10-Q 1 e400478_10q-cass.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------ FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarter ended March 31, 2004 Commission File No. 2-80070 ------------------ CASS INFORMATION SYSTEMS, INC. Incorporated under the laws of MISSOURI I.R.S. Employer Identification No. 43-1265338 13001 HOLLENBERG DRIVE, BRIDGETON, MISSOURI 63044 Telephone: (314) 506-5500 ------------------ Indicate by check mark whether the registrant 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 has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| The number of shares outstanding of registrant's only class of stock as of April 30, 2004: Common stock, par value $.50 per share - 3,683,272 shares outstanding. -------------------------------------------------------------------------------- This document constitutes part of a prospectus covering securities that have been registered under the Securities Act of 1933. -------------------------------------------------------------------------------- TABLE OF CONTENTS PART I - Financial Information Item 1. FINANCIAL STATEMENTS Consolidated Balance Sheets March 31, 2004 (unaudited) and December 31, 2003 ................................ 3 Consolidated Statements of Income Three months ended March 31, 2004 and 2003 (unaudited) .......................... 4 Consolidated Statements of Cash Flows Three months ended March 31, 2004 and 2003 (unaudited) .......................... 5 Notes to Consolidated Financial Statements (unaudited) ............................ 6 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ....................................................... 11 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ........................ 20 Item 4. CONTROLS AND PROCEDURES ........................................................... 20 PART II - Other Information - Items 1. - 6. ..................................................... 21 SIGNATURES ................................................................................ 22
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. 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. -2- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited) (Dollars in Thousands except Per Share Data)
March 31 December 31 2004 2003 Assets Cash and due from banks $ 14,045 $ 17,754 Federal funds sold and other short-term investments 25,075 44,613 --------- --------- Cash and cash equivalents 39,120 62,367 --------- --------- Investment in debt and equity securities available-for-sale, at fair value 65,023 69,147 Loans 460,110 469,032 Less: Allowance for loan losses 5,709 5,506 --------- --------- Loans, net 454,401 463,526 --------- --------- Premises and equipment, net 13,256 13,538 Bank owned life insurance 10,831 10,709 Goodwill 3,150 3,150 Other intangible assets, net 1,862 1,940 Other assets 16,140 15,319 --------- --------- Total assets $ 603,783 $ 639,696 ========= ========= Liabilities and Shareholders' Equity Liabilities: Deposits: Noninterest-bearing $ 98,059 $ 114,634 Interest-bearing 170,636 157,794 --------- --------- Total deposits 268,695 272,428 Accounts and drafts payable 259,626 293,769 Short-term borrowings 107 123 Other liabilities 8,946 8,584 --------- --------- Total liabilities 537,374 574,904 --------- --------- 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 and 4,494,510 and 4,160,110 shares issued at March 31, 2004 and December 31, 2003, respectively 2,247 2,080 Additional paid-in capital 19,314 8,466 Retained earnings 59,850 69,695 Common shares in treasury, at cost (813,058 shares at March 31, 2004 and 824,598 shares at December 31, 2003) (16,214) (16,442) Unamortized stock bonus awards (171) (129) Accumulated other comprehensive income 1,383 1,122 --------- --------- Total shareholders' equity 66,409 64,792 --------- --------- Total liabilities and shareholders' equity $ 603,783 $ 639,696 ========= =========
See accompanying notes to unaudited consolidated financial statements. -3- CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (Dollars in Thousands except Per Share Data)
Three Months Ended March 31 ------------------------ 2004 2003 Fee Revenue and Other Income: Freight and utility payment and processing revenue $ 7,598 $ 6,969 Software revenue 1,179 1,796 Bank service fees 414 426 Gains on sales of investment securities 441 -- Other 135 129 ---------- ---------- Total fee revenue and other income 9,767 9,320 ---------- ---------- Interest Income: Interest and fees on loans 6,454 6,416 Interest and dividends on debt and equity securities: Taxable 97 188 Exempt from federal income taxes 427 435 Interest on federal funds sold and other short-term investments 162 100 ---------- ---------- Total interest income 7,140 7,139 ---------- ---------- Interest Expense: Interest on deposits 567 451 Interest on short-term borrowings -- 9 ---------- ---------- Total interest expense 567 460 ---------- ---------- Net interest income 6,573 6,679 Provision for loan losses 200 90 ---------- ---------- Net interest income after provision for loan losses 6,373 6,589 ---------- ---------- Operating Expense: Salaries and employee benefits 9,157 9,352 Occupancy 458 436 Equipment 1,025 1,161 Other operating 2,842 2,846 ---------- ---------- Total operating expense 13,482 13,795 ---------- ---------- Income before income tax expense 2,658 2,114 Income tax expense 811 596 ---------- ---------- Net income $ 1,847 $ 1,518 ========== ========== Earnings per share*: Basic $ .50 $ .41 Diluted $ .50 $ .41 Weighted average shares outstanding*: Basic 3,668,393 3,698,252 Effect of stock options and awards 40,026 37,134 Diluted 3,708,419 3,735,386
* Earnings per share and weighted average shares outstanding for three months ended March 31, 2003 have been restated to reflect the 10% stock dividend issued in March 2004. See accompanying notes to unaudited consolidated financial statements. -4- CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in Thousands)
Three Months Ended March 31 --------------------- 2004 2003 Cash Flows From Operating Activities: Net income $ 1,847 $ 1,518 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,046 1,191 Gains on sales of investment securities (441) -- Provision for loan losses 200 90 Amortization of stock bonus awards 20 10 Tax benefit from exercise of stock options and bonuses 85 -- Decrease in accrued interest receivable 27 129 Deferred income tax benefit (474) (46) Increase in pension liability 296 292 Increase in income tax liability 662 275 Change in other assets (268) 63 Change in other liabilities (583) (299) Other operating activities, net -- 8 -------- -------- Net cash provided by operating activities 2,417 3,231 -------- -------- Cash Flows From Investing Activities: Proceeds from sales of investment securities available-for-sale 12,052 -- Proceeds from maturities of debt and equity securities available-for-sale 3,200 3,144 Purchase of debt and equity securities available-for-sale (10,407) -- Net decrease in loans 8,550 2,609 Purchases of premises and equipment, net (571) (1,039) -------- -------- Net cash provided by investing activities 12,824 4,714 -------- -------- Cash Flows From Financing Activities: Net decrease in noninterest-bearing demand deposits (16,575) (17,232) Net (decrease) increase in interest-bearing demand and savings deposits (7,128) 758 Net increase in time deposits 19,970 890 Net (decrease) increase in accounts and drafts payable (34,143) 40,583 Net decrease in short-term borrowings (16) (27,429) Cash proceeds from exercise of stock options 111 -- Cash paid for stock dividend fractional shares (4) -- Cash dividends paid (703) (707) -------- -------- Net cash used in financing activities (38,488) (3,137) -------- -------- Net (decrease) increase in cash and cash equivalents (23,247) 4,808 Cash and cash equivalents at beginning of period 62,367 30,006 -------- -------- Cash and cash equivalents at end of period $ 39,120 $ 34,814 ======== ======== Supplemental information: Cash paid for interest $ 513 $ 440 Cash paid for income taxes 660 182
See accompanying notes to unaudited consolidated financial statements. -5- CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1 - Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the consolidated financial statements and related footnotes included in the Cass Information System, Inc.'s ("the Company") Annual Report on Form 10-K for the year ended December 31, 2003. Certain amounts in the 2003 consolidated financial statements have been reclassified to conform to the 2004 presentation. Such reclassifications have no effect on previously reported net income or shareholders' equity. All share and per share data for 2003 has been restated to reflect the 10% stock dividend issued in March 2004. Note 2 - Impact of New Accounting Pronouncements In December 2003, the FASB issued Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities" (FIN 46R), which addresses how a business enterprise should evaluate whether it has controlling financial interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FIN 46, "Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51," issued in January 2003. Companies are required to apply FIN 46R to variable interest entities (VIEs) created after December 31, 2003. For variable interest in VIEs created before January 1, 2004, FIN 46R will be applied beginning on January 1, 2005. The Company is currently not a primary beneficiary of a VIE and therefore adoption of FIN 46R did not have a material impact on its consolidated financial statements. In November 2003, the Emerging Issues Task Force (EITF) reached a consensus on certain disclosure requirements under EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." The new disclosure requirements apply to investments in debt and marketable equity securities that are accounted under SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities," and SFAS 124, "Accounting for Certain Investments Held by Not-for-Profit Organizations." Effective for fiscal years ending after December 15, 2003 companies are required to disclose information about debt or marketable equity securities with market values below carrying values. The Company currently only has one security in an unrealized loss position with a fair value of $2,009,000 and an unrealized loss of $1,000. This security is a U.S. Treasury security that was purchased in the second half of 2003 and therefore has been in an unrealized loss position for less than one year and the loss is considered temporary. In December 2003, the FASB issued SFAS 132 (Revised 2003), "Employers' Disclosures about Pensions and Other Postretirement Benefits," which increases the disclosure requirements of the original statement by requiring more details about pension plan assets, benefit obligations, cash flows, benefit costs and related information and also requires companies to disclose various elements of pension and postretirement benefit costs in interim-period financial statements for quarters beginning after December 15, 2003. Additional disclosures pertaining to benefit payments are required for fiscal years ending after June 30, 2004. The disclosure requirements of SFAS 132 (Revised 2003) that are required for quarters beginning after December 15, 2003 are included in Note 11 of this report. -6- Note 3 - Loans by Type (In Thousands) March 31, 2004 December 31, 2003 -------------------------------------------------------------------------------- Commercial and industrial $104,398 $103,638 Real estate: Mortgage 178,231 184,221 Mortgage - Churches & Related 142,079 145,929 Construction 5,085 2,920 Construction - Churches & Related 18,816 16,378 Industrial revenue bonds 5,328 5,373 Installment 1,954 1,911 Other 4,219 8,662 -------------------------------------------------------------------------------- Total loans $460,110 $469,032 -------------------------------------------------------------------------------- Note 4 - Stock Repurchases The Company maintains a treasury stock buyback program and as of September 30, 2003 was authorized by the Board of Directors to repurchase up to 100,000 shares of its common stock. The Company did not repurchase any stock during the First Quarter of 2004 or 2003. Repurchases are made in the open market or through negotiated transactions from time to time depending on market conditions. Note 5 - Comprehensive Income For the three-month periods ended March 31, 2004 and 2003, unrealized gains and losses on debt and equity securities available-for-sale were the Company's only other comprehensive income component. Comprehensive income for the three-month periods ended March 31, 2004 and 2003 is summarized as follows:
Three Months Ended March 31 ------------------- (In Thousands) 2004 2003 -------------------------------------------------------------------------------------- Net income $ 1,847 $ 1,518 Other comprehensive income: Net unrealized gain on debt and equity securities available-for-sale, net of tax 552 96 Less: reclassification adjustment for realized gains on sales of debt and equity securities, available-for-sale, included in net income, net of tax (291) -- -------------------------------------------------------------------------------------- Total other comprehensive income 261 96 -------------------------------------------------------------------------------------- Total comprehensive income $ 2,108 $ 1,614 --------------------------------------------------------------------------------------
Note 6 - Industry Segment Information The services provided by the Company are classified into four reportable segments: Transportation Information Services, Utility Information Services, Banking Services and Government Software 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 Transportation Information Services segment provides freight invoice rating, payment, auditing, cost accounting and transportation information services to large corporate shippers. The Utility Information Services segment processes and pays utility invoices, including electricity, gas, water and telecommunications, for large corporate entities that have many locations or are heavy users of energy. The Banking Services segment provides banking services primarily to privately-held businesses and churches. The Government Software Services segment provides the public sector with integrated financial, property and human resource management systems through the Bank's wholly-owned subsidiary, Government e-Management Solutions, Inc. (GEMS). The Company's accounting policies for segments are the same as those described in the summary of significant accounting policies in the Company's Annual Report on Form 10-K for the year ended December 31, 2003. 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 fair value. -7- All three segments market their services 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 three month periods ended March, 2004 and 2003, is as follows:
Transportation Utility Governmental Corporate Information Information Banking Software and Elim- (In Thousands) Services Services Services Services inations Total ------------------------------------------------------------------------------------------------------------ Quarter Ended March 31, 2004 Total Revenues: Revenue from customers $ 8,170 $ 3,621 $ 3,170 $ 1,179 $ -- $ 16,140 Intersegment revenue 13 6 355 -- (374) -- Net Income (Loss) 630 784 859 (426) -- 1,847 Total Assets 237,494 64,362 301,670 6,175 (5,918) 603,783 Goodwill 223 -- -- 2,927 -- 3,150 Other intangible assets, net -- -- -- 1,458 404 1,862 Quarter Ended March 31, 2003 Total Revenues: Revenue from customers $ 7,898 $ 2,757 $ 3,458 $ 1,796 $ -- $ 15,909 Intersegment revenue 58 15 295 -- (368) -- Net Income 177 262 1,047 32 -- 1,518 Total Assets 238,373 59,593 278,538 6,878 (12,415) 570,967 Goodwill 223 -- -- 2,927 -- 3,150 Other intangible assets, net -- -- -- 1,769 379 2,148 ------------------------------------------------------------------------------------------------------------
Note 7 - Intangible Assets The Company accounts for intangible assets in accordance with SFAS 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. Intangible assets for the periods ended March 31, 2004 and December 31, 2003 are as follows: (In Thousands) March 31, 2004 December 31, 2003 -------------------------------------------------------------------------------- Goodwill $3,150 $3,150 Customer list 754 768 Software 704 768 Minimum pension liability 404 404 -------------------------------------------------------------------------------- Other intangible assets, net 1,862 1,940 -------------------------------------------------------------------------------- Total intangible assets $5,012 $5,090 -------------------------------------------------------------------------------- Customer list and software are amortized over 15 years and 4 years, respectively. The minimum pension liability was recorded in accordance with SFAS 87, "Employers' Accounting for Pensions", which requires the Company to record an additional minimum pension liability by the amount of which the accumulated benefit obligation exceeds the sum of the fair value of plan assets and accrued amount 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 are adjusted annually. Amortization of intangible assets amounted to $78,000 for both the three-month periods ended March 31, 2004 and 2003. Estimated amortization of intangibles over the next five years is as follows: $311,000 in 2004, 2005 and 2006 and $55,000 in 2007 and 2008. -8- Note 8 - Equity Investments in Non-Marketable Securities During 2003, the Company converted its $2,000,000 investment in a private imaging company from a convertible debenture into common stock. As part of the conversion, the Company committed to invest an additional $1,100,000 if certain conditions were met. The total investment of the Company in this entity was $3,100,000 at March 31, 2004 and $2,908,000 at December 31, 2003. At March 31, 2004 the Company had a 19.93% ownership interest in this entity and the Chairman and CEO of the Company was a member of the entity's Board of Directors. No business has been transacted between the companies during the year. The Company made its initial investment in this entity in 2001 through a convertible debenture. The business has since performed poorly and during 2003 received a commitment of an additional $3,000,000 from a new non-affiliated majority owner, in addition to the Company's additional commitment. The new majority owner is currently in the process of stabilizing the business and improving its financial performance. Should this business fail to meet its objectives, the Company's investment could be subject to future impairment. If the sales goals of this business are significantly exceeded, an additional investment may also be required. This investment, along with $355,000 of other investments in non-marketable securities, is included in other assets on the Company's consolidated balance sheets. Note 9 - Commitments and Contingencies 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 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 March 31, 2004, no amounts have been accrued for any estimated losses for these instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commercial and standby letters of credit are conditional commitments issued by the Company 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 3 years. 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 may obtain and liquidate the collateral to recover amounts paid under its guarantees on these financial instruments. Summarized credit-related financial instruments, including both commitments to extend credit and letters of credit and operating lease commitments at March 31, 2004 are as follows: Amount of Commitment Expiration per Period ------------------------------------------ Less than 1-3 (In Thousands) Total 1 year Years ------------------------------------------------------------------------ Unused loan commitments $23,967 $21,949 $ 2,018 Standby letters of credit 4,062 360 3,702 Commercial letters of credit 814 814 -- Operating lease commitments 620 413 207 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. -9- Note 10 - Stock-Based Compensation The Company maintains two stock-based compensation plans, a stock bonus plan and a stock option plan. Upon issuance of shares in the stock bonus plan a contra shareholders' equity amount is recorded for the fair value of the shares at the time of issuance and this amount is amortized to expense over the three-year vesting period. The stock option plan is accounted for under APB 25, "Accounting for Stock Issued to Employees", and accordingly the Company recognizes no compensation expense as the price of the Company's employee stock options equals the market price of the underlying stock on the date of grant. The Company elected not to adopt the recognition provisions of SFAS 123, "Accounting for Stock-Based Compensation", as amended by SFAS 148. An entity that continues to apply APB 25 shall disclose certain pro forma information as if the fair value-based accounting method in SFAS 123 had been used to account for stock-based compensation costs. The required disclosure provisions of SFAS 123, as amended by SFAS 148, are provided in the table below. The Company uses the Black-Scholes option-pricing model to determine the fair value of the stock options at the date of grant. There were 5,871 and 12,000 options granted in the First Quarter of 2004 and 2003, respectively. The following table represents the effect on basic and diluted earnings per share and weighted average assumptions used for the periods ended March 31, 2004 and 2003: Three Months Ended March 31 ----------------------- (In Thousands, except per share data) 2004 2003 ------------------------------------------------------------------------- Net income: As reported $ 1,847 $ 1,518 Add: Stock based compensation expense included in reported net income, net of tax 13 7 Less: Stock based compensation expense determined under the fair value based method for all awards, net of tax (20) (18) ------------------------------------------------------------------------- Pro forma net income $ 1,840 $ 1,507 ------------------------------------------------------------------------- Net income per common share: Basic, as reported $ .50 $ .41 Basic, pro forma .50 .41 Diluted, as reported .50 .41 Diluted, pro forma .50 .40 ------------------------------------------------------------------------- Weighted average assumptions: Risk-free interest rate 3.31% 3.34% Expected life 7 yrs. 7 yrs. Expected volatility 15% 15% Dividend yield 2.52% 3.39% ------------------------------------------------------------------------- Note 11 - Defined Pension 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. Disclosure information is based on a measurement date of December 31 of the corresponding year. The following table represents the components of the net periodic pension costs for the three-month periods ended March 31, 2004 and 2003: Estimated Actual (In Thousands, except per share data) 2004 2003 --------------------------------------------------------------------- Service cost - benefits earned during the year $ 1,126 $ 979 Interest cost on projected benefit obligation 1,245 1,105 Expected return on plan assets (1,234) (1,055) Net amortization 68 13 --------------------------------------------------------------------- Net periodic pension cost - annual 1,205 1,042 --------------------------------------------------------------------- Net periodic pension cost - three months ended March 31 $ 301 $ 261 --------------------------------------------------------------------- -10- Pension costs recorded to expense were $260,000 and $237,000 for the First Quarter of 2004 and 2003, respectively. The Company has not made any contribution to the plan for the three-month period ended March 31, 2004, but is expecting to contribute approximately $1,038,000 in 2004. In addition to the above funded benefit plan, the Company has an unfunded supplemental executive retirement plan which covers key executives of the Company. This 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 its defined benefit plan. The following table represents the components of the net periodic pension costs of the unfunded plan for the three-month periods ended March 31, 2004 and 2003: Estimated Actual (In Thousands, except per share data) 2004 2003 ---------------------------------------------------------------------- Service cost - benefits earned during the year $ -- $ (24) Interest cost on projected benefit obligation 110 107 Net amortization 62 62 ---------------------------------------------------------------------- Net periodic pension cost - annual 172 145 ---------------------------------------------------------------------- Net periodic pension cost - three months ended March 31 $ 43 $ 36 ---------------------------------------------------------------------- Pension costs recorded to expense were $36,000 and $47,000 for the First Quarter of 2004 and 2003, respectively. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Cass Information Systems, Inc. provides payment and information processing services to national manufacturing, distribution and retail enterprises from its processing centers in St. Louis, Missouri, Columbus, Ohio, and Boston, Massachusetts. The Company's services include freight invoice rating, payment processing, auditing, and the generation of cost accounting and transportation information. Cass also processes and pays utility invoices, including electricity, gas and telecommunications. Cass extracts, stores and presents information from freight and utility invoices, assisting our customers' transportation and energy managers in making decisions that will enable them to improve their 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 its St. Louis, Missouri based bank subsidiary, provides banking services in the St. Louis metropolitan area and other selected cities in the United States. In addition to supporting the Company's payment operations, it also provides banking services to its target markets, which include privately owned businesses and churches. The Company, through the Bank's subsidiary, Government e-Management Solutions, Inc. (GEMS), also develops and licenses integrated financial, property and human resource management systems to the public sector. The specific payment and information processing services provided to each customer are developed individually to meet each customer's specific requirements. These requirements can vary greatly from customer to customer. In addition, the degree of automation such as electronic data interchange (EDI), imaging, and web-enhanced solutions varies greatly among customers and industries. These factors combine so that pricing varies greatly among the customer base. In general however, Cass is compensated for its processing services through service fees and account balances that are generated during the payment process. The amount, type and calculation of service fees vary greatly by service offering, but generally follow the volume of transactions processed. Interest income from the balances generated during the payment processing cycle is affected by the amount of time Cass holds the funds prior to payment and the dollar volume processed. Both the number of transactions processed and the dollar volume processed are therefore key metrics followed by management. Other factors have a significant influence on revenue and profitability however, such as changes in the general level of interest rates which has a significant affect -11- on net interest income. The funds generated by these processing activities are invested in overnight investments, investment grade securities and loans generated by the Bank. The Bank earns most of its revenue from net interest income, or the difference between the interest earned on its loans and investments and the interest expense on its deposits. The Bank also assesses fees on other services such as cash management services. GEMS earns its revenue from the license of its enterprise software solutions and fees for its installation and maintenance. Industry-wide factors that impact the Company include the acceptance by large corporations of the outsourcing of key business functions such as freight and utility payment. 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 and the deregulation of energy costs. Economic factors that impact the Company include the general level of economic activity that can affect the volume and size of invoices processed, the ability to hire and retain qualified staff and the growth and quality of our loan portfolio. The general level of interest rates has a significant affect on the revenue of the Company. Finally, the general fiscal condition of the counties and municipalities that can benefit from GEMS' enterprise software can impact licenses sold and related revenue. Currently, management views Cass' major opportunity and challenge as the continued expansion of its payment and information processing service offerings and customer base. Management intends to accomplish this by maintaining our lead in applied technology, which, when combined with the security and processing controls of the Company's Bank, makes Cass unique in the industry. This trend has been positive over the past years and management anticipates that this should continue in 2004. The low level of interest rates has had a significant negative impact on net income over the past few years. While management doesn't anticipate that these rates will rise in the near term, the Company is well positioned to take advantage of rising rates when they occur. Management has been pleased with the growth in software revenue generated by GEMS during the past three years and is making additional investments to continue this trend. Management intends to continue to refine risk management practices, monitor and manage the quality of the loan portfolio and maintain a strong financial and liquidity position. Critical Accounting Policies The Company has prepared all of the consolidated financial information in this report in accordance with accounting principles generally accepted in the United States of America (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, they have been consistent and have not required any material changes. There can be no assurances that actual results will not differ from those estimates. Certain accounting policies that require significant management estimates and are deemed critical to our results of operations or financial position have been discussed with the Audit Committee of the Board of Directors and are described below. Allowance for Loan Losses. The Company performs periodic and systematic detailed reviews of its loan portfolio to assess overall collectability. The level of the allowance for loan losses reflects management's estimate of the collectability of the loan portfolio. Although these estimates are based on established methodologies for determining allowance requirements, actual results can differ significantly from estimated results. These policies affect all segments of the Company with the exception of governmental software services. The impact and associated risks related to these policies on our business operations are discussed in the " Allowance and Provision for Loan Losses" section of this report. Impairment of Assets. Management periodically evaluates certain long-term assets such as intangible assets including goodwill, foreclosed assets, internally developed software and investments in private equity securities for impairment. Generally, these assets are initially recorded at cost, and recognition of impairment is required when events and circumstances indicate that the carrying amounts of these assets will not be recoverable in the future. If impairment occurs, various methods of measuring impairment may be called for depending on the circumstances and type of asset, including quoted market prices, estimates based on similar assets, and estimates based on valuation techniques such as discounted projected cash flows. Assets held for sale are carried at the lower of cost or fair value less costs to sell. These policies affect all segments of the Company and require significant management assumptions and estimates that could result in materially different results if conditions or underlying circumstances change. -12- Results of Operations The following paragraphs more fully discuss the results of operations and changes in financial condition for the three-month period ended March 31, 2004 (the "First Quarter of 2004") compared to the three-month period ended March 31, 2003 (the "First Quarter of 2003"). The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes and with the statistical information and financial data appearing in this report as well as the Company's 2003 Annual Report on Form 10-K. Results of operations for the First Quarter of 2004 are not necessarily indicative of the results to be attained for any other period. Net Income The Company's net income was $1,847,000 for the First Quarter of 2004, a $329,000 or 22% increase compared to net income of $1,518,000 for the First Quarter of 2003. Diluted earnings per share were $.50 for the First Quarter of 2004, a 22.0% increase compared to $.41 for the First Quarter of 2003. The increase in net income in the First Quarter of 2004 over the First Quarter of 2003 was primarily a result of an increase in payment and processing revenue, gains on the sales of investment securities and a decrease in operating expenses. This was partially offset by a decrease in net interest income, due to lower interest rates and a decrease in software revenues. Return on average assets for the First Quarter of 2004 was 1.13% compared to 1.04% for the First Quarter of 2003. Return on average equity for the First Quarter of 2004 was 11.52% compared to 10.13% for the First Quarter of 2003. Fee Revenue and Other Income Fee revenue is principally derived from freight and utility payment and processing fees. Processing volumes related to these fees for the three-month periods ended March 31, 2004 and 2003 are as follows: Three Months Ended March 31 ---------------------------------- % (In Thousands) 2004 2003 Change -------------------------------------------------------------------------- Transportation Information Services: Invoice Bill Volume 5,429 5,666 (4.2%) Invoice Dollar Volume $2,221,646 $2,053,912 8.2% Payment and Processing Fees $ 4,946 $ 4,969 (.5%) Utility Information Services: Invoice Bill Volume 1,284 1,033 24.3% Invoice Dollar Volume $ 934,361 $ 825,361 13.2% Payment and Processing Fees $ 2,652 $ 2,000 32.6% Fees from the Transportation Information Services remained relatively flat. The decrease in transactions (invoice bill volume) exceeded the decrease in payment and processing fees due to a change in the mix of invoices processed over the same period last year. The percentage of small dollar, electronic transactions decreased and was replaced by larger dollar transactions that required a higher level of processing and produced greater fees. The increase in volumes and fees from the Utility Information Services division increased primarily due to new customers as the growth of this relatively new segment continues. Software revenue is down $617,000 or 34% from the First Quarter of 2003 primarily due to reduced license fee revenue generated from new customers. Although revenue generated by GEMS increased in each of the past three years, sales were off significantly in the First Quarter of 2004. Demand for software in the governmental sector has softened from last year. At this time management feels that this is a temporary condition. Bank service fees for the First Quarter of 2004 decreased a modest $12,000 or 3% compared to the First Quarter of 2003. Net gains of $441,000 were recognized on the sales of securities with proceeds of $12,052,000 during the First Quarter of 2004 and no gains were recognized in the First Quarter of 2003. Other income increased $6,000 in the First Quarter of 2004 compared with the First Quarter of 2003. -13- Net Interest Income First Quarter of 2004 compared to First Quarter of 2003: The Company's tax-equivalent net interest income decreased 2% or $113,000 from $6,939,000 to $6,826,000. The tax-equivalent net interest margin decreased from 5.27% to 4.58%. The decline in the general level of interest rates from a prime rate of 9.50% at the beginning of 2001 to the current rate of 4.00% continues to have an impact on the Company's net interest income and margin. The average yield on earning assets decreased to 4.96% in the First Quarter of 2004 from 5.62% in 2003. The Company is negatively affected by decreases in the level of interest rates due to the fact that its rate sensitive assets significantly exceed its rate sensitive liabilities. Conversely, the Company is positively affected by increases in the level of interest rates. This is primarily due to the noninterest-bearing liabilities generated by the Company in the form of accounts and drafts payable. Changes in interest rates will affect some earning assets such as federal funds sold and floating rate loans immediately and some earning assets, such as fixed rate loans and municipal bonds, over time. The Company partially offset the decrease in net interest income through an increase in earning assets. Total average earning assets increased $64,911,000 or 12% to $599,227,000. This increase was funded by both an increase in accounts and drafts payable due to the increase in payments processed and an increase in bank deposits due to the expansion of the Banks' customer base. Total average loans increased $29,360,000 or 7% to $463,461,000. This increase was attributable to new business relationships and was funded by the increase in accounts and drafts payable and growth in bank deposits. Although not enough to offset the decline in the level of interest rates, this increase in loans had a positive effect on interest income and the net interest margin due to the fact that loans are one of the Company's highest yielding earning assets for any given maturity. Total average investment in debt and equity securities decreased $1,506,000 or 2% to $64,638,000. Total average federal funds sold and other short-term investments increased $37,057,000 or 109% to $71,128,000. This increase provides additional liquidity and positions the Company to take advantage of higher interest rates should they occur. For more information on the changes in net interest income please refer to the tables on pages 14 and 15. Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rate and Interest Differential The following table shows the condensed average balance sheets for each of the periods reported, the 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.
First Quarter 2004 First Quarter 2003 Interest Interest -------------------------------- ---------------------------------- Average Income/ Yield/ Average Income/ Yield/ (Dollars in Thousands) Balance Expense Rate Balance Expense Rate ---------------------------------------------------------------------------------------------------------------- Assets (1) Earning assets: Loans (2),(3): Taxable $ 458,116 $6,387 5.61% $ 428,352 $ 6,345 6.01% Tax-exempt (4) 5,345 101 7.60 5,749 108 7.62 Debt and equity securities (5): Taxable 23,785 97 1.64 26,584 188 2.87 Tax-exempt (4) 40,853 646 6.36 39,560 658 6.75 Federal funds sold and other short-term investments 71,128 162 .92 34,071 100 1.19 ---------------------------------------------------------------------------------------------------------------- Total earning assets 599,227 7,393 4.96 534,316 7,399 5.62 Nonearning assets: Cash and due from banks 18,857 18,976 Premises and equipment, net 13,474 15,833 Intangible assets 5,063 5,349 Other assets 26,016 22,141 Allowance for loan losses (5,560) (5,327) ---------------------------------------------------------------------------------------------------------------- Total assets $ 657,077 $ 591,288 ---------------------------------------------------------------------------------------------------------------- Liabilities And Shareholders' Equity (1) Interest-bearing liabilities: Interest-bearing demand deposits 56,611 79 .56% $ 54,777 $ 117 .87% Savings deposits 30,387 51 .68 35,772 82 .93 Time deposits of $100 or more 48,454 267 2.22 42,666 213 2.02 Other time deposits 34,672 170 1.97 5,715 39 2.77 ---------------------------------------------------------------------------------------------------------------- Total interest-bearing deposits 170,124 567 1.34 138,930 451 1.32 Short-term borrowings 118 -- -- 2,574 9 1.42 ---------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 170,242 567 1.34 141,504 460 1.32 Noninterest-bearing liabilities: Demand deposits 100,436 94,893 Accounts and drafts payable 313,593 287,700 Other liabilities 8,343 6,401 ---------------------------------------------------------------------------------------------------------------- Total liabilities 592,614 530,498 Shareholders' equity 64,463 60,790 Total liabilities and shareholders' equity $ 657,077 $ 591,288 ---------------------------------------------------------------------------------------------------------------- Net interest income $6,826 $ 6,939 Interest spread 3.62% 4.30% Net interest margin 4.58% 5.27% ----------------------------------------------------------------------------------------------------------------
-14- 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 Note 1 to the Company's 2003 Consolidated Financial Statements. 3. Interest income on loans includes net loan fees of $41,000 and $11,000 for the First Quarter of 2004 and 2003, respectively. 4. Interest income is presented on a tax-equivalent basis assuming a tax rate of 34%. The tax-equivalent adjustment was approximately $253,000 and $260,000 for the First Quarter of 2004 and 2003, 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. Analysis of Net Interest Income Changes The following table presents the changes in interest income and expense between periods due to changes in volume and interest rates. That portion of the change in interest attributable to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the absolute dollar amounts of the change in each. First Quarter 2004 Over 2003 ------------------------- (In Thousands) Volume Rate Total ------------------------------------------------------------------------------- Increase (decrease) in interest income: Loans (1),(2): Taxable $ 458 $(416) $ 42 Tax-exempt (3) (7) -- (7) Debt and equity securities: Taxable (18) (73) (91) Tax-exempt (3) 23 (35) (12) Federal funds sold and other short-term investments 90 (28) 62 ------------------------------------------------------------------------------- Total interest income 546 (552) (6) ------------------------------------------------------------------------------- Interest expense on: Interest-bearing demand deposits 4 (42) (38) Savings deposits (11) (20) (31) Time deposits of $100 or more 32 22 54 Other time deposits 145 (14) 131 Short-term borrowings (4) (5) (9) ------------------------------------------------------------------------------- Total interest expense 166 (59) 107 ------------------------------------------------------------------------------- Net interest income $ 380 $(493) $(113) ------------------------------------------------------------------------------- 1. Average balances include nonaccrual loans. 2. Interest income includes net loan fees. 3. Interest income is presented on a tax-equivalent basis assuming a tax rate of 34%. -15- Allowance and Provision for Loan Losses A significant determinant of the Company's operating results is the provision for loan losses and the level of loans charged off. There was a $200,000 provision made for loan losses during the First Quarter of 2004 compared with $90,000 in the First Quarter of 2003. Net loans recovered for the First Quarter of 2004 were $3,000 compared to $4,000 for the First Quarter of 2003. The provision for loan losses can vary over time based on an ongoing assessment of the adequacy of the allowance for loan losses. The allowance for loan losses at March 31, 2004 was $5,709,000 and at December 31, 2003 was $5,506,000. The ratio of allowance for loan losses to total loans outstanding at March 31, 2004 was 1.24% compared to 1.17% at December 31, 2003. Nonperforming loans were $3,451,000 or .75% of total loans at March 31, 2004 compared to $4,393,000 or .94% of total loans at December 31, 2003. The decrease from December 31, 2003 is primarily due to two loans; one for $481,000 that was renegotiated in First Quarter of 2003 and is now current under the new terms of the agreement and a second loan for $376,000 that was foreclosed in the First Quarter of 2004 and is now being carried as other real estate owned. At March 31, 2004, impaired loans totaled $3,617,000, which included $1,041,000 of nonaccrual loans compared with impaired loans at December 31, 2003 of $4,393,000, which included $1,525,000 of nonaccrual loans. The allowance for loan losses on impaired loans was $966,000 at March 31, 2004 and there were no impaired loans without an allowance. The decrease in impaired loans from December 31, 2003 relates primarily to the decrease in nonperforming loans as explained in the previous paragraph. Total impaired loans decreased $4,395,000 from March 31, 2003 to March 31, 2004. A decrease of $4,482,000 in other impaired loans relates primarily to two loans totaling $4,252,000 that were renegotiated in 2002. These loans have been current under the terms of the agreement for over one year and are considered performing by management at March 31, 2004. The decrease of $2,834,000 in loans past due 90 days or more relates primarily to one loan with a balance of $2,000,000 at March 31, 2003 that was a convertible debenture, which the Company converted to common stock, as explained in Note 8 of this report. A second loan, with a balance of $791,000 at March 31, 2003, is included in nonaccrual loans at March 31, 2004 with a balance of $731,000. There was one loan with a balance of $481,000 that was classified as renegotiated in the First Quarter of 2003 that is current under the new terms of the loan and considered performing. These decreases were offset by an increase in nonaccrual loans of $992,000 relating primarily to two loans, the largest with a balance of $731,000 that is collateralized by real estate and has a SBA guarantee. There has been some delinquency in loan payments of this loan due to slower than expected lease-up of real estate property. The second loan, with a balance of $270,000, relates to a business that is no longer operating, although payments are being made as the inventory of the business is being sold. The current balance of $2,410,000 of loans renegotiated as of March 31, 2004 relates to two borrowers and although currently performing, are still considered impaired by management. The allowance for loan losses has been established and is maintained to absorb losses inherent in the loan portfolio. An ongoing assessment of risk of loss is performed to determine if the current balance of the allowance is adequate to cover probable losses in the portfolio. A charge or credit is made to expense to cover any deficiency or reduce any excess. The current methodology employed to determine the appropriate allowance consists of two components, specific and general. The Company develops specific valuation allowances on commercial, commercial real estate, and construction loans based on individual review of these loans and our estimate of the borrower's ability to repay the loan given the availability of collateral, other sources of cash flow and collection options available to us. The general component relates to all other loans, which are evaluated based on loan grade. The loan grade assigned to each -16- 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 Asset Quality The following table presents information as of and for the three month periods ended March 31, 2004 and 2003 pertaining to the Company's provision for loan losses and analysis of the allowance for loan losses.
Three Months Ended March 31 ------------------------ (Dollars in Thousands) 2004 2003 ------------------------------------------------------------------------------------ Allowance at beginning of period $ 5,506 $ 5,293 Provision charged to expense 200 90 Loans charged off (1) (2) Recoveries on loans previously charged off 4 6 ------------------------------------------------------------------------------------ Net loan recoveries 3 4 Allowance at end of period $ 5,709 $ 5,387 ------------------------------------------------------------------------------------ Loans outstanding: Average $ 463,461 $ 434,101 March 31 460,110 432,084 Ratio of allowance for loan losses to loans outstanding: Average 1.23% 1.24% March 31 1.24% 1.25% Nonperforming loans: Nonaccrual loans $ 1,041 $ 49 Loans past due 90 days or more -- 2,834 Renegotiated loans 2,410 481 ------------------------------------------------------------------------------------ Total non performing loans $ 3,451 $ 3,364 Other impaired loans $ 166 $ 4,648 Foreclosed assets $ 1,234 $ 1,112 ------------------------------------------------------------------------------------ Nonperforming loans as a percent of average loans .74% .77% ------------------------------------------------------------------------------------
The Bank currently has two properties which it is carrying as other real estate owned at what management believes to be fair value less cost to sell. The first property was foreclosed on August 8, 2001 and is recorded at $859,000 and the second property was foreclosed on March 2, 2004 and is recorded at $375,000. Operating Expense Total operating expense for the First Quarter of 2004 decreased $295,000 or 2% to $13,482,000 compared to the First Quarter of 2003. Salaries and benefits expense decreased $195,000 or 2% to $9,157,000 in the First Quarter of 2004 compared with the First Quarter of 2003. This decrease is primarily related to a reduction in the number of employees attributable to a series of technology initiatives put into place by the Information Services divisions. The decrease in salaries was partially offset by an increase in benefits expenses related to pension contribution and health insurance costs. Occupancy expense for the First Quarter of 2004 increased $22,000 or 5% to $458,000 from the First Quarter of 2003. This increase relates primarily to increases in both utility expense and building expenses related to leased property. -17- Equipment expense for the First Quarter of 2004 decreased $136,000 or 12% compared to the First Quarter of 2003. This decrease is primarily due to a decrease in hardware and software depreciation and amortization and a decrease in computer equipment maintenance from the consolidation of equipment within the transportation processing division. Other operating expense for the First Quarter of 2004 decreased $4,000 compared to the First Quarter of 2003. There was an increase in outsourced services of $133,000, which was mostly offset by a decrease in postage and supplies expense from the Company's Transportation Information Services division. Income tax expense for the First Quarter of 2004 was $811,000, an increase of $215,000 or 36% compared to the First Quarter of 2003. The effective tax rate for the First Quarter of 2004 was 31% compared with 28% in the First Quarter of 2003 due primarily to the lower proportion of income generated from tax-exempt investments in the First Quarter of 2004. Financial Condition Total assets at March 31, 2004 decreased $35,913,000 or 6% from December 31, 2003. Of this decrease $19,538,000 relates to a 44% decrease in federal funds sold and other short-term investments and $9,125,000 relates to a 2% decrease in loans, net of the allowance for loan losses. There was also a decrease of $4,124,000 in investments in debt and equity securities and $3,709,000 in cash and due from banks. Total liabilities were $537,374,000, a decrease of $37,530,000 or 7% from December 31, 2003. Total deposits at March 31, 2004 were $268,695,000, a decrease of $3,733,000 or 1%. Accounts and drafts payable were $259,626,000, a decrease of $34,143,000 or 12%. Total shareholders' equity at March 31, 2004 was $66,409,000, a $1,617,000 or 2% increase from December 31, 2003. The decrease in loans relates to the normal fluctuations in the loan portfolio that result from new advances, amortization of principal and payoffs. The Bank also participated loans to an unaffiliated bank as part of its risk management process. The decrease in debt and equity securities relates to the sale of $12,052,000 in securities and $3,200,000 in securities that matured that was offset by the purchase of $10,407,000 of additional securities. Federal funds sold and other short-term investments decreased due to a decrease in deposits and accounts and drafts payable from December 31, 2003 to March 31, 2004. The decrease in deposits reflects normal daily and seasonal fluctuations and the decrease in accounts and drafts payable was due primarily to the fact that these balances will fluctuate from period-end to period-end due to the payment processing cycle, which results in lower balances on days when checks clear and higher balances on days when checks are issued. For this reason, average balances are a more meaningful measure of accounts and drafts payable (for average balances refer to the table on pages 14 and 15). The increase in total shareholders' equity resulted from net income of $1,847,000; an increase of $261,000 in other comprehensive income; cash received on the exercise of stock options of $111,000; an $85,000 tax benefit on stock awards and the amortization of the stock bonus plan of $20,000; offset by dividends paid of $703,000 ($.21 per share) and $4,000 of cash paid for stock dividend fractional shares. Liquidity and Capital Resources The balances of liquid assets consists of cash and cash equivalents, which include cash and due from banks, federal funds sold and money market funds, and were $39,120,000 at March 31, 2004, a decrease of $23,247,000 or 37% from December 31, 2003. At March 31, 2004 these assets represented 6% of total assets. These funds are the Company's and its subsidiaries' primary source of liquidity to meet future expected and unexpected loan demand, depositor withdrawals or reductions in accounts and drafts payable. Secondary sources of liquidity include the investment portfolio and borrowing lines. Total investment in debt and equity securities was $65,023,000 at March 31, 2004, a decrease of $4,124,000 from December 31, 2003. These assets represented 11% of total assets at March 31, 2004. Of this total, 59% were state and political subdivision securities, 31% were U.S. Treasury securities, 9% were U.S. government agencies and 1% were other securities. Of the total portfolio, 26% mature in one year, 13% matures in one to five years, and 61% matures in five or more years. During the year the Company sold securities with a market value of $12,052,000 and a portion of these funds were reinvested in U.S. Treasury and agency securities. The Bank has unsecured lines at correspondent banks to purchase federal funds up to a maximum of $33,000,000. Additionally, the Bank maintains a line of credit at an unaffiliated financial institution in the maximum amount of $85,418,000 collateralized by securities sold under repurchase agreements. -18- The deposits of the Company's banking subsidiary have historically been stable, consisting of a sizable volume of core deposits related to customers that utilize many other commercial products of the Bank. The accounts and drafts payable generated by the Company has also historically been a stable source of funds. Net cash flows provided by operating activities were $2,417,000 for the First Quarter of 2004 compared with $3,231,000 for the First Quarter of 2003. This decrease is attributable to an additional $478,000 paid in corporate income taxes, the $441,000 gain on the sales of securities and other normal fluctuations in other asset and liability accounts. Net cash flows from investing and financing activities fluctuate greatly as the Company actively manages its investment and loan portfolios and customer activity influences changes in deposit and accounts and drafts payable balances. Further analysis of the changes in these account balances is discussed earlier in this report. Due to the daily fluctuations in these account balances, the analysis of changes in average balances, also discussed earlier in this report, can be more indicative of underlying activity than the period-end balances used in the statements of cash flows. Management anticipates that cash and cash equivalents, maturing investments and cash from operations will continue to be sufficient to fund the Company's operations and capital expenditures in 2004. The Company faces market risk to the extent that its net interest income and fair market value of equity are affected by changes in market interest rates. For information regarding the market risk of the Company's financial instruments, see Item 3. "QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK". Risk-based capital guidelines require the Company to meet a minimum total capital ratio of 8.0% of which at least 4.0% must consist of Tier 1 capital. Tier 1 capital generally consists of (a) common shareholders' equity (excluding the unrealized market value adjustments on the available-for-sale securities), (b) qualifying perpetual preferred stock and related surplus subject to certain limitations specified by the FDIC, (c) minority interests in the equity accounts of consolidated subsidiaries less (d) goodwill, (e) mortgage servicing rights within certain limits, and (f) any other intangible assets and investments in subsidiaries that the FDIC determines should be deducted from Tier 1 capital. The FDIC also requires a minimum leverage ratio of 3.0%, defined as the ratio of Tier 1 capital less purchased mortgage servicing rights to total assets, for banking organizations deemed the strongest and most highly rated by banking regulators. A higher minimum leverage ratio is required of less highly rated banking organizations. Total capital, a measure of capital adequacy, includes Tier 1 capital, allowance for loan losses, and debt considered equity for regulatory capital purposes. The Company and the Bank continue to exceed all regulatory capital requirements, as evidenced by the following capital amounts and ratios at March 31, 2004 and December 31, 2003: March 31, 2004 Amount Ratio ------------------------------------------------------------------------------- Total capital (to risk-weighted assets) Cass Information Systems, Inc. $66,117,000 12.78% Cass Commercial Bank 32,214,000 11.47 Tier I capital (to risk-weighted assets) Cass Information Systems, Inc. $60,408,000 11.68% Cass Commercial Bank 28,700,000 10.22 Tier I capital (to average assets) Cass Information Systems, Inc. $60,408,000 9.26% Cass Commercial Bank 28,700,000 9.14 ------------------------------------------------------------------------------- December 31, 2003 Amount Ratio ------------------------------------------------------------------------------- Total capital (to risk-weighted assets) Cass Information Systems, Inc. $64,480,000 12.07% Cass Commercial Bank 31,741,000 11.17 Tier I capital (to risk-weighted assets) Cass Information Systems, Inc. $58,974,000 11.04% Cass Commercial Bank 28,190,000 9.92 Tier I capital (to average assets) Cass Information Systems, Inc. $58,974,000 9.57% Cass Commercial Bank 28,190,000 9.49 ------------------------------------------------------------------------------- -19- Inflation The Company's assets and liabilities are primarily monetary, consisting of cash, cash equivalents, securities, loans, payables and deposits. Monetary assets and liabilities are those that can be converted into a fixed number of dollars. The Company's consolidated balance sheet reflects a net positive monetary position (monetary assets exceed monetary liabilities). During periods of inflation, the holding of a net positive monetary position will result in an overall decline in the purchasing power of a company. Management believes that replacement costs of equipment, furniture, and leasehold improvements will not materially affect operations. The rate of inflation does affect certain expenses, such as those for employee compensation, which may not be readily recoverable in the price of the Company's services. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As described in the Company's Annual Report on Form 10-K for the year ended December 31, 2003, the Company manages its interest rate risk through measurement techniques that include gap analysis and a simulation model. As part of the risk management process, asset/liability management policies are established and monitored by management. The policy objective is to limit the change in annualized net interest income to 15% from an immediate and sustained parallel change in interest rates of 200 basis points. Based on the Company's most recent evaluation, management does not believe the Company's risk position at March 31, 2004 has changed materially from that at December 31, 2003. ITEM 4. CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures designed to ensure that the information it is required to disclose in the reports it files with the SEC is recorded, processed, summarized and reported to management, including the Chief Executive Officer and Chief Financial Officer, within the time periods specified in the rules of the SEC. The Company's Chief Executive and Chief Financial Officers have reviewed and evaluated the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2004 and based on their evaluation believe that these procedures are effective to ensure that the Company is able to collect, process and disclose the information it is required to disclose in the reports it files with the SEC within the required time periods. There were no changes in the first quarter of 2004 in the Company's internal controls identified by the Chief Executive and Chief Financial Officers in connection with their evaluation that materially affected or are reasonably likely to materially affect the Company's internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). -20- PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES None ITEM 3. DEFAULTS IN SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibit 3.2 Amended and Restated Bylaws of Registrant. Exhibit 10.1 Form of Directors' Indemnification Agreement. Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports of Form 8-K The Company filed a report on Form 8-K under Items 7 and 12 dated January 29, 2004, reporting the announcement of the Company's earnings for the fourth quarter of 2004. -21- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CASS INFORMATION SYSTEMS, INC. DATE: May 7, 2004 By /s/ Lawrence A. Collett ------------------------------- Lawrence A. Collett Chairman and Chief Executive Officer DATE: May 7, 2004 By /s/ Eric H. Brunngraber ------------------------------- Eric H. Brunngraber Vice President-Secretary (Chief Financial and Accounting Officer) -22-