ITEM 1. BUSINESS
Description of Business
Cass Information Systems, Inc. ("Cass" or "the Company") is a leading provider of payment and information processing services to large manufacturing, distribution and retail enterprises across the United States. The Company provides freight invoice rating, payment, audit, cost accounting and transportation information to many of the nation's largest companies. It is also a leading processor and payer of utility invoices in the United States, including electricity, gas, water, telecommunication and refuse collection. In addition, the Company, through its wholly-owned bank subsidiary, Cass Commercial Bank ("the Bank"), provides banking services in the commercial, industrial and residential areas it serves. Its primary focus is to support the Company's payment operations and provide banking services to its target markets, which include privately-owned businesses and churches and church-related ministries. Services include commercial, real estate and personal loans; checking, savings and time deposit accounts and other cash management services. The Company, through its subsidiary, Government e-Management Solutions, Inc. ("GEMS"), also develops, licenses and installs integrated financial, property and human resource management systems to the public sector, primarily cities and counties. The principal offices of the Company are at 13001 Hollenberg Drive, Bridgeton, Missouri, 63044. Other operating locations are in Columbus, Ohio and Boston, Massachusetts. The Bank's headquarters are also located at the Bridgeton location and operates four other branches in the St. Louis metropolitan area. GEMS' offices are located in St. Louis County, Missouri.
Company Strategy and Core Competencies
Cass is an information services company with a primary focus on processing payables and payables-related transactions for large United States corporations. Cass possesses four core competencies that envelop most of its processing services.
Data acquisition - This refers to the gathering of data elements from diverse, heterogeneous sources and the building of complete databases for our customers. Data is the raw material of the information economy. Cass gathers vital data from complex and diverse input documents, electronic media, proprietary databases and data feeds, including data acquired from vendor invoices as well as customer procurement and sales systems. Through its numerous methods of obtaining streams and pieces of raw data, Cass is able to assemble vital data into centralized data management systems and warehouses, thus producing an engine to create the power of information for managing critical corporate functions and processing systems.
Data management - Once data is assembled, Cass is able to utilize the power from derived information to produce significant savings and benefits for its clients. This information is used to integrate into customers' unique financial and accounting systems, eliminating the need for internal accounting processing and to provide internal and external support for these critical systems. Information is also used to produce management and exception reporting for operational control, feedback, planning assistance and performance measurement.
Information delivery - Receiving information in the right place at the right time and in the required format is paramount for business survival. Cass' information delivery solutions provide reports, digital images, data files and retrieval capabilities through the Internet or directly into customer internal systems. Cass' proprietary Internet management delivery system is the foundation for driving these critical functions. Transaction, operational, control, status and processing exception information are all delivered through this system creating an efficient, accessible and highly reliable asset for Cass customers.
Financial exchange - Since Cass is unique among its competition in that it owns a commercial bank, it is also able to manage the movement of funds from its customers to their suppliers. This is a distinguishing factor which clearly requires the processing capability, operating systems and financial integrity of a banking organization. Cass provides immediate, accurate, controlled and protected funds management and transfer system capabilities for all of its customers. Old and costly check processing and delivery mechanisms are replaced with more efficient electronic cash management and funds transfer systems. Funds are managed and protected by our top-rated financial institution.
Cass' core competencies allow it to perform the highest levels of transaction processing in an integrated, efficient and systematic approach. Not only is Cass able to process the transaction, it is also able to collect the data defining the transaction and effect the financial payment governing its terms.
Cass' shared business processes - Accounting, Human Resources and Technology - support its core competencies. Cass' accounting function provides the internal control systems to ensure the highest levels of accountability and protection for customers. Cass' human resources provide experienced people dedicated to streamlining business procedures and reducing expenses. Cass' technology is proven and reliable. The need to safeguard data and secure the efficiency, speed and timeliness that governs its business is a priority within the organization. The ability to leverage technology over its strategic units allows Cass the advantage of deploying technology in a proven and reliable manner without endangering clients' strategic business and system requirements.
These core competencies enhanced through shared business processes drive Cass' strategic business units. Building upon these foundations Cass continues to explore new business opportunities that leverage these competencies and processes.
Marketing, Customers and Competition
The Company is one of the largest firms in the freight bill payment industry in the United States based on the total dollars of freight bills paid and items processed. Competition consists of two primary competitors and numerous small freight bill audit firms located throughout the United States. While offering freight payment services, few of these audit firms compete on a national basis. These competitors compete mainly on price, functionality and service levels.
The Company also competes with other companies, located throughout the United States, that pay utility bills and provide management reporting. Available data indicates that the Company is one of the largest providers of utility information processing and payment services. Due to the fact that this is a new market, the competitive environment for utility bill processing and payment is difficult to assess and is changing rapidly. Cass is unique among these competitors in that it is not exclusively affiliated with any one energy service provider (ESP). The ESPs market the Company's services adding value with their unique auditing, consulting and technological capabilities. Many of Cass' services are customized with the ESPs, providing a full-featured solution without any development costs to the ESP.
The Bank is organized as a Missouri trust company with banking powers and was founded in 1906. Due to its ownership of a federally insured commercial bank, the Company is a bank holding corporation and was originally organized in 1982 as Cass Commercial Corporation under the laws of Missouri and was approved by the Board of Governors of the Federal Reserve System in February 1983. The Company changed its name to Cass Information Systems, Inc. in January 2001. The Company's bank subsidiary encounters competition from other banks located throughout the St. Louis metropolitan area and other areas in which the Bank competes. Savings banks, credit unions, other financial institutions and non-bank providers of financial services also provide competition. The principal competition however, is represented by large bank holding companies that are able to offer a wide range of banking and related services through extensive branch networks.
The governmental software unit, GEMS, was acquired on January 2, 2001 when the Company's bank subsidiary foreclosed on the operating assets of a software company in order to protect its financial interests. The Bank sold these assets to a wholly owned subsidiary, and invested in and stabilized this business. From the date of foreclosure through December 31, 2002, these assets were accounted for as a foreclosed asset held for sale. On January 1, 2003, the Company reclassified the foreclosed assets relating to its software subsidiary, GEMS, from held for sale to held and used and consolidated its operations into those of the Company. GEMS markets its software applications and services to middle market cities and counties throughout the United States. GEMS competes with several competitors that market similar products to these governmental units. These firms compete on price, functionality and support. No one firm appears to have a dominant position in the marketplace.
The Company holds several trademarks for the payment and rating services it provides. These include: FreightPay(R), Transdata(R), TransInq(R), Ratemaker(R), Rate Advice(R), First Rate(R), Best Rate(R) and Rate Exchange(R). The Company and its subsidiaries are not dependent on any one customer for a significant portion of its business. It has a varied client base with no individual client exceeding 10% of total revenue. The Bank does however, target its services to privately-held businesses located in the St. Louis, Missouri area and church and church-related institutions located in St. Louis, Missouri and other selected cities located throughout the United States.
Employees
The Company and its subsidiaries had 633 full-time and 119 part-time employees as of December 31, 2003. Of these employees, the bank subsidiary had 64 full-time and 7 part-time employees and the bank's software subsidiary had 63 full-time and 3 part-time employees.
Supervision and Regulation
The Company and its bank subsidiary are extensively regulated under federal and state law. These laws and regulations are intended to protect depositors, not shareholders. The Bank is subject to regulation and supervision by the Missouri Division of Finance, the Federal Reserve Bank (the "FRB") and the Federal Deposit Insurance Corporation (the "FDIC"). The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended, and as such, it is subject to regulation, supervision and examination by the FRB. The Company is required to file quarterly and annual reports with the FRB and to provide to the FRB such additional information as the FRB may require, and it is subject to regular inspections by the FRB. Bank regulatory agencies use Capital Adequacy Guidelines in their examination and regulation of bank holding companies and banks. If the capital falls below the minimum levels established by these guidelines, the agencies may force certain remedial action to be taken. The Capital Adequacy Guidelines are of several types and include risk-based capital guidelines, which are designed to make capital requirements more sensitive to various risk profiles and account for off-balance sheet exposure; guidelines which consider market risk, which is the risk of loss due to change in value of assets and liabilities due to changes in interest rates; and guidelines that use a leverage ratio which places a constraint on the maximum degree of risk to which a bank holding company may leverage its equity capital base. For further discussion of the capital adequacy guidelines and ratios, please refer to Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 8, Note 2 of this report.
The FRB also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law or regulations or for unsafe or unsound practices. Both the FRB and Missouri Division of Finance also have restrictions on the amount of dividends that banks and bank holding companies may remit.
As a bank holding company, the Company must obtain prior approval from the FRB before acquiring ownership or control of more than 5% of the voting shares of another bank or bank holding company or acquiring all or substantially all of the assets of such a company. In many cases, prior approval is also required for the Company to engage in similar acquisitions involving a non-bank company or to engage in new non-bank activities. Any change in applicable laws or regulations may have a material effect on the business and prospects of the Company.
Website Availability of SEC Reports
Cass will, as soon as practicable after they are electronically filed with the Securities and Exchange Commission (SEC), make available free of charge on its website each of its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports of Form 8-K, all amendments to those reports, and its definitive proxy statements. The address of Cass's website is: www.cassinfo.com. All reports filed with the SEC are available at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 21549 or for more information call the Public Reference Room at 1-800-SEC-0330. The SEC also makes all filed reports available on their website at www.sec.gov.
The reference to our website address does not constitute incorporation by reference of the information contained on the website and should not be considered part of this report.
Financial Information about Segments
The revenues from external customers, net income (loss) and total assets by segment, for the three years ended December 31, 2003 are set forth in Item 8, Note 15 of this report.
Statistical Disclosure by Bank Holding Companies
For the statistical disclosure by bank holding companies refer to Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations".
ITEM 2.
ITEM 2. PROPERTIES
The Company's headquarters are located at 13001 Hollenberg Drive, Bridgeton, Missouri. This location is owned by the Company, and includes a building with approximately 61,500 square feet of office space. In March 2001, the Company moved into a newly-owned production facility of approximately 45,500 square feet located at 2675 Corporate Exchange Drive, Columbus, Ohio. The Company operates an additional production facility in Lowell, Massachusetts where approximately 25,800 square feet of office space is leased through October 31, 2005.
Cass Commercial Bank's headquarters are also located at 13001 Hollenberg Drive, Bridgeton, Missouri, 63044. The Bank leases approximately 20,500 square feet of the 61,500 square foot building. In addition, the Bank owns a banking facility near downtown St. Louis that consists of approximately 1,600 square feet with adjoining drive-up facilities. The Bank has additional leased facilities in Maryland Heights, Missouri (2,500 square feet); Fenton, Missouri (1,250 square feet) and Chesterfield, Missouri (2,850 square feet).
Government e-Management Solutions' headquarters are located at 121 Hunter Avenue - - Suite 100, St. Louis, Missouri, 63124. GEMS leases approximately 9,486 square feet.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are not involved in any pending proceedings other than ordinary routine litigation incidental to their businesses. Management believes none of these proceedings, if determined adversely, would have a material effect on the business or financial condition of the Company or its subsidiaries.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of 2003.
PART II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock trades on The Nasdaq Stock Market(R) under the symbol "CASS". As of March 5, 2004 there were 224 holders of record of the Company's common stock. High and low bid prices, as reported by Nasdaq and restated for stock dividends, for each quarter of 2003 and 2002 were as follows:
2003 2002 ---- ---- High Low High Low ---- --- ---- --- 1st Quarter $25.255 $22.183 $22.727 $20.009 2nd Quarter 30.455 23.364 22.615 20.779 3rd Quarter 30.773 25.782 23.160 19.524 4th Quarter 31.745 26.555 23.409 19.870
Cash dividends paid per share, restated for stock dividends, by the Company during the two most recent fiscal years were as follows:
2003 2002 ---- ----
March 15 $.191 $.173 June 15 .191 .173 September 15 .191 .173 December 15 .191 .191
Refer to Item 8 Notes 2 and 10 to the consolidated financial statements for additional shareholder information.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial information for each of the five years ended December 31, 2003. The selected financial data should be read in conjunction with the Company's consolidated financial statements and accompanying notes included in Item 8 of this report.
1. Interest income on loans includes net loan fees. 2. Per share information has been restated to reflect the 10% stock dividend declared in February 2004.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Cass Information Systems, Inc. provides payment and information processing services to national manufacturing, distribution and retail enterprises from its processing centers in St. Louis, Missouri, Columbus, Ohio, 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 and church-related ministries. The Company, through the Bank's subsidiary, GEMS, also develops and licenses integrated financial, property and human resource management systems to the public sector.
The specific payment and information processing services provided to each customer are developed individually to meet each customer's specific requirements. These requirements can vary greatly from customer to customer. In addition, the degree of automation such as electronic data interchange (EDI), imaging, and web-enhanced solutions varies greatly among customers and industries. These factors combine so that pricing varies greatly among the customer base. In general however, Cass is compensated for its processing services through service fees and account balances that are generated during the payment process. The amount, type and calculation of service fees vary greatly by service offering, but generally follow the volume of transactions processed. Interest income from the balances generated during the payment processing cycle is affected by the amount of time Cass holds the funds prior to payment and the dollar volume processed. Both the number of transactions processed and the dollar volume processed are therefore key metrics followed by management. Other factors will influence 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 most of its revenue from the license of its enterprise software solutions and its installation and maintenance services.
Industry-wide factors that impact the Company include the acceptance by large corporations of the outsourcing of key business functions such as freight 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 effect on the revenue of the Company. Finally, the general fiscal condition of the counties and municipalities that can benefit from GEMS' enterprise software can impact licenses sold and related revenue.
Currently, management views Cass' major opportunity and challenge as the continued expansion of its payment and information processing service offerings and customer base. Management intends to accomplish this by maintaining 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 is pleased with the growth in software revenue generated by GEMS 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.
Results of Operations
The results of 2003 compared to 2002 include the following significant items:
Payment and processing fees increased $3,818,000 or 16% to $28,440,000 as the number of transactions processed increased 2,993,000 or 12% to 27,977,000. This increase was driven by the expansion of the Company's customer base and number of services provided as well as an increase in national freight activity during the second half of the year.
Net interest income after provision for loan losses decreased $2,652,000 or 9% to $26,192,000 due to the dramatic decline in interest rates during the past few years. This decline occurred despite the fact that total loans, typically our highest-yielding asset for any given maturity, grew $34,343,000 or 8% to $469,032,000 and average earning assets grew $19,060,000 or 4% to $563,071,000. The growth in average earning assets was derived from both increases in deposits and accounts and drafts payable. Gains from the sale of securities were comparable to last year, $1,454,000 in 2003 and $1,477,000 in 2002.
On January 1, 2003, the Company reclassified the foreclosed assets relating to its software subsidiary, GEMS, from held for sale to held and used and consolidated its operations into those of the Bank subsidiary. On January 2, 2001, the Company's bank subsidiary foreclosed on these operating assets in order to protect its financial interests. The Bank sold these assets to a wholly owned subsidiary, and invested in and stabilized this business. From the date of foreclosure through December 31, 2002, these assets were accounted for as a foreclosed asset held for sale. Statement of Financial Accounting Standards (SFAS 144), "Accounting for the Impairment or Disposal of Long-Lived Assets", adopted by the Company on January 1, 2002, requires that if certain criteria are not met for long-lived asset (disposal) groups classified as held for sale by the end of the fiscal year in which SFAS 144 is initially applied, the related long-lived assets shall be reclassified as held and used. In 2003 revenues for this segment were $7,696,000 and operating profits were $107,000.
Bank service fees increased $147,000 or 9% to $1,806,000 due primarily to the fact that as the earnings credit rate granted customers on their account balances decreases with the general level of interest rates, the amount of service fees charged increases. Other income increased $399,000 or 147% to $671,000 due mainly to an investment in bank owned life insurance during 2002. Operating expenses, excluding the effects of the GEMS consolidation, increased a modest $996,000 or 2% to $47,571,000 due mainly to increases in salaries and health and worker's compensation insurance expenses.
The results of 2002 compared to 2001 include the following significant items:
Payment and processing fees increased $3,132,000 or 15% to $24,622,000 as the number of transactions processed increased 2,151,000 or 9% to 24,984,000. This increase was driven by the expansion of the Company's customer base and the services provided and offset the negative impact on processing volumes and fees caused by a decrease in national freight activity.
Net interest income after provision for loan losses decreased $3,406,000 or 11% to $28,844,000 due to the dramatic decline in the general level of interest rates. This decline occurred despite the fact that total loans, typically the Company's highest-yielding asset for any given maturity, grew $53,237,000 or 14% to $434,689,000 and average earning assets grew $22,737,000 or 4% to $544,011,000. The growth in average assets was derived from growth in Bank deposits, both interest and noninterest bearing. Gains from the sale of securities were $1,477,000 in 2002, which mitigated some of the impact of the decline in interest rates. No gains were realized in 2001.
Bank service fees increased $137,000 or 9% to $1,659,000 due to fact that as the earnings credit rate granted customers on their account balances decreases with the general level of interest rates, the amount of service fees charged increases. Operating expenses increased $1,846,000 or 4% to $46,575,000 due mainly to increased personnel expenses, equipment expenses and other expenses related to the increased volume and service offerings.
Fee Revenue and Other Income
The Company's fee revenue is derived mainly from freight and utility payment and processing fees. As the Company provides its freight and utility processing and payment services, it is compensated by service fees which are typically calculated on a per-item basis and by the accounts and drafts payable balances generated in the payment process which can be used to generate interest income. Processing volumes related to fees and accounts and drafts payable for the years ended December 31, 2003, 2002 and 2001 are as follows:
December 31, -------------------------------------- (In thousands) 2003 2002 2001 ================================================================================ Transportation Information Services: Invoice Transaction Volume 23,359 21,549 20,095 Invoice Dollar Volume $8,673,993 $7,715,588 $7,294,586
Utility Information Services: Transaction Volume 4,618 3,435 2,738 Transaction Dollar Volume $3,340,375 $2,634,269 $2,481,086 - --------------------------------------------------------------------------------
Fee revenue and other income in 2003 compared to 2002 include the following significant pre-tax components:
Freight and utility payment and processing fee revenue increased $3,818,000 or 16% to $28,440,000. Of the total payment and processing revenue, fees related to utility payment and processing increased $2,484,000 or 37% to $9,134,000 and fees relating to freight payment and processing services increased $1,334,000 or 7% to $19,306,000. These increases both relate to new customers and new product offerings. Utility processing volume and revenue, which represents a newer market, had higher percentage increases.
Software revenue in 2003 of $7,696,000 represents the revenue of the Bank's software subsidiary GEMS, which develops and licenses integrated financial, property and human resource management systems to the public sector. Prior to December 31, 2002, GEMS was accounted for as an asset held for sale and its operating results were not consolidated with those of the Company. SFAS 144, adopted by the company in 2002, now requires that GEMS be reclassified as an asset held and used. Consequently, Cass reclassified the entity's net assets and consolidated its operations with the parent company on January 1, 2003. Although unconsolidated in 2002 and 2001, software revenue was $5,526,000 and $4,187,000, respectively.
Bank service fees increased $147,000 or 9% to $1,806,000. This increase was due primarily to the fact that service fees increase as the value of noninterest bearing deposits, used to compensate the Bank for services provided, decrease as the general level of interest rates decreases.
During 2003 the Company recorded net gains of $1,454,000 on the sales of securities with a fair value of $38,454,000. During 2002, net gains of $1,477,000 were recorded on the sales of securities with a fair value of $63,945,000. These sales of securities were transacted to adjust the portfolio to reflect the changes in the interest rate environment, growth in the loan portfolio during the past two years and to offset the loss of interest income due to the dramatic decline in the general level of interest rates.
Other income increased $399,000 or 147% to $671,000. This increase was primarily due to income recognized from the increase in the cash surrender value of bank owned life insurance purchased by the Company in 2002.
Fee revenue and other income in 2002 compared to 2001 include the following significant pre-tax components:
Freight and utility payment and processing fee revenue increased $3,132,000 or 15% to $24,622,000. Of the total payment and processing revenue, fees related to utility payment and processing increased $2,188,000 or 49% to $6,650,000 and fees relating to freight payment and processing services increased $944,000 or 6% to $17,972,000. These increases both relate to new customers and new product offerings. Utility processing volume and revenue, which represents a newer market, had higher
percentage increases. Freight rating services revenue, a component of freight processing revenue, decreased $738,000 or 55% to $610,000. A change in the strategic direction of the Company from selling rating software to a new Internet-based delivery system of carrier rates occurred during 2000 and 2001. After December 31, 2001 the Company ceased support of the old product and therefore no longer recognized maintenance revenue. This new system offers the shipping community an expanded level of features, capabilities and ease of access.
Bank service fees increased $137,000 or 9% to $1,659,000. This increase was due primarily to the fact that service fees increase as the value of noninterest bearing deposits, used to compensate the Bank for services provided, decreases as the general level of interest rates decreases.
During 2002 the Company recorded net gains of $1,477,000 on the sales of securities with a fair value of $63,945,000. There were no gains realized in 2001. The sales of securities were transacted to adjust the portfolio to reflect the changes in the interest rate environment, growth in the loan portfolio and to offset the loss of interest income due to the dramatic decline in the general level of interest rates.
Other miscellaneous income increased $41,000 or 18% to $272,000. This increase was primarily due to income recognized from the increase in the cash surrender value of bank owned life insurance purchased by the Company in 2002.
Net Interest Income
Net interest income is the difference between interest earned on loans, investments, and other earning assets and interest expense on deposits and other interest-bearing liabilities. Net interest income is a significant source of the Company's revenues.
Net interest income in 2003 compared to 2002:
On a tax-equivalent basis, net interest income for 2003 totaled $27,310,000, a decrease of $3,156,000 or 10% from 2002. The net interest margin for 2003 was 4.85% compared to 5.60% in 2002. The following factors account for this decrease in net interest income and net interest margin:
The dramatic decrease in the general level of interest rates significantly impacted the Company's net interest income and margin. The prime rate decreased from 9.50% at the beginning of 2001 to 4.00% at the end of 2003 and the 5-year Treasury note rate decreased from 4.80% to 3.22% during this same period. The average yield on earning assets decreased to 5.18% in 2003 from 6.02% in 2002. The Company is negatively affected by decreases in the level of interest rates due to the fact that its rate sensitive assets significantly exceed its rate sensitive liabilities. Conversely, the Company is positively affected by increases in the level of interest rates. This is primarily due to the noninterest-bearing liabilities generated by the Company in the form of accounts and drafts payable. Changes in interest rates will affect some earning assets such as federal funds sold and floating rate loans immediately and some earning assets, such as fixed rate loans and municipal bonds, over time. More information is contained in Item 7A
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity
The Company faces market risk to the extent that its net interest income and its fair market value of equity are affected by changes in market interest rates. The asset/liability management discipline as applied at the Company seeks to limit the volatility, to the extent possible, of both net interest income and the fair market value of equity that can result from changes in market interest rates. This is accomplished by limiting the maturities of fixed rate investments, loans, and deposits; matching fixed rate assets and liabilities to the extent possible; and optimizing the mix of fees and net interest income. However, as discussed below, the Company's asset/liability position differs significantly from most other bank holding companies with significant positive cumulative "gaps" shown for each time horizon presented. This asset sensitive position is caused primarily by the operations of the Company, which generates large balances of accounts and drafts payable. These balances, which are noninterest bearing, contribute to the Company's historical high net interest margin but cause the Company to become susceptible to changes in interest rates, with a decreasing net interest margin and fair market value of equity in periods of declining interest rates and an increasing net interest margin and fair market value of equity in periods of rising interest rates.
The Company's Asset/Liability Management Committee (ALCO) measures the Company's interest rate risk sensitivity on a quarterly basis to monitor and manage the variability of earnings and fair market value of equity in various interest rate environments. The ALCO evaluates the Company's risk position to determine whether the level of exposure is significant enough to hedge a potential decline in earnings and value or whether the Company can safely increase risk to enhance returns. The ALCO uses gap reports, twelve-month net interest income simulations, and fair market value of equity analyses as its main analytical tools to provide management with insight into the Company's exposure to changing interest rates.
Management uses a gap report to review any significant mismatch between the repricing points of the Company's rate sensitive assets and liabilities in certain time horizons. A negative gap indicates that more liabilities reprice in that particular time frame and, if rates rise, these liabilities will reprice faster than the assets. A positive gap would indicate the opposite. Gap reports can be misleading in that they capture only the repricing timing within the balance sheet, and fail to capture other significant risks such as basis risk and embedded options risk. Basis risk involves the potential for the spread relationship between rates to change under different rate environments and embedded options risk relates to the potential for the alteration of the level and/or timing of cash flows given changes in rates.
Another measurement tool used by management is net interest income simulation, which forecasts net interest income during the coming twelve months under different interest rate scenarios in order to quantify potential changes in short term accounting income. Management has set policy limits specifying acceptable levels of interest rate risk given multiple simulated rate movements. These simulations are more informative than gap reports because they are able to capture more of the dynamics within the balance sheet, such as basis risk and embedded options risk. A table containing simulation results as of December 31, 2003 from an immediate and sustained parallel change in interest rates is shown below.
While net interest income simulations do a good job of capturing interest rate risk to short term earnings, they do not capture risk within the current balance sheet beyond twelve months. The Company uses fair market value of equity analyses to help identify longer-term risk that may reside on the current balance sheet. The fair market value of equity is represented by the present value of all future income streams generated by the current balance sheet. The Company measures the fair market value of equity as the net present value of all asset and liability cash flows discounted at forward rates suggested by the current Treasury curve plus appropriate credit spreads. This representation of the change in the fair market value of equity under different rate scenarios gives insight into the magnitude of risk to future earnings due to rate changes. Management has set policy limits relating to declines in the market value of equity. The table below contains the analysis, which illustrates the effects of an immediate and sustained parallel change in interest rates as of December 31, 2003:
% Change in % Change in Fair Change in Interest Rates Net Interest Income Market Value of Equity -------------------------------------------------------------------------- +200 basis points 10% 10% +100 basis points 5% 5% Stable Rates 0% 0% -100 basis points (7%) (7%) -200 basis points (13%) (14%)
Interest Rate Sensitive Position
The following table presents the Company's gap or interest rate risk position at December 31, 2003 for the various time periods indicated.
(1) Balances shown reflect earliest repricing date.
PART II.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CASS INFORMATIONS SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
CASS INFORMATIONS SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
*Earnings per share and weighted average shares outstanding have been restated to reflect the 10% stock dividend declared in February 2004.
See accompanying notes to consolidated financial statements.
CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
CASS INFORMATION SYSTEMS, INC. AND SUBSIDIARIES STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
*Share and per share data has been restated to reflect the 10% stock dividend declared in February 2004.
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 Summary of Significant Accounting Policies
Summary of Operations The Company provides payment and information services, which include processing and payment of freight and utility invoices, preparation of transportation management reports, auditing of freight charges and rating of freight shipments. The consolidated balance sheet caption, "Accounts and Drafts Payable," consists of obligations related to the payment services that are performed for customers. The Company also provides a full range of banking services to individual, corporate and institutional customers through its wholly-owned bank subsidiary and enterprise software solutions to governmental entities through its software subsidiary.
On January 9, 2001 the Company's subsidiary, Cass Information Systems, Inc. was merged into the parent company, Cass Commercial Corporation, and the parent's name was subsequently changed to Cass Information Systems, Inc.
Basis of Presentation The accounting and reporting policies of the Company and its subsidiaries conform to accounting policies generally accepted in the United States of America. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries after elimination of intercompany transactions. Certain amounts in the 2002 and 2001 consolidated financial statements have been reclassified to conform to the 2003 presentation. Such reclassifications have no effect on previously reported net income or shareholders' equity.
Use of Estimates In preparing the consolidated financial statements, Company management is required to make estimates and assumptions which significantly affect the reported amounts in the consolidated financial statements. A significant estimate, which is particularly susceptible to change in a short period of time, is the determination of the allowance for loan losses.
Investment in Debt and Equity Securities The Company classifies its debt and marketable equity securities as available-for-sale. Securities classified as available-for-sale are carried at fair value. Unrealized gains and losses, net of the related tax effect, are excluded from earnings and reported in accumulated other comprehensive income, a component of shareholders' equity. A decline in the fair value of any available-for-sale security below cost that is deemed other than temporary results in a charge to earnings and the establishment of a new cost basis for the security. To determine whether an impairment is other than temporary, the Company considers whether it has the ability and intent to hold the investment until a market place recovery and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for impairment, the severity and duration of the impairment, changes in value subsequent to year-end and forecasted performance of the investee. Premiums and discounts are amortized or accreted to interest income over the estimated lives of the securities. Interest income is recognized when earned. Gains and losses are calculated using the specific identification method. Investments in equity securities without readily determinable fair values are stated at cost.
Non-marketable Equity Investments The Company accounts for non-marketable equity investments under the cost method. Under the cost method of accounting, investments are carried at cost and are adjusted only for other than temporary declines in fair value, distributions of earnings and additional investments. The Company periodically evaluates whether any declines in fair value of its investments are other than temporary. In performing this evaluation, the Company considers various factors including any decline in market price, where available, the investee's financial condition, results of operations, operating trends and other financial ratios. Non-marketable equity investments are included in other assets on the consolidated balance sheets.
Interest on Loans Interest on loans is recognized based upon the principal amounts outstanding. It is the Company's policy to discontinue the accrual of interest when there is reasonable doubt as to the collectibility of principal or interest. Subsequent payments received on such loans are applied to principal if there is any doubt as to the collectibility of such principal; otherwise, these receipts are recorded as interest income. The accrual of interest on a loan is resumed when the loan is current as to payment of both principal and interest and/or the borrower demonstrates the ability to pay and remain current.
Impairment of Loans A loan is considered impaired when it is probable a creditor will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the loan agreement. When measuring impairment, the expected future cash flows of an impaired loan are discounted at the loan's effective interest rate. Alternatively, impairment could be measured by reference to an observable market price, if one exists, or the fair value of
the collateral for a collateral-dependent loan. Regardless of the historical measurement method used, the Company measures impairment based on the fair value of the collateral when the Company determines foreclosure is probable. Additionally, impairment of a restructured loan is measured by discounting the total expected future cash flows at the loan's effective rate of interest as stated in the original loan agreement. The Company uses its nonaccrual methods as discussed above for recognizing interest on impaired loans.
Allowance for Loan Losses The allowance for loan losses is increased by provisions charged to expense and reduced by net charge-offs. The provisions charged to expense are based on economic conditions, past losses, collection experience, risk characteristics of the portfolio and such other factors which, in management's judgment, deserve current recognition.
Management believes the allowance for loan losses is adequate to absorb losses in the loan portfolio. While management uses all available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. Additionally, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to increase the allowance for loan losses based on their judgments and interpretations about information available to them at the time of their examination.
Information Services Revenue Revenue from freight and utility payment related services is recognized when earned and fees are billed to customers, generally monthly.
Software Revenue Software revenue consists of license fees, hardware sales, maintenance fees and other service fees. License fees and hardware sales are recognized in accordance with Statement of Financial Position (SOP) 98-9, "Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions" and therefore revenue is deferred until the following criteria are met: (a) persuasive evidence of an arrangement exists, (b) delivery has occurred, (c) the fee is fixed and determinable and (d) collection is probable. Maintenance fees are normally paid in advance and cover a period of one year and therefore fees are recognized ratably over the maintenance term and the unamortized balance is carried as deferred income and included in other liabilities. Other services are provided on an as needed basis and revenue is recognized once the service has been completed and the customer is billed.
Premises and Equipment Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed over the estimated useful lives of the assets, or the respective lease terms for leasehold improvements, using straight-line and accelerated methods. Estimated useful lives do not exceed 40 years for buildings, 10 years for leasehold improvements and range from 3 to 7 years for software, equipment, furniture and fixtures. Maintenance and repairs are charged to expense as incurred.
Foreclosed assets On January 2, 2001, the Bank subsidiary foreclosed on certain operating assets of one borrower in order to protect the financial interest in that borrower. The Bank sold these assets to a wholly-owned subsidiary and invested in and stabilized this business. From the date of foreclosure through December 31, 2002, these assets had been accounted for as a foreclosed asset that is held for sale. At December 31, 2002 other assets includes $7,108,000 and other liabilities includes $1,810,000 related to this business.
The Company has adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", effective January 1, 2002. SFAS 144 requires that if certain criteria are not met for long-lived asset (disposal) groups classified as held for sale by the end of the fiscal year in which SFAS 144 is initially applied, the related long-lived assets shall be reclassified as held and used. Therefore, as of January 1, 2003, the Company reclassified these foreclosed assets as held and used and consolidated its operations into those of the Company.
Other real estate, included in other assets in the accompanying consolidated balance sheets, is recorded at fair value less estimated selling costs. If the fair value of other real estate declines subsequent to foreclosure, the difference is recorded as a valuation allowance through a charge to expense. Subsequent increases in fair value are recorded through reversal of the valuation allowance. Expenses incurred in maintaining the properties are charged to expense.
Intangible Assets Cost in excess of fair value of net assets acquired and fair value in excess of cost of net assets acquired have resulted from business acquisitions which were accounted for using the purchase method. The Company adopted the provisions of SFAS 142, "Goodwill and Other Intangible Assets", effective January 1, 2002 which requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. SFAS 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment in accordance with SFAS 144. Prior to the adoption of SFAS 142, goodwill was amortized on a straight-line basis over 15 years. The disclosure requirements of SFAS 142 are included in Item 8, Note 7 of this report.
Periodically, the Company reviews intangible assets for events or changes in circumstances that may indicate that the carrying amount of the assets may not be recoverable. Based on those reviews, adjustments of recorded amounts have not been required.
Income Taxes Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Cash and Cash Equivalents For purposes of the consolidated statements of cash flows, the Company considers cash and due from banks, federal funds sold and other short-term investments as segregated in the accompanying consolidated balance sheets to be cash equivalents.
Earnings Per Share Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS is computed by dividing net income by the weighted average number of common shares adjusted for the dilutive effect of outstanding stock options and awards. All per share data has been restated to reflect the 10% stock dividend declared in February 2004.
Stock Options The Company accounts for stock-based compensation under the stock option plan in accordance with 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 Company uses the Black-Scholes option-pricing model to determine the fair value of the stock options at the date of grant. There were 15,543 options granted in 2003, 6,930 options granted in 2002 and no options were granted in 2001. The required disclosure provisions of SFAS 123, as amended by SFAS 148, are provided in the table below.
*All share and per share amounts in this section have been adjusted to reflect the 10% stock dividend declared in February 2004.
Comprehensive Income Comprehensive income consists of net income, changes in net unrealized gains (losses) on available-for-sale securities and minimum pension liability adjustments and is presented in the accompanying consolidated statements of shareholders' equity and comprehensive income.
Recent and Prospective Accounting Pronouncements In November 2002, the Financial Accounting Standards Board (FASB) issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34." This interpretation elaborates on the disclosures to be made by a guarantor in its financial statements about its obligation under guarantees issued. The
interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the interpretation are applicable to guarantees issued or modified after December 31, 2002 and did not have a material effect on the Company's consolidated financial statements. The disclosure requirements are effective for financial statements of periods ending after December 15, 2002 and are included in Item 7 and Item 8, Note 14 of this report.
In December 2002, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123." This statement amends SFAS 123 "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in both the annual and interim financial statements. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2002 and are included above.
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 is not expected to have a material impact on the consolidated financial statements.
In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133. The new guidance amends SFAS 133 for decisions made: (a) as part of the Derivatives Implementation Group process that effectively required amendments to SFAS 133, (b) in connection with other Board projects dealing with financial instruments, and (c) regarding implementation issues raised in relation to the application of the definition of derivative. The amendments set forth in SFAS 149 improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. SFAS 149 is generally effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The provisions of SFAS 149 did not have a material impact on the Company's consolidated financial statements.
In May 2003, the FASB issued SFAS 150, "Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity," which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement requires that an issuer classify a financial instrument that is within its scope, which may have previously been reported as equity, as a liability (or an asset in some circumstances). This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatory redeemable financial instruments of nonpublic companies. The Company currently does not have any instruments that fall within the scope of SFAS 150 and therefore the adoption of SFAS 150 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 disclosure information about debt or marketable equity securities with market values below carrying values. The Company has adopted the disclosure requirements of EITF Issue No. 03-1 and they are included in Item 8, Note 3 of this report.
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 requirement of SFAS 132 (Revised 2003) that is required for fiscal years ending after December 15, 2003 are included in Item 8, Note 10 of this report.
Note 2 Capital Requirements And Regulatory Restrictions
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can result in certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and the Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulators to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets. Management believes as of December 31, 2003 and 2002, the Company and the Bank met all capital adequacy requirements to which they are subject.
The Bank is also subject to the regulatory framework for prompt corrective action. As of December 31, 2003 the most recent notification from the regulatory agencies categorized the Bank as well capitalized. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank's category.
Subsidiary dividends are a significant source of funds for payment of dividends by the Company to its shareholders. At December 31, 2003, unappropriated retained earnings of $8,922,000 were available at the Bank for the declaration of dividends to the Company without prior approval from regulatory authorities. However, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Bank's capital to be reduced below applicable minimum capital requirements.
Restricted funds on deposit used to meet regulatory reserve requirements amounted to approximately $663,000 and $707,000 at December 31, 2003 and 2002, respectively.
The Company and the Bank's actual and required capital amounts and ratios as of December 31, 2003 and 2002 are as follows:
Note 3 Investment in Debt and Equity Securities
Debt and marketable equity securities have been classified in the consolidated balance sheets according to management's intent. The amortized cost, gross unrealized gains, gross unrealized losses and fair value of debt and equity securities at December 31, 2003 and 2002, are summarized as follows:
The fair value of securities with unrealized losses at December 31, 2003 are as follows:
Fair Unrealized (In thousands) Value Losses -------------------------------------------------------------------------- U. S. Government treasuries $4,009 $ 1 Obligations of U.S. Government Corporations and agencies 1,994 11 State and political subdivisions 150 2 -------------------------------------------------------------------------- Total $6,153 $ 14 ==========================================================================
All the unrealized losses included in the table above have been in an unrealized loss position for less than one year. All unrealized losses are reviewed to determine whether the losses are other than temporary. Management believes that all unrealized losses are temporary since they are market driven and the Company has the ability to hold these securities until maturity.
The amortized cost and fair value of debt and equity securities at December 31, 2003, by contractual maturity, are shown in the following table. Expected maturities may differ from contractual maturities because borrowers have the right to prepay obligations with or without prepayment penalties.
------------------- Amortized Fair (In thousands) Cost Value -------------------------------------------------------------------------- Due in 1 year or less $14,097 $14,104 Due after 1 year through 5 years 8,656 8,776 Due after 5 years through 10 years 13,805 14,427 Due after 10 years 30,297 31,263 No stated maturity 577 577 -------------------------------------------------------------------------- Total $67,432 $69,147 ==========================================================================
The amortized cost of debt securities pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes at December 31, 2003 were $3,599,000 and there were no securities pledged at December 31, 2002.
Proceeds from sales of debt securities classified as available-for-sale were $38,454,000 and $63,945,000 for 2003 and 2002, respectively and there were no sales of debt and equity securities in 2001. Gross gains realized on the sales in 2003 were $1,454,000 and in 2002 gross realized gains were $1,501,000 and gross losses realized were $24,000.
Note 4 Loans
A summary of loan categories at December 31, 2003 and 2002, is as follows:
(In thousands) 2003 2002 -------------------------------------------------------------------------- Commercial and industrial $103,638 $101,116 Real estate: Mortgage 184,221 176,667 Mortgage - Church & related 145,929 105,458 Construction 2,920 3,101 Construction - Church & related 16,378 36,074 Industrial revenue bonds 5,373 5,773 Installment 1,911 1,918 Other 8,662 4,582 -------------------------------------------------------------------------- Total $469,032 $434,689 ==========================================================================
The Company originates commercial, industrial, real estate and installment loans to businesses, churches and consumers throughout the metropolitan St. Louis area. The Company also originates church and church-related loans outside the metropolitan St. Louis area. The Company does not have any particular concentration of credit in any one economic sector; however, a substantial portion of the commercial and industrial loans are extended to privately held commercial companies in this market area, and are generally secured by the assets of the business. The Company also has a substantial portion of real estate loans that are extended to churches, in this market area and selected cities throughout the United States, which are secured by mortgages.
Loan transactions involving executive officers and directors of the Company and its subsidiaries and loans to affiliates of executive officers and directors for the year ended December 31, 2003, are summarized below. Such loans were made in the normal course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other persons, and did not involve more than the normal risk of collectibility.
(In thousands) -------------------------------------------------------------------------- Aggregate balance, January 1, 2003 $3,374 New loans -- Payments 89 -------------------------------------------------------------------------- Aggregate balance, December 31, 2003 $3,285 ==========================================================================
A summary of the activity in the allowance for loan losses for 2003, 2002 and 2001 is as follows:
(In thousands) 2003 2002 2001 -------------------------------------------------------------------------- Balance, January 1 $ 5,293 $ 4,906 $ 4,897 Provision charged to expense 190 500 60 Loans charged off (2) (152) (110) Recoveries of loans previously charged off 25 39 59 -------------------------------------------------------------------------- Net loan recoveries (charge-offs) 23 (113) (51) -------------------------------------------------------------------------- Balance, December 31 $ 5,506 $ 5,293 $ 4,906 ==========================================================================
The following is a summary of information pertaining to impaired loans at December 31, 2003 and 2002:
(In thousands) 2003 2002 -------------------------------------------------------------------------- Impaired loans without a valuation allowance $ -- $ -- Impaired loans with a valuation allowance 4,393 10,369 Allowance for loan losses related to impaired loans 627 431 --------------------------------------------------------------------------
Impaired loans consist primarily of renegotiated loans, nonaccrual loans and loans 90 days past due and still accruing interest. Impaired loans continuing to accrue interest were $2,868,000 and $10,319,000 at December 31, 2003 and 2002, respectively. Of these, loans delinquent 90 days or more and still accruing interest at December 31, 2003 and 2002 totaled $147,000 and $4,891,000, respectively. The average balance of impaired loans during 2003 and 2002 was $5,736,000 and $6,626,000, respectively. Income that would have been recognized on non-accrual and renegotiated loans under the original terms of the contract was $272,000, $346,000 and $65,000 for 2003, 2002 and 2001, respectively. Income that was recognized on non-accrual and renegotiated loans was $164,000, $328,000 and $9,000 for 2003, 2002 and 2001, respectively.
Note 5 Premises and Equipment
A summary of premises and equipment at December 31, 2003 and 2002, is as follows:
(In thousands) 2003 2002 -------------------------------------------------------------------------- Land $ 873 $ 873 Buildings 10,374 10,288 Leasehold improvements 968 968 Furniture, fixtures and equipment 18,125 16,799 Purchased software 3,383 3,105 Internally developed software 4,474 4,130 -------------------------------------------------------------------------- 38,197 36,163 Less accumulated depreciation and amortization 24,659 20,804 -------------------------------------------------------------------------- Total $13,538 $15,359 ==========================================================================
Depreciation and amortization charged to expense in 2003, 2002 and 2001 amounted to $3,689,000, $3,638,000 and $3,085,000, respectively.
The Company and its subsidiaries lease various premises and equipment under operating lease agreements, which expire at various dates through 2007. The following is a schedule, by year, of future minimum rental payments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 2003:
(In thousands) -------------------------------------------------------------------------- 2004 $461 2005 226 2006 42 2007 7 -------------------------------------------------------------------------- Total $736 ==========================================================================
Rental expense for 2003, 2002 and 2001 was $686,000, $604,000 and $761,000, respectively.
Note 6 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. As of December 31, 2003, the total investment of the Company in this entity was $2,908,000 and is included in other assets in the accompanying consolidated balance sheets. At December 31, 2003 the Company had an effective 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. The primary condition for any additional investment by the Company is the amount of the new majority owner's actual financial investment. Should this business fail to meet its objectives, the Company's investment could be subject to future impairment.
This investment, along with $368,000 of other investments in non-marketable securities, is included in other assets on the Company's consolidated balance sheets.
Note 7 Acquired 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. Details of the Company's intangible assets as of December 31, 2003 are as follows:
Gross Carrying Accumulated (In thousands) Amount Amortization Net - -------------------------------------------------------------------------------- Amortized intangible assets: Customer list $ 823 $ (55) $ 768 Software 1,024 (256) 768 - -------------------------------------------------------------------------------- Total amortized intangible assets 1,847 (311) 1,536 - -------------------------------------------------------------------------------- Unamortized intangible assets: Goodwill 3,377 (227)* 3,150 Minimum pension liability 404 -- 404 - -------------------------------------------------------------------------------- Total unamortized intangible assets 3,781 (227) 3,554 - -------------------------------------------------------------------------------- Total intangible assets $5,628 $ (538) $5,090 - --------------------------------------------------------------------------------
*Amortization through December 31, 2001 prior to adoption of SFAS 142.
On January 1, 2003 the Company acquired $2,927,000 of goodwill, $823,000 of customer list and $1,024,000 in software related to the consolidation of GEMS, which is further discussed in Item 1 and 7 of this report. The 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 that 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 $311,000 and $91,000 for the years ended December 31, 2003 and 2001, respectively. There was no amortization of intangibles for the year ended December 31, 2002. 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 Interest-Bearing Deposits
Interest-bearing deposits consist of the following at December 31, 2003 and 2002:
(In thousands) 2003 2002 -------------------------------------------------------------------------- NOW and Money Market Deposit Accounts $ 53,983 $ 53,543 Savings deposits 32,626 32,724 Time deposits: Less than $100 27,909 5,611 $100 or more 43,276 42,288 -------------------------------------------------------------------------- Total $157,794 $134,166 ==========================================================================
Interest on deposits consist of the following for 2003, 2002 and 2001:
(In thousands) 2003 2002 2001 -------------------------------------------------------------------------- NOW and Money Market Deposit Accounts $ 371 $ 632 $1,544 Savings deposits 281 528 1,761 Time deposits: Less than $100 351 178 195 $100 or more 844 902 363 -------------------------------------------------------------------------- Total $1,847 $2,240 $3,863 ==========================================================================
The scheduled maturities of certificates of deposit at December 31, 2003 and 2002, are summarized as follows:
2003 2002 ---------------------------------------- Percent Percent (In thousands) Amount of Total Amount of Total -------------------------------------------------------------------------- Due within: One year $50,991 71.6% $42,678 89.1% Two years 8,826 12.4 3,066 6.4 Three years 276 .4 920 1.9 Four years 1,265 1.8 10 -- Five years 9,827 13.8 1,225 2.6 -------------------------------------------------------------------------- Total $71,185 100.0% $47,899 100.0% ==========================================================================
Note 9 Short-Term Borrowings
Company short-term borrowings consist mainly of federal funds purchased and tax deposits of the United States Treasury. At December 31, 2003 the bank subsidiary had short-term borrowings of $123,000 that consisted of borrowings from the Treasury related to tax deposits received from customers not yet drawn upon by the Treasury. These borrowings are secured by U.S. Treasury and Agency securities. The average amount of all borrowings for 2003 was $943,000 at an average rate of 1.48% and the maximum amount outstanding at the end of any month during the year was $21,523,000. At December 31, 2002 the bank subsidiary borrowed $37,438,000 in federal funds at a year-end weighted average rate of 1.56%. Of this amount, $17,438,000 were unsecured borrowings and $20,000,000 were borrowings from the Federal Home Loan Bank secured by commercial and residential mortgage loans. Average borrowings for 2002 were $1,485,000 with an average rate of 2.22%. The borrowings for the month ended December 31, 2002 was the maximum amount that was outstanding at the end of any month during the year.
Note 10 Employee Benefits
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.
A summary of the activity in the defined benefit pension plan's benefit obligation, assets, funded status and amounts recognized in the Company's consolidated balance sheets at December 31, 2003 and 2002, is as follows:
(In thousands) 2003 2002 -------------------------------------------------------------------------- Benefit obligation: Balance, January 1 $ 16,461 $ 14,166 Service cost 979 952 Interest cost 1,105 1,012 Actuarial loss 1,718 551 Benefits paid (237) (220) -------------------------------------------------------------------------- Balance, December 31 $ 20,026 $ 16,461 ========================================================================== Plan assets: Fair value, January 1 $ 12,797 $ 12,640 Actual return 1,622 (524) Employer contribution 903 901 Benefits paid (237) (220) -------------------------------------------------------------------------- Fair value, December 31 $ 15,085 $ 12,797 ========================================================================== Funded status: Unfunded projected benefits obligation $ (4,941) $ (3,664) Unrecognized prior service cost 90 103 Unrecognized net loss 2,614 1,463 -------------------------------------------------------------------------- Accrued pension cost $ (2,237) $ (2,098) ==========================================================================
The accumulated benefit obligation was $15,970,000 and $12,826,000 for the periods ended December 31, 2003 and 2002, respectively. The Company expects to contribute approximately $975,000 to the plan in 2004.
The following represent the major assumptions used to determine the benefit obligation of the plan:
2003 2002 2001 -------------------------------------------------------------------------- Weighted average discount rate 6.25% 7.00% 7.25% Rate of increase in compensation levels 4.00% 4.00% 4.00%
The pension cost for 2003, 2002 and 2001 was $1,042,000, $948,000 and $700,000, respectively, and included the following components:
The following represent the major assumptions used to determine the net benefit cost of the plan:
2003 2002 2001 -------------------------------------------------------------------------- Weighted average discount rate 7.00% 7.25% 7.50% Rate of increase in compensation levels 4.00% 4.00% 4.00% Expected long-term rate of return on assets 8.00% 8.00% 8.00%
The asset allocation for the defined benefit pension plan as of the measurement date, by asset category, is as follows:
Percentage of Plan Assets -------------------------------------------------------------------------- Asset Class 2003 2002 -------------------------------------------------------------------------- Equity securities 34.6% 25.6% Debt securities 65.1% 73.7% Cash and cash equivalents .3% .7% -------------------------------------------------------------------------- Total 100.0% 100.0% ==========================================================================
The investment objective for the defined benefit pension plan is to maximize total return with a tolerance for average risk. Asset allocation strongly favors fixed income investments, with a target allocation of approximately 67% fixed income, 33% equities, and 0% cash. Due to volatility in the market, this target allocation is not always desirable and asset allocations can fluctuate between acceptable ranges. The fixed income component is invested in pooled investment grade securities. The equity component is invested in pooled large cap stocks. More aggressive or volatile sectors, although currently not employed, can be represented in the asset mix to pursue higher returns with proper diversification. The assumed long-term rate of return on assets is 8.0% as derived below:
The 8% assumption falls within the expected range.
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 pension cost for 2003, 2002 and 2001 for the supplemental executive retirement plan was $145,000, $177,000 and $220,000 respectively, and included the following components:
(In thousands) 2003 2002 2001 -------------------------------------------------------------------------- Service cost - benefits earned during the year $ (24) $ (13) $ 11 Interest cost on projected benefit obligations 107 124 120 Net amortization and deferral 62 66 89 -------------------------------------------------------------------------- Net periodic pension cost $ 145 $ 177 $ 220 ==========================================================================
A summary of the activity in the supplemental executive retirement plan's benefit obligation, funded status and amounts recognized in the Company's consolidated balance sheets at December 31, 2003 and 2002, is as follows:
(In thousands) 2003 2002 -------------------------------------------------------------------------- Benefit obligation: Balance, January 1 $ 1,878 $ 1,787 Service cost (24) (13) Interest cost 107 124 Actuarial gain (266) (20) -------------------------------------------------------------------------- Balance, December 31 $ 1,695 $ 1,878 ========================================================================== Funded status: Unfunded projected benefits obligation $(1,695) $(1,878) Unrecognized prior service cost 404 454 Unrecognized actuarial loss 105 383 -------------------------------------------------------------------------- Accrued pension cost (1,186) (1,041) Minimum liability adjustment (419) (379) -------------------------------------------------------------------------- Accrued pension cost $(1,605) $(1,420) ==========================================================================
The accumulated benefit obligation was $1,605,000 and $1,420,000 for the periods ended December 31, 2003 and 2002, respectively. Since this is an unfunded plan there are no plan assets. The major assumptions used to determine the projected benefit obligation and net benefit cost are the same as those in the defined plan explained above.
The provisions of SFAS 87, "Employers' Accounting for Pensions", required the Company to record an additional minimum liability of $419,000 and $379,000 at December 31, 2003 and 2002, respectively. This liability represents the amount by which the accumulated benefit obligation exceeds the sum of the fair value of plan assets and accrued amounts previously recorded. The additional liability is offset by an intangible asset to the extent of previously unrecognized prior service cost. The intangible assets of $404,000 and $379,000 at December 31, 2003 and 2002, respectively, are included in other intangible assets on the accompanying consolidated balance sheets. The remaining amount at December 31, 2003 of $15,000 is recorded, net of tax, as an accumulated other comprehensive loss.
The Company maintains a noncontributory profit sharing plan, which covers most of its employees. Employer contributions are calculated based upon formulas which relate to current operating results and other factors. Profit sharing expense recognized in the consolidated statements of income in 2003, 2002 and 2001 was $1,755,000, $1,632,000 and $1,588,000, respectively.
The Company sponsors a defined contribution 401(k) plan to provide additional retirement benefits to substantially all employees. Contributions under the 401(k) plan for 2003, 2002 and 2001 were $333,000, $277,000 and $260,000, respectively.
Stock Option and Bonus Plans*
The Company maintains a restricted stock bonus plan which provides for the issuance of up to 115,500 shares of common stock, the purpose of which is to permit grants of shares, subject to restrictions, to key employees and non-employee directors of the Company as a means of retaining and rewarding them for long-term performance. During 2003, 2002 and 2001, 6,501 shares, 1,040 shares and 693 shares, respectively, were granted with weighted average per share market prices of $24.74 in 2003, $21.21 in 2002 and $16.97 in 2001. The fair value of such shares, which is based on the market price on the date of
grant, has been recorded in the consolidated financial statements through the establishment of a contra shareholders' equity account which is amortized to expense over the three-year vesting period. Amortization of the restricted stock bonus awards totaled $57,000 for 2003, $22,000 for 2002 and $80,000 for 2001. At December 31, 2003 the weighted-average grant date fair value and weighted average contractual life for outstanding shares of restricted stock was $24.16 and 2.04 years, respectively.
A summary of restricted stock bonus share activity follows:
The Company also maintains a performance-based stock option plan, which provides for the granting of options to acquire up to 462,000 shares of Company common stock. Options vest over a period not to exceed seven years.
The following table summarizes stock options outstanding as of December 31, 2003:
Weighted Average Exercise Options Remaining Price Outstanding Contractual Life --------------------------------------------------------------------- $ 8.94 8,428 1.00 years 17.63 6,930 1.88 19.91 4,042 2.00 21.33 2,310 2.00 21.86 65,084 2.00 22.04 8,731 1.11 22.50 12,000 6.00 24.75 3,543 6.00
Changes in options outstanding were as follows: Weighted Average Shares Exercise Price -------------------------------------------------------------------------- Balance at December 31, 2000 186,439 $15.25 Exercised (12,017) 8.94 Forfeited (2,497) 17.91 -------------------------------------------------------------------------- Balance at December 31, 2001 171,925 15.65 Granted 6,930 19.92 Exercised (44,850) 8.94 Forfeited (4,042) 21.86 -------------------------------------------------------------------------- Balance at December 31, 2002 129,963 18.01 Granted 15,543 23.01 Exercised (27,508) 10.81 Forfeited (6,930) 19.92 -------------------------------------------------------------------------- Balance at December 31, 2003 111,068 $20.37 ==========================================================================
At December 31, 2003, 19,647 shares were exercisable with a weighted average exercise price of $15.40.
*All share and per share amounts in this section have been restated to reflect a 10% stock dividend declared in February 2004.
Note 11 Other Operating Expense
Details of other operating expense for 2003, 2002 and 2001 are as follows:
(In thousands) 2003 2002 2001 -------------------------------------------------------------------------- Postage, printing and supplies $ 2,886 $ 2,906 $ 2,662 Advertising and business development 1,929 1,382 1,280 Professional fees 2,268 1,964 1,740 Outside service fees 1,316 1,175 1,006 Data processing services 207 231 416 Telecommunications 561 510 605 Other 2,325 1,192 1,062 -------------------------------------------------------------------------- Total other operating expense $11,492 $ 9,360 $ 8,771 ==========================================================================
Note 12 Income Taxes
The components of income tax expense for 2003, 2002 and 2001 are as follows:
(In thousands) 2003 2002 2001 -------------------------------------------------------------------------- Current: Federal $ 3,571 $ 2,883 $ 2,571 State 481 419 407 Deferred (599) (315) 761 -------------------------------------------------------------------------- Total income tax expense $ 3,453 $ 2,987 $ 3,739 ==========================================================================
A reconciliation of expected income tax expense, computed by applying the effective federal statutory rate of 34% for 2003, 2002 and 2001 to income before income tax expense, to reported income tax expense is as follows:
(In thousands) 2003 2002 2001 -------------------------------------------------------------------------- Expected income tax expense $ 3,861 $ 3,502 $ 3,660 (Reductions) increases resulting from: Tax-exempt interest (793) (800) (229) State taxes, net of federal benefit 317 277 269 Other, net 68 8 39 -------------------------------------------------------------------------- Total income tax expense $ 3,453 $ 2,987 $ 3,739 ==========================================================================
The tax effects of temporary differences which give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2003 and 2002, are presented below:
(In thousands) 2003 2002 -------------------------------------------------------------------------- Deferred tax assets: Allowance for loan losses $ 1,952 $ 1,452 Accrued pension cost 783 724 Deferred revenue 626 -- Other 491 459 -------------------------------------------------------------------------- Total deferred tax assets 3,852 2,635 -------------------------------------------------------------------------- Deferred tax liabilities: Unrealized gain on investment in debt and equity securities available-for-sale (583) (615) Premises and equipment (641) (724) Intangibles (532) -- Other (179) (237) -------------------------------------------------------------------------- Total deferred tax liabilities (1,935) (1,576) -------------------------------------------------------------------------- Net deferred tax assets $ 1,917 $ 1,059 ==========================================================================
A valuation allowance would be provided on deferred tax assets when it is more likely than not that some portion of the assets will not be realized. The Company has not established a valuation allowance at December 31, 2003 or 2002, due to management's belief that all criteria for recognition have been met, including the existence of a history of taxes paid sufficient to support the realization of deferred tax assets.
Note 13 Contingencies
The Company and its subsidiaries are involved in various pending legal actions and proceedings in which claims for damages are asserted. Management, after discussion with legal counsel, believes the ultimate resolution of these legal actions and proceedings will not have a material effect upon the Company's consolidated financial position or results of operations.
Note 14 Disclosures About Financial Instruments
The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, commercial letters of credit and standby letters of credit. The Company's maximum potential exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, commercial letters of credit and standby letters of credit is represented by the contractual amounts of those instruments. At December 31, 2003, no amounts have been accrued for any estimated losses for these instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commercial and standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These off-balance sheet financial instruments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The approximate remaining term of commercial and standby letters of credit range from less than 1 to 5 years. Since these financial instruments may expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. Commitments to extend credit and letters of credit are subject to the same underwriting standards as those financial instruments included on the consolidated balance sheets. The Company evaluates each customer's credit-worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of the credit, is based on management's credit evaluation of the borrower. Collateral held varies, but is generally accounts receivable, inventory, residential or income-producing commercial property or equipment. In the event of nonperformance, the Company may obtain and liquidate the collateral to recover amounts paid under its guarantees on these financial instruments.
The following table shows conditional commitments to extend credit, standby letters of credit and commercial letters at December 31, 2003 and 2002:
(In thousands) 2003 2002 -------------------------------------------------------------------------- Conditional commitments to extend credit $20,941 $29,463 Standby letters of credit 4,516 5,663 Commercial letters of credit 347 100 --------------------------------------------------------------------------
Following is a summary of the carrying amounts and fair values of the Company's financial instruments at December 31, 2003 and 2002:
The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value:
Cash and Other Short-term Instruments For cash and cash equivalents, accrued interest receivable, accounts and drafts payable, short-term borrowings and accrued interest payable, the carrying amount is a reasonable estimate of fair value because of the demand nature or short maturities of these instruments.
Investment in Debt and Equity Securities Fair values are based on quoted market prices or dealer quotes.
Loans The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
Deposits The fair value of demand deposits, savings deposits and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value estimates above do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market nor the benefit derived from the customer relationship inherent in existing deposits.
Commitments to Extend Credit and Standby Letters of Credit The fair value of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the likelihood of the counterparties drawing on such financial instruments and the present credit-worthiness of such counterparties. The Company believes such commitments have been made at terms which are competitive in the markets in which it operates; however, no premium or discount is offered thereon.
Limitations Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets or liabilities that are not considered financial assets or liabilities include premises and equipment and the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market (core deposit intangible). In addition, tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.
Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on management's judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Note 15 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 Note 1 of this report. Management evaluates segment performance based on net income after allocations for corporate expenses and income taxes. Transactions between segments are accounted for at what management believes to be market value.
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 periods ended December 31, 2003, 2002 and 2001, is as follows:
Note 16 Condensed Financial Information of Parent Company
Following are the condensed balance sheets of the Company (parent company only) as of December 31, 2003 and 2002, and the related condensed statements of income and cash flows for each of the years in the three-year period ended December 31, 2003.
Condensed Balance Sheets December 31 ------------------------ (In thousands) 2003 2002 -------------------------------------------------------------------------- Assets: Cash and due from banks $ 346 $ 2,599 Short-term investments 26,666 -- Investment in debt and equity securities, available-for-sale 63,679 54,854 Loans, net 207,134 205,240 Investment in subsidiary 32,709 29,910 Premises and equipment, net 11,879 14,354 Other assets 21,536 17,538 -------------------------------------------------------------------------- Total assets $363,949 $324,495 ========================================================================== Liabilities and Shareholders' Equity: Accounts and drafts payable $293,769 $223,621 Borrowings from subsidiary -- 35,861 Other liabilities 5,388 3,967 -------------------------------------------------------------------------- Total liabilities 299,157 263,449 Total shareholders' equity 64,792 61,046 -------------------------------------------------------------------------- Total liabilities and shareholders' equity $363,949 $324,495 ==========================================================================
Note 17 SUPPLEMENTARY FINANCIAL INFORMATION (Unaudited)
*Basic and diluted earnings per share have been adjusted to reflect the 10% stock dividend declared in February 2004.
Independent Auditors' Report
The Board of Directors and Shareholders of Cass Information Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Cass Information Systems, Inc. and subsidiaries (the Company) as of December 31, 2003 and 2002, and the related consolidated statements of income, cash flows, and shareholders' equity and comprehensive income for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cass Information Systems, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
St. Louis, Missouri February 27, 2004
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
NONE
ITEM 9A.
ITEM 9A. 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 December 31, 2003 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 fourth quarter of 2003 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).
PART III.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning directors and executive officers of the Registrant is incorporated herein by reference from the Company's definitive Proxy Statement for its 2004 Annual Meeting of Shareholders, a copy of which will be filed with the Securities and Exchange Commission (SEC) no later than 120 days after the close of the fiscal year.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by reference from the Company's definitive Proxy Statement for its 2004 Annual Meeting of Shareholders, a copy of which will be filed with the SEC no later than 120 days after the close of the fiscal year.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the Company's definitive Proxy Statement for its 2004 Annual Meeting of Shareholders, a copy of which will be filed with the SEC no later than 120 days after the close of the fiscal year.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and transactions is incorporated herein by reference from the Company's definitive Proxy Statement for its 2004 Annual Meeting of Shareholders, a copy of which will be filed with the SEC no later than 120 days after the close of the fiscal year.
Item 14.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information concerning fees billed by the Company's principal accountant for services is incorporated herein by reference from the Company's definitive Proxy Statement for its 2004 Annual Meeting of Shareholders, a copy of which will be filed with the SEC no later than 120 days after the close of the fiscal year.
PART IV.
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are incorporated by reference in or filed as an exhibit to this Report:
(1) and (2) Financial Statements and Financial Statement Schedules
Submitted as a separate section of this report.
(3) Exhibits
3.1 Restated Articles of Incorporation of Registrant, incorporated by reference to Exhibit 4.1 to Form S-8 Registration Statement No. 333-44499, filed with the SEC on January 20, 1998
3.2 Bylaws of Registrant, incorporated by reference to Exhibit 4.2 to Form S-8 Registration Statement No. 333-44499, filed with the SEC on January 20, 1998
10.1 1995 Restricted Stock Bonus Plan, as amended to January 19, 1999, including form of Restriction Agreement, incorporated by reference to Exhibit 4.3 to Post-Effective Amendment No. 2 to Form S-8 Registration Statement No. 33-91456, filed with the SEC on February 16, 1999
10.2 1995 Performance-Based Stock Option Plan, as amended to January 19, 1999, including forms of Option Agreements, incorporated by reference to Exhibit 4.3 to Post-Effective Amendment No. 2 to Form S-8 Registration Statement No. 33-91568, filed with the SEC on February 16, 1999
21 Subsidiaries of registrant
23 Consent of KPMG LLP
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
The Company filed a report on Form 8-K under Items 7 and 9 dated October 23, 2003, reporting the announcement of the Company's earnings for the third quarter of 2003.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
CASS INFORMATION SYSTEMS, INC.
Date: March 8, 2004 By /s/ Lawrence A. Collett ---------------------------------------- Lawrence A. Collett Chairman and Chief Executive Officer
Date: March 8, 2004 By /s/ Eric H. Brunngraber ---------------------------------------- Eric H. Brunngraber Vice President-Secretary (Chief Financial and Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below on the dates indicated by the following persons on behalf of the Company and in their capacity as a member of the Board of Directors of the Company.
Date: March 8, 2004 By /s/ Robert J. Bodine ---------------------------------------- Robert J. Bodine
Date: March 8, 2004 By /s/ Eric H. Brunngraber ---------------------------------------- Eric H. Brunngraber
Date: March 8, 2004 By /s/ Bryan S. Chapell ---------------------------------------- Bryan S. Chapell
Date: March 8, 2004 By /s/ Lawrence A. Collett ---------------------------------------- Lawrence A. Collett
Date: March 8, 2004 By /s/ Thomas J. Fucoloro ---------------------------------------- Thomas J. Fucoloro
Date: March 8, 2004 By /s/ Wayne J. Grace ---------------------------------------- Wayne J. Grace
Date: March 8, 2004 By /s/ Harry J. Krieg ---------------------------------------- Harry J. Krieg
Date: March 8, 2004 By /s/ Howard A. Kuehner ---------------------------------------- Howard A. Kuehner
Date: March 8, 2004 By /s/ Jake Nania ---------------------------------------- Jake Nania
Date: March 8, 2004 By /s/ Irving A. Shepard ---------------------------------------- Irving A. Shepard
Date: March 8, 2004 By /s/ A. J. Signorelli ---------------------------------------- A. J. Signorelli
Date: March 8, 2004 By /s/ Bruce E. Woodruff ---------------------------------------- Bruce E. Woodruff