10-Q 1 e400671_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 June 30, 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 July 30, 2004: Common stock, par value $.50 per share - 3,685,111 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 June 30, 2004 (unaudited) and December 31, 2003 .................. 3 Consolidated Statements of Income Three and six months ended June 30, 2004 and 2003 (unaudited) .... 4 Consolidated Statements of Cash Flows Six months ended June 30, 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 .... 23 Item 4. CONTROLS AND PROCEDURES ....................................... 23 PART II - Other Information - Items 1. - 6. ................................. 24 SIGNATURES ............................................................ 25 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)
June 30 December 31 2004 2003 Assets Cash and due from banks $ 21,994 $ 17,754 Federal funds sold and other short-term investments 63,095 44,613 --------- --------- Cash and cash equivalents 85,089 62,367 --------- --------- Investment in debt and equity securities available-for-sale, at fair value 87,336 69,147 Loans 474,560 469,032 Less: Allowance for loan losses 5,865 5,506 --------- --------- Loans, net 468,695 463,526 --------- --------- Premises and equipment, net 12,710 13,538 Bank owned life insurance 10,860 10,709 Goodwill 3,150 3,150 Other intangible assets, net 1,784 1,940 Other assets 18,538 15,319 --------- --------- Total assets $ 688,162 $ 639,696 ========= ========= Liabilities and Shareholders' Equity Liabilities: Deposits: Noninterest-bearing $ 102,988 $ 114,634 Interest-bearing 194,712 157,794 --------- --------- Total deposits 297,700 272,428 Accounts and drafts payable 315,773 293,769 Short-term borrowings 107 123 Other liabilities 8,746 8,584 --------- --------- Total liabilities 622,326 574,904 --------- --------- 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 June 30, 2004 and December 31, 2003, respectively 2,247 2,080 Additional paid-in capital 18,359 8,466 Retained earnings 61,776 69,695 Common shares in treasury, at cost (809,399 shares at June 30, 2004 and 824,598 shares at December 31, 2003) (16,139) (16,442) Unamortized stock bonus awards (211) (129) Accumulated other comprehensive (loss) income (196) 1,122 --------- --------- Total shareholders' equity 65,836 64,792 --------- --------- Total liabilities and shareholders' equity $ 688,162 $ 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 Six Months Ended June 30 June 30 ------------------------ ------------------------ 2004 2003 2004 2003 Fee Revenue and Other Income: Freight and utility payment and processing revenue $ 7,621 $ 6,870 $ 15,219 $ 13,839 Software revenue 1,134 1,854 2,313 3,650 Bank service fees 430 465 844 891 Gains on sales of investment securities -- 1,362 441 1,362 Other 177 136 312 265 ---------- ---------- ---------- ---------- Total fee revenue and other income 9,362 10,687 19,129 20,007 ---------- ---------- ---------- ---------- Interest Income: Interest and fees on loans 6,432 6,319 12,886 12,735 Interest and dividends on debt and equity securities: Taxable 116 133 213 321 Exempt from federal income taxes 465 351 892 786 Interest on federal funds sold and other short-term investments 199 126 361 226 ---------- ---------- ---------- ---------- Total interest income 7,212 6,929 14,352 14,068 ---------- ---------- ---------- ---------- Interest Expense: Interest on deposits 738 439 1,305 890 Interest on short-term borrowings -- 5 -- 14 ---------- ---------- ---------- ---------- Total interest expense 738 444 1,305 904 ---------- ---------- ---------- ---------- Net interest income 6,474 6,485 13,047 13,164 Provision for loan losses 150 -- 350 90 ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 6,324 6,485 12,697 13,074 ---------- ---------- ---------- ---------- Operating Expense: Salaries and employee benefits 9,301 9,400 18,458 18,752 Occupancy 436 457 894 893 Equipment 986 1,121 2,011 2,282 Other operating 2,590 2,918 5,432 5,764 ---------- ---------- ---------- ---------- Total operating expense 13,313 13,896 26,795 27,691 ---------- ---------- ---------- ---------- Income before income tax expense 2,373 3,276 5,031 5,390 Income tax expense 673 1,037 1,484 1,633 ---------- ---------- ---------- ---------- Net income $ 1,700 $ 2,239 $ 3,547 $ 3,757 ========== ========== ========== ========== Earnings per share: Basic $ .47 $ .61 $ .97 $ 1.02 Diluted $ .45 $ .60 $ .95 $ 1.01 Weighted average shares outstanding: Basic 3,674,409 3,689,165 3,671,401 3,693,683 Effect of dilutive stock options and awards 51,490 33,398 45,758 35,266 Diluted 3,725,899 3,722,563 3,717,159 3,728,949
See accompanying notes to unaudited consolidated financial statements. -4- CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in Thousands)
Six Months Ended June 30 --------------------- 2004 2003 Cash Flows From Operating Activities: Net income $ 3,547 $ 3,757 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,071 2,369 Provision for loan losses 350 90 Amortization of stock bonus awards 45 25 Tax benefit from exercise of stock option and bonus awards 99 173 Decrease in accrued interest receivable 159 685 (Decrease) increase in deferred income (100) 1,796 Deferred income tax benefit (1,287) (757) (Decrease) increase in income tax liability (689) 1,190 Increase in pension liability 697 573 Gains on sales of investment securities (441) (1,362) Change in other assets (1,221) (113) Change in other liabilities 288 (1,395) Other operating activities, net (2) 9 -------- -------- Net cash provided by operating activities 3,516 7,040 -------- -------- Cash Flows From Investing Activities: Proceeds from sales of debt securities available-for-sale 12,052 24,534 Proceeds from maturities of debt and equity securities available-for-sale 9,200 7,197 Purchase of debt and equity securities available-for-sale (41,247) (1,038) Net increase in loans (5,894) (10,922) Purchases of premises and equipment, net (836) (1,348) -------- -------- Net cash (used in) provided by investing activities (26,725) 18,423 -------- -------- Cash Flows From Financing Activities: Net decrease in noninterest-bearing demand deposits (11,646) (5,257) Net increase (decrease) in interest-bearing demand and savings deposits 24,063 (1,037) Net increase in time deposits 12,855 16,091 Net increase in accounts and drafts payable 22,004 45,521 Net decrease in short-term borrowings (16) (37,420) Cash proceeds from exercise of stock options 151 236 Cash paid for stock dividend fractional shares (4) -- Cash dividends paid (1,476) (1,414) Purchase of common shares for treasury -- (1,764) -------- -------- Net cash provided by financing activities 45,931 14,956 -------- -------- Net increase in cash and cash equivalents 22,722 40,419 Cash and cash equivalents at beginning of period 62,367 30,006 -------- -------- Cash and cash equivalents at end of period $ 85,089 $ 70,425 ======== ======== Supplemental information: Cash paid for interest $ 1,238 $ 899 Cash paid for income taxes 2,658 695 Transfer of loans to other real estate owned 375 -- Transfer of loans to other equity investments -- 2,000
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 U.S. generally accepted accounting principles 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 U.S. generally accepted accounting principles 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 June 30, 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 the adoption of FIN 46R did not have a material impact on its consolidated financial statements. 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) are included in Note 11 of this report. Note 3 - Loans by Type (In Thousands) June 30, 2004 December 31, 2003 -------------------------------------------------------------------------------- Commercial and industrial $106,716 $103,638 Real estate: Mortgage 177,525 184,221 Mortgage - churches & related 159,870 145,929 Construction 14,787 2,920 Construction - churches & related 5,957 16,378 Industrial revenue bonds 5,283 5,373 Installment 1,294 1,911 Other 3,128 8,662 -------------------------------------------------------------------------------- Total loans $474,560 $469,032 -------------------------------------------------------------------------------- Note 4 - Stock Repurchases The Company maintains a treasury stock buyback program and as of June 30, 2004 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 six months ended June 30, 2004 and repurchased 59,237 shares for $1,764,000 during the first six months ended June 30, 2003. Repurchases are made in the open market or through negotiated transactions from time to time depending on market conditions. -6- Note 5 - Comprehensive Income For the three and six month periods ended June 30, 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 and six month periods ended June 30, 2004 and 2003 is summarized as follows:
Three Months Ended Six Months Ended June 30 June 30 ------------------- ------------------ (In Thousands) 2004 2003 2004 2003 -------------------------------------------------------------------------------------------------------------- Net Income $ 1,700 $ 2,239 $ 3,547 $ 3,757 Other comprehensive income: Net unrealized (loss) gain on debt and equity securities available-for-sale, net of tax (1,579) 575 (1,027) 671 Less: reclassification adjustment for realized gains on sales of debt and equity securities, available-for-sale, included in net income, net of tax -- (899) (291) (899) -------------------------------------------------------------------------------------------------------------- Total other comprehensive loss (1,579) (324) (1,318) (228) -------------------------------------------------------------------------------------------------------------- Total comprehensive income $ 121 $ 1,915 $ 2,229 $ 3,529 --------------------------------------------------------------------------------------------------------------
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. All four 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 and six month periods ended June 30, 2004 and 2003, is as follows: -7-
Transportation Utility Government Corporate Information Information Banking Software and Elim- (In Thousands) Services Services Services Services inations Total --------------------------------------------------------------------------------------------------------------------------- Quarter Ended June 30, 2004 Total Revenues: Revenue from customers $ 8,105 $ 3,354 $ 3,093 $ 1,134 $ -- $ 15,686 Intersegment revenue 9 -- 355 -- (364) -- Net Income (Loss) 838 651 862 (651) -- 1,700 Total Assets 281,699 70,104 334,260 5,980 (3,881) 688,162 Goodwill 223 -- -- 2,927 -- 3,150 Other intangibles, net -- -- -- 1,380 404 1,784 Quarter Ended June 30, 2003 Total Revenues: Revenue from customers $ 8,658 $ 3,190 $ 3,470 $ 1,854 $ -- $ 17,172 Intersegment revenue 44 12 326 -- (382) -- Net Income (Loss) 812 439 994 (6) -- 2,239 Total Assets 265,783 69,416 298,592 7,013 (47,754) 593,050 Goodwill 223 -- -- 2,927 -- 3,150 Other intangibles, net -- -- -- 1,691 379 2,070 --------------------------------------------------------------------------------------------------------------------------- Six Months Ended June 30, 2004 Total Revenues: Revenue from customers $ 16,275 $ 6,975 $ 6,263 $ 2,313 $ -- $ 31,826 Intersegment revenue 22 6 710 -- (738) -- Net Income (Loss) 1,468 1,435 1,721 (1,077) -- 3,547 Total Assets 281,699 70,104 334,260 5,980 (3,881) 688,162 Goodwill 223 -- -- 2,927 -- 3,150 Other intangible assets, net -- -- -- 1,380 404 1,784 Six Months Ended June 30, 2003 Total Revenues: Revenue from customers $ 16,556 $ 5,947 $ 6,928 $ 3,650 $ -- $ 33,081 Intersegment revenue 102 27 621 -- (750) -- Net Income (Loss) 989 701 2,041 26 -- 3,757 Total Assets 265,783 69,416 298,592 7,013 (47,754) 593,050 Goodwill 223 -- -- 2,927 -- 3,150 Other intangible assets, net -- -- -- 1,691 379 2,070 ---------------------------------------------------------------------------------------------------------------------------
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 June 30, 2004 and December 31, 2003 are as follows:
June 30, 2004 December 31, 2003 ---------------------------------------------------------------------------------------------------- Gross Carrying Accumulated Gross Carrying Accumulated (In Thousands) Amount Amortization Amount Amortization ---------------------------------------------------------------------------------------------------- Amortized intangible assets: Customer list $ 823 $ (83) $ 823 $ (55) Acquired software 1,024 (384) 1,024 (256) ---------------------------------------------------------------------------------------------------- Total amortized intangibles 1,847 (467) 1,847 (311) ---------------------------------------------------------------------------------------------------- Unamortized intangible assets: Goodwill 3,377 (227)* 3,377 (227)* Minimum pension liability 404 -- 404 -- ---------------------------------------------------------------------------------------------------- Total unamortized intangibles 3,781 (227) 3,781 (227) ---------------------------------------------------------------------------------------------------- Total intangible assets $5,628 $ (694) $5,628 $ (538) ----------------------------------------------------------------------------------------------------
*Amortization through December 31, 2001 prior to adoption of SFAS 142. 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. -8- Amortization of intangible assets amounted to $77,000 for both the three-month periods ended June 30, 2004 and 2003 and $155,000 for both the six-month periods ended June 30, 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. Note 8 - Equity Investments in Non-Marketable Securities During 2003, the Company converted a $2,000,000 investment in a private imaging company from a convertible debenture into common stock. As part of the conversion, the Company committed to 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 June 30, 2004 and $2,908,000 at December 31, 2003. At June 30, 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. In addition, the Company has committed to a $2,400,000 line of credit to this entity, with a 50% interest sold to the new majority owner, for working capital purposes. As of June 30, 2004 the Company's interest in this line amounted to $933,000. This business has performed poorly during the past few years and during 2003 received an additional $3,000,000 equity investment from the 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. Operations have recently become profitable. However, should this business fail to meet its objectives, the Company's investment could be subject to future impairment. This investment, along with $543,000 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 June 30, 2004, no amounts have been accrued for any estimated losses for these instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commercial and standby letters of credit are conditional commitments issued by the Company or its subsidiaries to guarantee the performance of a customer to a third party. These off-balance sheet financial instruments generally have fixed expiration dates or other termination clauses and may require payment of a fee. 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 or its subsidiaries 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 June 30, 2004 are as follows: Amount of Commitment Expiration per Period ------------------------------------------ Less than 1-3 (In Thousands) Total 1 year Years --------------------------------------------------------------------------- Unused loan commitments $21,670 $19,054 $ 2,616 Standby letters of credit 3,754 3,137 617 Commercial letters of credit 554 554 -- Operating lease commitments 463 366 97 -9- 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 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 2,759 and 3,543 options granted in the Second Quarter of 2004 and 2003, respectively. For the First Half of 2004 and 2003 there were 8,630 and 15,543 options granted, respectively. The following table represents the effect on basic and diluted earnings per share and weighted average assumptions used for the periods ended June 30, 2004 and 2003:
Three Months Ended Six Months Ended June 30 June 30 --------------------------- --------------------------- (In Thousands, except per share data) 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------------------------------- Net income: As reported $ 1,700 $ 2,239 $ 3,547 $ 3,757 Add: Stock based compensation expense included in reported net income, net of tax 16 9 29 16 Less: Stock based compensation expense determined under the fair value based method for all awards, net of tax (23) (20) (43) (38) ------------------------------------------------------------------------------------------------------------------------- Pro forma net income $ 1,693 $ 2,228 $ 3,533 $ 3,735 ------------------------------------------------------------------------------------------------------------------------- Net income per common share: Basic, as reported $ .47 $ .61 $ .97 $ 1.02 Basic, proforma .46 .60 .96 1.01 Diluted, as reported .45 .60 .95 1.01 Diluted, proforma .45 .60 .95 1.00 ------------------------------------------------------------------------------------------------------------------------- Weighted average assumptions: Risk-free interest rate 4.11% 2.84% 3.58% 3.22% Expected life 7 yrs. 7 yrs. 7 yrs. 7 yrs. Expected volatility 15% 15% 15% 15% Dividend yield 2.34% 3.09% 2.46% 3.32% -------------------------------------------------------------------------------------------------------------------------
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. -10- The following table represents the components of the net periodic pension costs for the three and six-month periods ended June 30, 2004 and 2003: Estimated Actual (In Thousands, except per share data) 2004 2003 ------------------------------------------------------------------------- Service cost - benefits earned during the year $ 1,186 $ 979 Interest cost on projected benefit obligation 1,238 1,105 Expected return on plan assets (1,234) (1,055) Net amortization 60 13 ------------------------------------------------------------------------- Net periodic pension cost - annual 1,250 1,042 ------------------------------------------------------------------------- Pension costs recorded to expense were $365,000 and $237,000 for the Second Quarter of 2004 and 2003, respectively. Pension costs recorded to expense were $625,000 and $474,000 for the First Half of 2004 and 2003, respectively. The Company has not made any contribution to the plan during the six-month period ended June 30, 2004, but is expecting to contribute approximately $1,083,000 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 and its 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 and six-month periods ended June 30, 2004 and 2003: Estimated Actual (In Thousands, except per share data) 2004 2003 -------------------------------------------------------------------------- Service cost - benefits earned during the year $ (57) $ (24) Interest cost on projected benefit obligation 116 107 Net amortization 51 62 -------------------------------------------------------------------------- Net periodic pension cost - annual 110 145 -------------------------------------------------------------------------- Pension costs recorded to expense were $37,000 and $46,000 for the Second Quarter of 2004 and 2003, respectively and were $73,000 and $93,000 for the First Half 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 with the data 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 -11- 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 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 Cass' 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 during 2004 and beyond. In addition, management is exploring possible strategic alliances and potential acquisitions to accelerate this growth. In July 2004, the Company announced that it had reached an agreement to acquire the operating assets and selected liabilities of ProfitLab, Inc. ProfitLab is a leading provider of telecom auditing and application services. This acquisition should further strengthen and expand Cass' payment and data analysis services and tools for Fortune 1000 customers. The acquisition is expected to close in the third quarter of 2004. Should the acquisition close, the initial impact on the Company's earnings would be negative. Based on recent performance the annualized, after tax, loss of ProfitLab is anticipated to be in the area of $500,000 to $650,000 or $.13 to $.17 diluted earnings per share. While benefits are expected to occur from integrating certain operational areas, it may take some time before such benefits are achieved. As part of the acquisition, Cass has agreed to provide employment for certain staff members and to maintain operations in Greenville, South Carolina for periods of two and three years, respectively. The low level of interest rates has had a significant negative impact on net income during the past few years. Although management doesn't anticipate when and how quickly these rates may increase, the Company is positioned to take advantage of rising rates should they occur. Management had been pleased with the growth in software revenue generated by GEMS during the last three years, but is disappointed with software sales this year. It appears that lack of activity in the marketplace has negatively impacted sales but active interest, as measured by the number of requests for proposals received, seems to be improving. 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, 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. -12- Allowance for Loan Losses. The Company performs periodic and systematic detailed reviews of its loan portfolio to assess overall collectability. The level of the allowance for loan losses reflects management's estimate of the collectability of the loan portfolio. Although these estimates are based on established methodologies for determining allowance requirements, actual results can differ significantly from estimated results. These policies affect all segments of the Company with the exception of governmental software services. The impact and associated risks related to these policies on our business operations are discussed in the " Allowance and Provision for Loan Losses" section of this report. Impairment of Assets. Management periodically evaluates certain long-term assets such as intangible assets including goodwill, foreclosed assets, internally developed software and investments in private equity securities for impairment. Generally, these assets are initially recorded at cost, and recognition of impairment is required when events and circumstances indicate that the carrying amounts of these assets will not be recoverable in the future. If impairment occurs, various methods of measuring impairment may be called for depending on the circumstances and type of asset, including quoted market prices, estimates based on similar assets, and estimates based on valuation techniques such as discounted projected cash flows. Assets held for sale are carried at the lower of cost or fair value less costs to sell. These policies affect all segments of the Company and require significant management assumptions and estimates that could result in materially different results if conditions or underlying circumstances change. Results of Operations The following paragraphs more fully discuss the results of operations and changes in financial condition for the three-month period ended June 30, 2004 (the "Second Quarter of 2004") compared to the three-month period ended June 30, 2003 (the "Second Quarter of 2003") and the six-month period ended June 30, 2004 (the "First Half of 2004") compared to the six-month period ended June 30, 2003 (the "First Half 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 Second 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 $1,700,000 for the Second Quarter of 2004, a $539,000 or 24.1% decrease compared to net income of $2,239,000 for the Second Quarter of 2003. The Company's net income for the First Half of 2004 was $3,547,000, a $210,000 or 5.6% decrease compared to net income of $3,757,000 for the First Half of 2003. Diluted earnings per share were $.45 for the Second Quarter of 2004, a 25.0% decrease compared to $.60 for the Second Quarter of 2003. Diluted earnings per share were $.95 for the First Half of 2004, a 5.9% decrease compared with $1.01 for the First Half of 2003. The decrease in net income in the Second Quarter of 2004 over the Second Quarter of 2003 was primarily a result of gains on the sales of equity securities recognized in the Second Quarter of 2003 with no gains recognized in the Second Quarter of 2004, compounded by a decrease in software revenue recorded by the Company's software subsidiary, GEMS. This was partially offset by an increase in payment and processing revenue and a decrease in operating expenses. The decrease in net income in the First Half of 2004 was the result of more gains recognized in the First Half of 2003 compared with the First Half of 2004 and a decrease in software revenue, offset by increased revenue from payment and processing fees and a decrease in operating expenses. Return on average assets for the Second Quarter of 2004 was .99% compared to 1.51% for the Second Quarter of 2003. Return on average assets for the First Half of 2004 was 1.06% compared to 1.28% for the First Half of 2003. Return on average equity for the Second Quarter of 2004 was 10.60% compared to 14.74% for the Second Quarter of 2003. Return on average equity for the First Half of 2004 was 11.06% compared to 12.45% for the First Half of 2003. -13- 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 and six-month periods ended June 30, 2004 and 2003 are as follows:
Three Months Ended Six Months Ended June 30 June 30 ---------------------------------- --------------------------------- % % (In Thousands) 2004 2003 Change 2004 2003 Change -------------------------------------------------------------------------------------------------------------- Transportation Information Services: Invoice Bill Volume 5,921 5,810 1.9% 11,350 11,476 (1.1%) Invoice Dollar Volume $2,416,168 $2,154,256 12.2% $4,637,814 $4,208,168 10.2% Payment and processing fees $ 5,049 $ 4,670 8.1% $ 9,995 $ 9,639 3.7% Utility Information Services: Invoice Transaction Volume 1,286 1,116 15.2% 2,570 2,149 19.6% Invoice Dollar Volume $ 895,730 $ 788,714 13.6% $1,830,091 $1,614,075 13.4% Payment and processing fees $ 2,572 $ 2,200 16.9% $ 5,224 $ 4,200 24.4%
Second Quarter of 2004 compared to Second Quarter of 2003: Transaction volume from the Transportation Information Services division for the Second Quarter of 2004 increased mainly due to increased activity from existing clients which more than offset the loss of some high transaction/low dollar volume parcel business. Total dollar volume processed from this division increased during this period. Fees for the period grew due to the increased volume and additional services provided. The increase in volume and fees from the Utility Information Services division increased primarily due to new customers as the growth of this segment continues. Software revenue was down $720,000 or 39% from the Second 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 this year to date. Demand for software in the governmental sector appears to have softened from last year. At this time management feels that this is a temporary condition. Bank service fees decreased $35,000 or 8% due to the decrease in miscellaneous services provided to other banks. Net gains of $1,362,000 were recognized on the sales of securities during the Second Quarter of 2003 with no gains recognized in the Second Quarter of 2004. Other income increased $41,000 or 30% primarily due to income recognized from death proceeds from company owned life insurance. First Half of 2004 compared to First Half of 2003: Transportation transaction volume for the First Half of 2004 decreased slightly from 2003 due to the same loss of high transaction/low dollar parcel business mentioned above. Most of this volume was replaced by larger dollar transactions that required a higher level of processing and produced greater fees. Transaction dollar volume was up and fee revenue increased during the first half. Utility volume and fees increased due to new customers as this segment continues to grow. Software revenue from GEMS was down $1,337,000 or 37% during the First Half of 2004 due to the same factors discussed above for the second quarter. Bank service fees decreased $47,000 or 5% due to the decrease in miscellaneous services provided to other banks. Gains on the sales of securities for the First Half of 2004 were $441,000 compared to gains of $1,362,000 for the First Half of 2003. Other income increased $47,000 or 18% due to the death proceeds from company owned life insurance. Net Interest Income Second Quarter of 2004 compared to Second Quarter of 2003: The Company's tax-equivalent net interest income increased 1% or $49,000 from $6,700,000 to $6,749,000. The tax-equivalent net interest margin decreased from 5.02% to 4.33%. The decline in the general level of interest rates from the beginning of 2001 continues to have a negative impact on the Company's net interest income and margin. The average yield on earning assets decreased to 4.80% in the Second Quarter of 2004 from 5.36% 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. -14- The Company was able to offset the decrease in net interest income due to the decline in the general level of interest rates through an increase in earning assets. Total average earning assets increased $92,643,000 or 17% to $627,453,000. This increase was funded by both an increase in accounts and drafts payable due to the increase in dollar volume processed and an increase in bank deposits due to the expansion of the Banks' customer base. Total average loans increased $31,840,000 or 7% to $467,292,000. 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 increased $18,531,000 or 34% to $73,170,000. Total average federal funds sold and other short-term investments increased $42,272,000 or 95% to $86,991,000. 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 the pages that follow. First Half of 2004 compared to First Half of 2003: The Company's tax-equivalent net interest income decreased $64,000 from $13,639,000 to $13,575,000. The tax-equivalent net interest margin decreased from 5.15% to 4.45% as the decline in the general level of interest rates from the beginning of 2001 continues to have an impact on the Company's net interest income and margin. The average yield on earning assets decreased to 4.88% in the First Half of 2004 from 5.49% in 2003. The Company partially offset the decrease in net interest income through an increase in earning assets. Total average earning assets increased $78,774,000 or 15% to $613,338,000. This increase was funded by both an increase in accounts and drafts payable due to the increase in dollars processed and an increase in bank deposits due to the expansion of the Banks' customer base. Total average loans increased $30,595,000 or 7% to $465,375,000. 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 increased $8,544,000 or 14% to $68,904,000. Total average federal funds sold and other short-term investments increased $39,635,000 or 101% to $79,059,000. 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 the pages that follow. 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. -15-
Second Quarter 2004 Second 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 $ 461,990 $ 6,366 5.54% $ 429,749 $ 6,248 5.83% Tax-exempt (4) 5,302 100 7.59 5,703 108 7.60 Debt and equity securities (5): Taxable 26,621 116 1.75 22,806 133 2.34 Tax-exempt (4) 46,549 705 6.09 31,833 529 6.67 Federal funds sold and other short-term investments 86,991 200 .92 44,719 126 1.13 ------------------------------------------------------------------------------------------------------------------ Total earning assets 627,453 7,487 4.80 534,810 7,144 5.36 Nonearning assets: Cash and due from banks 25,601 20,398 Premises and equipment, net 13,108 15,236 Goodwill and other intangibles 4,985 5,271 Other assets 25,511 23,377 Allowance for loan losses (5,764) (5,390) ------------------------------------------------------------------------------------------------------------------ Total assets $ 690,894 $ 593,702 ------------------------------------------------------------------------------------------------------------------ Liabilities And Shareholders' Equity (1) Interest-bearing liabilities: Interest-bearing demand deposits $ 64,755 $ 165 1.02% $ 51,014 $ 104 .82% Savings deposits 29,507 77 1.05 35,962 81 .90 Time deposits of $100 or more 55,083 304 2.22 42,913 203 1.90 Other time deposits 37,231 192 2.07 8,184 51 2.50 ------------------------------------------------------------------------------------------------------------------ Total interest-bearing deposits 186,576 738 1.59 138,073 439 1.28 Short-term borrowings 94 -- -- 1,101 5 1.82 ------------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities 186,670 738 1.59 139,174 444 1.28 Noninterest-bearing liabilities: Demand deposits 104,913 95,418 Accounts and drafts payable 326,380 290,158 Other liabilities 8,422 8,029 ------------------------------------------------------------------------------------------------------------------ Total liabilities 626,385 532,779 Shareholders' equity 64,509 60,923 Total liabilities and shareholders' equity $ 690,894 $ 593,702 ------------------------------------------------------------------------------------------------------------------ Net interest income $ 6,749 $ 6,700 Interest spread 3.21% 4.08% Net interest margin 4.33% 5.02% ------------------------------------------------------------------------------------------------------------------
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 $49,000 and $24,000 for the Second 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 $275,000 and $215,000 for the Second 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. -16-
First Half of 2004 First Half of 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 $ 460,052 $ 12,753 5.57% $ 429,054 $ 12,593 5.92% Tax-exempt (4) 5,323 201 7.59 5,726 216 7.61 Debt and equity securities (5): Taxable 25,203 213 1.70 24,685 321 2.62 Tax-exempt (4) 43,701 1,351 6.22 35,675 1,187 6.71 Federal funds sold and other short-term investments 79,059 362 .92 39,424 226 1.16 ------------------------------------------------------------------------------------------------------------------ Total earning assets 613,338 14,880 4.88 534,564 14,543 5.49 Nonearning assets: Cash and due from banks 22,229 19,691 Premises and equipment, net 13,291 15,533 Goodwill and other intangibles 5,024 5,310 Other assets 25,764 22,762 Allowance for loan losses (5,662) (5,359) ------------------------------------------------------------------------------------------------------------------ Total assets $ 673,984 $ 592,501 ------------------------------------------------------------------------------------------------------------------ Liabilities And Shareholders' Equity (1) Interest-bearing liabilities: Interest-bearing demand deposits $ 60,683 $ 244 .81% $ 52,885 $ 221 .84% Savings deposits 29,947 128 .86 35,868 163 .92 Time deposits of $100 or more 51,768 571 2.22 42,790 416 1.96 Other time deposits 35,951 362 2.02 6,957 90 2.61 ------------------------------------------------------------------------------------------------------------------ Total interest-bearing deposits 178,349 1,305 1.47 138,500 890 1.30 Short-term borrowings 106 -- -- 1,833 14 1.54 ------------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities 178,455 1,305 1.47 140,333 904 1.30 Noninterest-bearing liabilities: Demand deposits 102,675 95,151 Accounts and drafts payable 319,985 288,936 Other liabilities 8,383 7,225 ------------------------------------------------------------------------------------------------------------------ Total liabilities 609,498 531,645 Shareholders' equity 64,486 60,856 Total liabilities and shareholders' equity $ 673,984 $ 592,501 ------------------------------------------------------------------------------------------------------------------ Net interest income $ 13,575 $ 13,639 Interest spread 3.41% 4.19% Net interest margin 4.45% 5.15% ------------------------------------------------------------------------------------------------------------------
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 $90,000 and $35,000 for the First Half 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 $528,000 and $475,000 for the First Half 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. -17- 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. Second Quarter 2004 Over 2003 ------------------------- (In Thousands) Volume Rate Total ------------------------------------------------------------------------------- Increase (decrease) in interest income: Loans (1),(2): Taxable $ 444 $(326) $ 118 Tax-exempt (3) (8) -- (8) Debt and equity securities: Taxable 20 (37) (17) Tax-exempt (3) 225 (49) 176 Federal funds sold and other short-term investments 100 (26) 74 ------------------------------------------------------------------------------- Total interest income 781 (438) 343 ------------------------------------------------------------------------------- Interest expense on: Interest-bearing demand deposits 31 30 61 Savings deposits (16) 12 (4) Time deposits of $100 or more 63 38 101 Other time deposits 151 (10) 141 Short-term borrowings (2) (3) (5) ------------------------------------------------------------------------------- Total interest expense 227 67 294 ------------------------------------------------------------------------------- Net interest income $ 554 $(505) $ 49 ------------------------------------------------------------------------------- 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%. First Half 2004 Over 2003 ------------------------- (In Thousands) Volume Rate Total ------------------------------------------------------------------------------- Increase (decrease) in interest income: Loans (1),(2): Taxable $ 905 $(745) $ 160 Tax-exempt (3) (15) -- (15) Debt and equity securities: Taxable 7 (115) (108) Tax-exempt (3) 256 (92) 164 Federal funds sold and other short-term investments 190 (54) 136 ------------------------------------------------------------------------------- Total interest income 1,343 (1,006) 337 ------------------------------------------------------------------------------- Interest expense on: Interest-bearing demand deposits 32 (9) 23 Savings deposits (25) (10) (35) Time deposits of $100 or more 95 60 155 Other time deposits 297 (25) 272 Short-term borrowings (7) (7) (14) ------------------------------------------------------------------------------- Total interest expense 392 9 401 ------------------------------------------------------------------------------- Net interest income $ 951 $(1,015) $ (64) ------------------------------------------------------------------------------- 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%. -18- 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 $150,000 provision made for loan losses during the Second Quarter of 2004 and no provision made in the Second Quarter of 2003. There was a $350,000 provision made for the First Half of 2004 compared with a $90,000 provision for the First Half of 2003. Net loans recovered for both the Second Quarter of 2004 and 2003 were $6,000. Net loans recovered for the First Half of 2004 were $9,000 compared to $10,000 for the First Half 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 June 30, 2004 was $5,865,000 and at December 31, 2003 was $5,506,000. The ratio of allowance for loan losses to total loans outstanding at June 30, 2004 was 1.24% compared to 1.17% at December 31, 2003. Nonperforming loans were $3,467,000 or .73% of total loans at June 30, 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 June 30, 2004, impaired loans totaled $3,627,000, which included $1,057,000 of nonaccrual loans and $2,410,000 of renegotiated loans compared with impaired loans at December 31, 2003 of $4,393,000, which included $1,525,000 of nonaccrual loans and $2,721,000 of renegotiated loans. The allowance for loan losses on impaired loans was $960,000 at June 30, 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 $2,330,000 from June 30, 2003 to June 30, 2004. Of this decrease $4,070,000 relates to other impaired loans consisting primarily of two loans totaling $4,229,000 at June 30, 2003 that were renegotiated in 2002 and are now currently performing. This decrease was partially offset by an increase of $1,929,000 in renegotiated loans, which relates primarily to one borrower with a balance of $2,240,000 as of June 30, 2004 and although currently performing, is still considered impaired by management. The balance of nonaccrual loans at June 30, 2004 consists primarily of two loans, one with a balance of $713,000 that is collateralized by real estate and has a SBA guarantee and a second loan with a balance of $265,000 relates to a business that is no longer operating, although payments are being made as the inventory of the business is being sold. The 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 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. -19- Summary of Asset Quality The following table presents information as of and for the three and six-month periods ended June 30, 2004 and 2003 pertaining to the Company's provision for loan losses and analysis of the allowance for loan losses.
Three Months Ended Six Months Ended June 30 June 30 ------------------------ ------------------------ (Dollars in Thousands) 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------------------------ Allowance at beginning of period $ 5,709 $ 5,387 $ 5,506 $ 5,293 Provision charged to expense 150 -- 350 90 Loans charged off -- -- 1 2 Recoveries on loans previously charged off 6 6 10 12 ------------------------------------------------------------------------------------------------------------------ Net loans (recovered) charged-off (6) (6) (9) (10) Allowance at end of period $ 5,865 $ 5,393 $ 5,865 $ 5,393 ------------------------------------------------------------------------------------------------------------------ Loans outstanding: Average $ 467,292 $ 435,452 $ 465,375 $ 434,780 June 30 474,560 443,621 474,560 443,621 Ratio of allowance for loan losses to loans outstanding: Average 1.26% 1.24% 1.26% 1.24% June 30 1.24 1.22 1.24 1.22 Nonperforming loans: Nonaccrual loans $ 1,057 $ 1,206 $ 1,057 $ 1,206 Loans past due 90 days or more -- 40 -- 40 Renegotiated loans 2,410 481 2,410 481 ------------------------------------------------------------------------------------------------------------------ Total non performing loans $ 3,467 $ 1,727 $ 3,467 $ 1,727 Other impaired loans 160 $ 4,230 $ 160 $ 4,230 Foreclosed assets 1,234 $ 1,154 $ 1,234 $ 1,154 ------------------------------------------------------------------------------------------------------------------ Nonperforming loans as percentage of average loans .74% .40% .74% .40% ------------------------------------------------------------------------------------------------------------------
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 Second Quarter of 2004 decreased $583,000 or 4% to $13,313,000 compared to the Second Quarter of 2003. Total operating expense for the First Half of 2004 decreased $896,000 or 3% to $26,795,000 from the First Half of 2003. Salaries and benefits expense decreased $99,000 or 1% to $9,301,000 in the Second Quarter of 2004 compared with the Second Quarter of 2003 and decreased $294,000 or 2% for the First Half of 2004 compared with the First Half of 2003. These decreases are 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 expense was partially offset by annual salary increases and an increase in benefits expense related to pension costs. Occupancy expense for the Second Quarter of 2004 decreased $21,000 or 5% to $436,000 from the Second Quarter of 2003 and increased a modest $1,000 in the First Half of 2004 compared with the First Half of 2003. The decrease for the quarter relates primarily to a decrease in utility expense and premise maintenance and repairs. Equipment expense for the Second Quarter of 2004 decreased $135,000 or 12% compared to the Second Quarter of 2003 and decreased $271,000 or 12% for the First Half of 2004 compared with the First Half of 2003. These decreases relate primarily to a decrease in software amortization in both the Information Services divisions and a decrease in hardware depreciation and computer equipment maintenance expense from the consolidation of equipment within the Transportation Information Services division. Other operating expense for the Second Quarter of 2004 decreased $328,000 or 11% compared to the Second Quarter of 2003 and decreased $332,000 or 6% for the First Half of 2004 compared with the First Half of 2003. The decreases for the quarter and half were primarily from decreases in postage and supply expense in -20- the Transportation Information Services division related to technology initiatives put into place over the past two years. These decreases were offset by an increase in outsourced programming services primarily in the Company's government software division. Income tax expense for the Second Quarter of 2004 decreased $364,000 or 35% compared to the Second Quarter of 2003 and decreased $149,000 or 9% for the First Half of 2004 compared with the First Half of 2003. The effective tax rate for the Second Quarter of 2004 was 28% compared with 32% in the Second Quarter of 2003 and was 29% for the First Half of 2004 compared with 30% in 2003. The decrease in the effective tax rate was due to higher balances of tax-exempt investments in 2004. Financial Condition Total assets at June 30, 2004 increased $48,466,000 or 8% from December 31, 2003. The majority of this increase relates to the Company's earning assets that experienced an increase of $18,482,000 or 41% in federal funds sold and other short-term investments, $18,189,000 or 26% increase in investments in debt and equity securities and $5,169,000 or 1% increase in loans, net of the allowance for loan losses. Total liabilities were $622,326,000, an increase of $47,422,000 or 8% from December 31, 2003. Total deposits at June 30, 2004 were $297,700,000, an increase of $25,272,000 or 9%. Accounts and drafts payable were $315,773,000, an increase of $22,004,000 or 7%. Total shareholders' equity at June 30, 2004 was $65,836,000 a $1,044,000 or 2% increase from December 31, 2003. The increase in loans relates to the normal fluctuations of the loan portfolio. The increase in debt and equity securities relates to the purchase of $41,247,000 in securities, primarily of tax-exempt municipal securities. These purchases were partially offset by the sale of securities earlier in the year and the normal maturity of securities throughout the year. Federal funds sold and other short-term investments increased due to the increase in deposits and accounts and drafts payable from December 31, 2003 to June 30, 2004. The increase in deposits reflects the Bank's ongoing marketing efforts to attract deposits and increase in accounts and drafts payable was due the increase in the dollar volume of invoices processed. Accounts and drafts payable 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. The increase in total shareholders' equity resulted from net income of $3,547,000; cash received on the exercise of stock options of $151,000; a $99,000 tax benefit on stock awards and the amortization of the stock bonus plan of $45,000; offset by dividends paid of $1,476,000 ($.42 per share); a decrease in other comprehensive income of $1,318,000 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 $85,089,000 at June 30, 2004, an increase of $22,722,000 or 36% from December 31, 2003. At June 30, 2004 these assets represented 12% of total assets. These funds are the Company's and its subsidiaries' primary source of liquidity to meet future expected and unexpected loan demand, depositor withdrawals or reductions in accounts and drafts payable. Secondary sources of liquidity include the investment portfolio and borrowing lines. Total investment in debt and equity securities was $87,336,000 at June 30, 2004, an increase of $18,189,000 from December 31, 2003. These assets represented 13% of total assets at June 30, 2004. Of this total, 69% were state and political subdivision securities, 23% were U.S. Treasury securities, 7% were U.S. government agencies and 1% were other securities. Of the total portfolio, 19% mature in one year, 14% matures in one to five years, and 67% 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 $29,000,000. 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. -21- 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 $3,516,000 for the First Half of 2004 compared with $7,040,000 for the First Half of 2003. This decrease is attributable to an additional $1,963,000 paid in corporate income taxes, a $100,000 decrease in deferred income versus a $1,796,000 increase in the First Half of 2003 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 June 30, 2004 and December 31, 2003: June 30, 2004 Amount Ratio ------------------------------------------------------------------------------- Total capital (to risk-weighted assets) Cass Information Systems, Inc. $67,357,000 12.30% Cass Commercial Bank 32,669,000 11.11 Tier I capital (to risk-weighted assets) Cass Information Systems, Inc. $61,492,000 11.22% Cass Commercial Bank 28,990,000 9.86 Tier I capital (to average assets) Cass Information Systems, Inc. $61,492,000 9.42% Cass Commercial Bank 28,990,000 9.00 ------------------------------------------------------------------------------- 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 ------------------------------------------------------------------------------- -22- 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 June 30, 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 Principal Financial Officer, within the time periods specified in the rules of the SEC. The Company's Chief Executive and Principal 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 June 30, 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 second quarter of 2004 in the Company's internal controls identified by the Chief Executive and Principal 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). -23- PART II. OTHER INFORMATION ITEM 1. 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 business or financial condition of the Company or its subsidiaries. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS The Company maintains a treasury stock buyback program and as of June 30, 2004 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 six months ended June 30, 2004 and repurchased 59,237 shares for $1,764,000 during the first six months ended June 30, 2003. Repurchases are made in the open market or through negotiated transactions from time to time depending on market conditions. ITEM 3. DEFAULTS IN SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the annual meeting of the shareholders of Cass Information Systems, Inc. held on April 19, 2004, the following proposal was voted on and approved: The following is a summary of votes cast. No broker non-votes were received. Proposal to elect four Directors for a term of three years ending 2007; Withheld For Authority --------- --------- Lawrence A. Collett 2,610,553 46,184 Wayne J. Grace 2,611,040 45,697 Irving A. Shepard 2,537,201 119,536 Andrew J. Signorelli 2,589,835 66,902 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 April 19, 2004, reporting the announcement of the Company's earnings for the first quarter of 2004. -24- 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: August 6, 2004 By /s/ Lawrence A. Collett --------------------------- Lawrence A. Collett Chairman and Chief Executive Officer DATE: August 6, 2004 By /s/ Eric H. Brunngraber Eric H. Brunngraber --------------------------- Vice President-Secretary (Principal Financial and Accounting Officer) -25-