UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transaction period from to ---------- ---------- COMMISSION FILE NUMBER 333-3250 -------- FIRST INTERSTATE BANCSYSTEM, INC. --------------------------------- (Exact name of registrant as specified in its charter) Montana 81-0331430 ------------------------------- ------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) PO Box 30918, 401 North 31st Street, Billings, MT 59116-0918 ------------------------------------------------------------ (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 406/255-5390 ------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes X No ----- ------ The Registrant had 7,966,768 shares of common stock outstanding on March 31, 1999. 1
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Quarterly Report on Form 10-Q <TABLE> <CAPTION> Index Page ----- ---- <S> <C> <C> PART I. FINANCIAL INFORMATION Item 1 - Financial Statements Consolidated Balance Sheets March 31, 1999 (unaudited) and December 31, 1998 3 Consolidated Statements of Income Three months ended March 31, 1999 and 1998 (unaudited) 4 Consolidated Statements of Comprehensive Income Three months ended March 31, 1999 and 1998 (unaudited) 5 Consolidated Statements of Cash Flows Three months ended March 31, 1999 and 1998 (unaudited) 6 Notes to Unaudited Consolidated Financial Statements 7 Item 2 - Management's Discussion and Analysis of Financial Condition And Results of Operations 9 Item 3 - Quantitative and Qualitative Disclosures about Market Risk 14 PART II. OTHER INFORMATION Item 1 - Legal Proceedings 15 Item 2 - Changes in Securities 15 Item 3 - Defaults on Senior Securities 15 Item 4 - Submission of Matters to a Vote of Security Holders 15 Item 5 - Other Information 15 Item 6 - Exhibits and Reports on Form 8-K 15 SIGNATURES 16 </TABLE> 2
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Consolidated Balance Sheets (Dollars in thousands, except share and per share data) <TABLE> <CAPTION> March 31, ASSETS 1999 December 31, (unaudited) 1998 ----------- ------------ <S> <C> <C> Cash and due from banks $ 138,415 154,527 Federal funds sold 6,805 31,930 Interest bearing deposits in banks 56 17,562 Investment securities: Available-for-sale 389,597 379,393 Held-to-maturity 260,634 299,285 ---------- ---------- 650,231 678,678 Loans 1,512,902 1,484,459 Less allowance for loan losses 29,289 28,803 ---------- ---------- Net loans 1,483,613 1,455,656 Premises and equipment, net 64,469 63,382 Accrued interest receivable 23,156 22,433 Goodwill, net of accumulated amortization of $11,542 at March 31, 1999 (unaudited) and $10,950 at December 31, 1998 28,745 29,337 Other real estate owned, net 607 1,113 Deferred tax asset 5,904 5,498 Other assets 19,165 18,717 ---------- ---------- $2,421,166 2,478,833 ---------- ---------- ---------- ---------- LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Noninterest bearing $ 376,633 390,998 Interest bearing 1,637,073 1,650,934 ---------- ---------- Total deposits 2,013,706 2,041,932 Federal funds purchased 1,300 1,675 Securities sold under repurchase agreements 145,686 173,593 Accrued interest payable 12,351 13,364 Accounts payable and accrued expenses 10,150 10,622 Other borrowed funds 7,006 9,828 Long-term debt 23,838 24,288 ---------- ---------- Total liabilities 2,214,037 2,275,302 Mandatorily redeemable preferred securities of subsidiary trust 40,000 40,000 Stockholders' equity: Common stock without par value; authorized 20,000,000 shares; issued and outstanding 7,966,768 shares as of March 31, 1999 (unaudited) and 7,988,573 shares as of December 31, 1998 10,145 10,001 Retained earnings 156,658 151,362 Accumulated other comprehensive income 326 2,168 ---------- ---------- Total stockholders' equity 167,129 163,531 ---------- ---------- $2,421,166 2,478,833 ---------- ---------- Book value per common share $ 20.98 20.47 ---------- ---------- ---------- ---------- </TABLE> SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. 3
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Consolidated Statements of Income (Dollars in thousands, except share and per share data) (Unaudited) <TABLE> <CAPTION> For the three months ended March 31, ------------------------- 1999 1998 ---------- ---------- <S> <C> <C> Interest income: Interest and fees on loans $34,623 35,191 Interest and dividends on investment securities: Taxable 8,771 6,323 Exempt from Federal taxes 795 326 Interest on deposits with banks 58 195 Interest on Federal funds sold 292 966 ------- ------- Total interest income 44,539 43,001 ------- ------- Interest expense: Interest on deposits 16,579 16,237 Interest on Federal funds purchased 16 38 Interest on securities sold under repurchase agreements 1,468 1,774 Interest on other borrowed funds 83 108 Interest on long-term debt 502 661 Interest on mandatorily redeemable preferred securities of subsidiary trust 882 888 ------- ------- Total interest expense 19,530 19,706 ------- ------- Net interest income 25,009 23,295 Provision for loan losses 786 1,065 ------- ------- Net interest income after provision for loan losses 24,223 22,230 Non-interest income: Income from fiduciary activities 1,179 1,101 Service charges on deposit accounts 2,562 2,490 Data processing 1,709 2,078 Other fees 1,379 1,200 Net investment securities gains -- 42 Other real estate income, net 380 185 Other income 436 414 ------- ------- Total non-interest income 7,645 7,510 ------- ------- Non-interest expenses: Salaries and wages 8,961 7,797 Employee benefits 1,929 2,807 Occupancy, net 1,738 1,611 Furniture and equipment 2,261 2,052 FDIC insurance 58 54 Goodwill and core deposits amortization 592 694 Other expenses 5,056 4,936 ------- ------- Total non-interest expenses 20,595 19,951 ------- ------- Income before income taxes 11,273 9,789 Income tax expense 4,060 3,715 ------- ------- Net income $ 7,213 6,074 ------- ------- ------- ------- Basic earnings per common share $ 0.90 0.75 ------- ------- Diluted earnings per common share $ 0.89 0.75 ------- ------- ------- ------- Dividends per common share $ 0.24 0.22 ------- ------- ------- ------- </TABLE> SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. 4
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income (Dollars in thousands) (Unaudited) <TABLE> <CAPTION> For the three months ended March 31, ------------------------ 1999 1998 ----------- ---------- <S> <C> <C> Net income $ 7,213 6,074 Other comprehensive income, net of tax: Unrealized gains (losses) on investment securities: Realized and unrealized holding losses arising during period (3,020) (151) Add: reclassification adjustment for (gains) losses included in net income -- (42) ----------- ---------- Other comprehensive loss, before tax (3,020) (193) Income tax expense related to items of other comprehensive income 1,178 75 ----------- ---------- Other comprehensive loss, after tax (1,842) (118) ----------- ---------- Comprehensive income $ 5,371 5,956 ----------- ---------- ----------- ---------- </TABLE> SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. 5
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (Dollars in thousands) (Unaudited) <TABLE> <CAPTION> For the three months ended March 31, ------------------------- 1999 1998 ----------- ---------- <S> <C> <C> Cash flows from operating activities: Net income $ 7,213 $ 6,074 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan and other real estate losses 786 1,065 Depreciation and amortization 2,292 2,189 Net discount accretion on investment securities (22) (143) Gain on sales of investments -- (42) Gain on sales of other real estate owned (403) (232) Loss (gain) on sales of property and equipment (25) 94 Provision for deferred income taxes 634 (6) Decrease (increase) in interest receivable (723) 842 Decrease (increase) in other assets (472) 145 Increase (decrease) in accrued interest payable (1,013) 534 Increase in accounts payable and accrued expenses 712 632 ----------- ---------- Net cash provided by operating activities 8,979 11,152 ----------- ---------- Cash flows from investing activities: Purchases of investment securities: Held-to-maturity (25,574) (5,597) Available-for-sale (32,582) (111,356) Proceeds from maturities and paydowns of investment securities: Held-to-maturity 64,225 28,599 Available-for-sale 19,518 22,675 Proceeds from sales of available-for-sale investment securities -- 25,152 Extensions of credit to customers, net of repayments (29,761) 7,321 Recoveries of loans charged-off 824 797 Proceeds from sales of other real estate 1,103 408 Capital distributions from joint venture -- 200 Capital expenditures, net (2,762) (2,165) ----------- ---------- Net cash used in investing activities (5,009) (33,966) ----------- ---------- Cash flows from financing activities: Net increase (decrease) in deposits (28,226) 32,238 Net decrease in Federal funds and repurchase agreements (28,282) (18,797) Net decrease in other borrowed funds (2,822) (1,915) Proceeds from long-term borrowings -- 1,428 Repayments of long-term borrowings (450) (1,599) Net decrease in debt issuance costs 24 3 Proceeds from issuance of common stock 178 58 Payments to retire common stock (1,218) (334) Dividends paid on common stock (1,917) (1,765) ----------- ---------- Net cash provided by (used in) financing activities (62,713) 9,317 ----------- ---------- Net decrease in cash and cash equivalents (58,743) (13,497) Cash and cash equivalents at beginning of period 204,019 229,147 ----------- ---------- Cash and cash equivalents at end of period 145,276 215,650 ----------- ---------- ----------- ---------- Supplemental disclosure of cash flow information: Cash paid during the period for interest 20,543 20,242 Cash paid during the period for taxes 3,995 -- </TABLE> Noncash investing and financing activities - The Company transferred loans of $194 and $255 to other real estate owned during the three month periods ended March 31, 1999 and 1998. SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. 6
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Notes to Unaudited Consolidated Financial Statements (Dollars in thousands, except share and per share data) (1) BASIS OF PRESENTATION In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (all of which are of a normal recurring nature) necessary to present fairly the financial position at March 31, 1999 and December 31, 1998, and the results of operations and cash flows for the three month periods ended March 31, 1999 and 1998 in conformity with generally accepted accounting principles. The balance sheet information at December 31, 1998 is derived from audited consolidated financial statements, however, certain reclassifications have been made to conform to the March 31, 1999 presentation. In June 1998, the Financial Standards Accounting Board issued Statement of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The statement is effective for all fiscal quarters or fiscal years beginning after June 15, 1999. As of March 31, 1999, the Company was not engaged in hedging activities nor did it hold any free-standing derivative instruments. (2) PER SHARE DATA Basic earnings per common share (EPS) is calculated by dividing net income by the weighted average number of common shares outstanding during the period presented. Diluted earnings per common share is calculated by dividing net income by the weighted average number of common shares and potential common shares outstanding during the period. The following table shows weighted average common shares and weighted average potential common shares for the three month periods ended March 31, 1999 and 1998. <TABLE> <CAPTION> Three months ended 3/31/99 3/31/98 ----------- ---------- <S> <C> <C> Weighted average common shares 7,982,673 8,023,800 Weighted average potential common shares 134,962 77,510 </TABLE> There were no anti-dilutive potential common shares outstanding as of March 31, 1999 or 1998. (3) CASH DIVIDENDS On April 15, 1999, the Company declared and paid a cash dividend on first quarter earnings of $0.27 per share to stockholders of record on that date. It has been the Company's practice to pay quarterly dividends based upon earnings. The April 1999 dividend represents 30% of the Company's net income for the quarter ended March 31, 1999. (4) COMMITMENTS AND CONTINGENCIES In the normal course of business, the Company is involved in various claims and litigation. In the opinion of management, following consultation with legal counsel, the ultimate liability or disposition thereof will not have a material adverse effect on the consolidated financial condition, results of operations or liquidity. 7
FIRST INTERSTATE BANCSYSTEM, INC. AND SUBSIDIARIES Notes to Unaudited Consolidated Financial Statements (Dollars in thousands, except share and per share data) The Company owns a 50% ownership interest in an aircraft and is jointly and severally liable for aircraft indebtedness of $1.6 million as of March 31, 1999. The indebtedness is funded by a banking subsidiary of the Company. The Company is an anchor tenant in a building owned by a joint venture partnership in which the Company owns a 50% partnership interest. The Company is jointly and severally liable for joint venture partnership indebtedness of $9.8 million as of March 31, 1999. The Company is a 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 and standby letters of credit. These instruments involve, in varying degrees, elements of credit and interest rate risk in excess of amounts recorded in the consolidated balance sheet. Standby letters of credit and financial guarantees written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Most commitments extend for no more than two years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds various collateral supporting those commitments for which collateral is deemed necessary. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties. 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion focuses on significant factors affecting the financial condition and results of operations of First Interstate BancSystem, Inc. and subsidiaries ("the Company") during the three month period ended March 31, 1999, with comparisons to 1998 as applicable. All earnings per share figures presented are basic and do not account for the dilutive effect of potential common shares. FORWARD LOOKING STATEMENTS Certain statements contained in this review are "forward looking statements" that involve risk and uncertainties. The Company wishes to caution readers that the following factors, among others, may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include general economic and business conditions in those areas in which the Company operates, credit quality, demographic changes, competition, fluctuations in interest rates, changes in business strategy or development plans and changes in governmental regulations. ASSET LIABILITY MANAGEMENT INTEREST RATE SENSITIVITY. The primary objective of the Company's asset liability management process is to optimize net interest income while prudently managing balance sheet risks by understanding the levels of risk accompanying its decisions and monitoring and managing these risks. The ability to optimize net interest margin is largely dependent on the achievement of an interest rate spread that can be managed during fluctuations of interest rates. Interest sensitivity is a measure of the extent to which net interest income will be affected by market interest rates over a period of time. Management monitors the sensitivity of net interest margin by utilizing income simulation models and traditional gap analysis. LIQUIDITY. The objective of liquidity management is to maintain the Company's ability to meet the day-to-day cash flow requirements of its customers who either wish to withdraw funds or require funds to meet their credit needs. The Company manages its liquidity position to meet the needs of its customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of its stockholders. The Company monitors the sources and uses of funds on a daily basis to maintain an acceptable liquidity position, principally through deposit receipts and check payments; loan originations, extensions, and repayments; and management of investment securities. Additional sources of liquidity include Federal funds lines, other borrowings and access to the capital markets. CAPITAL ADEQUACY. The objective of capital adequacy is to provide adequate capitalization to assure depositor, investor and regulatory confidence. The intent is to provide sufficient capital funds to support growth and to absorb fluctuations in income so that operations can continue in periods of uncertainty while at the same time ensuring investable funds are available to foster expansion. OVERVIEW The Company reported net income of $7.2 million, or $0.90 per share for the three months ended March 31, 1999, as compared to $6.1 million, or $0.75 per share recorded in the same period in 1998. This increase in earnings is largely due to net interest income provided through internal growth in both deposits and loans. 9
EARNING ASSETS Earning assets of $2,170 million at March 31, 1999 decreased $43 million, or 1.9%, from $2,213 million at December 31, 1998. The mix of earning assets changed little from December 31, 1998 with loans comprising approximately 70% and investment securities comprising approximately 30% at March 31, 1999 compared to 67% and 31%, respectively, at December 31, 1998. LOANS. Total loans increased $29 million, or 1.9%, to $1,513 million as of March 31, 1999 from $1,484 million as of December 31, 1998. All major categories of loans, except residential real estate and agriculture, increased from December 31, 1998 with the most dramatic growth occurring in commercial, commercial real estate and indirect consumer lending. Management attributes this growth to its continuing business strategy of being a lending bank. INVESTMENT SECURITIES. The Company's investment portfolio is managed to result in the highest yield while meeting the Company's liquidity needs and meeting pledging requirements for public funds deposits and securities sold under repurchase agreements. The portfolio is comprised of U.S. Treasury securities, U.S. government agency securities, tax exempt securities, corporate securities, other mortgage-backed securities and other equity securities. Investment securities decreased $29 million, or 4.2%, to $650 million as of March 31, 1999, from $679 million as of December 31, 1998. Proceeds from maturities, sales and principal payments during the first quarter were used to fund increases in other earning assets, primarily loans, and to reduce borrowings. INTEREST BEARING DEPOSITS IN BANKS AND FEDERAL FUNDS SOLD. Interest bearing deposits in bank consist of funds on deposit with the Federal Home Loan Bank. These deposits, along with Federal funds sold, are used by the Company's banking subsidiaries to fund the daily liquidity needs of the Company. Interest bearing deposits in bank and Federal funds sold decreased $43 million, in aggregate, to $7 million as of March 31, 1999 from $49 million as of December 31, 1998. This decrease is primarily due to a decline in available funds resulting from seasonal decreases in customer deposits at the Company's banking subsidiaries. Available funds were invested in higher yielding assets, principally loans, and used to reduce borrowings. INCOME FROM EARNING ASSETS. Interest income increased $1.5 million, or 3.6%, to $44.5 million for the three months ended March 31, 1999 from $43.0 million for the same period in 1998. This increase resulted from greater volumes of interest earning assets generated through internal growth. Total average earning assets at March 31, 1999 of $2,175 million yielded 8.31% during the first quarter of 1999 while average earning assets of $1,991 million at March 31, 1998 yielded 8.76% for the same period in 1998. FUNDING SOURCES The Company utilizes traditional funding sources to support its earning asset portfolio including deposits, borrowings, Federal funds purchased and repurchase agreements. DEPOSITS. Total deposits decreased $28 million, or 1.4%, to $2,014 million as of March 31, 1999 from $2,042 million as of December 31, 1998. This decrease in deposits is an expected seasonal decrease that historically occurs during the first half of the year. Yields on interest-bearing deposits decreased 15 basis points to 4.11% during the first quarter of 1999 compared to 4.46% during the first quarter of 1998. OTHER FUNDING SOURCES. Other funding sources include Federal funds purchased for one day periods, other borrowed funds consisting primarily of short-term borrowings from the Federal Home Loan Bank, repurchase agreements with primarily commercial depositors and long-term debt. These other funding sources decreased $31 million, or 15.1%, to $178 million as of March 31, 1999 from $209 million as of December 31, 1998. Yields on other funding sources decreased 54 basis points to 4.57% for the three months ended March 31, 1999 from 5.11% for the same period in the prior year. Because the Company's funding requirements were primarily met through the liquidation of investment securities, interest bearing deposits in bank and Federal funds sold, other funding sources decreased during the first quarter of 1999. 10
EQUITY During 1998, the Company determined the future grants of stock options would no longer include stock appreciation rights (SARs). Grantees with outstanding SARs were given an election to convert their SARs to stock options with similar terms in a one-for-one exchange. In January 1999, 106,300 SARs were exchanged for stock options resulting in an increase in stockholders' equity and a reduction of accrued expenses of $1 million. NET INTEREST INCOME The most significant impact on the Company's net interest income between periods is derived from the interaction of changes in the volume of and rates earned or paid on interest earning assets and interest bearing liabilities. The volume of loans, investment securities and other earning assets, compared to the volume of interest bearing deposits and indebtedness, combined with the spread, produces the changes in net interest income between periods. Net interest income of $25.0 million for the quarter ended March 31, 1999 increased $1.7 million, or 7.4%, from $23.3 million for the same period in the prior year. The net interest margin ratio of 4.75% for the three months ended March 31, 1999 decreased 4 basis points from 4.79% for the same period in the prior year. PROVISION FOR LOAN LOSS The loan loss provision for each year is dependent on many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management's assessment of the quality of the loan portfolio, the value of the underlying collateral on problem loans and the general economic conditions in the Company's markets. The Company performs a quarterly assessment of risks inherent in its loan portfolio, as well as a detailed review of each asset determined to have identified weaknesses. The provision for loan losses is maintained at a level that is, in management's judgment, adequate to absorb losses inherent in the loan portfolio given past, present and expected conditions. Fluctuations in the provision for loan losses result from management's assessment of the adequacy of the allowance for loan losses. Actual loan losses may vary from current estimates. The provision for loan losses decreased $279,000, or 26.2%, to $786,000 for the three months ended March 31, 1999 from $1 million for the same period in the prior year. OTHER OPERATING INCOME The Company's principal sources of other operating income include service charges on deposit accounts, data processing fees, income from fiduciary activities, comprised principally of fees earned on trust assets, and other fee income. Other operating income increased $135,000, or 1.8%, to $7.6 million for the three months ended March 31, 1999 from $7.5 million for the same period in 1998 with all four of the principal categories showing increases except data processing fees. Significant fluctuations are discussed below: DATA PROCESSING FEES. Data processing fees decreased $369,000, or 17.8%, to $1.7 million for the quarter ended March 31, 1999 from $2.1 million for the same period in 1998 primarily due to a non-recurring termination fee of $300,000 recorded during the first quarter of 1998. INCOME FROM FIDUCIARY ACTIVITIES. Revenues from fiduciary activities increased 7.1% to $1.2 million for the three months ended March 31, 1999 from $1.1 million for the three months ended March 31, 1998 due to increases in the value of assets under trust management. OTHER FEE INCOME. Other fee income, comprised of other service charges, commissions and fees, increased $179,000, or 14.9%, to $1.4 million for the quarter ended March 31, 1999 as compared to $1.2 million for the same period in the prior year. Approximately $104,000 of this increase is due to increases in brokerage service fees. The Company began expanding the range and scope of brokerage services offered through its banking subsidiaries in December 1997. The remaining increase is primarily due to loan servicing income resulting from strong loan demands combined with the acquisition of servicing rights for 3,769 loans purchased in January 1999. 11
OTHER REAL ESTATE INCOME. Net other real estate (OREO) income increased $195,000 to $380,000 for the three months ended March 31, 1999 as compared to $185,000 during the same period in 1998. Variations in net OREO income during the periods resulted principally from fluctuations in gains and losses on sales of OREO. Net OREO income is directly related to prevailing economic conditions, and such income could decrease significantly should an unfavorable shift occur in the economic conditions of the Company's markets. OTHER OPERATING EXPENSE Other operating expenses increased $644,000, or 3.2%, to $20.6 million for the quarter ended March 31, 1999 from $20.0 million for the same period in 1998. Increases in salaries and wages, furniture and equipment and occupancy expenses were partially offset by decreases in employee benefits expense. SALARIES AND WAGES EXPENSE. Salaries and wages expense increased $1.2 million, or 14.9%, to $9.0 million for the three months ended March 31, 1999 as compared to $7.8 million for the same period in the prior year. This increase is primarily attributable to inflationary wage increases and the additional staffing requirements needed to support the three new branch banks opened since March 1998. EMPLOYEE BENEFITS EXPENSE. Employee benefits expense decreased $878,000, or 31.3%, to $1.9 million for the quarter ended March 31, 1999 from $2.8 million for the same period in 1998. Exclusive of non-recurring expense of $290,000 for group health insurance premiums recorded during the first quarter of 1998, employee benefits expense decreased $588,000 or 20.9%. In January 1999, the holders of SARs were provided an option to exchange their SARs for stock options. All holders opted for this exchange resulting in a decrease in SAR expense of $760,000 during the first quarter of 1999. This decrease was partially offset by increases in employee benefits expense attributable to increases in staffing levels and inflation as discussed above. OCCUPANCY. Occupancy expense increased $127,000, or 7.9%, to $1.7 million for the three months ended March 31, 1999 compared to $1.6 million for the same period in 1998. This increase is primarily due to additional depreciation and rent expenses associated with the addition of new facilities and remodeling of existing facilities. FURNITURE AND EQUIPMENT. Furniture and equipment expenses increased $209,000, or 10.2% to $2.3 million for the three months ended March 31, 1999 from $2.1 million for the same period in 1998. This increase is primarily the result of depreciation, repairs and maintenance expenses associated with additional branches opened since March 1998 and the remodeling of Company facilities. Also contributing to the increase are costs with upgrades of various computer hardware and software used in the Company's operations. YEAR 2000 During 1997 the Company established a Year 2000 Taskforce charged with the responsibility of ensuring all internal and external information and non-information technology systems critical to business functions are Year 2000 compliant. The taskforce developed a five phase "key step plan". Each phase is identified and described below: - - Education - during this phase Year 2000 issues relating to the Company are identified, resources are committed and an overall strategy is developed. - - Assessment - during the assessment phase three areas of concern are identified: internal computing systems and programs consisting of hardware, software, networks, processing platforms and computer programs; environmental and non-information technology systems including security systems, heating, ventilation and air conditioning systems, elevators, and vault systems; and, external vendors and suppliers including entities providing the Company with hardware, software, and office equipment. - - Renovation - code enhancements, hardware and software upgrades, system replacements, vendor certifications are completed during the renovation phase. 12
- - Validation - in this phase, systems will be tested to ensure they will function properly in the Year 2000. Any errors noted during the validation phase will be corrected and the systems will be retested. This phase will continue until all systems are compliant. - - Special Support - the Company will provide staffing support to monitor all systems as the new century approaches and develop contingency plans in the event a system fails. Currently, the Company has completed the education, assessment and renovation phases of the key step plan and the validation phase is substantially complete for all critical business systems. Validation will continue through 1999 as new software releases and hardware upgrades are received and implemented. Validation of all secondary systems is currently expected to be completed by September 30, 1999. To date, the validation phase has not revealed any material Year 2000 issues in any of the Company's internal systems or programs. The Company's internal audit department has been reviewing validation results. The Company is in the process of developing a contingency plan. This plan, called the Business Resumption Contingency Plan, will address mitigation of risks associated with system failures at critical dates including staffing issues security concerns, customer communication, utility failures, hot-site identification and backup system identification. This plan is currently anticipated to be completed by June 30, 1999. Management currently estimates total costs of the Company's Year 2000 compliance to be less than $300,000, of which $163,000 has already been incurred. Of the 39 critical business systems identified, only one system is an internally developed system. The cost of renovation of external system is generally included in the annual maintenance fees paid to suppliers and has not been included in the cost estimates presented. All Year 2000 costs are expensed as incurred. There are many risks associated with the Year 2000 issue, including the possibility of a failure of third parties to remediate their own Year 2000 issues. The failure of third parties with which the Company has financial or operational relationships such as clearing organizations, regulatory agencies, business customers, suppliers and utilities, to remediate their technology systems in a timely manner could result in a material financial risk to the Company. While the Company exercises no control over such third parties, the Company's Year 2000 project plan includes a survey assessment of critical third parties response and remediation plans and their potential impact to the Company. The Company's expectations about future costs and the timely completion of its Year 2000 modifications are subject to uncertainties that could cause actual results to differ materially from what has been discussed above. ACQUISITIONS On May 7, 1999, First Interstate Bank in Montana purchased the net assets of the Helena and Belgrade branches of First National Bank of Montana at a premium of $225,000. At the purchase date, the acquired branches had loans and deposits of approximately $1 million and $4 million, respectively. The Company has entered into a definitive agreement to purchase all of the outstanding stock of Security State Bank Shares, a one-bank holding company with three branch offices located in Polson, Montana. The total cash purchase price to be paid at closing is $11.8 million. The transaction is expected to close during the second quarter of 1999. Security State Bank Shares has total loans of approximately $35 million and total deposits of approximately $62 million. 13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As of March 31, 1999, there have been no material changes in the quantitative and qualitative information about market risk provided pursuant to Item 305 of Regulation S-K as presented in the Company's December 31, 1998 Form 10-K. 14
PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None. ITEM 2. CHANGES IN SECURITIES None. ITEM 3. DEFAULTS UPON SENIOR INDEBTEDNESS None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION Not applicable or required. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27. Financial Data Schedule. (b) No reports were filed on Form 8-K during the quarter ended March 31, 1999. 15
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized: FIRST INTERSTATE BANCSYSTEM, INC. Date May 14, 1999 /s/ THOMAS W. SCOTT ------------------------------- --------------------------------------- Thomas W. Scott President and Chief Executive Officer Date May 14, 1999 /s/ TERRILL R. MOORE ------------------------------- --------------------------------------- Terrill R. Moore Senior Vice President and Chief Financial Officer 16