Cass Information Systems - 10-Q quarterly report FY2011 Q2

Yes               X                           No                       

Yes               X                           No                       

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes                                             No               X     

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This report may contain or incorporate by reference forward-looking statements made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Although we believe that, in making any such statements, our expectations are based on reasonable assumptions, forward-looking statements are not guarantees of future performance and involve risks, uncertainties, and other factors beyond our control, which may cause future performance to be materially different from expected performance summarized in the forward-looking statements. These risks, uncertainties and other factors are discussed in the section Part I, Item 1A, “Risk Factors” of the Company’s 2010 Annual Report on Form 10-K, filed with the Securities and Exchange Commission (“SEC”), which may be updated from time to time in our future filings with the SEC. We undertake no obligation to publicly update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, or changes to future results over time.

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See accompanying notes to unaudited consolidated financial statements.

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See accompanying notes to unaudited consolidated financial statements.

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See accompanying notes to unaudited consolidated financial statements.

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Note 1 - Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Certain amounts in the 2010 consolidated financial statements have been reclassified to conform to the 2011 presentation. For further information, refer to the audited consolidated financial statements and related footnotes included in Cass Information System, Inc.’s (“the Company” or “Cass”) Annual Report on Form 10-K for the year ended December 31, 2010.

Note 2 – Intangible Assets

The Company accounts for intangible assets in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 350, “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 are as follows:

The customer list is amortized over seven years. Amortization of intangible assets amounted to $54,000 for both of the six-month periods ended June 30, 2011 and 2010. Estimated amortization of intangibles over the next five years is as follows: $107,000 in 2011 and 2012 and $54,000 in 2013.

Note 3 – Earnings Per Share

Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding. Diluted earnings per share is computed by dividing net income by the sum of the weighted-average number of common shares outstanding and the weighted-average number of potential common shares outstanding. There were no anti-dilutive shares in the three-month and six-month periods ended June 30, 2011 and 2010. The calculations of basic and diluted earnings per share are as follows:

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Note 4 – Stock Repurchases

The Company maintains a treasury stock buyback program pursuant to which the Board of Directors has authorized the repurchase of up to 300,000 shares of the Company’s common stock. The Company did not repurchase any shares during the six-month periods ended June 30, 2011 and 2010. As of June 30, 2011, 168,000 shares remained available for repurchase under the program. Repurchases are made in the open market or through negotiated transactions from time to time depending on market conditions.

Note 5 – Comprehensive Income

For the three and six-month periods ended June 30, 2011 and 2010, unrealized gains and losses on securities available-for-sale and reclassification adjustments for gains included in net income were the Company’s other comprehensive income components. Comprehensive income is summarized as follows:

Note 6 – Industry Segment Information

The services provided by the Company are classified into two reportable segments: Information Services and Banking Services. Each of these segments provides distinct services that are marketed through different channels. They are managed separately due to their unique service, processing and capital requirements.

The Information Services segment provides freight, utility and telecommunication invoice processing and payment services to large corporations. The Banking Services segment provides banking services primarily to privately-held businesses and churches.

The Company’s accounting policies for segments are the same as those described in the summary of significant accounting policies in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. Management evaluates segment performance based on net income after allocations for corporate expenses and income taxes. Transactions between segments are accounted for at what management believes to be fair value.

All revenue originates from and all long-lived assets are located within North America, and no revenue from any customer of any segment exceeds 10% of the Company’s consolidated revenue.

Assets represent actual assets owned by Information Services and there is no allocation methodology used. Loans are sold by Banking Services to Information Services to create liquidity when the Bank’s loan-to-deposit ratio is greater than 100%. Segment interest from customers is the actual interest earned on the loans owned by Information Services and Banking Services, respectively.

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Note 7 – Loans by Type

A summary of loan categories by segment and class is as follows:

The following tables present the aging of loans by loan classification at June 30, 2011 and December 31, 2010:

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The following tables present the recorded investment and unpaid principal balance for impaired loans at June 30, 2011 and December 31, 2010:

Impaired loans consist primarily of nonaccrual loans, loans greater than 90 days past due and still accruing interest, and troubled debt restructurings continuing to accrue interest. Management measures impairment in accordance with FASB ASC 310, “Allowance for Credit Losses.” At June 30, 2011 and December 31, 2010, all impaired loans were evaluated based on the fair value of the collateral. The fair value of the collateral is based upon an observable market price or current appraised value and therefore, the Company classifies these assets as nonrecurring Level 2. There were no loans delinquent 90 days or more and still accruing interest at June 30, 2011 and December 31, 2010. At June 30, 2011 there were two loans totaling $4,486,000 classified as troubled debt restructurings, with a total pre-modification loan balance of $4,486,000. There were no troubled debt restructurings at December 31, 2010. There are two foreclosed loans with a book value of $1,910,000 which have been reclassified as other real estate owned (included in other assets) as of June 30, 2011 and December 31, 2010.

The following table presents the credit exposure of the loan portfolio by internally assigned credit grade as of June 30, 2011 and December 31, 2010:

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The following table provides information regarding the changes in the allowance for loan losses by segment from December 31, 2010 to June 30, 2011:

Note 8 – Commitments and Contingencies

In the normal course of business, the Company is party to activities that contain credit, market and operational risks that are not reflected in whole or in part in the Company’s consolidated financial statements. Such activities include traditional off-balance sheet credit-related financial instruments and commitments under operating leases. These financial instruments include commitments to extend credit, commercial letters of credit and standby letters of credit. The Company’s maximum potential exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, commercial letters of credit and standby letters of credit is represented by the contractual amounts of those instruments. At June 30, 2011 and December 31, 2010, no amounts have been accrued for any estimated losses for these instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commercial and standby letters of credit are conditional commitments issued by the Company or its subsidiaries to guarantee the performance of a customer to a third party. These off-balance sheet financial instruments generally have fixed expiration dates or other termination clauses and may require payment of a fee. At June 30, 2011, the balance of unused loan commitments, standby and commercial letters of credit were $16,451,000, $21,752,000 and $4,030,000, respectively. Since some of the financial instruments may expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. Commitments to extend credit and letters of credit are subject to the same underwriting standards as those financial instruments included on the consolidated balance sheets. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of the credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but is generally accounts receivable, inventory, residential or income-producing commercial property or equipment. In the event of nonperformance, the Company or its subsidiaries may obtain and liquidate the collateral to recover amounts paid under its guarantees on these financial instruments.

The following table summarizes contractual cash obligations of the Company related to operating lease commitments and time deposits at June 30, 2011:

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 9 – Stock-Based Compensation

In 2007, the Board and the Company’s shareholders approved the 2007 Omnibus Incentive Stock Plan (the “Omnibus Plan”). The Omnibus Plan permits the issuance of up to 880,000 shares of the Company’s common stock in the form of stock options, stock appreciation rights (“SARs”), restricted stock, restricted stock units and performance awards. The Company issues shares out of treasury stock for these awards. During the six months ended June 30, 2011, 26,017 restricted shares and 75,016 SARs were granted under the Omnibus Plan.

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The Company also maintains its other stock-based incentive plans for the restricted common stock previously awarded and the options previously issued and still outstanding. These plans have been superseded by the Omnibus Plan and accordingly, any available restricted stock and stock option grants not yet issued have been cancelled.

Restricted shares are amortized to expense over the three-year vesting period. As of June 30, 2011, the total unrecognized compensation expense related to non-vested common stock was $1,287,000 and the related weighted-average period over which it is expected to be recognized is approximately 1.5 years.

Following is a summary of the activity of the restricted stock:

Stock options vest and expire over a period not to exceed seven years. As of June 30, 2011, the total unrecognized compensation expense related to non-vested stock options was $22,000, and the related weighted-average period over which it is expected to be recognized is approximately 1.6 years. Following is a summary of the activity of the stock options during the six-month period ended June 30, 2011:

The total intrinsic value of options exercised was $156,000 and $60,000 for the six-month periods ended June 30, 2011 and 2010, respectively. Following is a summary of the activity of the non-vested stock options during the six-month period ended June 30, 2011:

SARs vest over a three-year period, with one-third of the shares vesting and becoming exercisable each year on the anniversary date of the grant, and they expire 10 years from the original grant date. As of June 30, 2011, the total unrecognized compensation expense was $902,000 and the related weighted-average period over which it is expected to be recognized is 1.4 years. Following is a summary of the activity of the Company’s SARs program for the six-month period ended June 30, 2011:

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Following is a summary of the activity of the non-vested SARs during the six-month period ended June 30, 2011:

The Company uses the Black-Scholes pricing model to determine the fair value of the SARs at the date of grant. Following are the assumptions used to estimate the per-share fair value of SARs granted:

The risk-free interest rate is based on the zero-coupon U.S. Treasury yield for the period equal to the expected life of the SARs at the time of the grant. The expected life was derived using the historical exercise activity. The Company uses historical volatility for a period equal to the expected life of the rights using average monthly closing market prices of the Company’s stock as reported on The Nasdaq Global Market. The expected dividend yield is based on the Company’s current rate of annual dividends.

Note 10 – Defined Pension Plans

The Company has a noncontributory defined benefit pension plan, which covers most of its employees. The Company accrues and makes contributions designed to fund normal service costs on a current basis using the projected unit credit with service proration method to amortize prior service costs arising from improvements in pension benefits and qualifying service prior to the establishment of the plan over a period of approximately 30 years. Disclosure information is based on a measurement date of December 31 of the corresponding year. The following table represents the components of the net periodic pension costs:

Pension costs recorded to expense related to the noncontributory defined benefit pension plan were $466,000 and $542,000 for the three-month periods ended June 30, 2011 and 2010, respectively, and totaled $932,000 and $1,084,000 for the six-month periods ended June 30, 2011 and 2010, respectively. The Company made a contribution of $450,000 to the plan during the three-month period ended June 30, 2011, for a total of $900,000 for the six-month period ending June 30, 2011 and expects to contribute at least an additional $900,000 in 2011.

In addition to the above funded benefit plan, the Company has an unfunded supplemental executive retirement plan which covers key executives of the Company. This is a noncontributory plan in which the Company and its subsidiaries make accruals designed to fund normal service costs on a current basis using the same method and criteria as its defined benefit plan. The following table represents the components of the net periodic pension costs for 2010 and an estimate for 2011:

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Pension costs recorded to expense related to the unfunded supplemental executive retirement plan were $159,000 and $168,000 for the three-month periods ended June 30, 2011 and 2010, respectively, and were $317,000 and $330,000 for the six-month periods ended June 30, 2011 and 2010, respectively.

Note 11 – Income Taxes

As of June 30, 2011, the Company’s unrecognized tax benefits were approximately $2,155,000, of which $1,671,000 would, if recognized, affect the Company’s effective tax rate. As of December 31, 2010, the Company's unrecognized tax benefits were approximately $1,877,000, of which $1,465,000 would, if recognized, affect the Company's effective tax rate. During the next twelve months, the Company may realize a reduction of its unrecognized tax benefits of approximately $451,000 due to the lapse of federal and state statutes of limitations.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. The Company had $135,000 and $106,000 of gross interest accrued as of June 30, 2011 and December 31, 2010, respectively. There were no penalties for unrecognized tax benefits accrued at June 30, 2011 and December 31, 2010.

The Company is subject to income tax in the U.S. federal jurisdiction and numerous state jurisdictions. U.S. federal income tax returns for tax years 2007 through 2009 remain subject to examination by the Internal Revenue Service. In addition, the Company is subject to state tax examinations for the tax years 2006 through 2009.

Note 12 – Investment Securities Available for Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. The Company’s investment securities available-for-sale are measured at fair value using Level 2 valuations. The market evaluation utilizes several sources which include “observable inputs” rather than “significant unobservable inputs” and therefore falls into the Level 2 category. The amortized cost, gross unrealized gains, gross unrealized losses and fair value of investment securities are summarized as follows:

The fair values of securities with unrealized losses are as follows:

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There were 47 securities (none greater than 12 months) in an unrealized loss position as of June 30, 2011. There were 61 securities (none greater than 12 months) in an unrealized loss position as of December 31, 2010. All unrealized losses were reviewed to determine whether the losses were other than temporary. Management believes that all unrealized losses are temporary since they were market driven, and the Company has the ability and intent to hold these securities until recovery.

The amortized cost and fair value of investment securities 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.

There were no securities pledged to secure public deposits and for other purposes at June 30, 2011.

Proceeds from sales of investment securities classified as available for sale were $4,904,000 and $0 for the three months ended June 30, 2011 and 2010, respectively, and were $5,405,000 and $0 for the six months ended June 30, 2011 and 2010, respectively. Gross realized gains were $48,000 and $0 for the three months ended June 30, 2011 and 2010, respectively, and were $48,000 and $0 for the six months ended June 30, 2011 and 2010, respectively.

Note 13 – Fair Value of Financial Instruments

Following is a summary of the carrying amounts and fair values of the Company’s financial instruments:

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

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Note 14 – Subsequent Events

In accordance with FASB ASC 855, “Subsequent Events,” the Company has evaluated subsequent events after the consolidated balance sheet date of June 30, 2011 and there were no events identified that would require additional disclosures to prevent the Company’s consolidated financial statements from being misleading.

Cass provides payment and information processing services to large manufacturing, distribution and retail enterprises from its processing centers in St. Louis, Missouri, Columbus, Ohio, Boston, Massachusetts, Greenville, South Carolina and Wellington, Kansas. The Company’s services include freight invoice rating, payment processing, auditing, and the generation of accounting and transportation information. Cass also processes and pays utility invoices, which include electricity, gas and telecommunications expenses and is a provider of telecom expense management solutions. Cass extracts, stores, and presents information from freight, utility and telecommunication invoices, assisting its customers’ transportation, energy and information technology managers in making decisions that will enable them to improve operating performance. The Company receives data from multiple sources, electronic and otherwise, and processes the data to accomplish the specific operating requirements of its customers. It then provides the data in a central repository for access and archiving. The data is finally transformed into information through the Company’s databases that allow client interaction as required and provides Internet-based tools for analytical processing. The Company also, through Cass Commercial Bank, its St. Louis, Missouri based bank subsidiary (the “Bank”), provides banking services in the St. Louis metropolitan area, Orange County, California and other selected cities in the United States. In addition to supporting the Company’s payment operations, the Bank provides banking services to its target markets, which include privately-owned businesses and churches and church-related ministries.

The specific payment and information processing services provided to each customer are developed individually to meet each customer’s requirements, which can vary greatly. In addition, the degree of automation such as electronic data interchange, imaging, and web-based solutions varies greatly among customers and industries. These factors combine so that pricing varies greatly among the customer base. In general, however, Cass is compensated for its processing services through service fees and investment of account balances generated during the payment process. The amount, type and calculation of service fees vary greatly by service offering, but generally follow the volume of transactions processed. Interest income from the balances generated during the payment processing cycle is affected by the amount of time Cass holds the funds prior to payment and the dollar volume processed. Both the number of transactions processed and the dollar volume processed are therefore key metrics followed by management. Other factors will also influence revenue and profitability, such as changes in the general level of interest rates, which have a significant effect on net interest income. The funds generated by these processing activities are invested in overnight investments, investment grade securities and loans generated by the Bank. The Bank earns most of its revenue from net interest income, or the difference between the interest earned on its loans and investments and the interest paid on its deposits and other borrowings. The Bank also assesses fees on other services such as cash management services.

Industry-wide factors that impact the Company include the willingness of large corporations to outsource key business functions such as freight, utility and telecommunication payment and audit. The benefits that can be achieved by outsourcing transaction processing and the management information generated by Cass’ systems can be influenced by factors such as the competitive pressures within industries to improve profitability, the general level of transportation costs, deregulation of energy costs and consolidation of telecommunication providers. Economic factors that impact the Company include the general level of economic activity that can affect the volume and size of invoices processed, the ability to hire and retain qualified staff, and the growth and quality of the loan portfolio. As lower levels of economic activity are encountered the number and total dollar amount of transactions processed by the Company may decline, thereby reducing fee revenue, interest income, and possibly liquidity. Conversely, improving economic conditions will tend to increase fee revenue, interest income and liquidity. The general level of interest rates also has a significant effect on the revenue of the Company. As discussed in greater detail in Item 7A, “Quantitative and Qualitative Disclosures about Market Risk,” in the Company’s 2010 Annual Report on Form 10-K, a decline in the general level of interest rates can have a negative impact on net interest income.

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Currently, management views Cass’ major opportunity as the continued expansion of its payment and information processing service offering and customer base. Management intends to accomplish this by maintaining the Company’s lead in applied technology, which when combined with the security and processing controls of the Bank, makes Cass unique in the industry.

The Company has prepared the consolidated financial statements in this report in accordance with the FASB Accounting Standards Codification (“ASC”). In preparing the consolidated financial statements, management makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. These estimates have been generally accurate in the past, have been consistent and have not required any material changes. There can be no assurances that actual results will not differ from those estimates. Certain accounting policies that require significant management estimates and are deemed critical to our results of operations or financial position have been discussed with the Audit Committee of the Board of Directors and are described below.

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The following paragraphs more fully discuss the results of operations and changes in financial condition for the three-month period ended June 30, 2011 (“Second Quarter of 2011”) compared to the three-month period ended June 30, 2010 (“Second Quarter of 2010”) and the six-month period ended June 30, 2011 (“First Half of 2011”) compared to the six-month period ended June 30, 2010 (“First Half of 2010”). The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes and with the statistical information and financial data appearing in this report, as well as in the Company's 2010 Annual Report on Form 10-K. Results of operations for the Second Quarter of 2011 are not necessarily indicative of the results to be attained for any other period.

The following table summarizes the Company’s operating results:

The Company’s fee revenue is derived mainly from transportation and utility processing and payment fees. As the Company provides its processing and payment services, it is compensated by service fees which are typically calculated on a per-item basis and by the accounts and drafts payable balances generated in the payment process which can be used to generate interest income. Processing volumes related to fees and accounts and drafts payable were as follows:

Second Quarter of 2011 compared to Second Quarter of 2010:

Transportation and utility transaction volumes were up 12% and 10%, respectively, and dollar volumes were up 25% and 4%, respectively, due to new business and improved activity for existing customers.

Bank service fees increased $84,000, or 28%, due to an increase in letter of credit fees offset by a slight decline in account analysis fees. There were $48,000 gains on sales of securities in the Second Quarter of 2011.

First Half of 2011 compared to First Half of 2010:

Transportation and utility transaction volumes were up 11% and 10%, respectively, and dollar volumes were up 23% and 4%, respectively, due to new business and improved activity for existing customers.

Bank service fees increased $95,000, or 15%, due to increased letter of credit fees and commission and exchange fees offset by a decrease in account analysis fees as more customers chose to pay for services with compensating balances rather than fees. There were $48,000 gains on sales of securities in the First Half of 2011.

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Net interest income is the difference between interest earned on loans, investments, and other earning assets and interest expense on deposits and other interest-bearing liabilities. Net interest income is a significant source of the Company’s revenues. The following table summarizes the changes in net interest income and related factors:

Second Quarter of 2011 compared to Second Quarter of 2010:

Second Quarter 2011 average earning assets increased 13% compared to the same period in the prior year (see discussion in the following paragraphs). The yield on earning assets and the tax equivalent net interest margin both decreased in 2011 as the general level of interest rates declined; however, the significant increase in average earning assets caused net interest income to increase 8% on a tax equivalent basis. 

Total average loans increased $35,385,000, or 5%, to $710,399,000 for the Second Quarter of 2011 as compared to the Second Quarter of 2010. This increase was attributable to the continuing successful marketing efforts by the Company’s lending staff. Average investment securities increased $40,291,000, or 18%, to $258,653,000, as the Company took advantage of buying opportunities in the market.

Total average interest-bearing deposits for the Second Quarter of 2011 increased $60,725,000, or 18%, to $395,590,000 compared to the Second Quarter of 2010, primarily due to customers transferring funds from lower-yielding investments at other institutions. Average accounts and drafts payable increased $56,546,000, or 11%, as freight and utility payment processing activities increased.

First Half of 2011 compared to First Half of 2010:

First Half of 2011 average earning assets increased 15% compared to the same period in the prior year (see discussion in the following paragraphs). The yield on earning assets and the tax equivalent net interest margin both decreased in 2011 as the general level of interest rates declined; however, the significant increase in average earning assets caused net interest income to increase 10% on a tax equivalent basis.

Total average loans increased $46,259,000, or 7%, to $708,064,000 for the First Half of 2011 as compared to the First Half of 2010. This increase was attributable to the continuing successful marketing efforts by the Company’s lending staff. Average investment securities increased $42,188,000, or 20%, to $258,025,000, as the Company took advantage of buying opportunities in the market.

Total average interest-bearing deposits for the First Half of 2011 increased $73,221,000, or 22%, to $402,292,000 compared to the First Half of 2010, primarily due to customers transferring funds from lower-yielding investments at other institutions. Average accounts and drafts payable increased $57,182,000, or 11%, as freight and utility payment processing activities increased.

For more information on the changes in net interest income, please refer to the tables that follow.

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The following tables show the condensed average balance sheets for each of the periods reported, the tax-equivalent interest income and expense on each category of interest-earning assets and interest-bearing liabilities, and the average yield on such categories of interest-earning assets and the average rates paid on such categories of interest-bearing liabilities for each of the periods reported.

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