximately 2,000 square feet of office space is
leased through July 2011.
The Bank's headquarters are also located at 13001 Hollenberg Drive, Bridgeton,
Missouri. 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, Missouri that consists of approximately 1,750 square feet
with adjoining drive-up facilities. The Bank has additional leased facilities in
Maryland Heights, Missouri (2,500 square feet), Fenton, Missouri (2,000 square
feet), Chesterfield, Missouri (2,850 square feet) and Santa Ana, California
(3,400 square feet).
Management believes that these facilities are suitable and adequate for the
Company's operations.
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 2006.
7
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is quoted on The Nasdaq Global Market(R) under the
symbol "CASS". As of March 2, 2007, there were 236 holders of record of the
Company's common stock. High and low sale prices, as reported by Nasdaq and
adjusted for the 50% stock dividends issued September 15, 2006 and September 15,
2005, for each quarter of 2006 and 2005 were as follows:
2006 2005
---- ----
High Low High Low
1st Quarter $ 23.793 $ 20.667 $ 18.218 $ 15.111
2nd Quarter 35.507 24.233 19.111 16.667
3rd Quarter 36.980 27.387 26.666 17.693
4th Quarter 39.450 31.100 23.400 19.700
Cash dividends paid per share, restated for stock dividends, by the Company
during the two most recent fiscal years were as follows:
2006 2005
---- ----
March 15 $ .107 $ .093
June 15 .106 .093
September 15 .107 .094
December 15 .120 .107
The Company maintains a treasury stock buyback program pursuant to which the
Board of Directors has authorized the repurchase of up to 150,000 shares of the
Company's common stock. The Company repurchased 30,000 shares during 2006 for
$870,000 and 63,997 shares for $1,434,000 in 2005. The Company did not
repurchase any shares in the three months ended December 31, 2006. As of
December 31, 2006, 120,000 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.
Securities Authorized for Issuance under Equity Compensation Plans
Number of securities
remaining available for
Number of securities to Weighted-average future issuance under
be issued upon exercise exercise price of equity compensation plans
of outstanding options, outstanding options, (excluding securities
warrants and rights warrants and rights reflected in column (a))
Plan Category (a) (b) (c)
---------------------------------------------------------------------------------------------------------------
Equity compensation plans 110,286 $16.92 503,492(2)
approved by security holders(1)
Equity compensation plans not _ _ _
approved by security holders
Total 110,286 $16.92 503,492(2)
Note: All share information has been restated to reflect the 50% stock dividend
on September 15, 2006.
(1) These plans are the Company's 1995 Performance-Based Stock Option Plan and
1995 Restricted Stock Bonus Plan.
(2) Includes 403,767 shares available for issuance under the 1995
Performance-Based Stock Option Plan and 99,725 shares available for
issuance under the 1995 Restricted Stock Bonus Plan.
Refer to Note 14 to the consolidated financial statements for information
concerning stock options and bonus plans.
8
Performance Quoted on The NASDAQ Stock Market for the last Five Fiscal Years
The following graph compares the cumulative total returns over the last five
fiscal years of a hypothetical investment of $100 in shares of common stock of
the Company with a hypothetical investment of $100 in the NASDAQ stock market
(US) and in the index of NASDAQ computer and data processing stocks. The graph
assumes $100 was invested on December 31, 2001, with dividends reinvested.
Returns are based on period end prices.
[TABULAR REPRESENTATION OF LINE CHART]
Cass Nasdaq Nasdaq Computer
Information Stock Market and Data
Date Systems, Inc. (US) Processing Stocks
12/31/2001 12/31/2001 100.000 100.000 100.000
1/31/2002 100.000 99.239 99.475
2/28/2002 102.347 88.920 89.641
3/28/2002 103.253 94.751 92.274
4/30/2002 102.039 86.879 78.120
5/31/2002 103.150 83.047 73.128
6/28/2002 103.271 75.524 73.336
7/31/2002 101.180 68.628 64.407
8/30/2002 95.390 67.899 64.729
9/30/2002 96.848 60.597 56.729
10/31/2002 97.601 68.875 68.573
11/29/2002 101.993 76.553 77.599
12/31/2002 12/31/2002 108.942 69.131 68.957
1/31/2003 112.485 68.383 67.416
2/28/2003 117.445 69.344 67.019
3/31/2003 117.154 69.544 67.179
4/30/2003 144.467 75.865 72.393
5/30/2003 117.823 82.526 76.203
6/30/2003 134.353 83.850 77.940
7/31/2003 131.183 89.627 80.652
8/29/2003 140.537 93.536 84.341
9/30/2003 149.215 92.320 85.085
10/31/2003 140.116 99.753 87.817
11/28/2003 135.656 101.231 87.277
12/31/2003 12/31/2003 150.919 103.365 90.849
1/30/2004 151.785 106.429 93.257
2/27/2004 156.886 104.426 89.483
3/31/2004 172.362 102.648 84.879
4/30/2004 180.286 99.246 83.380
5/28/2004 195.836 102.542 86.922
6/30/2004 201.938 105.693 92.317
7/30/2004 204.222 97.626 85.305
8/31/2004 190.269 95.235 81.812
9/30/2004 188.721 98.077 86.327
10/29/2004 188.721 102.053 90.951
11/30/2004 179.540 108.341 97.042
12/31/2004 12/31/2004 179.284 112.489 100.044
1/31/2005 182.567 106.636 96.195
2/28/2005 188.184 106.030 92.820
3/31/2005 198.591 103.334 90.288
4/29/2005 196.012 99.574 89.698
5/31/2005 206.329 107.273 96.440
6/30/2005 212.623 106.837 94.540
7/29/2005 230.331 113.655 97.727
8/31/2005 286.280 111.852 99.133
9/30/2005 244.379 111.942 98.925
10/31/2005 257.652 110.504 100.803
11/30/2005 249.806 116.531 105.543
12/30/2005 12/30/2005 260.522 114.881 103.436
1/31/2006 260.718 119.953 107.815
2/28/2006 262.484 118.760 102.902
3/31/2006 281.419 121.855 106.272
4/28/2006 353.962 120.896 104.152
5/31/2006 394.255 113.602 96.318
6/30/2006 385.163 113.602 99.569
7/31/2006 395.604 109.271 97.015
8/31/2006 421.214 114.122 102.410
9/29/2006 394.115 118.051 108.526
10/31/2006 445.298 123.832 114.581
11/30/2006 459.939 127.068 118.124
12/29/2006 12/29/2006 432.035 126.216 116.086
9
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial information for each of the five
years ended December 31. 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) 2006 2005 2004 2003 2002
----------------------------------------------------------------------------------------------------------------
Fee revenue and other income $42,821 $ 38,653 $ 34,047 $ 32,371 $ 28,030
Interest income on loans (1) 36,164 32,214 27,055 25,601 26,197
Interest income on debt and equity securities 3,627 2,441 2,558 2,033 4,733
Other interest income 7,262 3,596 1,120 609 687
Total interest income 47,053 38,251 30,733 28,243 31,617
Interest expense on deposits 6,414 4,486 3,024 1,847 2,240
Interest expense on short-term borrowings 7 5 1 14 33
Interest on subordinated convertible debenture s 198 196 70 -- --
Total interest expense 6,619 4,687 3,095 1,861 2,273
Net interest income 40,434 33,564 27,638 26,382 29,344
Provision for loan losses 1,150 775 550 190 500
Net interest income after provision 39,284 32,789 27,088 26,192 28,844
Operating expense 58,277 55,216 47,045 47,383 46,575
Income before income tax expense 23,828 16,226 14,090 11,180 10,299
Income tax expense 8,367 4,982 4,209 3,385 2,987
----------------------------------------------------------------------------------------------------------------
Income from continuing operations $15,461 $ 11,244 $ 9,881 $ 7,795 $ 7,312
----------------------------------------------------------------------------------------------------------------
Net (loss) income from discontinued operations (395) (298) (1,876) 107 --
Net income 15,066 10,946 8,005 7,902 7,312
Diluted earnings per share from
continuing operations 1.82 $ 1.33 $ 1.17 $ .93 $ .87
Diluted earnings per share 1.77 1.29 .95 .95 .87
Dividends per share .440 .387 .365 .339 .315
----------------------------------------------------------------------------------------------------------------
Dividend payout ratio 24.31% 29.24% 37.79% 35.61% 35.94%
Average total assets $839,208 $ 776,899 $ 709,518 $ 626,451 $602,446
Average net loans 516,164 506,898 471,412 438,072 399,018
Average debt and equity securities 91,555 71,037 78,745 57,729 97,668
Average total deposits 278,546 290,555 292,379 249,951 240,640
Average subordinated convertible debentures 3,700 3,700 1,314 -- --
Average total shareholders' equity 79,736 71,892 65,804 61,346 57,300
----------------------------------------------------------------------------------------------------------------
Return on average total assets 1.80% 1.41% 1.13% 1.26% 1.21%
Return on average equity 18.89% 15.23 12.16 12.88 12.76
Average equity to assets ratio 9.50 9.25 9.27 9.79 9.51
Equity to assets ratio at year-end 9.78 9.20 9.71 10.03 10.59
Net interest margin 5.50 4.95 4.48 4.85 5.60
Allowance for loan losses to loans at year-end 1.31 1.19 1.21 1.17 1.22
Nonperforming assets to loans and foreclosed
assets .16 .28 .18 1.12 3.50
Net loan charge-offs (recoveries) to average
loans outstanding .16 .10 -- (0.01) 0.03
----------------------------------------------------------------------------------------------------------------
1. Interest income on loans includes net loan fees.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis provides information about the financial
condition and results of operations of the Company for the years ended December
31, 2006, 2005 and 2004. All share and per share data have been restated to give
effect to the 10%, 50% and 50% stock dividends issued on March 15, 2004,
September 15, 2005 and September 15, 2006, respectively. This discussion and
analysis should be read in conjunction with the Company's consolidated financial
statements and accompanying notes and other selected financial data presented
elsewhere in this report.
10
Executive Overview
Cass Information Systems, Inc. provides payment and information processing
services to large manufacturing, distribution and retail enterprises from its
processing centers in St. Louis, Missouri, Columbus, Ohio, Boston,
Massachusetts, Greenville, South Carolina and Wellington, Kansas. The Company's
services include freight invoice rating, payment processing, auditing, and the
generation of accounting and transportation information. Cass also processes and
pays utility invoices, which includes electricity, gas and telecommunications
expenses and is a provider of telecom expense management solutions. Cass
extracts, stores and presents information from freight, utility and
telecommunication invoices, assisting its customers' transportation, energy and
information technology managers in making decisions that will enable them to
improve operating performance. The Company receives data from multiple 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 Cass Commercial Bank, its St. Louis, Missouri based bank
subsidiary, provides banking services in the St. Louis metropolitan area, Orange
County, California and other selected cities in the United States. In addition
to supporting the Company's payment operations, the Bank provides banking
services to its target markets, which include privately owned businesses and
churches and church-related ministries.
The specific payment and information processing services provided to each
customer are developed individually to meet each customer's requirements, which
can vary greatly. In addition, the degree of automation such as electronic data
interchange ("EDI"), imaging, and web-based 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
have a significant effect 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 paid on its deposits. The Bank also
assesses fees on other services such as cash management 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 the loan portfolio. The general level of interest rates
also has a significant effect on the revenue of the Company.
On December 30, 2005, the Company's bank subsidiary sold the operating assets of
its wholly owned subsidiary, Government e-Management Solutions, Inc. ("GEMS").
The assets, liabilities and operating results of GEMS have been presented as
discontinued operations for all periods.
In the fourth quarter 2005, the Company recognized a $3,100,000 impairment
charge on its investment in a private imaging company. As of December 31, 2006,
the Company's remaining financial interest in this entity was a $350,000 line of
credit.
On July 7, 2006, the Company acquired 100% of the stock of NTransit, Inc., a
company whose service provides auditing and expense management of parcel
shipments. While this acquisition does not meet the Regulation S-X criteria of a
significant business combination, it positions the Company to expand its
offerings in the specialized service and expertise in parcel shipping, which is
a unique segment of the transportation industry that has experienced tremendous
growth in recent years.
The Company had an excellent year in 2006; surpassing management's expectations.
Total fee revenue and other income from continuing operations increased
$4,168,000 or 11% and net interest income increased $6,495,000 or 20% while
increases in total operating expenses were held to $3,061,000 or 6%. These
results were driven by a 2,882,000 or 10% increase in items processed,
$3,499,184,000 or 21% increase in dollars processed and strong expense control
11
combined with a rise in the general level of interest rates. The asset quality
of the Company's loans and investments remains strong.
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.
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 past, 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 both segments of the
Company. 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. The Company 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 both segments of the Company and require significant management
assumptions and estimates that could result in materially different results if
conditions or underlying circumstances change.
Income Taxes. The objectives of accounting for income taxes are to recognize the
amount of taxes payable or refundable for the current year and deferred tax
liabilities and assets for the future tax consequences of events that have been
recognized in an entity's financial statements or tax returns. Judgment is
required in addressing the future tax consequences of events that have been
recognized in the Company's financial statements or tax returns such as the
realization of deferred tax assets, changes in tax laws or interpretations
thereof. In addition, the Company is subject to the continuous examination of
its income tax returns by the Internal Revenue Service and other taxing
authorities. A change in the assessment of the outcomes of such matters could
materially impact its consolidated financial statements.
Pension Plans. The amounts recognized in the consolidated financial statements
related to pension are determined from actuarial valuations. Inherent in these
valuations are assumptions including expected return on plan assets, discount
rates at which the liabilities could be settled at December 31, 2006, rate of
increase in future compensation levels and mortality rates. These assumptions
are updated annually and are disclosed in Note 13 to the Consolidated Financial
Statements. In September 2006, the FASB issued Statement No. 158, "Employers'
Accounting for Defined Benefit Pension and Other Postretirement Plans - an
amendment of FASB Statements No. 87, 88, 106, and 132(R)" ("SFAS No. 158"). SFAS
No. 158 requires companies to recognize the overfunded or underfunded status of
a defined benefit postretirement plan as an asset or liability in its statement
of financial position and to recognize changes in that funded status in the year
in which the changes occur through comprehensive income. The funded status is
measured as the difference between the fair value of the plan assets and the
benefit obligation as of the date of its fiscal year-end. The Company recognized
the required changes and disclosures in its consolidated 2006 financial
statements.
12
Summary of Results
December 31, % Change
---------------------------------------- --------------------------
(In thousands, except per share data) 2006 2005 2004 2006 v 2005 2005 v 2004
---------------------------------------------------------------------------------------------------------------------
Total Processing Volume 30,885 28,003 25,045 10.3% 11.8%
Total Processing Dollars $19,871,281 $16,372,097 $13,452,868 21.4% 21.7%
Payment and Processing Fees $40,343 $35,901 $30,695 12.4% 17.0%
Net Investment Income $39,284 $32,789 $27,088 19.8% 21.0%
Total Net Revenues $82,105 $71,442 $61,135 14.9% 16.9%
Average Earning Assets $762,397 $697,285 $643,847 9.3% 8.3%
Net Interest Margin* 5.50% 4.95% 4.48% 11.1% 10.5%
Impairment of Equity Investment -- $3,100 -- N/A N/A
Net Income from Continuing Operations $15,461 $11,244 $9,881 37.5% 13.8%
Diluted EPS from Continuing Operations $1.82 $1.33 $1.17 36.8% 13.7%
Net Income $15,066 $10,946 $8,005 37.6% 36.7%
Diluted Earnings per Share $1.77 $1.29 $.95 37.2% 35.8%
Return on Average Assets 1.80% 1.41% 1.13%
Return on Average Equity 18.89% 15.23% 12.16%
---------------------------------------------------------------------------------------------------------------------
* Presented on a tax-equivalent basis
The results of 2006 compared to 2005 include the following significant items:
Payment and processing fee revenue from continuing operations increased as
the number of transactions processed increased. This increase was driven
mainly by the expansion of the Company's customer base and number of
services offered. It is the Company's strategy to expand processing revenue
by 1) actively marketing the Company's existing product lines in freight,
utility, and telecom payment and processing, 2) expanding the Company's
service offerings to the markets currently served and 3) expanding into new
markets by leveraging its payment and processing capabilities. The August
2006 acquisition of NTransit, Inc. was part of this strategy.
Net interest income after provision for loan losses increased $6,495,000
due to an increase in the general level of interest rates and a $65,112,000
increase in average earning assets. The net interest margin on a tax
equivalent basis was 5.50% in 2006 compared to 4.95% in 2005. The growth in
average earning assets was funded mainly by increases in accounts and
drafts payable due to the increase in dollars processed.
There were no gains from the sale of securities in 2006 compared to gains
of $547,000 last year. Bank service fees increased $90,000 or 6% to
$1,625,000. Other income from continuing operations remained fairly
constant, $853,000 in 2006 and $670,000 in 2005. Operating expenses from
continuing operations increased $3,061,000 due mainly to expenses relating
to the increase in processing activity.
The results of 2005 compared to 2004 include the following significant items:
Payment and processing fee revenue from continuing operations increased as
the number of transactions processed increased. This increase was driven
mainly by the expansion of the Company's customer base and number of
services offered. It is the Company's strategy to expand processing revenue
by 1) actively marketing the Company's existing product lines in freight,
utility, and telecom payment and processing, 2) expanding the Company's
service offerings to the markets currently served and 3) expanding into new
markets by leveraging its payment and processing capabilities. The August
2004 acquisition of Cass' telecom group was part of this strategy. This
acquisition, although not yet accretive to earnings, significantly
increased the Company's audit and telecom expense management capabilities.
Net interest income after provision for loan losses increased $5,701,000
due primarily to an increase in the general level of interest rates. The
net interest margin on a tax equivalent basis was 4.95% in 2005 compared to
4.48% in 2004. Another significant contributor to the increase in net
interest income was a $53,438,000 increase in average earning assets. The
growth in average earning assets was funded mainly by increases in accounts
and drafts payable due to the increase in dollars processed.
Gains from the sale of securities decreased $498,000 to $547,000 compared
to 2004's $1,045,000. Bank service fees decreased $184,000 or 11% to
$1,535,000 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 from continuing operations remained fairly constant, $670,000
in 2005 and $588,000 in 2004. Excluding the $3,100,000 impairment charge
relating to the Company's investment in a private imaging company,
operating expenses from continuing operations increased $5,071,000 due
mainly to
13
expenses relating to the increase in processing activity along with the
additional expenses related to the telecom group which was acquired in
August 2004.
In addition to the factors above relating to the results of continuing
operations for 2005, net income, diluted earnings per share, return on
assets and return on equity were also affected by a $298,000 net loss from
GEMS' discontinued operations which included a $1,336,000 gain on the sale
of its operating assets.
Fee Revenue and Other Income from Continuing Operations
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, fee
revenue and other income for the years ended December 31, 2006, 2005 and 2004
were as follows:
December 31, % Change
---------------------------------------- --------------------------
(In thousands) 2006 2005 2004 2006 v 2005 2005 v 2004
---------------------------------------------------------------------------------------------------------------------
Freight Invoice Transaction Volume 24,220 22,348 19,847 8.4% 12.6%
Freight Invoice Dollar Volume $14,199,389 $11,949,052 $9,752,203 18.8% 22.5%
Utility Transaction Volume 6,665 5,655 5,198 17.9% 8.8%
Utility Transaction Dollar Volume $5,671,892 $4,423,045 $3,700,665 28.2% 19.5%
Payment and processing revenue $40,343 $35,901 $30,695 12.4% 17.0%
Bank service fees $1,625 $1,535 $1,719 5.9% (10.7%)
Gains on sales of investment securities -- $547 $1,045 N/A (47.7%)
Other $853 $670 $588 27.3% 13.9%
---------------------------------------------------------------------------------------------------------------------
Fee revenue and other income in 2006 compared to 2005 include the following
significant pre-tax components:
Freight volume increased by 1,872,000 transactions during the past year. This
increase was due mainly to a significant amount of new business in 2006. In
addition to these factors, higher dollar volume during the last three years has
been affected by higher dollars processed per shipment due to escalating fuel
costs and an increase in general economic activity. Utility volume also
experienced solid growth, adding more than 1,010,000 transactions in 2006. This
growth was due mainly to new business. These transaction volume increases drove
most of the $4,442,000 increase in payment and processing revenue.
Fee revenue and other income in 2005 compared to 2004 include the following
significant pre-tax components:
Freight volume increased by 2,501,000 transactions during this time period. This
increase was due mainly to the assimilation of a significant amount of new
business in 2005 and the continuation of a strong business climate for many
companies in the customer base. In addition to these factors, higher dollar
volume during the last three years has been affected by higher dollars processed
per shipment due to escalating fuel costs and an increase in general economic
activity. Utility volume also experienced solid growth, adding more than 450,000
transactions in 2005. This growth was due mainly to new business. While new
business grew about the same rate as in the past, the Company was negatively
impacted by the loss of two high transaction customers, which accounted for a
decrease of 175,000 transactions. The loss of these two customers was not
material from a profitability standpoint. The higher rate of growth in utility
dollars compared to utility volume was due to the conversion of a large customer
to payables from data entry only, an increasing market share in the industrial
vertical market which generates higher dollars per bill and higher commodity
costs that raise the average dollars per bill. These transaction volume
increases drove most of the $5,206,000 increase in payment and processing
revenue. The telecom group, which was acquired in August 2004, contributed
$2,493,000 of payment and processing fees for 2005 and $538,000 in 2004.
Bank service fees decreased $184,000 during this time period. This decrease was
due primarily to the fact that service fees decrease as the credit allowance for
non-interest bearing deposits increases, due to the general level of interest
rate increases. During 2005 the Company recorded net gains of $547,000 on the
sales of securities. During 2004, net gains of $1,045,000 were recorded on the
sales of securities. These securities sales 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
miscellaneous income increased $82,000 from 2004.
14
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 tax-equivalent
net interest income and related factors for the three periods ended December 31,
2006, 2005 and 2004:
% Change % Change
(In Thousands) 2006 2005 2004 2006 v. 2005 2005 v. 2004
--------------------------------------------------------------------------------------------------------
Average earning assets $762,397 $697,285 $643,847 9.3% 8.3%
Net interest income 41,950 34,534 28,838 21.4% 19.8%
Net interest margin* 5.50% 4.95% 4.48% 11.1% 10.5%
Yield on earning assets 6.37% 5.62% 4.96% 13.3% 13.3%
Rate on interest bearing liabilities 3.62% 2.45% 1.64% 47.8% 49.4%
--------------------------------------------------------------------------------------------------------
*Presented on a tax-equivalent basis
Net interest income in 2006 compared to 2005:
The increase in net interest income was caused by the combination of a
significant increase in earning assets combined with a significant increase
in net interest margin. The increase in earning assets was funded mainly by
the increase in accounts and drafts payable due to the increased dollars
processed. The increase in net interest margin was due mainly to the rise
in the general level of interest rates and also the increase in the amount
of earning assets. The Company is positively affected by increases 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 negatively affected by decreases in the level of interest rates.
This is primarily due to the non-interest-bearing liabilities generated by
the Company in the form of accounts and drafts payable. More information is
contained in the tables below and in Item 7A of this report.
Total average loans increased $9,401,000 or 2% to $522,367,000. 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 decreased
$20,518,000 or 29% to $91,555,000. The investment portfolio will expand and
contract over time as the interest rate environment changes and the Company
manages its liquidity and interest rate position. Total average federal
funds sold and other short-term investments increased $35,193,000 or 31% to
$148,475,000. This increase was funded by the increase in accounts and
drafts payable.
The Bank's average interest-bearing deposits remained relatively flat with
a $8,027,000 or 4% decrease compared to the prior year due to the Company's
increase in liquidity and resulting decreased need for higher-cost funding.
Average demand deposits decreased $3,982,000 or 4% due to the fact that
balances and service fees associated with these deposits decrease as the
credit allowance for non-interest bearing deposits increases due to the
general level of interest rate increases. Average rates paid on
interest-bearing liabilities increased from 2.45% to 3.61% as the general
level of interest rates increased. This represents increased rate
competition for savings deposits and certificates of deposit in the markets
served by the Company's subsidiary bank.
Net interest income in 2005 compared to 2004:
The increase in net interest income was caused by the combination of a
significant increase in earning assets combined with a significant increase
in net interest margin. The increase in earning assets was funded mainly by
the increase in accounts and drafts payable due to the increased dollars
processed. The increase in net interest margin was due mainly to the rise
in the general level of interest rates and also the increase in the size of
the loan portfolio. Loans are the Company's highest yielding earning asset
for any given maturity. The Company is positively affected by increases 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 negatively affected by decreases in the level of interest rates.
This is primarily due to the non-interest-bearing liabilities generated by
the Company in the form of accounts and drafts payable. More information is
contained in the tables below and in Item 7A of this report.
Total average loans increased $35,732,000 or 7% to $512,966,000. 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.
15
Total average investment in debt and equity securities decreased $7,708,000
or 10% to $71,037,000. The investment portfolio will expand and contract
over time as the interest rate environment changes and the Company manages
its liquidity and interest rate position. Total average federal funds sold
and other short-term investments increased $25,414,000 or 29% to
$113,282,000. This increase was funded by the increase in accounts and
drafts payable and provides the Company with additional liquidity to take
advantage of higher interest rates.
The Bank's average interest-bearing deposits remained relatively flat with
a $554,000 or 0.3% decrease compared to the prior year due to the Company's
increase in liquidity and resulting decreased need for higher-cost funding.
Average demand deposits decreased $1,270,000 or 1% due to the fact that
balances and service fees associated with these deposits decrease as the
credit allowance for non-interest bearing deposits increases due to the
general level of interest rate increases. Average rates paid on
interest-bearing liabilities increased from 1.64% to 2.45% as the general
level of interest rates increased.
16
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:
2006 2005 2004
--------------------------- ---------------------------- ---------------------------
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 $516,958 $35,923 6.95% $508,151 $32,012 6.30% $471,995 $26,807 5.68%
Tax-exempt (4) 5,409 371 6.86 4,815 310 6.44 5,239 376 7.18
Securities (5):
Taxable 24,506 1,052 4.29 28,610 831 2.90 26,603 476 1.79
Tax-exempt (4) 67,049 3,961 5.91 42,427 2,472 5.83 52,142 3,154 6.05
Federal funds sold and other
short-term investments 148,475 7,262 4.89 113,282 3,596 3.17 87,868 1,120 1.27
----------------------------------------------------------------------------------------------------------------------------------
Total earning assets 762,397 48,569 6.37 697,285 39,221 5.62 643,847 31,933 4.96
Nonearning assets:
Cash and due from banks 28,645 28,874 23,035
Premises and equipment, net 12,641 11,269 12,034
Bank owned life insurance 11,763 11,298 10,874
Goodwill and other
intangibles, net 6,167 5,499 2,381
Other assets 23,531 22,541 16,485
Assets related to discontinued
operations 267 6,201 6,684
Allowance for loan losses (6,203) (6,068) (5,822)
----------------------------------------------------------------------------------------------------------------------------------
Total assets 839,208 $776,899 $709,518
----------------------------------------------------------------------------------------------------------------------------------
Liabilities And Shareholders' Equity (1)
Interest-bearing liabilities:
Interest-bearing demand
deposits $71,043 $1,831 2.58 $80,976 $1,485 1.83% $ 73,792 $ 845 1.15%
Savings deposits 25,113 730 2.91 26,622 458 1.72 29,712 293 .99
Time deposits of
$100 or more 53,550 2,556 4.77 43,967 1,401 3.19 49,540 1,160 2.34
Other time deposits 29,511 1,297 4.40 35,679 1,142 3.20 34,754 726 2.09
----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 179,217 6,414 3.58 187,244 4,486 2.40 187,798 3,024 1.61
Short-term borrowings 161 7 4.46 165 5 3.03 91 1 1.10
Subordinated convertible
debentures 3,700 198 5.35 3,700 196 5.30 1,314 70 5.33
----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 183,078 6,619 3.62 191,109 4,687 2.45 189,203 3,095 1.64
Noninterest-bearing liabilities:
Demand deposits 99,329 103,311 104,581
Accounts and drafts payable 468,303 401,258 341,247
Other liabilities 8,107 7,472 6,896
Liabilities related to
discontinued operations 655 1,857 1,787
----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 759,472 705,007 643,714
Shareholders' equity 79,736 71,892 65,804
----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity 839,208 $776,899 $709,518
----------------------------------------------------------------------------------------------------------------------------------
Net interest income $41,950 $34,534 $28,838
Net interest margin 5.50% 4.95% 4.48%
Interest spread 2.75% 3.17% 3.32%
==================================================================================================================================
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 $213,000, $161,000 and
$178,000 for 2006, 2005 and 2004, respectively.
4. Interest income is presented on a tax-equivalent basis assuming a tax rate
of 35% for 2006 and 2005 and 34% for 2004. The tax-equivalent adjustment
was approximately $1,516,000, $970,000 and $1,200,000 for 2006, 2005 and
2004, 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.
17
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.
2006 Over 2005 2005 Over 2004
------------------------------ ------------------------------
(Dollars in thousands) Volume(1) Rate(1) Total Volume(1) Rate(1) Total
----------------------------------------------------------------------------------------------------------------
Increase (decrease) in interest income:
Loans (2,3):
Taxable $563 $3,348 $3,911 $2,146 $3,059 $5,205
Tax-exempt (4) 40 21 61 (29) (37) (66)
Securities:
Taxable (132) 352 220 38 317 355
Tax-exempt (4) 1,454 36 1,490 (570) (112) (682)
Federal funds sold and other
short-term investments 1,338 2,328 3,666 402 2,074 2,476
----------------------------------------------------------------------------------------------------------------
Total interest income $3,263 $6,085 $9,348 $1,987 $5,301 $7,288
----------------------------------------------------------------------------------------------------------------
Interest expense on:
Interest-bearing demand deposits (199) 545 346 89 551 640
Savings deposits (27) 299 272 (33) 198 165
Time deposits of $100 or more 352 803 1,155 (141) 382 241
Other time deposits (220) 375 155 20 396 416
Short-term borrowings -- 2 2 1 3 4
Subordinated convertible debenture -- 2 2 126 0 126
----------------------------------------------------------------------------------------------------------------
Total interest expense (94) 2,026 1,932 62 1,530 1,592
----------------------------------------------------------------------------------------------------------------
Net interest income $3,357 $4,059 $7,416 $1,925 $3,771 $5,696
----------------------------------------------------------------------------------------------------------------
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 35% for 2006 and 2005 and 34% for 2004.
Loan Portfolio
Interest earned on the loan portfolio is a primary source of income for the
Company. The loan portfolio was $504,125,000 and represented 59% of the
Company's total assets as of December 31, 2006 and generated $36,164,000 in
revenue during the year then ended. The following tables show the composition of
the loan portfolio at the end of the periods indicated and remaining maturities
for loans as of December 31, 2006.
Loans by Type
(At December 31)
(Dollars in thousands) 2006 2005 2004 2003 2002
-----------------------------------------------------------------------------------------
Commercial and industrial $113,162 $146,892 $117,777 $103,638 $101,116
Real estate:
Commercial/church mortgage 352,044 348,554 346,711 330,150 282,125
Construction 29,779 28,170 25,838 19,298 39,175
Industrial revenue bonds 6,293 4,514 4,955 5,373 5,773
Installment -- 107 1,741 1,911 1,918
Other 2,847 1,069 3,426 8,662 4,582
-----------------------------------------------------------------------------------------
Total loans $504,125 $529,306 $500,448 $469,032 $434,689
-----------------------------------------------------------------------------------------
Loans by Maturity
(At December 31, 2006)
One Year Over 1 Year Over
Or Less Through 5 Years 5 Years
------- --------------- -------
Fixed Floating Fixed Floating Fixed Floating
(Dollars in thousands) Rate Rate Rate Rate(1) Rate Rate(1) Total
-----------------------------------------------------------------------------------------------------------------
Commercial and industrial $ 3,507 $ 16,804 $ 24,374 $ 58,536 $ 6,528 $ 3,413 $ 113,162
Real estate:
18
Commercial/church 50,411 16,106 259,565 24,082 605 1,275 352,044
Construction 9,921 12,373 7,485 -- -- -- 29,779
Industrial revenue bonds 55 -- 3,010 -- 3,228 -- 6,293
Other 1,147 28 847 638 -- 187 2,847
-----------------------------------------------------------------------------------------------------------------
Total loans $ 65,041 $ 45,311 $295,281 $ 83,256 $ 10,361 $ 4,875 $ 504,125
-----------------------------------------------------------------------------------------------------------------
(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
borrower, including accounts receivable, inventory, machinery and equipment, and
the real estate from which the borrower 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, 2005 to December 31, 2006:
Total loans decreased $25,181,000 or 5% to $504,125,000. This decrease was
due mainly to the reduction in commercial and industrial loans as loans
were paid down. At year-end, church and church-related real estate and
construction credits totaled $226,664,000, which represents a 14% increase
over 2005. 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, 2004 to December 31, 2005:
Total loans increased $28,858,000 or 6% to $529,306,000. 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 $199,082,000, which represents a 15%
increase over 2004. 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.
Provision and Allowance for Loan Losses
The Company recorded a provision for loan losses of $1,150,000 in 2006, $775,000
in 2005 and $550,000 in 2004. The amount of the provisions for loan losses was
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 2006 was primarily the result of reserves made for specific problem loans.
The amount of the provision will fluctuate as determined by these quarterly
analyses. The Company had net loan charge-offs of $842,000 in 2006, net loan
charge-offs of $528,000 in 2005 and net loan charge-offs of $19,000 in 2004. The
allowance for loan losses was $6,592,000 at December 31, 2006, compared to
$6,284,000 at December 31, 2005 and $6,037,000 at December 31, 2004. The
year-end 2006 allowance represented 1.31% of outstanding loans, compared to
1.19% at year-end 2005 and 1.21% at year-end 2004. From December 31, 2005 to
December 31, 2006, the level of nonperforming loans decreased $669,000 from
$1,464,000 to $795,000, which represents .16% 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. Charges or credits are made to expense
to cover any deficiency or reduce any excess, as required. 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 an estimate of the borrower's ability to
repay the loan given the availability of collateral, other sources of cash flow
and collection options available. The general component relates to all other
loans, which are evaluated based on loan grade. The loan grade assigned to
19
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) 2006 2005 2004 2003 2002
--------------------------------------------------------------------------------------------------------------------
Allowance at beginning of year $6,284 $6,037 $5,506 $5,293 $4,906
--------------------------------------------------------------------------------------------------------------------
Loans charged-off:
Commercial and industrial loans and
industrial revenue bonds (IRB's) 864 532 -- -- 152
Real estate:
Commercial/church mortgage -- 22 48 -- --
Construction -- -- -- -- --
Other -- 1 -- 2 --
--------------------------------------------------------------------------------------------------------------------
Total loans charged-off 864 555 48 2 152
--------------------------------------------------------------------------------------------------------------------
Recoveries of loans previously charged-off:
Commercial, industrial and IRB's 22 10 29 25 39
Real estate:
Commercial/church mortgage -- 13 -- -- --
Construction -- -- -- -- --
Installment -- 4 -- -- --
--------------------------------------------------------------------------------------------------------------------
Total recoveries of loans previously charged-off 22 27 29 25 39
====================================================================================================================
Net loans charged-off (recovered) 842 528 19 (23) 113
Provision charged to expense 1,150 775 550 190 500
--------------------------------------------------------------------------------------------------------------------
Allowance at end of year $6,592 $6,284 $6,037 $5,506 $5,293
--------------------------------------------------------------------------------------------------------------------
Loans outstanding:
Average $522,367 $512,966 $477,234 $443,452 $404,093
December 31 504,125 529,306 500,448 469,032 434,689
Ratio of allowance for loan losses to loans outstanding:
Average 1.26% 1.23% 1.26% 1.24% 1.31%
December 31 1.31% 1.19% 1.21% 1.17% 1.22%
Ratio of net charge-offs (recoveries) to
average loans outstanding .16% .10% -- (.01)% .03%
--------------------------------------------------------------------------------------------------------------------
Allocation of allowance for loan losses(1):
Commercial, industrial and IRB's $3,507 $3,419 $3,066 $2,575 $2,167
Real estate:
Commercial/church mortgage 2,723 2,645 2,742 2,761 2,780
Construction 271 200 207 152 302
Other loans 91 20 22 18 44
--------------------------------------------------------------------------------------------------------------------
Total $6,592 $6,284 $6,037 $5,506 $5,293
--------------------------------------------------------------------------------------------------------------------
Percent of categories to total loans:
Commercial and industrial and IRB's 22.5% 28.6% 24.5% 23.2% 24.6%
Real estate:
Commercial/church mortgage 69.8 65.9 69.3 70.4 64.9
Construction 5.9 5.3 5.2 4.1 9.0
Other 1.8 .2 1.0 2.3 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.
Nonperforming Assets
20
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 collectability 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 $152,000 for the year ended December 31, 2006. Of this amount,
approximately $25,000 was actually recorded as interest income on such loans.
Total nonaccrual commercial loans consists of three loans totaling $795,000 that
relate to businesses that are for sale or are in the process of liquidation.
Reserves have been established for the estimated loss exposure.
At December 31, 2006, approximately $7,415,000 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 $3,865,000 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 borrower, there still
remains risk as to the collectability of all amounts under the loan agreement.
The remaining loans are closely monitored by management and have specific
reserves established for the estimated loss exposure.
The Company does not have any foreign loans. The Company's loan portfolio does
not include a significant amount of single family real estate mortgages 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.
Summary of Nonperforming Assets
December 31,
----------------------------------------------
(Dollars in thousands) 2006 2005 2004 2003 2002
-----------------------------------------------------------------------------------------
Commercial, industrial and IRB's:
Nonaccrual $ 795 $ 983 $ 297 $ 318 $ 51
Contractually past due 90 days
or more and still accruing -- -- -- -- --
Renegotiated loans -- -- -- 2,240 --
Real estate-construction on nonaccrual -- -- -- -- --
Real estate-mortgage:
Nonaccrual -- -- 69 1,207 --
Contractually past due 90 days
or more and still accruing -- 481 4 147 3,388
Renegotiated loans -- -- 168 481 4,252
Other loans contractually past due 90
days and still accruing -- -- -- -- 1,503
-----------------------------------------------------------------------------------------
Total nonperforming loans 795 1,464 538 4,393 9,194
-----------------------------------------------------------------------------------------
Total foreclosed assets -- -- 375 859 6,241
-----------------------------------------------------------------------------------------
Total nonperforming assets $ 795 $ 1,464 $ 913 $5,252 $15,435
=========================================================================================
Operating Expenses from Continuing Operations
Operating expenses from continuing operations in 2006 compared to 2005 include
the following significant pre-tax components:
Salaries and employees benefits expense increased $4,632,000 or 12% to
$42,676,000. This is mainly attributable to additional staff related to the
increase in processing volume, annual salary increases and the associated
increase in benefit expenses.
Occupancy expense increased $38,000 or 2% to $1,979,000.
Equipment expense increased $133,000 or 5% to $2,928,000. This increase is
primarily due to depreciation related to capital expenditures in 2005 and
2006.
Amortization of intangibles increased $54,000 or 31% to $226,000 due to the
intangible assets acquired in the acquisition of NTransit in July 2006.
21
Other operating expense increased $1,304,000 or 14% to $10,468,000. This
increase related to several factors including a $443,000 increase in
advertising and business development expense as the Company expanded its
marketing efforts and a $402,000 increase in outside services, which
reflects higher auditing and legal activities. In addition, promotional
expense increased $262,000 because of the Company's 100th year anniversary
activities and increases in charitable contributions. Postage, and delivery
expense increased $178,000 due to increased processing volume. More details
on the components of other operating expenses are contained in Item 8, Note
15 of this report.
Operating expenses from continuing operations in 2005 compared to 2004 include
the following significant pre-tax components:
Salaries and employee benefits expense increased $4,486,000 or 13% to
$38,044,000. Of this increase, $1,329,000 was related to the acquisition of
Cass' telecom group in August 2004. The remaining increase is mainly
attributable to additional staff related to the increase in processing
volume, annual salary increases and the associated increase in benefit
expenses.
Occupancy expense increased $352,000 or 22% to $1,941,000. Of this
increase, $56,000 relates to the acquisition of Cass' telecom group in
August 2004. The remaining increase is primarily due to an increase in rent
expense on leased office space. This includes the relocation of three Bank
branches to improved facilities.
Equipment expense decreased $481,000 or 15% to $2,795,000. This decrease is
primarily due to software that was capitalized in 2000 and 2001 that is now
fully amortized.
Amortization of intangibles increased $115,000 or 202% to $172,000 due to
the intangible assets acquired in the acquisition of Cass' telecom group in
August 2004.
The impairment of equity investment expense recognized in 2005 relates to
the $3,100,000 impairment charge of the Company's minority equity interest
in a private imaging company. As of December 31, 2005 the Company's
remaining financial interest in this entity was a $1,152,000 interest in a
secured line of credit participated with the entity's majority owner for
working capital purposes.
Other operating expense increased $599,000 or 7% to $9,164,000. This
increase relates to several factors including an $186,000 increase in
advertising and business development expense as the Company expanded its
marketing efforts and a $235,000 increase in outside services, which
reflects higher auditing and legal activities. In addition, postage,
printing and supplies expense increased $95,000 due to increased processing
volume and a $96,000 increase in telecommunications expense was related to
an increase in the Company's business activities. The increase in operating
expense that relates to the fact that Cass' telecom group was not held for
the entire year during 2004 totaled $546,000. More details on the
components of other operating expenses are contained in Item 8, Note 15 of
this report.
Income Tax Expense
Income tax expense from continuing operations in 2006 totaled $8,367,000
compared to $4,982,000 in 2005 and $4,209,000 in 2004. When measured as a
percent of income before income taxes and discontinued operations, the Company's
effective tax rate was 35% in 2006, 31% in 2005 and 30% in 2004. The effective
tax rate varies from year-to-year primarily due to changes in the Company's
amount of investment in tax-exempt municipal bonds and income recognized on bank
owned life insurance. The Company's income tax (benefit) expense from
discontinued operations was ($280,000), $557,000 and ($947,000) with effective
rates of 41%, 215% and 34% for the years 2006, 2005 and 2004, respectively. The
increase from 2004 to 2005 was primarily the result of differences between book
and tax valuations resulting from the foreclosure, consolidation and sale of
GEMS.
Investment Portfolio
Investment portfolio changes from December 31, 2005 to December 31, 2006:
U.S. Treasury securities decreased $6,006,000 or 26% to $16,824,000. U.S.
government-sponsored corporation and agency securities decreased $1,993,000
or 40% to $2,985,000. State and political subdivision securities increased
$15,886,000 or 24% to $82,207,000. 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 loan demand
and 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
22
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 accounts and drafts payable. The changes in asset mix reflect
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, 2004 to December 31, 2005:
U.S. Treasury securities increased $931,000 or 4% to $22,830,000. U.S.
government corporation and agency securities decreased $1,116,000 or 18% to
$4,978,000. State and political subdivision securities increased
$17,788,000 or 37% to $66,321,000. 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 loan demand
and 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 accounts and drafts
payable. The changes in asset mix reflect the relative interest rates of
the alternative investments and management's liquidity and interest rate
forecasts at the time funds became available for investment.
There was no single issuer of securities in the investment portfolio at December
31, 2006, other than U.S. government-sponsored corporations and agencies, for
which the aggregate amortized cost exceeded 10% of total shareholders' equity.
Investment by Type
December 31,
----------------------------------
(Dollars in thousands) 2006 2005 2004
------------------------------------------------------------------------------------------
U.S. Treasury securities $ 16,824 $ 22,830 $ 21,899
U.S. government-sponsored corporations and agencies 2,985 4,978 6,094
State and political subdivisions 82,207 66,321 48,533
Stock of the Federal Home Loan Bank 451 448 403
Stock of the Federal Reserve Bank 282 282 201
------------------------------------------------------------------------------------------
Total investments $ 102,749 $ 94,859 $ 77,130
------------------------------------------------------------------------------------------
Investment in Debt Securities by Maturity
(At December 31, 2006)
Within Over 1 to Over 5 to Over
(Dollars in thousands) 1 Year 5 Years 10 Years 10 Years Yield
---------------------------------------------------------------------------------------------------------------
U.S. Treasury securities $ 16,824 $ -- $ -- $ -- 4.86%
U.S. government-sponsored corporations
and agencies 1,515 1,470 -- -- 4.30%
State and political subdivisions(1) -- 25,327 54,737 2,143 5.83%
---------------------------------------------------------------------------------------------------------------
Total investment in debt securities $ 18,339 $ 26,797 $ 54,737 $ 2,143
---------------------------------------------------------------------------------------------------------------
Weighted average yield 4.85% 5.10% 6.14% 6.01% 5.62%
---------------------------------------------------------------------------------------------------------------
1. Weighted average yield is presented on a tax-equivalent basis assuming a
tax rate of 35%.
Deposits and Accounts and Drafts Payable
Noninterest-bearing demand deposits decreased $9,809,000 or 8% from December 31,
2005 to $106,587,000 at December 31, 2006. The average balances of these
deposits decreased $3,982,000 or 4% from 2005 to $99,329,000 in 2006. The
decrease in ending balances relates mainly to normal daily fluctuations in these
accounts. These balances are mainly maintained by commercial customers and
churches and can fluctuate significantly on a daily basis. Therefore, management
believes that average balances are a more meaningful measure of deposit trends.
Interest-bearing deposits increased $12,705,000 or 7% from December 31, 2005 to
$183,307,000 at December 31, 2006. The average balances of these deposits
declined to $179,217,000 in 2006 from $187,244,000 in 2005, as some customers
transferred funds to higher-yielding accounts at other financial institutions.
Accounts and drafts payable generated by the Company in its payment processing
operations increased $22,582,000 or 5% from December 31, 2005 to $468,393,000 at
December 31, 2006. The average balances of these funds increased $67,045,000 or
17% from 2005 to $468,303,000 in 2006. 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
23
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, 2006)
(Dollars in thousands)
--------------------------------------------------------------------------------
Three months or less $ 28,315
Three to six months 24,002
Six to twelve months 6,364
Over twelve months 2,462
---------
Total $ 61,143
--------------------------------------------------------------------------------
Short-term Borrowings
Short-term borrowings decreased $7,000 or 4% from December 31, 2005 to $181,000
at December 31, 2006. Average balances of these funds decreased $4,000 or 2%
from 2005 to $161,000 during 2006. These funds usually are tax deposits of the
U.S. Treasury although they can include federal funds purchased at times to meet
short term liquidity requirements. 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, 2006 and 2005 were
$3,700,000 and average balances of these funds were $3,700,000 for the year. The
debentures were issued on August 24, 2004 as part of the Company's purchase of
its telecom group. 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
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 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 consist of cash and cash equivalents, which
include cash and due from banks, federal funds sold, and money market funds, and
were $196,504,000 at December 31, 2006, an increase of $46,812,000 or 31% from
December 31, 2005. At December 31, 2006 these assets represented 23% 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 securities available-for-sale at fair value was
$102,749,000 at December 31, 2006, an increase of $7,890,000 or 8% from December
31, 2005. These assets represented 12% of total assets at December 31, 2006. Of
this total, 81% were state and political subdivision securities, 16% were U.S.
Treasury securities, and 3% were U.S. government agencies. Of the total
portfolio, 18% mature in one year, 24% mature after one year through five years,
55% mature after five years through ten years and 3% after ten years. The
Company did not sell any securities available-for-sale during 2006.
The Bank has unsecured lines of credit 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
$63,034,000 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 have also historically been a stable source of
funds.
24
Net cash flows provided by operating activities of continuing operations for the
years 2006, 2005 and 2004 were $17,031,000, $13,420,000 and $11,759,000
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, management believes that 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 2007.
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 continue to exceed all regulatory capital
requirements, as evidenced by the capital ratios at December 31, 2006 as shown
in Item 8, Note 3 of this report.
In 2006, cash dividends paid were $.440 per share for a total of $3,666,000, a
15% increase over the prior year, which is attributable to an increase in the
per share amount paid and additional shares outstanding. On July 18, 2006, the
Company declared a 50% stock dividend payable to holders of record on September
1, 2006. On August 16, 2005, the Company declared a 50% stock dividend payable
to holders of record on September 2, 2005.
Shareholders' equity was $83,921,000, or 10% of total assets, at December 31,
2006, an increase of $8,640,000 over the balance at December 31, 2005. This
increase resulted from net income of $15,066,000, proceeds from the exercise of
stock options of $327,000, an increase in other comprehensive income of $550,000
and other items of $120,000 related to the stock dividend and bonuses and other
items of $227,000, which were offset by cash dividends paid of $3,666,000, the
pension adjustment per SFAS No. 158 of $3,114,000 and repurchase of shares of
$870,000.
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, 2006, unappropriated retained
earnings of $3,287,000 were available at the Bank for the declaration of
dividends to the Company without prior approval from regulatory authorities.
The Company also maintains a treasury stock buyback program pursuant to which
the Board of Directors has authorized the repurchase of up to 150,000 shares of
the Company's common stock. The Company repurchased 30,000 shares in 2006 for
$870,000 and 63,997 shares during 2005 for $1,434,000. As of December 31, 2006,
120,000 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.
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, 2006, 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, 2006, the balance of loan commitments, standby and commercial letters of
credit were $22,506,000, $ 6,417,000 and $2,650,000, 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
25
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 the Cass telecom group.
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 $21.42 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 please refer to Item 8, Note
11 of this report.
The following table summarizes contractual cash obligations of the Company
related to operating and capital lease commitments, time deposits and
convertible subordinated debentures at December 31, 2006:
Amount of Commitment Expiration per Period
------------------------------------------
Less than 1-3 3-5 Over 5
(Dollars in thousands at December 31, 2006) Total 1 year Years Years Years Years
---------------------------------------------------------------------------------------------------------
Operating lease commitments $ 4,165 $ 656 $ 1,125 $ 820 $ 1,564
Time deposits 88,796 84,928 2,489 1,379 --
Convertible subordinated debentures* 3,700 - - - 3,700
---------------------------------------------------------------------------------------------------------
Total $96,661 $85,584 $ 3,614 $ 2,199 $ 5,264
---------------------------------------------------------------------------------------------------------
* Includes principal payments only.
During 2006, the Company contributed $3,200,000 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 2006 these
assumptions were as follows:
------------------------------------------------------------
Weighted average discount rate 6.0%
Rate of increase in compensation levels 4.0%
Expected long-term rate of return on assets 7.5%
------------------------------------------------------------
Impact of New Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123 (Revised 2004), "Share-Based
Payment" ("SFAS No. 123R"). SFAS No. 123R addresses the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. The Statement eliminates the ability to account for share-based
compensation transactions using APB Opinion No. 25, "Accounting for Stock Issued
to Employees", and generally requires instead that such transactions be
accounted for using a fair-value based method. For public entities, the cost of
employee services received in exchange for an award of equity instruments, such
as stock options, will be measured based on the grant-date fair value of those
instruments, and that cost will be recognized over the period during which an
employee is required to provide service in exchange for the award (usually the
vesting period). This Statement was adopted by the Company on January 1, 2006.
The implementation of SFAS No. 123R did not have a material effect on the
Company's financial condition or results of operations. See Note 10 to the
consolidated financial statements.
In November 2005, the Financial Accounting Standards Board ("FASB") issued FASB
Staff Position ("FSP") FAS 115-1 and 124-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments." The guidance addresses
the determination of when an investment is considered impaired, whether that
impairment is other than temporary, and the measurement of an impairment loss.
The FSP also includes accounting considerations subsequent to the recognition of
an other-than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. The guidance in this FSP amends FASB Statement No. 115, "Accounting
for Certain Investments in Debt and Equity Securities," and adds a footnote to
APB Opinion No. 18, "The Equity Method of Accounting for Investments in Common
Stock." The guidance in this FSP nullifies certain requirements of the Emerging
Issues Task Force ("EITF"), Issue No. 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments," and supersedes EITF
Abstracts, Topic D-44, "Recognition of Other-Than-Temporary Impairment upon the
Planned Sale of a Security Whose Cost Exceeds Fair Value." The Company applied
this guidance effective January 1, 2006 and there was no material impact on its
consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154 "Accounting Changes and Error
Corrections" as a replacement of APB Opinion No. 20 and FASB Statement No. 3.
This Statement applies to all voluntary changes in accounting principles and
changes required by an accounting pronouncement in the unusual instance that the
26
pronouncement does not include specific transition provisions. This Statement
carries forward without change the guidance contained in APB Opinion No. 20 for
reporting the correction of an error in previously issued financial statements
and a change in accounting estimate. This Statement also carries forward the
guidance in APB Opinion No. 20 requiring justification of a change in accounting
principle on the basis of preferability. This Statement was adopted by the
Company on January 1, 2006 and there was no material impact on its consolidated
financial statements.
In June 2006, the FASB issued FASB Interpretation No. 48 "Accounting for
Uncertainty in Income Taxes", an Interpretation of SFAS No. 109 "Accounting for
Income Taxes". FASB Interpretation No. 48 clarifies the accounting for
uncertainty in income taxes in financial statements and prescribes a recognition
threshold and measurement attribute for financial statement recognition and
measurement of a tax position taken or expected to be taken. The Interpretation
also provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. The FASB
Interpretation is effective for fiscal years beginning after December 15, 2006.
The Company implemented FASB Interpretation No. 48 on January 1, 2007, which did
not have a material impact on the Company's consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB
Statements No. 87, 88, 106, and 132(R)" ("SFAS No. 158"). SFAS No. 158 requires
companies to recognize the overfunded or underfunded status of a defined benefit
postretirement plan as an asset or liability in its statement of financial
position and to recognize changes in that funded status in the year in which the
changes occur through comprehensive income. The funded status is measured as the
difference between the fair value of the plan assets and the projected benefit
obligation as of the date of its fiscal year-end. The Company recognized the
required changes and disclosures in its consolidated 2006 financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" ("SAB No. 108"). SAB No. 108
provides interpretive guidance on the consideration of the effects of prior year
misstatements in quantifying current year misstatements for the purpose of a
materiality assessment. This statement is effective for fiscal years ending
after November 15, 2006. This bulletin did not have an impact on the Company's
consolidated financial statements.
In February 2007, the FASB issued Statement No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities" ("SFAS No. 159"). SFAS No. 159
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles and expands disclosures about fair
value measurements. This statement is effective for financial statements issued
for fiscal years beginning after November 15, 2007 and interim periods within
those fiscal years. The Company is currently assessing the impact of SFAS No.
159 on its financial statements.
27
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity
The Company faces market risk to the extent that its net interest income and its
fair market value of equity are affected by changes in market interest rates.
The asset/liability management discipline as applied by the Company seeks to
limit the volatility, to the extent possible, of both net interest income and
the fair market value of equity that can result from changes in market interest
rates. This is accomplished by limiting the maturities of fixed rate
investments, loans, and deposits; matching fixed rate assets and liabilities to
the extent possible; and optimizing the mix of fees and net interest income.
However, as discussed below, the Company's asset/liability position differs
significantly from most other bank holding companies with significant positive
cumulative "gaps" shown for each time horizon presented. This asset sensitive
position is caused primarily by the operations of the Company, which generate
large balances of accounts and drafts payable. These balances, which are
noninterest bearing, contribute to the Company's historical high net interest
margin but cause the Company to become susceptible to changes in interest rates,
with a decreasing net interest margin and fair market value of equity in periods
of declining interest rates and an increasing net interest margin and fair
market value of equity in periods of rising interest rates.
The Company's Asset/Liability Committee ("ALCO") measures the Company's interest
rate risk sensitivity on a quarterly basis to monitor and manage the variability
of earnings and fair market value of equity in various interest rate
environments. The ALCO evaluates the Company's risk position to determine
whether the level of exposure is significant enough to hedge a potential decline
in earnings and value or whether the Company can safely increase risk to enhance
returns. The ALCO uses gap reports, twelve-month net interest income
simulations, and fair market value of equity analyses as its main analytical
tools to provide management with insight into the Company's exposure to changing
interest rates.
Management uses a gap report to review any significant mismatch between the
re-pricing points of the Company's rate sensitive assets and liabilities in
certain time horizons. A negative gap indicates that more liabilities re-price
in that particular time frame and, if rates rise, these liabilities will
re-price faster than the assets. A positive gap would indicate the opposite. Gap
reports can be misleading in that they capture only the re-pricing timing within
the balance sheet, and fail to capture other significant risks such as basis
risk and embedded options risk. Basis risk involves the potential for the spread
relationship between rates to change under different rate environments and
embedded options risk relates to the potential for the alteration of the level
and/or timing of cash flows given changes in rates.
Another measurement tool used by management is net interest income simulation,
which forecasts net interest income during the coming twelve months under
different interest rate scenarios in order to quantify potential changes in
short term accounting income. Management has set policy limits specifying
acceptable levels of interest rate risk given multiple simulated rate movements.
These simulations are more informative than gap reports because they are able to
capture more of the dynamics within the balance sheet, such as basis risk and
embedded options risk. A table containing simulation results as of December 31,
2006, from an immediate and sustained parallel change in interest rates is shown
below.
While net interest income simulations do an adequate job of capturing interest
rate risk to short term earnings, they do not capture risk within the current
balance sheet beyond twelve months. The Company uses fair market value of equity
analyses to help identify longer-term risk that may reside on the current
balance sheet. The fair market value of equity is represented by the present
value of all future income streams generated by the current balance sheet. The
Company measures the fair market value of equity as the net present value of all
asset and liability cash flows discounted at forward rates suggested by the
current Treasury curve plus appropriate credit spreads. This representation of
the change in the fair market value of equity under different rate scenarios
gives insight into the magnitude of risk to future earnings due to rate changes.
Management has set policy limits relating to declines in the market value of
equity. The table below contains the analysis, which illustrates the effects of
an immediate and sustained parallel change in interest rates as of December 31,
2006:
% Change in % Change in Fair
Change in Interest Rates Net Interest Income Market Value of Equity
-------------------------------------------------------------------------
+200 basis points 10% 11%
+100 basis points 5% 6%
Stable Rates ---- ----
-100 basis points (5%) (7%)
-200 basis points (12%) (15%)
28
Interest Rate Sensitivity Position
The following table presents the Company's gap or interest rate risk position at
December 31, 2006 for the various time periods indicated.
Variable 0-90 91-180 181-364 1-5 Over 5
(Dollars in thousands) Rate days days days years Years Total
-------------------------------------------------------------------------------------------------------------------
Earning assets:
Loans:
Taxable $133,442 $23,973 $9,999 $31,014 $292,272 $7,132 $497,832
Tax-exempt 55 3,010 3,228 6,293
Debt and equity securities(1):
Taxable -- 16,849 -- 1,522 1,500 -- 19,871
Tax-exempt -- -- -- -- 25,488 56,071 81,559
Other 733 -- -- -- -- -- 733
Federal funds sold and other
Short- term investments 169,509 -- -- -- -- -- 169,509
-------------------------------------------------------------------------------------------------------------------
Total earning assets $303,684 $40,822 $10,054 $32,536 $322,270 $66,431 $775,797
===================================================================================================================
Interest-sensitive liabilities:
Money market accounts $46,454 $ -- $ -- $ -- $ -- $ -- $46,454
Now accounts 20,134 -- -- -- -- -- 20,134
Savings deposits 27,923 -- -- -- -- -- 27,923
Time deposits:
$100K and more -- 28,315 24,002 6,364 2,462 -- 61,143
Less than $100K -- 13,969 9,696 2,582 1,406 -- 27,653
Federal funds purchased and
Other-short term borrowing 181 -- -- -- -- -- 181
Subordinated convertible debentures -- -- -- -- -- 3,700 3,700
-------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities $94,692 $42,284 $33,698 $8,946 $3,868 $3,700 $187,188
===================================================================================================================
Interest sensitivity gap:
Periodic $208,992 $(1,463) $(23,644) $ 23,590 $318,402 $ 62,731 $588,608
Cumulative 208,992 207,529 183,885 207,475 525,877 588,608 588,608
Ratio of interest-bearing assets
to interest-bearing liabilities:
Periodic 3.21 0.97 0.30 3.64 83.32 17.95 4.14
Cumulative 3.21 2.52 2.08 2.16 3.87 4.14 4.14
===================================================================================================================
(1)Balances shown reflect earliest re-pricing date.
29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
------------------------
(In thousands, except share and per share data) 2006 2005
------------------------------------------------------------------------------------------------------
Assets
Cash and due from banks $ 26,995 $ 29,561
Federal funds sold and other short-term investments 169,509 120,131
-------- --------
Cash and cash equivalents 196,504 149,692
-------- --------
Securities available-for-sale, at fair value 102,749 94,859
Loans 504,125 529,306
Less: Allowance for loan losses 6,592 6,284
-------- --------
Loans, net 497,533 523,022
-------- --------
Premises and equipment, net 12,898 11,987
Investment in bank owned life insurance 12,024 11,545
Payments in excess of funding 9,333 7,665
Goodwill 7,471 4,398
Assets related to discontinued operations -- 400
Other intangible assets, net 1,156 935
Other assets 18,803 14,195
-------- --------
Total assets $858,471 $818,698
======== ========
Liabilities and Shareholders' Equity
Liabilities:
Deposits:
Noninterest-bearing $106,587 $116,396
Interest-bearing 183,307 170,602
-------- --------
Total deposits 289,894 286,998
Accounts and drafts payable 468,393 445,811
Short-term borrowings 181 188
Subordinated convertible debentures 3,700 3,700
Liabilities related to discontinued operations 277 1,848
Other liabilities 12,105 4,872
-------- --------
Total liabilities 774,550 743,417
-------- --------
Shareholders' Equity:
Preferred stock, par value $.50 per share; 2,000,000
shares authorized and no shares issued -- --
Common stock, par value $.50 per share;
20,000,000 shares authorized; 9,112,484 and 6,336,593
shares issued at December 31, 2006 and 2005, respectively 4,556 3,168
Additional paid-in capital 17,896 18,326
Retained earnings 81,516 71,506
Common shares in treasury, at cost (784,773 and 836,457
shares at December 31, 2006 and 2005, respectively) (17,077) (17,313)
Accumulated other comprehensive loss (2,970) (406)
-------- --------
Total shareholders' equity 83,921 75,281
-------- --------
Total liabilities and shareholders' equity $858,471 $818,698
======== ========
See accompanying notes to consolidated financial statements.
30
CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
December 31,
-------------------------------------------
(In thousands, except share and per share data) 2006 2005 2004
-------------------------------------------------------------------------------------------------------------
Fee Revenue and Other Income:
Information services payment and processing revenue $ 40,343 $ 35,901 $ 30,695
Bank service fees 1,625 1,535 1,719
Gains on sales of investment securities -- 547 1,045
Other 853 670 588
-------- -------- --------
Total fee revenue and other income 42,821 38,653 34,047
-------- -------- --------
Interest Income:
Interest and fees on loans 36,164 32,214 27,055
Interest and dividends on securities:
Taxable 1,052 831 476
Exempt from federal income taxes 2,575 1,610 2,082
Interest on federal funds sold and
other short-term investments 7,262 3,596 1,120
-------- -------- --------
Total interest income 47,053 38,251 30,733
-------- -------- --------
Interest Expense:
Interest on deposits 6,414 4,486 3,024
Interest on short-term borrowings 7 5 1
Interest on subordinated convertible debentures 198 196 70
-------- -------- --------
Total interest expense 6,619 4,687 3,095
-------- -------- --------
Net interest income 40,434 33,564 27,638
Provision for loan losses 1,150 775 550
-------- -------- --------
Net interest income after provision
for loan losses 39,284 32,789 27,088
-------- -------- --------
Operating Expense:
Salaries and employee benefits 42,676 38,044 33,558
Occupancy 1,979 1,941 1,589
Equipment 2,928 2,795 3,276
Amortization of intangible assets 226 172 57
Impairment of equity investment -- 3,100 --
Other operating 10,468 9,164 8,565
-------- -------- --------
Total operating expense 58,277 55,216 47,045
-------- -------- --------
Income before income tax expense and discontinued
operations 23,828 16,226 14,090
Income tax expense 8,367 4,982 4,209
-------- -------- --------
Net income from continuing operations 15,461 11,244 9,881
-------- -------- --------
Income (loss) from discontinued operations
before income tax expense (675) 259 (2,823)
Income tax (benefit) expense (280) 557 (947)
-------- -------- --------
Net loss from discontinued operations (395) (298) (1,876)
-------- -------- --------
Net income $ 15,066 $ 10,946 $ 8,005
======== ======== ========
Basic Earnings Per Share:
From continuing operations $ 1.86 $ 1.36 $ 1.19
From discontinued operations (.05) (.03) (.22)
Basic earnings per share 1.81 1.33 .97
Diluted Earnings Per Share:
From continuing operations $ 1.82 $ 1.33 $ 1.17
From discontinued operations (.05) (.04) (.22)
Diluted earnings per share 1.77 1.29 .95
See accompanying notes to consolidated financial statements.
31
CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
December 31,
----------------------------------------------
(Dollars in thousands) 2006 2005 2004
-----------------------------------------------------------------------------------------------------------------
Cash Flows From Operating Activities:
Net income from continuing operations $ 15,461 $ 11,244 $ 9,881
Adjustments to reconcile net income from continuing operations
to net cash provided by operating activities:
Depreciation and amortization 2,049 2,073 3,278
Gains on sales of investment securities -- (547) (1,045)
Stock-based compensation expense 227 134 96
Provision for loan losses 1,150 775 550
Deferred income tax benefit (289) (921) (558)
Increase (decrease) in income tax liability 1,628 (181) (1,295)
Impairment of equity investment -- 3,100 --
Other operating activities, net (3,195) (2,257) 852
Operating activities of discontinued operations (1,536) (967) (951)
--------- ---------- ---------
Net cash provided by operating activities 15,495 12,453 10,808
--------- ---------- ---------
Cash Flows From Investing Activities:
From continuing operations:
Proceeds from sales of securities available-for-sale -- 12,950 27,195
Proceeds from maturities of securities available-for-sale 83,510 77,150 31,200
Purchase of securities available-for-sale (90,326) (108,545) (66,525)
Net decrease (increase) in loans 24,339 (29,386) (31,810)
Increase in payments in excess of funding (1,668) (667) (778)
Purchases of premises and equipment, net (2,953) (2,582) (1,399)
Payment for business acquisitions, net of cash acquired (3,172) -- (2,092)
Proceeds from sale of discontinued operations 205 6,600 --
Investing activities of discontinued operations -- (98) (193)
--------- ---------- ---------
Net cash provided by (used in) investing activities 9,935 (44,578) (44,402)
--------- ---------- ---------
Cash Flows From Financing Activities:
From continuing operations:
Net (decrease) increase in noninterest-bearing deposits (9,809) 20,034 (18,272)
Net (decrease) increase in interest-bearing demand
and savings deposits (9,038) (87) 16,947
Net increase (decrease) in time deposits 21,743 (8,578) 4,446
Net increase in accounts and drafts payable 22,582 87,338 58,484
Cash proceeds from exercise of stock options 327 144 190
Cash dividends paid (3,666) (3,201) (3,025)
Purchase of common shares for treasury (870) (1,434) --
Other financing activities, net 113 58 --
--------- ---------- ---------
Net cash provided by financing activities 21,382 94,274 58,770
--------- ---------- ---------
Net increase in cash and cash equivalents 46,812 62,149 25,176
Cash and cash equivalents at beginning of year 149,692 87,543 62,367
--------- ---------- ---------
Cash and cash equivalents at end of year $ 196,504 $ 149,692 $ 87,543
========= ========== =========
Supplemental information:
Cash paid for interest $ 6,171 $ 4,618 $ 3,019
Cash paid for income taxes 8,136 6,792 5,155
Noncash transactions:
Other real estate transferred from loans $ -- $ -- $ 375
Issuance of subordinated convertible debentures -- -- 3,700
See accompanying notes to consolidated financial statements.
32
CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Accumulated
Additional Other Comp-
(In thousands, except Common Paid-in Retained Treasury Comprehensive rehensive
per share data) Stock Capital Earnings Stock Income (Loss) Total Income
------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2003 $2,080 $8,337 $69,695 $(16,442) $1,122 $64,792
Net income 8,005 8,005 $8,005
Cash dividends ($.365 per share) (3,025) (3,025)
10% common stock dividend 167 9,819 (9,990) (4)
Other comprehensive income (loss):
Net unrealized gain on debt securities
available-for-sale, net of tax 261 261 261
Reclassification adjustment for gains
on sales of investment securities,
available-for-sale, net of tax (690) (690) (690)
Minimum pension liability
adjustment, net of tax (150) (150) (150)
Issuance of 8,744 common shares
pursuant to Stock Bonus Plan (74) 74 --
Amortization of Stock Bonus Plan awards 96 96
Exercise of stock options (82) 272 190
Excess tax benefit on stock awards 114 114
---------------------------------------------------------------------------------------
Balance, December 31, 2004 2,247 18,210 64,685 (16,096) 543 69,589
Comprehensive income for 2004 7,426
=======
Net income 10,946 10,946 10,946
Cash dividends ($.387 per share) (3,201) (3,201)
50% common stock dividend 921 (924) (3)
Purchase of 42,665 common shares (1,434) (1,434)
Other comprehensive income (loss):
Net unrealized loss on debt securities (510) (510) (510)
available-for-sale, net of tax
Reclassification adjustment for gains
on sales of investment securities, (361) (361) (361)
available-for-sale, net of tax
Minimum pension liability (78) (78) (78)
adjustment, net of tax
Issuance of 8,238 common shares
pursuant to Stock Bonus Plan (70) 70 --
Amortization of Stock Bonus Plan awards 134 134
Exercise of stock options (3) 147 144
Excess tax benefit on stock awards 55 55
---------------------------------------------------------------------------------------
Balance, December 31, 2005 3,168 18,326 71,506 (17,313) (406) 75,281
=======================================================================================
Comprehensive income for 2005 9,997
=======
Net income 15,066 15,066 15,066
Cash dividends ($.440 per share) (3,666) (3,666)
50% common stock dividend 1,388 (1,390) (2)
Purchase of 30,000 common shares (870) (870)
Other comprehensive income (loss):
Net unrealized gain on debt securities 550 550 550
available-for-sale, net of tax
Adoption of SFAS 158 (3,114) (3,114) 162
Issuance of 15,010 common shares
pursuant to Stock Bonus Plan (198) 198 --
Exercise of stock options (581) 908 327
Excess tax benefit on stock awards 122 122
Stock-based compensation expense 227 227
---------------------------------------------------------------------------------------
Balance, December 31, 2006 $4,556 $17,896 $81,516 $(17,077) $(2,970) $83,921
=======================================================================================
Comprehensive income for 2006 $15,778
=======
See accompanying notes to consolidated financial statements.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1
Summary of Significant Accounting Policies
Summary of Operations The Company provides payment and information services,
which include processing and payment of freight, utility and telecommunications
invoices. These services include the acquisition and management of data,
information delivery and financial exchange. The consolidated balance sheet
captions, "Accounts and drafts payable" and "Payments in excess of funding,"
consist of obligations related to the payment services that are performed for
customers. The Company also provides a full range of banking services to
individual, corporate and institutional customers through its wholly owned bank
subsidiary.
Basis of Presentation The accounting and reporting policies of the Company and
its subsidiaries conform to U.S. generally accepted accounting principles. The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries after elimination of intercompany transactions.
Certain amounts in the 2005 and 2004 consolidated financial statements have been
reclassified to conform to the 2006 presentation. Such reclassifications have no
effect on previously reported net income or shareholders' equity. The Company's
bank subsidiary sold the assets of GEMS, its wholly owned subsidiary, on
December 30, 2005. The assets, liabilities and results of operations of GEMS
have been presented as discontinued operations. See Note 2 for more details. The
Company issued 50% stock dividends on September 15, 2006 and on September 15,
2005 and the share and per share information have been restated for all periods
presented in the accompanying consolidated financial statements.
Use of Estimates In preparing the consolidated financial statements, Company
management is required to make estimates and assumptions which significantly
affect the reported amounts in the consolidated financial statements. A
significant estimate, which is particularly susceptible to change in a short
period of time, is the determination of the allowance for loan losses.
Cash and Cash Equivalents For purposes of the consolidated statements of cash
flows, the Company considers cash and due from banks, federal funds sold and
other short-term investments as segregated in the accompanying consolidated
balance sheets to be cash equivalents.
Investment in Debt and Equity Securities The Company classifies its debt and
marketable equity securities as available-for-sale. Securities classified as
available-for-sale are carried at fair value. Unrealized gains and losses, net
of the related tax effect, are excluded from earnings and reported in
accumulated other comprehensive income, a component of shareholders' equity. A
decline in the fair value of any available-for-sale security below cost that is
deemed other than temporary results in a charge to earnings and the
establishment of a new cost basis for the security. To determine whether
impairment is other than temporary, the Company considers whether it has the
ability and intent to hold the investment until a marketplace recovery and
considers whether evidence indicating the cost of the investment is recoverable
outweighs evidence to the contrary. Evidence considered in this assessment
includes the reasons for impairment, the severity and duration of the
impairment, changes in value subsequent to year-end and forecasted performance
of the investee. Premiums and discounts are amortized or accreted to interest
income over the estimated lives of the securities using the level-yield method.
Interest income is recognized when earned. Gains and losses are calculated using
the specific identification method.
Allowance for Loan Losses The allowance for loan losses is increased by
provisions charged to expense and is available to absorb charge offs, net of
recoveries. Management utilizes a systematic, documented approach in determining
the appropriate level of the allowance for loan losses. Management's approach,
which provides for general and specific allowances, is based on current economic
conditions, past losses, collection experience, risk characteristics of the
portfolio, assessments of collateral values by obtaining independent appraisals
for significant properties, and such other factors which, in management's
judgment, deserve current recognition in estimating loan losses.
Management believes the allowance for loan losses is adequate to absorb probable
losses in the loan portfolio. While management uses all available information to
recognize losses on loans, future additions to the allowance may be necessary
based on changes in economic conditions. Additionally, various regulatory
agencies, as an integral part of their examination process, periodically review
the Company's allowance for loan losses. Such 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.
Premises and Equipment Premises and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation is computed over the
estimated useful lives of the assets, or the respective lease terms for
leasehold improvements, using straight-line and accelerated methods. Estimated
useful lives do not exceed 40 years for
34
buildings, the lesser of 10 years or the life of the lease for leasehold
improvements and range from 3 to 7 years for software, equipment, furniture and
fixtures. Maintenance and repairs are charged to expense as incurred.
Intangible Assets Cost in excess of fair value of net assets acquired have
resulted from business acquisitions, which were accounted for using the purchase
method. Goodwill and intangible assets with indefinite useful lives are not
amortized, but instead are tested for impairment at least annually. Intangible
assets with definite useful lives are amortized over their respective estimated
useful lives.
Periodically, the Company reviews intangible assets for events or changes in
circumstances that may indicate that the carrying amount of the assets may not
be recoverable. Based on those reviews, adjustments of recorded amounts have not
been required.
Non-marketable Equity Investments The Company accounts for non-marketable equity
investments, in which it holds less than a 20% ownership in, 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.
Non-marketable equity investments are included in other assets on the
consolidated balance sheets.
Foreclosed Assets Other real estate, included in other assets in the
accompanying consolidated balance sheets, is recorded at the lower of cost or
fair value less costs to sell. If the fair value of other real estate declines
subsequent to foreclosure, the difference is recorded as a valuation allowance
through a charge to expense. Subsequent increases in fair value are recorded
through reversal of the valuation allowance. Expenses incurred in maintaining
the properties are charged to expense.
Treasury Stock Purchases of the Company's common stock are recorded at cost.
Upon reissuance, treasury stock is reduced based upon the average cost basis of
shares held.
Comprehensive Income Comprehensive income consists of net income, changes in net
unrealized gains (losses) on available-for-sale securities and minimum pension
liability adjustments and is presented in the accompanying consolidated
statements of shareholders' equity and comprehensive income.
Interest on Loans Interest on loans is recognized based upon the principal
amounts outstanding. It is the Company's policy to discontinue the accrual of
interest when there is reasonable doubt as to the collectability of principal or
interest. Subsequent payments received on such loans are applied to principal if
there is any doubt as to the collectability of such principal; otherwise, these
receipts are recorded as interest income. The accrual of interest on a loan is
resumed when the loan is current as to payment of both principal and interest
and/or the borrower demonstrates the ability to pay and remain current.
Impairment of Loans A loan is considered impaired when it is probable that a
creditor will be unable to collect all amounts due, both principal and interest,
according to the contractual terms of the loan agreement. When measuring
impairment, the expected future cash flows of an impaired loan are discounted at
the loan's effective interest rate. Alternatively, impairment could be measured
by reference to an observable market price, if one exists, or the fair value of
the collateral for a collateral-dependent loan. Regardless of the historical
measurement method used, the Company measures impairment based on the fair value
of the collateral when the Company determines foreclosure is probable.
Additionally, impairment of a restructured loan is measured by discounting the
total expected future cash flows at the loan's effective rate of interest as
stated in the original loan agreement. The Company uses its nonaccrual methods
as discussed above for recognizing interest on impaired loans.
Information Services Revenue A majority of the Company's revenues are
attributable to fees for providing services. These services include freight
invoice rating, payment processing, auditing, and the generation of accounting
and transportation information. The Company also processes, pays and generates
management information from electric, gas, telecommunications and other
invoices. The specific payment and information processing services provided to
each customer are developed individually to meet each customer's specific
requirements. The Company enters into service agreements with customers
typically for fixed fees per transaction that are invoiced monthly. Revenues are
recognized in the period services are rendered and earned under the service
agreements, as long as collection is reasonably assured.
Income Taxes Deferred tax assets and liabilities are recognized for the
estimated future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates in effect for the year in which those temporary
differences are expected to be recovered or settled. Deferred tax assets are
reduced if necessary, by a deferred tax asset valuation allowance. In the event
that management determines it will not be able to realize all or part of net
deferred tax assets in the future, the Company adjusts the recorded value of
deferred tax assets, which
35
would result in a direct charge to income tax expense in the period that such
determination is made. Likewise, the Company will reverse the valuation
allowance when realization of the deferred tax asset is expected. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
Earnings Per Share Basic earnings per share is computed by dividing net income
by the weighted-average number of common shares outstanding. Diluted earnings
per share is computed by dividing net income, adjusted for the net income effect
of the interest expense on the outstanding convertible debentures, by the sum of
the weighted-average number of common shares outstanding and the
weighted-average number of potential common shares outstanding.
Stock-Based Compensation The Company adopted Statement of Financial Accounting
Standards No. 123 ("SFAS No. 123") in 2000. As provided by SFAS No. 123, the
Company applied the intrinsic value-based method, as outlined in Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees," and related interpretations, in accounting for stock options and
restriced stock awards. Under the intrinsic value-based method, no compensation
expense was recognized if the exercise price of the Company's employee stock
options equaled the market price of the underlying stock on the date of the
grant. Accordingly, no compensation cost was recognized for stock options
granted to employees, since all options granted under the Company's share
incentive programs had an exercise price equal to the market value of the
underlying common stock on the date of the grant.
Effective January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123R ("SFAS No. 123R") "Share-based Payment." This statement
supersedes SFAS No. 123. SFAS No. 123R requires that all stock-based
compensation be recognized as an expense in the financial statements and that
such cost be measured at the fair value of the award. This statement was adopted
using the modified prospective method of application, which requires the Company
to recognize compensation expense on a prospective basis. Therefore, prior
period financial statements have not been restated. Under this method, in
addition to reflecting compensation expense for new share-based awards, expense
is also recognized to reflect the remaining service period of awards that had
been included in pro forma disclosures required by SFAS No. 123 in prior
periods. SFAS No. 123R also requires that excess tax benefits related to stock
option exercises and restricted stock awards be reflected as financing cash
inflows instead of operating cash inflows.
The pro forma disclosures for 2005 and 2004 required by SFAS No. 123 are
provided in the table below.
(In thousands, except per share data) 2005 2004
-------------------------------------------------------------------------------------------
Net income from continuing operations:
As reported $11,244 $9,881
Add: Stock based compensation expense
included in reported net income, net of tax 86 63
Less: Stock based compensation expense
determined under the fair value based method
for all awards, net of tax (105) (109)
-------------------------------------------------------------------------------------------
Pro forma net income from continuing operations $11,225 $9,835
Net income effect of subordinated convertible
debentures 108 39
-------------------------------------------------------------------------------------------
Proforma net income from continuing operations
assuming dilution $11,333 $9,874
-------------------------------------------------------------------------------------------
Net income from continuing operations per common share: (1)
Basic, as reported $ 1.36 $ 1.19
Basic, proforma 1.36 1.19
Diluted, as reported 1.33 1.17
Diluted, proforma 1.32 1.17
-------------------------------------------------------------------------------------------
(1) Per share data for 2005 and 2004 have been restated for the 50% stock
dividends paid on September 15, 2006 and 2005.
Pension Plans The amounts recognized in the consolidated financial statements
related to pension are determined from actuarial valuations. Inherent in these
valuations are assumptions including expected return on plan assets, discount
rates at which the liabilities could be settled at December 31, 2006, rate of
increase in future compensation levels and mortality rates. These assumptions
are updated annually and are disclosed in Note 13. In September 2006, the FASB
issued Statement No. 158, "Employers' Accounting for Defined Benefit Pension and
Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106,
and 132(R)" ("SFAS No. 158"). SFAS No. 158 requires companies to recognize the
overfunded or underfunded status of a defined benefit postretirement plan as an
asset or liability in its statement of financial position and to recognize
changes in that funded status in the year in which the
36
changes occur through comprehensive income. The funded status is measured as the
difference between the fair value of the plan assets and the projected benefit
obligation as of the date of its fiscal year-end. The Company recognized the
required changes and disclosures in its consolidated 2006 financial statements.
Impact of New Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123 (Revised 2004), "Share-Based
Payment". This Statement addresses the accounting for transactions in which an
entity exchanges its equity instruments for goods or services. The Statement
eliminates the ability to account for share-based compensation transactions
using APB Opinion No. 25, "Accounting for Stock Issued to Employees", and
generally requires instead that such transactions be accounted for using a
fair-value based method. For public entities, the cost of employee services
received in exchange for an award of equity instruments, such as stock options,
will be measured based on the grant-date fair value of those instruments, and
that cost will be recognized over the period during which an employee is
required to provide service in exchange for the award (usually the vesting
period). This Statement was adopted by the Company on January 1, 2006. The
implementation of SFAS No. 123R did not have a material effect on the Company's
financial condition or results of operations. See Note 13 to the consolidated
financial statements.
In November 2005, the Financial Accounting Standards Board ("FASB") issued FASB
Staff Position ("FSP") FAS 115-1 and 124-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments." The guidance addresses
the determination of when an investment is considered impaired, whether that
impairment is other than temporary, and the measurement of an impairment loss.
The FSP also includes accounting considerations subsequent to the recognition of
an other-than-temporary impairment and requires certain disclosures about
unrealized losses that have not been recognized as other-than-temporary
impairments. The guidance in this FSP amends FASB Statement No. 115, "Accounting
for Certain Investments in Debt and Equity Securities," and adds a footnote to
APB Opinion No. 18, "The Equity Method of Accounting for Investments in Common
Stock." The guidance in this FSP nullifies certain requirements of the Emerging
Issues Task Force ("EITF"), Issue No. 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments," and supersedes EITF
Abstracts, Topic D-44, "Recognition of Other-Than-Temporary Impairment upon the
Planned Sale of a Security Whose Cost Exceeds Fair Value." The Company applied
this guidance effective January 1, 2006 and there was no material impact on its
consolidated financial statements.
In May 2005, the FASB issued SFAS No. 154 "Accounting Changes and Error
Corrections" as a replacement of APB Opinion No. 20 and FASB Statement No. 3.
This Statement applies to all voluntary changes in accounting principles and
changes required by an accounting pronouncement in the unusual instance that the
pronouncement does not include specific transition provisions. This Statement
carries forward without change the guidance contained in APB Opinion No. 20 for
reporting the correction of an error in previously issued financial statements
and a change in accounting estimate. This Statement also carries forward the
guidance in APB Opinion No. 20 requiring justification of a change in accounting
principle on the basis of preferability. This Statement was adopted by the
Company on January 1, 2006 and there was no material impact on its consolidated
financial statements.
In June 2006, the FASB issued FASB Interpretation No. 48 "Accounting for
Uncertainty in Income Taxes", an Interpretation of SFAS No. 109 "Accounting for
Income Taxes". FASB Interpretation No. 48 clarifies the accounting for
uncertainty in income taxes in financial statements and prescribes a recognition
threshold and measurement attribute for financial statement recognition and
measurement of a tax position taken or expected to be taken. The Interpretation
also provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. The FASB
Interpretation is effective for fiscal years beginning after December 15, 2006.
The Company implemented FASB Interpretation No. 48 on January 1, 2007, which did
not have a material impact on the Company's consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements"("SAB No. 108"). SAB No. 108
provides interpretive guidance on the consideration of the effects of prior year
misstatements in quantifying current year misstatements for the purpose of a
materiality assessment. This statement is effective for fiscal years ending
after November 15, 2006. This bulletin did not have an impact on the Company's
consolidated financial statements.
In February 2007, the FASB issued Statement No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities" ("SFAS No. 159"). SFAS No. 159
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles and expands disclosures about fair
value measurements. This statement is effective for financial statements issued
for fiscal years beginning after November 15, 2007 and interim periods within
those fiscal years. The Company is currently assessing the impact of SFAS No.
159 on its financial statements.
37
Note 2
Acquisitions and Dispositions
On July 7, 2006, the Company acquired 100% of the common stock of NTransit,
Inc., a company whose service provides auditing and expense management of parcel
shipments. While this acquisition does not meet the Regulation S-X criteria of a
significant business combination, it positions the Company to expand its
offerings in the specialized service and expertise in parcel shipping, which is
a unique segment of the transportation industry that has experienced tremendous
growth in recent years. Pro forma results, assuming the NTransit, Inc.
acquisition had been consummated January 1, 2005, would not be significantly
different than reported.
On December 30, 2005, the Company's bank subsidiary sold the operating assets of
its wholly-owned subsidiary, Government e-Management Solutions, Inc. ("GEMS").
In accordance with FASB Statement No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets" the assets, liabilities and operating results of
GEMS, including the gain on sale in 2005, have been presented as discontinued
operations for all periods.
Note 3
Capital Requirements And Regulatory Restrictions
The Company and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can result in certain mandatory, and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's consolidated financial statements. Under
capital adequacy guidelines, the Company and the Bank must meet specific capital
guidelines that involve quantitative measures of assets, liabilities and certain
off-balance sheet items as calculated under regulatory accounting practices. The
Company and the Bank's capital amounts and classifications are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors.
Quantitative measures established by regulators to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios of total
and Tier I capital to risk-weighted assets, and of Tier I capital to average
assets. Management believes that as of December 31, 2006 and 2005, the Company
and the Bank met all capital adequacy requirements to which they are subject.
The Bank is also subject to the regulatory framework for prompt corrective
action. As of December 31, 2006, the most recent notification from the
regulatory agencies categorized the Bank as well capitalized. To be categorized
as well capitalized, the Bank must maintain minimum total risk-based, Tier I
risk-based, and Tier I leverage ratios as set forth in the table below. There
are no conditions or events since that notification that management believes
have changed the Bank's category.
Subsidiary dividends are a significant source of funds for payment of dividends
by the Company to its shareholders. At December 31, 2006, unappropriated
retained earnings of $3,287,000 were available at the Bank for the declaration
of dividends to the Company without prior approval from regulatory authorities.
However, dividends paid by the Bank to the Company would be prohibited if the
effect thereof would cause the Bank's capital to be reduced below applicable
minimum capital requirements.
Restricted funds on deposit used to meet regulatory reserve requirements
amounted to approximately $1,000,000 and $525,000 at December 31, 2006 and 2005,
respectively.
The Company and the Bank's actual and required capital amounts and ratios as of
December 31, 2006 and 2005 are as follows:
Requirement
Capital to be well
Actual requirements capitalized
---------------------------------------------------------------------
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
------------------------------------------------------------------------------------------------------------------
At December 31, 2006
Total capital (to risk-weighted assets):
Cass Information Systems, Inc. $85,205 13.64% $49,978 8.00% $ N/A N/A%
Cass Commercial Bank 42,242 14.19% 23,815 8.00% 29,769 10.00%
Tier I capital (to risk-weighted assets):
Cass Information Systems, Inc. 74,913 11.99% 24,989 4.00% N/A N/A%
Cass Commercial Bank 38,511 12.94% 11,908 4.00% 17,861 6.00%
Tier I capital (to average assets):
Cass Information Systems, Inc. 74,913 8.65% 26,248 3.00% N/A N/A%
Cass Commercial Bank 38,511 11.25% 10,273 3.00% 17,122 5.00%
38
At December 31, 2005
Total capital (to risk-weighted assets):
Cass Information Systems, Inc. $80,066 12.80% $50,036 8.00% $ N/A N/A%
Cass Commercial Bank 42,597 14.64 23,277 8.00 29,096 10.00%
Tier I capital (to risk-weighted assets):
Cass Information Systems, Inc. $70,082 11.21% $25,018 4.00% $ N/A N/A%
Cass Commercial Bank 38,251 13.15 11,638 4.00 17,457 6.00%
Tier I capital (to average assets):
Cass Information Systems, Inc. $70,082 8.52% $24,691 3.00% $ N/A N/A%
Cass Commercial Bank 38,251 11.16 10,279 3.00 17,132 5.00%
Note 4
Investment in Debt and Equity Securities
Debt and marketable equity securities have been classified in the consolidated
balance sheets as available for sale according to management's intent. The
amortized cost, gross unrealized gains, gross unrealized losses and fair value
of debt and equity securities at December 31, 2006 and 2005, are summarized as
follows:
2006
Gross Gross
Amortized Unrealized Unrealized Fair
(In thousands) Cost Gains Losses Value
-----------------------------------------------------------------------------------------------
U.S. Treasury securities $ 16,849 $ -- $ 25 $ 16,824
Obligations of U.S. government-sponsored
corporations and agencies 3,022 -- 37 2,985
State and political subdivisions 81,559 862 214 82,207
-----------------------------------------------------------------------------------------------
Total debt securities 101,430 862 276 102,016
Stock in Federal Reserve Bank and
Federal Home Loan Bank 733 -- -- 733
-----------------------------------------------------------------------------------------------
Total $ 102,163 $ 862 $ 276 $102,749
===============================================================================================
2005
Gross Gross
Amortized Unrealized Unrealized Fair
(In thousands) Cost Gains Losses Value
-----------------------------------------------------------------------------------------------
U.S. Treasury securities $ 22,877 $ -- $ 47 $ 22,830
Obligations of U.S. government-sponsored
corporations and agencies 5,047 -- 69 4,978
State and political subdivisions 66,474 289 442 66,321
-----------------------------------------------------------------------------------------------
Total debt securities 94,398 289 558 94,129
Stock in Federal Reserve Bank and
Federal Home Loan Bank 730 -- -- 730
-----------------------------------------------------------------------------------------------
Total $ 95,128 $ 289 $ 558 $ 94,859
===============================================================================================
The fair values of securities with unrealized losses at December 31, 2006 and
2005 are as follows:
2006
---------------------------------------------------------------------------------
Less than 12 months 12 months or more Total
---------------------------------------------------------------------------------
Estimated Unrealized Estimated Unrealized Estimated Unrealized
(In thousands) fair value losses fair value losses fair value losses
----------------------------------------------------------------------------------------------------------------------
U. S. Treasury securities $ 16,824 $ 25 $ -- $ -- $ 16,824 $ 25
Obligations of U.S.
government-sponsored
corporations and agencies -- -- 2,985 37 2,985 37
State and political subdivisions 11,729 37 10,622 177 22,351 214
---------------------------------------------------------------------------------------------------------------------
Total $ 28,553 $ 62 $ 13,607 $ 214 $ 42,160 $ 276
=====================================================================================================================
2005
---------------------------------------------------------------------------------
Less than 12 months 12 months or more Total
---------------------------------------------------------------------------------
Estimated Unrealized Estimated Unrealized Estimated Unrealized
(In thousands) fair value losses fair value losses fair value losses
----------------------------------------------------------------------------------------------------------------------
U. S. Treasury securities $ 19,857 $ 21 $ 2,973 $ 26 $ 22,830 $ 47
39
Obligations of U.S.
government-sponsored
corporations and agencies 3,004 43 1,974 26 4,978 69
State and political subdivisions 35,538 271 5,041 171 40,579 442
---------------------------------------------------------------------------------------------------------------------
Total $ 58,399 $ 335 $ 9,988 $ 223 $ 68,387 $ 558
=====================================================================================================================
There were 38 securities (17 greater than 12 months) in an unrealized loss
position as of December 31, 2006. All unrealized losses are reviewed to
determine whether the losses are other than temporary. Management believes that
all unrealized losses are temporary since they are market driven and the Company
has the ability and intent to hold these securities until maturity.
There were 57 securities (10 greater than 12 months) in an unrealized loss
position included as of December 31, 2005. All unrealized losses are reviewed to
determine whether the losses are other than temporary. Management believes that
all unrealized losses are temporary since they are market driven and the Company
has the ability and intent to hold these securities until maturity.
The amortized cost and fair value of debt and equity securities at December 31,
2006, by contractual maturity, are shown in the following table. Expected
maturities may differ from contractual maturities because borrowers have the
right to prepay obligations with or without prepayment penalties.
(Dollars in thousands) 2006
--------------------------------------------------------------------------------------------
Amortized Cost Fair Value
Due in 1 year or less $ 18,371 $ 18,339
Due after 1 year through 5 years 24,677 24,468
Due after 5 years through 10 years 55,037 55,853
Due after 10 years 3,345 3,356
No stated maturity 733 733
--------------------------------------------------------------------------------------------
Total $102,163 $102,749
============================================================================================
The amortized cost of debt securities pledged to secure public deposits,
securities sold under agreements to repurchase and for other purposes at
December 31, 2006 and 2005 were $5,006,000 and $13,027,000, respectively.
Proceeds from sales of debt securities classified as available-for-sale were $0,
$12,950,000 and $27,195,000 for 2006, 2005 and 2004, respectively. Gross
realized gains and losses on the sales were $0 in 2006, and gains of $547,000
and losses of $0 in 2005 and gains of $1,048,000 and losses of $3,000 in 2004.
Note 5
Loans
A summary of loan categories at December 31, 2006 and 2005 is as follows:
(Dollars in thousands) 2006 2005
--------------------------------------------------------------------------------------------
Commercial and industrial $ 113,162 $ 146,892
Real estate:
Commercial 140,095 164,590
Mortgage - Church & related 211,949 183,964
Construction 15,064 13,052
Construction - Church & related 14,715 15,118
Industrial revenue bonds 6,293 4,514
Other 2,847 1,176
--------------------------------------------------------------------------------------------
Total $ 504,125 $ 529,306
============================================================================================
The Company originates commercial, industrial and real estate loans to
businesses, churches and consumers throughout the metropolitan St. Louis,
Missouri area, Orange County, California and other selected cities in the United
States. The Company does not have any particular concentration of credit in any
one economic sector; however, a substantial portion of the commercial and
industrial loans are extended to privately-held commercial companies in this
market area, and are generally secured by the assets of the business. The
Company also has a substantial portion of real estate loans secured by mortgages
that are extended to churches in this market area and selected cities throughout
the United States.
Loan transactions involving executive officers and directors of the Company and
its subsidiaries and loans to affiliates of executive officers and directors for
the year ended December 31, 2006, are summarized below. Such loans were made in
the normal course of business on substantially the same terms, including
interest rates and collateral, as those
40
prevailing at the same time for comparable transactions with other persons, and
did not involve more than the normal risk of collectability.
(In thousands)
---------------------------------------------------------------------------
Aggregate balance, January 1, 2006 $ 4,151
New loans --
Payments 3,190
---------------------------------------------------------------------------
Aggregate balance, December 31, 2006 $ 961
===========================================================================
A summary of the activity in the allowance for loan losses for 2006, 2005 and
2004 is as follows:
(In thousands) 2006 2005 2004
--------------------------------------------------------------------------------------------
Balance, January 1 $ 6,284 $ 6,037 $ 5,506
Provision charged to expense 1,150 775 550
Loans charged off (864) (555) (48)
Recoveries of loans previously
charged off 22 27 29
--------------------------------------------------------------------------------------------
Net loan charge-offs (842) (528) (19)
--------------------------------------------------------------------------------------------
Balance, December 31 $ 6,592 $ 6,284 $ 6,037
============================================================================================
The following is a summary of information pertaining to impaired loans at
December 31, 2006 and 2005:
(In thousands) 2006 2005
--------------------------------------------------------------------------------------------
Impaired loans without a valuation allowance $ -- $ --
Impaired loans with a valuation allowance 795 3,545
Allowance for loan losses related to impaired loans 395 1,567
--------------------------------------------------------------------------------------------
Impaired loans consist primarily of renegotiated loans, nonaccrual loans and
loans greater than 90 days past due and still accruing interest. In 2005,
impaired loans included a loan for $2,080,000 related to one borrower that,
although current, management had doubts as to the collectability of all amounts
under the agreement. In 2006, this loan is current. There were no impaired loans
continuing to accrue interest at December 31, 2006 compared to $2,561,000 at
December 31, 2005. Nonaccrual loans were $795,000 and $983,000 at December 31,
2006 and 2005, respectively. Loans delinquent 90 days or more and still accruing
interest at December 31, 2005 totaled $481,000. The average balance of impaired
loans during 2006 and 2005 was $ 1,177,000 and $3,103,000, respectively. Income
that would have been recognized on non-accrual loans under the original terms of
the contract was $152,000, $114,000 and $38,000 for 2006, 2005 and 2004,
respectively. Income that was recognized on non-accrual loans was $25,000,
$32,000 and $15,000 for 2006, 2005 and 2004, respectively. There were no
foreclosed loans which have been reclassified and held as other real estate
owned as of December 31, 2006. There was no other real estate owned included in
other assets on the consolidated balance sheet at December 31, 2006 and 2005.
Note 6
Premises and Equipment
A summary of premises and equipment at December 31, 2006 and 2005, is as
follows:
(In thousands) 2006 2005
--------------------------------------------------------------------------------------------
Land $ 873 $ 873
Buildings 10,453 10,472
Leasehold improvements 2,013 1,596
Furniture, fixtures and equipment 18,312 17,659
Purchased software 4,672 3,585
Internally developed software 4,037 4,130
--------------------------------------------------------------------------------------------
40,360 38,315
Less accumulated depreciation and amortization 27,462 26,328
--------------------------------------------------------------------------------------------
Total $ 12,898 $ 11,987
============================================================================================
Total depreciation and amortization charged to expense in 2006, 2005 and 2004
amounted to $2,042,000, $1,971,000 and $2,679,000, respectively.
The Company and its subsidiaries lease various premises and equipment under
operating lease agreements, which expire at various dates through 2020. Rental
expense for 2006, 2005 and 2004 was $614,000, $552,000 and $305,000,
respectively. The following is a schedule, by year, of future minimum rental
payments required under operating leases that have initial or remaining
noncancelable lease terms in excess of one year as of December 31, 2006:
41
(In thousands) Amount
-----------------------------------------------------------------------------
2007 $ 657
2008 656
2009 469
2010 415
2011 404
2012 and after 1,564
-----------------------------------------------------------------------------
Total $ 4,165
=============================================================================
Note 7
Equity Investments in Non-Marketable Securities
In 2005, the Company recognized a $3,100,000 impairment charge for an investment
in a private imaging company. As of December 31, 2006 and 2005, the Company's
equity investment was $0.
Non-marketable equity investments in low-income housing projects are included in
other assets on the Company's consolidated balance sheets. The total balances of
these investments at December 31, 2006 and 2005 were $329,000 and $447,000,
respectively.
Note 8
Acquired Intangible Assets
The Company accounts for intangible assets in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets," which requires that intangibles with
indefinite useful lives be tested annually for impairment and those with finite
useful lives be amortized over their useful lives. Details of the Company's
intangible assets as of December 31, 2006 and 2005 are as follows:
December 31, 2006 December 31, 2005
-------------------------------- -------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
(In thousands) Amount Amortization Amount Amortization
----------------------------------------------------------------------------------------------------------------
Assets eligible for amortization:
Software $ 862 (402) $ 862 (230)
Customer List 750 (54) - -
----------------------------------------------------------------------------------------------------------------
Total 1,612 (456) 862 (230)
----------------------------------------------------------------------------------------------------------------
Assets not eligible for amortization:
Goodwill 7,698 (227)* 4,625 (227)*
Minimum pension liability -- -- 303 --
----------------------------------------------------------------------------------------------------------------
Total 7,698 (227) 4,928 (227)
----------------------------------------------------------------------------------------------------------------
Total intangible assets 9,310 (683) $ 5,790 $ (457)
----------------------------------------------------------------------------------------------------------------
*Amortization through December 31, 2001 prior to adoption of SFAS No. 142.
Software is amortized over 4-5 years and the customer list that was acquired in
the NTransit purchase is amortized over seven years. Goodwill includes
$3,073,000 acquired in 2006 in the NTransit purchase. The minimum pension
liability was recorded in accordance with SFAS No. 87, "Employers' Accounting
for Pensions", which requires the Company to record an additional minimum
pension liability by the amount that the accumulated benefit obligation exceeds
the sum of the fair value of plan assets and accrued amounts previously recorded
and offset this liability by an intangible asset to the extent of previously
unrecognized prior service costs. The liability and corresponding intangible
asset have been eliminated in accordance with SFAS No. 158.
The weighted average amortization period at December 31, 2006 was six years for
all amortized intangible assets combined. Amortization of intangible assets
amounted to $226,000, $172,000 and $57,000 for the years ended December 31,
2006, 2005 and 2004 respectively. Estimated future amortization of intangibles
is as follows: $280,000 in 2007 and 2008, $222,000 in 2009 and $107,000 in 2010
and 2011.
Note 9
Interest-Bearing Deposits
Interest-bearing deposits consist of the following at December 31, 2006 and
2005:
(In thousands) 2006 2005
-----------------------------------------------------------------------------------------------
NOW and money market deposit accounts $ 66,588 $ 80,656
Savings deposits 27,923 22,893
Time deposits:
42
Less than $100 27,653 30,564
$100 or more 61,143 36,489
-----------------------------------------------------------------------------------------------
Total $ 183,307 $ 170,602
===============================================================================================
Interest on deposits consist of the following for 2006, 2005 and 2004:
(In thousands) 2006 2005 2004
-----------------------------------------------------------------------------------------------
NOW and money market deposit accounts $ 1,831 $ 1,485 $ 845
Savings deposits 730 458 293
Time deposits:
Less than $100 1,297 1,142 726
$100 or more 2,556 1,401 1,160
-----------------------------------------------------------------------------------------------
Total $ 6,414 $ 4,486 $ 3,024
===============================================================================================
The scheduled maturities of time deposits at December 31, 2006 and 2005 are
summarized as follows:
2006 2005
---------------------------------------------------
Percent Percent
(In thousands) Amount of Total Amount of Total
-----------------------------------------------------------------------------------------------
Due within:
One year $84,928 95.6% $45,304 67.6%
Two years 2,262 2.5% 3,240 4.8
Three years 227 .3% 11,825 17.6
Four years 1,235 1.4% 4,601 6.9
Five years 144 .2% 2,083 3.1
-----------------------------------------------------------------------------------------------
Total $88,796 100% $67,053 100.0%
===============================================================================================
Note 10
Short-Term Borrowings
Company short-term borrowings consist mainly of federal funds purchased and tax
deposits of the United States Treasury. At December 31, 2006 and 2005 the bank
subsidiary had short-term borrowings of $181,000 and $188,000, respectively that
consisted of borrowings from the Treasury related to tax deposits received from
customers not yet drawn upon by the Treasury. These borrowings are secured by
U.S. Treasury and agency securities. The average amount of all borrowings for
2006 was $161,000 at an average rate of 4.46% and the maximum amount outstanding
at the end of any month during the year was $225,000. The average amount of
borrowings for 2005 was $165,000 at an average rate of 3.03% and the maximum
amount outstanding at the end of any month during the year was $229,000.
Note 11
Subordinated Convertible Debentures
On August 24, 2004, the Company issued $3,700,000 of 5.33% subordinated
convertible debentures in partial consideration for the acquisition of the
assets of PROFITLAB, Inc. Interest is payable annually on the anniversary date
of the acquisition. The holders of the debentures can convert up to 20% of the
principal amount into fully paid and non-assessable shares of the common stock
of the Company at a rate per share of $21.42 after the third anniversary of the
issuance date. After the fourth anniversary date an additional 30% can be
converted under the same terms. After the fifth anniversary date, 100% can be
converted under the same terms. The securities mature 10 years after the date of
issuance. The debentures may be called by the Company without penalty after
August 24, 2010.
Note 12
Common Stock and Earnings Per Share
The table below shows activity in the outstanding shares of the Company's common
stock during 2006.
-----------------------------------------------------------------------------
Shares outstanding at January 1, 2006 5,500,136
Issuance of common stock:
50% stock dividend, issued September 15, 2006 2,744,082
Issued under Stock Bonus Plan* 10,007
Stock options exercised* 93,486
Stock repurchased* (20,000)
-----------------------------------------------------------------------------
Shares outstanding at December 31, 2006 8,327,711
-----------------------------------------------------------------------------
*Not restated for stock dividend, issued September 15, 2006.
Basic earnings per share is computed by dividing net income by the
weighted-average number of common shares outstanding. Diluted earnings per share
is computed by dividing net income, adjusted for the net income effect of the
43
interest expense on the outstanding convertible debentures, by the sum of the
weighted-average number of common shares outstanding and the weighted-average
number of potential common shares outstanding. Under the treasury stock method,
outstanding stock options are dilutive when the average market price of the
Company's common stock, combined with the effect of any unamortized compensation
expense, exceeds the option price during a period. In addition, proceeds from
the assumed exercise of dilutive options along with the related tax benefit are
assumed to be used to repurchase common shares at the average market price of
such stock during the period. Anti-dilutive shares are those option shares with
exercise prices in excess of the current market value.
The calculations of basic and diluted earnings per share for the periods ended
December 31, 2006, 2005 and 2004 are as follows:
(Dollars in thousands, except per share data) 2006 2005 2004
----------------------------------------------------------------------------------------------------------------
Basic
Net income from continuing operations $ 15,461 $ 11,244 $ 9,881
Net loss from discontinued operations (395) (298) (1,876)
---------------------------------------------------------------------------------------------------------------
Net income $ 15,066 $ 10,946 $ 8,005
----------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding 8,310,171 8,262,713 8,268,227
---------------------------------------------------------------------------------------------------------------
Basic earnings per share from continuing operations $ 1.86 $ 1.36 $ 1.19
Basic earnings per share from discontinued operations (.05) (.03) (.22)
---------------------------------------------------------------------------------------------------------------
Basic earnings per share $ 1.81 $ 1.33 $ .97
---------------------------------------------------------------------------------------------------------------
Diluted
Net income from continuing operations $ 15,461 $ 11,244 $ 9,881
Net income effect of 5.33% convertible debentures 109 108 39
----------------------------------------------------------------------------------------------------------------
Net income, assuming dilution, from continuing operations 15,570 11,352 9,920
Net loss from discontinued operations (395) (298) (1,876)
----------------------------------------------------------------------------------------------------------------
Net income $ 15,175 $ 11,054 $ 8,044
----------------------------------------------------------------------------------------------------------------
Weighted-average common shares outstanding 8,310,171 8,262,713 8,268,227
Effect of dilutive stock options and awards 67,830 118,172 103,194
Effect of 5.33% convertible debentures 172,717 172,717 61,014
---------------------------------------------------------------------------------------------------------------
Weighted-average common shares outstanding assuming dilution 8,550,718 8,553,602 8,432,435
----------------------------------------------------------------------------------------------------------------
Diluted earnings per share from continuing operations $ 1.82 $ 1.33 $ 1.17
Diluted earnings per share from discontinued operations (.05) (.04) (.22)
----------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 1.77 $ 1.29 $ .95
----------------------------------------------------------------------------------------------------------------
Share and per share data in the schedule above have been restated for the 50%
stock dividends on September 15, 2006 and 2005.
Note 13
Employee Benefit Plans
The Company has a noncontributory defined benefit pension plan, which covers
most of its employees. The Company accrues and makes contributions designed to
fund normal service costs on a current basis using the projected unit credit
with service proration method to amortize prior service costs arising from
improvements in pension benefits and qualifying service prior to the
establishment of the plan over a period of approximately 30 years.
The Company also has an unfunded supplemental executive retirement plan (SERP)
which covers key executives of the Company. The SERP is a noncontributory plan
in which the Company's subsidiaries make accruals designed to fund normal
service costs on a current basis using the same method and criteria as the Plan.
On December 31, 2006 the Company adopted the provisions of SFAS No. 158,
"Employers' Accounting for Defined Benefit Pension and Other Postretirement
Plans - an amendment of FASB Statements No. 87, 88, 106 and 132(R)," (SFAS No.
158). SFAS No. 158 requires recognition of the overfunded or underfunded status
through comprehensive income in the year in which they occur. SFAS No. 158 was
adopted on a prospective basis as required. Prior years' amounts have not been
restated.
The prior accounting for defined pension and other postretirement plans allowed
for delayed recognition of changes in plan assets and benefit obligations and
recognition of a liability that may have been less than the underfunded status
of the plans or an asset for plans that may have been underfunded. The following
table illustrates the incremental effect
44
of applying SFAS No. 158 for the Company's defined benefit pension plan and the
SERP on individual line items in the Company's consolidated balance sheet as of
December 31, 2006.
Adjustment
------------------------
Defined Benefit
(Dollars In Thousands) Before Adoption Plan SERP After Adoption
---------------------------------------------------------------
Other intangible assets $ 1,459 $ -- (303) $ 1,156
Other assets 17,495 1,068 240 18,803
--------- ----
Total assets 857,466 1,068 (63) 858,471
--------- ----
Other liabilities 7,986 3,784 335 12,105
--------- ----
Total liabilities 770,431 3,784 335 774,550
--------- ----
Accumulated comprehensive income (loss) 144 (2,716) (398) (2,970)
Total shareholders' equity 87,035 (2,716) (398) 83,921
Total liabilities and shareholders' equity 857,466 1,068 (63) 858,471
A summary of the activity in the Plan's projected benefit obligation, assets,
funded status and amounts recognized in the Company's consolidated balance
sheets at December 31, 2006 and 2005, is as follows:
(In thousands) 2006 2005
--------------------------------------------------------------------------------------------
Projected benefit obligation:
Balance, January 1 $ 26,535 $ 22,951
Service cost 1,554 1,292
Interest cost 1,565 1,384
Actuarial (loss) gain (99) 1,342
Benefits paid (578) (434)
--------------------------------------------------------------------------------------------
Balance, December 31 $ 28,977 $ 26,535
============================================================================================
Plan assets:
Fair value, January 1 $ 20,702 $ 16,994
Actual return 1,869 1,154
Employer contribution 3,200 2,988
Benefits paid (578) (434)
--------------------------------------------------------------------------------------------
Fair value, December 31 $ 25,193 $ 20,702
============================================================================================
Funded status:
Unfunded projected benefits obligation $ (3,784) $ (5,833)
Unrecognized prior service cost -- 74
Unrecognized net loss -- 4,871
--------------------------------------------------------------------------------------------
Prepaid (accrued) pension asset / liabilty $ (3,784) $ (888)
============================================================================================
The following represent the major assumptions used to determine the projected
benefit obligation of the Plan. The Plan's expected benefit cash flows are
discounted using the Citibank Pension Discount Curve rates.
2006 2005 2004
------------------------------------------------------------------------
Weighted average discount rate 6.00% 5.75% 6.00%
Rate of increase in compensation levels 4.00% 4.00% 4.00%
The accumulated benefit obligation was $23,092,000 and $21,338,000 as of
December 31, 2006 and 2005, respectively. The Company expects to contribute
approximately $1,800,000 to the Plan in 2007. The following pension benefit
payments, which reflect expected future service, as appropriate, are expected to
be paid:
2007 $723,000
2008 939,000
2009 1,005,000
2010 1,090,000
2011 1,097,000
2012 - 2016 6,800,000
45
The Plan's pension cost for 2006, 2005 and 2004 was $ 1,786,000, $1,473,000 and
$1,250,000, respectively, and included the following components:
(In thousands) 2006 2005 2004
-------------------------------------------------------------------------------------
Service cost - benefits earned during the year $1,554 $ 1,292 $ 1,186
Interest cost on projected benefit obligations 1,565 1,384 1,237
Expected return on plan assets (1,603) (1,312) (1,233)
Net amortization and deferral 270 109 60
-------------------------------------------------------------------------------------
Net periodic pension cost $1,786 $ 1,473 $ 1,250
=====================================================================================
The estimate of the total amount to be recognized in net periodic benefit cost
and other comprehensive income for 2007 is $1,489,000.
The following represent the major assumptions used to determine the net benefit
cost of the Plan:
2006 2005 2004
------------------------------------------------------------------------------------------
Weighted average discount rate 5.75% 6.00% 6.25%
Rate of increase in compensation levels 4.00% 4.00% 4.00%
Expected long-term rate of return on assets 7.50% 7.50% 8.00%
The asset allocation for the defined benefit pension plan as of the measurement
date, by asset category, is as follows:
Percentage of
Plan Assets
----------------------------------------------------------------------------------
Asset Class 2006 2005
----------------------------------------------------------------------------------
Equity securities 43.8% 39.6%
Debt securities 55.8% 59.8%
Cash and cash equivalents 0.4% 0.6%
----------------------------------------------------------------------------------
Total 100.0% 100.0%
----------------------------------------------------------------------------------
The investment objective for the Plan is to maximize total return with a
tolerance for average risk. Asset allocation strongly favors fixed income
investments, with a target allocation of approximately 67% fixed income, 33%
equities, and 0% cash. Due to volatility in the market, this target allocation
is not always desirable and asset allocations can fluctuate between acceptable
ranges. The fixed income component is invested in pooled investment grade
securities. The equity component is invested in pooled large cap stocks. More
aggressive or volatile sectors, although currently not employed, can be
represented in the asset mix to pursue higher returns with proper
diversification. The assumed long-term rate of return on assets, which falls
within the expected range, is 7.5% as derived below:
Expected Long-Term Contribution to
Asset Class Return on Class X Allocation = Assumption
-------------------------------------------------------------------------------------------------
Equity securities 7 - 9% 44% 3.1% - 4.0%
Fixed income 5 - 7% 56% 2.8% - 3.9%
-------------------------------------------------------------------------------------------------
5.9% - 7.9%
=================================================================================================
A summary of the activity in the SERP projected benefit obligation, funded
status and amounts recognized in the Company's consolidated balance sheets at
December 31, 2006 and 2005, is as follows:
(In thousands) 2006 2005
-------------------------------------------------------------------------------------------------
Benefit obligation:
Balance, January 1 $ 2,888 $ 1,966
Service cost (benefit) 43 (34)
Interest cost 150 161
Actuarial (gain) loss (336) 795
-------------------------------------------------------------------------------------------------
Balance, December 31 $ 2,745 $ 2,888
=================================================================================================
Funded status:
Unfunded projected benefits obligation $ (2,745) $(2,888)
Unrecognized prior service cost 252 303
Unrecognized actuarial loss 755 1,120
-------------------------------------------------------------------------------------------------
Accrued pension cost (1,738) (1,465)
Minimum liability adjustment -- (673)
-------------------------------------------------------------------------------------------------
Accrued pension cost $ (1,738) $(2,138)
=================================================================================================
46
The SERP's pension cost for 2006, 2005 and 2004 was $304,000, $191,000, and
$110,000, respectively, and included the following components:
(In thousands) 2006 2005 2004
--------------------------------------------------------------------------------------------
Service cost - benefits earned during the year $ 43 $ (34) $ (57)
Interest cost on projected benefit obligations 150 161 117
Net amortization and deferral 111 64 50
--------------------------------------------------------------------------------------------
Net periodic pension cost $ 304 $ 191 $ 110
--------------------------------------------------------------------------------------------
The accumulated benefit obligation was $2,107,000 and $2,138,000 for the periods
ended December 31, 2006 and 2005, respectively. Since this is an unfunded plan
there are no plan assets. Benefits paid on the plan were $32,000 in 2006,
$20,000 in 2005 and $9,000 in 2004. Expected future benefits over the next 10
years are as follows:
2007 $ 31,000
2008 224,000
2009 224,000
2010 223,000
2011 223,000
2012 - 2016 1,104,000
The major assumptions used to determine the projected benefit obligation and net
benefit cost are the same as those in the defined plan explained above. The
estimate of the total amount to be recognized in net periodic benefit cost and
other comprehensive income for 2007 is $233,000.
The pre-tax amounts in accumulated other comprehensive income (loss) as of
December 31 were as follows:
The Plan SERP
--------------- ---------------
2006 2005 2006 2005
------ ------ ------ ------
(In thousands)
Prior service cost $ 66 $ -- $ 252 $ --
Net actuarial loss 4,245 -- 755 --
Minimum liability adjustment -- -- -- (370)
------ ------ ------ ------
Total $4,311 $ -- $1,007 $ (370)
====== ====== ====== ======
The estimated pre-tax prior service cost and net actuarial loss in accumulated
other comprehensive income (loss) at December 31, 2006 expected to be recognized
as components of net periodic benefit cost in 2007 for the Plan were $8,000 and
$116,000 respectively. The estimated pre-tax prior service credit and net
actuarial loss in accumulated other comprehensive income (loss) at December 31,
2006, expected to be recognized as components of net periodic benefit cost in
2007 for SERP are $50,000 and $50,000 respectively.
The minimum liability concept, including recognition of an intangible asset, has
been eliminated under SFAS No. 158 effective December 31, 2006. Prior to the
adoption of SFAS No. 158, a minimum liability adjustment for the SERP was
recognized in accumulated other comprehensive income (loss) to the extent there
was an unfunded accumulated benefit obligation that had not been recognized in
the balance sheet. A minimum pension liability of $75,000 after-tax ($117,000
pre-tax) was recognized in accumulated other comprehensive loss as of December
31, 2006, prior to the adoption of SFAS No. 158, representing a $253,000
adjustment (pre-tax) for the change in the additional minimum liability for the
year ended December 31, 2006. A minimum pension liability of $237,000 after-tax
($370,000 pre-tax) was included in accumulated other comprehensive income (loss)
in the Company's balance sheet as of December 31, 2005. The adjustment for the
change in the additional minimum liability decreased accumulated other
comprehensive income (loss) by $162,000 after-tax ($253,000 pre-tax) for the
year ended December 31, 2006.
The Company also maintains a noncontributory profit sharing plan, which covers
most of its employees. Employer contributions are calculated based upon formulas
which relate to current operating results and other factors. Profit sharing
expense recognized in the consolidated statements of income in 2006, 2005 and
2004 was $3,524,000, $2,543,000 and $1,781,000, respectively.
The Company also sponsors a defined contribution 401(k) plan to provide
additional retirement benefits to substantially all employees. Contributions
under the 401(k) plan for 2006, 2005 and 2004 were $349,000, $334,000 and
$310,000, respectively.
47
Note 14
Stock Bonus and Option Plans
(All shares and per share amounts have been restated for the 50% stock dividends
issued September 15, 2006 and September 15, 2005).
The Company maintains a restricted stock bonus plan which provides for the
issuance of up to 259,875 shares of common stock, the purpose of which is to
permit grants of shares, subject to restrictions, to key employees and
non-employee directors of the Company as a means of retaining and rewarding them
for long-term performance. During 2006, 2005 and 2004, 15,010 shares 8,463
shares and 8,744 shares, respectively, were granted with weighted average per
share market values at date of grant of $26.58 in 2006, $16.35 in 2005 and
$14.63 in 2004. The fair value of such shares, which is based on the market
price on the date of grant, is amortized to expense over the three-year vesting
period. Amortization of the restricted stock bonus awards totaled $197,000 for
2006, $134,000 for 2005 and $96,000 for 2004. At December 31, 2006 the
weighted-average grant date fair value and weighted average contractual life for
outstanding shares of restricted stock was $22.88 and .97 years, respectively.
As of December 31, 2006, the total unrecognized compensation expense related to
non-vested stock awards was $514,000.
Changes in restricted shares outstanding were as follows:
Shares Fair Value
-----------------------------------------------------------------------------
Balance at December 31, 2005 18,695 14.47
Granted 15,010 26.58
Vested (10,459) 13.52
Forfeited (765) 19.79
-----------------------------------------------------------------------------
Balance at December 31, 2006 22,481 22.88
-----------------------------------------------------------------------------
The Company also maintains a performance-based stock option plan, which provides
for the granting of options to purchase up to 1,039,000 shares of common stock.
Options currently vest and expire over a period not to exceed seven years. The
plans authorize the grant of awards in the form of options intended to qualify
as incentive stock options under Section 422 of the Internal Revenue Code and
options that do not qualify (non-statutory stock options).
For the year ended December 31, 2006, there were 5,505 non-qualified options
exercised that generated a tax benefit and 134,724 were incentive stock options
that did not generate any excess tax benefits for the Company. During 2006, the
Company recognized stock option expense of $30,000. As of December 31, 2006, the
total unrecognized compensation expense related to non-vested stock options was
$134,000 and the related weighted-average period over which it is expected to be
recognized is approximately 4.8 years.
The Company uses the Black-Scholes option-pricing model to determine the fair
value of the stock options at the date of grant. Following are the assumptions
used to estimate the fair value of option grants during the years ended December
31, 2006 and 2005:
----------------------------------------------------------------------------
2006 2005
Risk-free interest rate 4.37% 3.97%
Expected life 7 yrs. 7 yrs.
Expected volatility 5.00% 15.00%
Expected dividend yield 1.88% 2.32%
----------------------------------------------------------------------------
The risk-free interest rate is based on the zero-coupon U.S. Treasury yield for
the period equal to the expected life of the options at the time of the grant.
The expected life was derived using the historical exercise activity. The
Company uses historical volatility for a period equal to the expected life of
the options using average monthly closing market prices of the Company's stock.
The expected dividend yield is determined based on the Company's current rate of
annual dividends.
The following table summarizes stock options outstanding as of December 31,
2006:
Weighted Average
Exercise Options Remaining
Price Outstanding Contractual Life
------------------------------------------------------------
$ 9.717 428 2.0
10.000 26,999 3.0
10.998 3,792 3.0
13.455 13,208 4.0
48
15.960 4,488 4.0
16.893 3,375 4.0
15.889 4,351 5.0
16.222 7,240 5.0
22.733 23,924 6.0
Changes in options outstanding were as follows:
Weighted Average
Shares Exercise Price
-------------------------------------------------------------------------------------------------
Balance at December 31, 2003 249,903 $ 9.05
Granted 22,793 14.65
Exercised (32,414) 5.84
Forfeited (4,410) 9.71
-------------------------------------------------------------------------------------------------
Balance at December 31, 2004 235,872 10.02
Granted 13,241 16.07
Exercised (27,668) 9.29
Forfeited (11,594) 10.15
-------------------------------------------------------------------------------------------------
Balance at December 31, 2005 209,851 10.67
-------------------------------------------------------------------------------------------------
Granted 25,227 22.73
Exercised (140,229) 9.71
Forfeited (7,044) 14.58
-------------------------------------------------------------------------------------------------
Balance at December 31, 2006 87,805 15.40
=================================================================================================
Exercisable at December 31, 2006 2,399 $ 9.95
=================================================================================================
The total intrinsic value of options exercised during 2006 was $1,728,000. The
total intrinsic value of options exercised during 2005 was $216,000. The average
remaining contractual term for options exercisable as of December 31, 2006 was
2.8 years and the aggregate intrinsic value was $65,000.
A summary of the activity of the non-vested options during 2006 is shown below.
Weighted-
Average
Grant Date
Shares Fair Value
-----------------------------------------------------------------
Non-vested at December 31, 2005 168,047 $1.82
Granted 25,227 3.25
Vested (100,824) 1.68
Forfeited (7,044) 2.20
-----------------------------------------------------------------
Non-vested at December 31, 2006 85,406 $2.38
=================================================================
Note 15
Other Operating Expense
Details of other operating expense for 2006, 2005 and 2004 are as follows:
(In thousands) 2006 2005 2004
-------------------------------------------------------------------------------------------
Postage and supplies $ 2,502 $ 2,310 $ 2,215
Promotional Expense 1,552 1,289 1,103
Professional fees 1,997 1,750 1,746
Outside service fees 2,088 1,946 1,711
Data processing services 232 220 202
Telecommunications 578 522 426
Other 1,519 1,127 1,162
-------------------------------------------------------------------------------------------
Total other operating expense $ 10,468 $ 9,164 $ 8,565
===========================================================================================
Note 16
Income Taxes
The components of income tax expense (benefit) from continuing operations for
2006, 2005 and 2004 are as follows:
(In thousands) 2006 2005 2004
-------------------------------------------------------------------------------------------------
Current:
49
Federal $ 7,196 $ 5,171 $ 4,277
State 1,460 732 490
Deferred (289) (921) (558)
-------------------------------------------------------------------------------------------------
Total income tax expense $ 8,367 $ 4,982 $ 4,209
=================================================================================================
A reconciliation of expected income tax expense (benefit), computed by applying
the effective federal statutory rate of 35% for 2006 and 2005 and 34% for 2004
to income from continuing operations before income tax expense, to reported
income tax expense is as follows:
(In thousands) 2006 2005 2004
-------------------------------------------------------------------------------------------------
Expected income tax expense: $ 8,340 $ 5,517 $ 4,791
(Reductions) increases resulting from
Tax-exempt income (1,151) (769) (964)
State taxes, net of federal benefit 949 483 323
Other, net 229 (249) 59
-------------------------------------------------------------------------------------------------
Total income tax expense $ 8,367 $ 4,982 $ 4,209
=================================================================================================
The tax effects of temporary differences which give rise to significant portions
of the deferred tax assets and deferred tax liabilities at December 31, 2006 and
2005, are presented below:
(In thousands) 2006 2005
---------------------------------------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $ 2,513 $ 2,396
SFAS No. 158 pension funding liability 2,416 --
Security impairment write-down 1,152 1,182
Accrued pension cost -- 338
Net operating loss carry forward(1) 582 584
SERP Accrual -- 548
Deferred revenue 53 58
Minimum pension liability -- 133
Unrealized loss on investment in securities available-for-sale -- 99
Other 130 57
----------------------------------------------------------------------------------------
Total deferred tax assets $ 6,846 $ 5,395
---------------------------------------------------------------------------------------------
Deferred tax liabilities:
Premises and equipment (3) (174)
Intangible/assets (427) (83)
Unrealized gain on investment in securities available-for-sale (205) --
Other (154) (177)
---------------------------------------------------------------------------------------------
Total deferred tax liabilities (789) (434)
---------------------------------------------------------------------------------------------
Net deferred tax assets $ 6,057 $ 4,961
---------------------------------------------------------------------------------------------
1. As of December 31, 2006, the Company had approximately $ 1,700,000 of net
operating loss carryforwards as a result of the acquisition of Franklin
Bancorp. The utilization of the net operating loss carryforward is subject
to Section 382 of the Internal Revenue Code and limits the Company's use to
approximately $120,000 per year during the carryforward period, which
expires in 2019.
A valuation allowance would be provided on deferred tax assets when it is more
likely than not that some portion of the assets will not be realized. The
Company has not established a valuation allowance at December 31, 2006 or 2005,
due to management's belief that all criteria for recognition have been met,
including the existence of a history of taxes paid sufficient to support the
realization of deferred tax assets.
The Company's income tax (benefit) expense from discontinued operations was
($280,000), $557,000, ($947,000) with effective rates of 41%, 215% and 34% for
the years 2006, 2005 and 2004, respectively. The decrease from 2005 to 2006 was
primarily the result of differences between book and tax valuations resulting
from the sale of GEMS.
Note 17
Contingencies
The Company and its subsidiaries are involved in various pending legal actions
and proceedings in which claims for damages are asserted. Management, after
discussion with legal counsel, believes the ultimate resolution of these legal
actions and proceedings will not have a material effect upon the Company's
consolidated financial position or results of operations.
Note 18
Disclosures About Financial Instruments
The Company is party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit, commercial
50
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, 2006, 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
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. The approximate remaining
term of commercial and standby letters of credit range from less than 1 to 5
years. Since these 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 may obtain and liquidate
the collateral to recover amounts paid under its guarantees on these financial
instruments.
The following table shows conditional commitments to extend credit, standby
letters of credit and commercial letters at December 31, 2006 and 2005:
(In thousands) 2006 2005
-------------------------------------------------------------------------------------------------
Conditional commitments to extend credit $ 22,506 $ 21,834
Standby letters of credit 6,417 7,407
Commercial letters of credit 2,650 6,533
-------------------------------------------------------------------------------------------------
Following is a summary of the carrying amounts and fair values of the Company's
financial instruments at December 31, 2006 and 2005:
2006 2005
-----------------------------------------------------
Carrying Fair Carrying Fair
(In thousands) Amount Value Amount Value
-------------------------------------------------------------------------------------------------
Balance sheet assets:
Cash and cash equivalents $ 196,504 $ 196,504 $ 149,692 $ 149,692
Investment in debt and equity securities 102,749 102,749 94,859 94,859
Loans, net 497,533 494,735 523,022 516,917
Accrued interest receivable 4,140 4,140 3,324 3,324
------------------------------------------------------------------------------------------------
Total $ 800,926 $ 798,128 $ 770,897 $ 764,792
================================================================================================
Balance sheet liabilities:
Deposits $ 289,894 $ 289,894 $ 286,998 $ 286,998
Accounts and drafts payable 468,393 468,393 445,811 445,811
Short-term borrowings 181 181 188 188
Subordinated convertible debentures 3,700 3,110 3,700 3,564
Accrued interest payable 744 744 296 296
------------------------------------------------------------------------------------------------
Total $ 762,912 $ 762,322 $ 736,993 $ 736,857
================================================================================================
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Cash and Other Short-term Instruments For cash and cash equivalents, accrued
interest receivable, accounts and drafts payable, short-term borrowings and
accrued interest payable, the carrying amount is a reasonable estimate of fair
value because of the demand nature or short maturities of these instruments.
Investment in Debt and Equity Securities Fair values are based on quoted market
prices or dealer quotes.
Loans The fair value of loans is estimated by discounting the future cash flows
using the current rates at which similar loans would be made to borrowers with
similar credit ratings and for the same remaining maturities.
Deposits The fair value of demand deposits, savings deposits and certain money
market deposits is the amount payable on demand at the reporting date. The fair
value of fixed-maturity certificates of deposit is estimated using the rates
currently offered for deposits of similar remaining maturities. The fair value
estimates above do not include the benefit that results from the low-cost
funding provided by the deposit liabilities compared to the cost of borrowing
funds in the market nor the benefit derived from the customer relationship
inherent in existing deposits.
Subordinated Convertible Debentures The fair value of convertible subordinated
debentures is estimated by discounting the projected future cash flows using
estimated current rates for similar borrowings.
51
Commitments to Extend Credit and Standby Letters of Credit The fair value of
commitments to extend credit and standby letters of credit is estimated using
the fees currently charged to enter into similar agreements, taking into account
the remaining terms of the agreements, the likelihood of the counterparties
drawing on such financial instruments and the present credit-worthiness of such
counterparties. The Company believes such commitments have been made at terms
which are competitive in the markets in which it operates; however, no premium
or discount is offered thereon.
Limitations Fair value estimates are based on existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. Other significant assets or liabilities that are not
considered financial assets or liabilities include premises and equipment and
the benefit that results from the low-cost funding provided by the deposit
liabilities compared to the cost of borrowing funds in the market (core deposit
intangible). In addition, tax ramifications related to the realization of the
unrealized gains and losses can have a significant effect on fair value
estimates and have not been considered in any of the estimates.
Because no market exists for a significant portion of the Company's financial
instruments, fair value estimates are based on management's judgments regarding
future expected loss experience, current economic conditions, risk
characteristics of various financial instruments and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and, therefore, cannot be determined with precision.
Changes in assumptions could significantly affect the estimates.
Note 19
Industry Segment Information
The services provided by the Company are classified into two reportable
segments: Information Services and Banking Services. Each of these segments
provides distinct services that are marketed through different channels. They
are managed separately due to their unique service, processing and capital
requirements.
The Information Services segment provides freight, utility and telecommunication
invoice processing and payment services to large corporations. The Banking
Services segment provides banking services primarily to privately held
businesses and churches.
The Company's accounting policies for segments are the same as those described
in Note 1 of this report. Management evaluates segment performance based on net
income after allocations for corporate expenses and income taxes. Transactions
between segments are accounted for at what management believes to be market
value. Information for prior periods have been restated to reflect changes in
the composition of the Company's segments.
All revenue originates from and all long-lived assets are located within the
United States and no revenue from any customer of any segment exceeds 10% of the
Company's consolidated revenue.
Summarized information about the Company's operations in each industry segment
for the periods ended December 31, 2006, 2005 and 2004, is as follows:
Corporate
Information Banking and
(In thousands) Services Services Eliminations Total
-------------------------------------------------------------------------------------------------------------------
2006
Fee revenue and other income:
Income from customers $ 41,180 $ 1,641 $ -- $ 42,821
Intersegment income (expense) 1,487 1,741 (3,228) --
Net interest income (expense) after
provision for loan losses:
Interest from customers 25,500 13,784 -- 39,284
Intersegment interest 349 (349) -- --
Depreciation and amortization 1,889 379 -- 2,268
Income taxes 5,431 2,936 -- 8,367
Net income from continuing operations 11,151 4,310 -- 15,461
Goodwill 7,335 136 -- 7,471
Other intangible assets, net 1,156 -- -- 1,156
Assets related to discontinued operations -- -- -- --
Total assets $ 527,227 $ 333,454 $ (2,210) $ 858,471
------------------------------------------------------------------------------------------------------------------
2005
Fee revenue and other income:
Income from customers $ 35,901 $ 2,752 $ -- $ 38,653
52
Intersegment income (expense) 1,323 1,597 (2,920) --
Net interest income (expense) after
provision for loan losses:
Interest from customers 19,436 13,353 -- 32,789
Intersegment interest 163 (163) -- --
Depreciation and amortization 1,865 278 -- 2,143
Income taxes 2,615 2,367 -- 4,982
Net income from continuing operations 6,499 4,745 -- 11,244
Goodwill 4,262 136 -- 4,398
Other intangible assets, net 935 -- -- 935
Assets related to discontinued operations -- -- 400 400
Total assets $ 489,857 $ 338,107 $ (9,266) $ 818,698
------------------------------------------------------------------------------------------------------------------
2004
Fee revenue and other income:
Income from customers $ 32,320 $ 1,727 $ -- $ 34,047
Intersegment income (expense) -- 1,467 (1,467) --
Net interest income (expense) after
provision for loan losses:
Interest from customers 15,652 11,436 -- 27,088
Intersegment interest 62 (62) -- --
Depreciation and amortization 2,904 314 60 3,278
Income taxes 2,006 2,203 -- 4,209
Net income from continuing operations 6,225 3,656 -- 9,881
Goodwill 4,262 171 -- 4,433
Other intangible assets, net 805 -- 353 1,158
Assets related to discontinued operations -- -- 6,566 6,566
Total assets $ 397,722 $314,625 $ 4,174 $716,521
------------------------------------------------------------------------------------------------------------------
53
Note 20
Condensed Financial Information of Parent Company
Following are the condensed balance sheets of the Company (parent company only)
as of December 31, 2006 and 2005, and the related condensed statements of income
and cash flows for each of the years in the three-year period ended December 31,
2006.
Condensed Balance Sheets
December 31
-----------------------------------
(In thousands) 2006 2005
----------------------------------------------------------------------------------------------------------
Assets:
Cash and due from banks $ 10,472 $ 12,113
Short-term investments 127,419 71,911
Investment in debt and equity securities,
available-for-sale 98,519 89,621
Loans, net 234,718 270,579
Investment in subsidiary 38,641 38,367
Premises and equipment, net 11,574 10,591
Other assets 44,525 35,041
----------------------------------------------------------------------------------------------------------
Total assets $ 565,868 $ 528,223
==========================================================================================================
Liabilities and Shareholders' Equity:
Accounts and drafts payable $ 468,393 $ 445,811
Subordinated convertible debentures 3,700 3,700
Other liabilities 9,854 3,431
----------------------------------------------------------------------------------------------------------
Total liabilities 481,947 452,942
Total shareholders' equity 83,921 75,281
----------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 565,868 $ 528,223
==========================================================================================================
Condensed Statements of Income
December 31
----------------------------------------
(In thousands) 2006 2005 2004
-----------------------------------------------------------------------------------------------------
Income from subsidiary:
Dividends $ 3,655 $ 3,200 $ --
Interest 422 197 75
Management fees 1,487 1,323 1,032
-----------------------------------------------------------------------------------------------------
Income from subsidiary 5,564 4,720 1,107
Information services revenue 40,343 35,901 30,695
Net interest income after provision 23,401 18,189 14,574
Gains on sales of investment securities -- 547 1,045
Other income 838 608 581
----------------------------------------------------------------------------------------------------
Total income $ 70,146 $ 59,965 $ 48,002
-----------------------------------------------------------------------------------------------------
Expenses:
Salaries and employee benefits $ 37,479 $ 33,337 $ 28,963
Other expenses 12,430 14,315 10,808
-----------------------------------------------------------------------------------------------------
Total expenses $ 49,909 $ 47,652 $ 39,771
-----------------------------------------------------------------------------------------------------
Income before income tax and equity in
undistributed income of subsidiary 20,237 12,313 8,231
Income tax expense 5,431 2,614 2,006
-----------------------------------------------------------------------------------------------------
Income before undistributed income
of subsidiary 14,806 9,699 6,225
Equity in undistributed income of subsidiary 260 1,247 1,780
-----------------------------------------------------------------------------------------------------
Net income $ 15,066 $ 10,946 $ 8,005
=====================================================================================================
54
Condensed Statements of Cash Flows
December 31
------------------------------------------
(In thousands) 2006 2005 2004
-----------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 15,066 $ 10,946 $ 8,005
Adjustments to reconcile net income to
net cash provided by operating activities:
Equity in undistributed income
of subsidiary (260) (1,247) (1,780)
Net change in other assets (6,288) 41 (4,077)
Net change in other liabilities 2,457 (1,350) (651)
Amortization of stock bonus awards 196 134 96
Other, net 1,889 1,743 2,440
-----------------------------------------------------------------------------------------------------
Net cash provided by
operating activities 13,060 10,267 4,033
-----------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Net increase in securities (8,065) (18,975) (8,254)
Net increase (decrease) in loans 35,861 (53,753) (9,692)
Payment for business acquisitions, net of
cash acquired (3,172) -- (2,092)
Purchases of premises and equipment, net (2,188) (1,344) (1,197)
-----------------------------------------------------------------------------------------------------
Net cash used in investing activities 22,436 (74,072) (21,235)
-----------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase in accounts
and drafts payable 22,582 87,338 58,484
Cash dividends paid (3,666) (3,201) (3,025)
Purchases of common shares for treasury (870) (1,434) --
Other financing activities 325 136 (279)
-----------------------------------------------------------------------------------------------------
Net cash provided by
financing activities 18,371 82,839 55,180
-----------------------------------------------------------------------------------------------------
Net increase in cash and
cash equivalents 53,867 19,034 37,978
Cash and cash equivalents at beginning of year 84,024 64,990 27,012
-----------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $137,891 $ 84,024 $ 64,990
-----------------------------------------------------------------------------------------------------
55
Note 21
SUPPLEMENTARY FINANCIAL INFORMATION
(Unaudited)
First Second Third Fourth
(In thousands, except per share data) Quarter Quarter Quarter Quarter YTD
---------------------------------------------------------------------------------------------------------
2006
Fee revenue and other income $ 10,466 $ 10,354 $ 10,928 $ 11,073 $ 42,821
Interest income 10,956 11,374 12,251 12,472 47,053
Interest expense 1,315 1,514 1,781 2,009 6,619
---------------------------------------------------------------------------------------------------------
Net interest income 9,641 9,860 10,470 10,463 40,434
Provision for loan losses 150 150 200 650 1,150
Operating expenses 13,869 14,284 15,021 15,103 58,277
Income tax expense 2,136 2,056 2,205 1,970 8,367
---------------------------------------------------------------------------------------------------------
Net income from continuing operations 3,952 3,724 3,972 3,813 15,461
Net loss from discontinued
operations before income taxes -- (325) (150) (200) (675)
Benefits from income taxes -- 136 62 82 280
---------------------------------------------------------------------------------------------------------
Net loss from discontinued operations -- (189) (88) (118) (395)
---------------------------------------------------------------------------------------------------------
Net income $ 3,952 $ 3,535 $ 3,884 $ 3,695 $ 15,066
=========================================================================================================
Net income per share:
Basic earnings per share from
continuing operations $ .47 $ .45 $ .48 $ .46 $ 1.86
Basic earnings per share from
discontinued operations -- (.02) (.01) (.02) (0.05)
Basic earnings per share .47 .43 .47 .44 1.81
Diluted earnings per share from
continuing operations .47 .43 .47 .45 1.82
Diluted earnings per share from
discontinued operations -- (.02) (.01) (.02) (0.05)
Diluted earnings per share .47 .41 .46 .43 1.77
=========================================================================================================
2005
Fee revenue and other income $ 9,681 $ 9,283 $ 9,720 $ 9,969 $ 38,653
Interest income 8,518 9,189 9,813 10,731 38,251
Interest expense 992 1,216 1,229 1,250 4,687
---------------------------------------------------------------------------------------------------------
Net interest income 7,526 7,973 8,584 9,481 33,564
Provision for loan losses 200 200 225 150 775
Operating expense 12,587 13,039 13,144 13,346 52,116
Impairment of equity investment -- -- -- 3,100 3,100
Income tax expense 1,469 1,407 1,670 436 4,982
---------------------------------------------------------------------------------------------------------
Net income from continuing operations 2,951 2,610 3,265 2,418 11,244
Net income (loss) from discontinued
operations before income taxes (275) (39) (259) 832 259
(Benefit from) Provision for income taxes (91) (13) (87) 748 557
---------------------------------------------------------------------------------------------------------
Net income (loss) from discontinued operations (184) (26) (172) 84 (298)
---------------------------------------------------------------------------------------------------------
Net income $ 2,767 $ 2,584 $ 3,093 $ 2,502 $ 10,946
=========================================================================================================
Net income per share:
Basic earnings per share from
continuing operations $ 0.35 $ 0.33 $ 0.39 $ 0.29 $ 1.36
Basic earnings per share from
discontinued operations (0.02) (0.01) (0.02) 0.02 (0.03)
Basic earnings per share 0.33 0.32 0.37 0.31 1.33
Diluted earnings per share from
continuing operations 0.35 0.31 0.38 0.29 1.33
Diluted earnings per share from
discontinued operations (0.02) (0.01) (0.01) 0.00 (0.04)
Diluted earnings per share 0.33 0.30 0.37 0.29 1.29
=========================================================================================================
56
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Cass Information Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Cass Information
Systems, Inc. and subsidiaries (the Company) as of December 31, 2006 and 2005,
and the related consolidated statements of income, cash flows, and shareholders'
equity and comprehensive income for each of the years in the three-year period
ended December 31, 2006. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 2006 and 2005, and the results of its their operations and their
cash flows for each of the years in the three-year period ended December 31,
2006, in conformity with U.S. generally accepted accounting principles.
As discussed in notes 1 and 13 to the consolidated financial statements, as of
December 31, 2006, the Company adopted Statement of Financial Accounting
Standard No. 158, Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2006, based on
criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission, and our report
dated March 9, 2007 expressed an unqualified opinion on management's assessment
of, and the effective operation of, internal control over financial reporting.
/s/ KPMG LLP
St. Louis, Missouri
March 9, 2007
57
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
NONE
ITEM 9A. CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including
our principal executive officer and principal financial officer, we conducted an
evaluation of our disclosure controls and procedures, as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of
December 31, 2006. Based on this evaluation, our principal executive officer and
our principal financial officer concluded that our disclosure controls and
procedures were effective as of December 31, 2006.
There have not been changes in our internal control over financial reporting
that occurred during our fourth fiscal quarter that have materially affected or
are reasonably likely to materially affect our internal control over financial
reporting.
Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rules
13a-15(f) and 15d-15(f). All internal control systems, no matter how well
designed, have inherent limitations. Therefore, even those systems determined to
be effective can provide only reasonable assurance with respect to financial
statement preparation and presentations.
Under the supervision and with the participation of our management, including
principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of our internal control over financial reporting
based on the framework in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on our
evaluation under the framework in Internal Control - Integrated Framework, our
management concluded that our internal control over financial reporting was
effective as of December 31, 2006.
Our management's assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2006 has been audited by KPMG LLP, an
independent registered public accounting firm, as stated in their report which
follows.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Cass Information Systems, Inc.:
We have audited management's assessment, included in the accompanying Management
Report on Internal Control over Financial Reporting, that Cass Information
Systems, Inc. and subsidiaries (the Company) maintained effective internal
control over financial reporting as of December 31, 2006, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
58
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective
internal control over financial reporting as of December 31, 2006, is fairly
stated, in all material respects, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also, in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2006, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of
the Company as of December 31, 2006 and 2005, and the related consolidated
statements of income, cash flows, and shareholders' equity and comprehensive
income for each of the years in the three-year period ended December 31, 2006,
and our report dated March 9, 2007 expressed an unqualified opinion on those
consolidated financial statements.
/s/ KPMG LLP
St. Louis, Missouri
March 9, 2007
ITEM 9B. OTHER INFORMATION
NONE
PART III.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE OF THE
REGISTRANT
Information required by this item 10 is incorporated herein by reference from
the following sections of the Company's definitive Proxy Statement for its 2007
Annual Meeting of Shareholders ("2007 Proxy Statement"), a copy of which will be
filed with the Securities and Exchange Commission (SEC) no later than 120 days
after the close of the fiscal year: "Election of Directors" and "Executive
Officers" (please note that "Section 16(a) Beneficial Ownership Reporting
Compliance" is within the "Executive Officers" section).
The Company has adopted a Code of Conduct and Business Ethics policy, applicable
to all Company directors, executive officers and employees. The policy is
publicly available and can be viewed on the Company's website at
www.cassinfo.com. The Company intends to satisfy the disclosure requirement
under Item 10 of Form 8-K regarding the amendment to, or a waiver from, a
provision of this policy that applies to the Company's principal executive
officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions and that relates to any
element of the code of ethics definition enumerated in Item 406(b) of Regulation
S-K by posting such information on its website.
There have been no material changes to the procedures by which stockholders may
recommend nominees to the Board.
ITEM 11. EXECUTIVE COMPENSATION
59
Information required pursuant to this item 11 is incorporated herein by
reference from the sections entitled "Executive Officers" and "Election of
Directors" of the Company's 2007 Proxy Statement, a copy of which will be filed
with the SEC no later than 120 days after the close of the fiscal year.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information required pursuant to this item 12 is incorporated herein by
reference from the sections entitled "Executive Officers" and "Election of
Directors" of the Company's 2007 Proxy Statement, a copy of which will be filed
with the SEC no later than 120 days after the close of the fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
Information required by this item 13 is incorporated herein by reference from
the sections entitled "Executive Officers" and "Election of Directors" of the
Company's 2007 Proxy Statement, a copy of which will be filed with the SEC no
later than 120 days after the close of the fiscal year.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning our principal accountant's fees and services is
incorporated herein by reference from the section "Ratification of Appointment
of Independent Registered Public Accounting Firm" of the Company's 2007 Proxy
Statement, a copy of which will be filed with the SEC no later than 120 days
after the close of the fiscal year.
PART IV.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are incorporated by reference in or filed as an
exhibit to this Report:
(1) and (2) Financial Statements and Financial Statement Schedules
Submitted as a separate section of this report.
(3) Exhibits listed under (b) of this Item 15.
(b) Exhibits
2.1 GEMS Asset Purchase Agreement, incorporated by reference to Form
8-K, filed with the SEC on January 4, 2006 (File No 333 - 44497).
3.1 Restated Articles of Incorporation of Registrant, incorporated by
reference to Exhibit 4.1 to Form S-8 Registration Statement No.
333-44499, filed with the SEC on January 20, 1998.
3.2 Articles of Merger of Cass Commercial Corporation, incorporated
by reference to Exhibit 3.1 to the quarterly report on Form 10-Q
for the quarter ended September 30, 2006 (File No. 333 - 44497).
3.3 Amended and Restated Bylaws of Registrant, incorporated by
reference to Exhibit 3.2 to the quarterly report on Form 10-Q for
the quarter ended March 31, 2003 (File No 333 - 44497).
10.1 1995 Restricted Stock Bonus Plan, as amended to January 19, 1999,
including form of Restriction Agreement, incorporated by
reference to Exhibit 4.3 to Post-Effective Amendment No. 2 to
Form S-8 Registration Statement No. 33-91456, filed with the SEC
on February 16, 1999.
10.2 1995 Performance-Based Stock Option Plan, as amended to January
19, 1999, including forms of Option Agreements, incorporated by
reference to Exhibit 4.3 to Post-Effective Amendment No. 2 to
Form S-8 Registration Statement No. 33-91568, filed with the SEC
on February 16, 1999.
60
10.3 Form of Directors' Indemnification Agreement, incorporated by
reference to Exhibit 10.1 to the quarterly report on Form 10-Q
for the quarter ended March 31, 2003 (File No 333 - 44497).
21 Subsidiaries of registrant.
23 Consent of Independent Registered Public Accounting Firm.
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(c) None
61
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CASS INFORMATION SYSTEMS, INC.
Date: March 9, 2007 By /s/ Lawrence A. Collett
---------------------------------------
Lawrence A. Collett
Chairman and Chief Executive Officer
(Principal Executive Officer)
Date: March 9, 2007 By /s/ P. Stephen Appelbaum
---------------------------------------
P. Stephen Appelbaum
Chief Financial Officer
(Principal Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below on the dates indicated by the following persons on
behalf of the Company and in their capacity as a member of the Board of
Directors of the Company.
Date: March 9, 2007 By /s/ Robert J. Bodine
------------------------------
Robert J. Bodine
Date: March 9, 2007 By /s/ K. Dane Brooksher
------------------------------
K. Dane Brooksher
Date: March 9, 2007 By /s/ Eric H. Brunngraber
------------------------------
Eric H. Brunngraber
Date: March 9, 2007 By /s/ Bryan S. Chapell
------------------------------
Bryan S. Chapell
Date: March 9, 2007 By /s/ Lawrence A. Collett
------------------------------
Lawrence A. Collett
Date: March 9, 2007 By /s/ Robert A. Ebel
------------------------------
Robert A. Ebel
Date: March 9, 2007 By /s/ Benjamin F. Edwards, IV
------------------------------
Benjamin F. Edwards, IV
Date: March 9, 2007 By /s/ Wayne J. Grace
------------------------------
Wayne J. Grace
Date: March 9, 2007 By /s/ Harry J. Krieg
------------------------------
Harry J. Krieg
Date: March 9, 2007 By /s/ Irving A. Shepard
------------------------------
Irving A. Shepard
Date: March 9, 2007 By /s/ A. J. Signorelli
------------------------------
A. J. Signorelli
Date: March 9, 2007 By /s/ Franklin D. Wicks, Jr.
------------------------------
Franklin D. Wicks, Jr.
62