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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
COMMISSION FILE NUMBER 0-23971
CITIZENS SOUTH BANKING CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 54-2069979
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
519 South New Hope Road, Gastonia, North Carolina 28054-4040
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(Address of principal executive offices)
Registrant's telephone number, including area code: (704) 868-5200
Indicate by check [X] 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 [ ]
Indicate by check whether the Registrant is an accelerated filer.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date:
Common stock, $0.01 par value
7,249,530 shares outstanding as of May 5, 2005.
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CITIZENS SOUTH BANKING CORPORATION
INDEX
Page
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PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements............................. 1
Consolidated Statements of Financial Condition
March 31, 2005 and December 31, 2004 ...................... 1
Consolidated Statements of Operations
three months ended March 31, 2005 and 2004 ................... 2
Consolidated Statements of Comprehensive Income
three months ended March 31, 2005 and 2004.................... 3
Consolidated Statements of Changes in Stockholders' Equity
three months ended March 31, 2005 and 2004.................... 4
Consolidated Statements of Cash Flows
three months ended March 31, 2005 and 2004.................... 5
Notes to Consolidated Financial Statements........................ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 16
Item 4. Controls and Procedures....................................... 16
PART II. OTHER INFORMATION.................................................. 16
SIGNATURES.................................................................. 19
Exhibit 31.1 Certification of Chief Executive Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.............. 20
Exhibit 31.2 Certification of Chief Financial Officer Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.............. 21
Exhibit 32.1 Statement of Chief Executive Officer Furnished Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.............. 22
Exhibit 32.2 Statement of Chief Financial Officer Furnished Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.............. 23
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CITIZENS SOUTH BANKING CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(dollars in thousands, except per share data)
March 31, December 31,
2005 2004
------------- -------------
(unaudited)
ASSETS:
Cash and due from banks ............................................ $ 6,486 $ 5,800
Interest-earning bank balances ..................................... 13,779 5,790
------------- -------------
Cash and cash equivalents ....................................... 20,265 11,590
Investment securities available-for-sale, at fair value ............ 42,332 52,407
Mortgage-backed and related securities available-for-sale,
at fair value ..................................................... 74,026 81,169
Loans receivable, net of unearned income ........................... 327,783 317,156
Allowance for loan losses .......................................... (3,184) (3,029)
------------- -------------
Loans, net ...................................................... 324,599 314,127
Real estate owned .................................................. 423 806
Accrued interest receivable ........................................ 1,703 1,662
Premises and equipment, net ........................................ 17,127 17,363
Federal Home Loan Bank stock ....................................... 3,849 3,461
Cash value of bank-owned life insurance policies ................... 13,038 12,885
Intangible assets .................................................. 7,473 7,560
Other assets ....................................................... 6,253 5,931
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Total assets .................................................... $ 511,088 $ 508,961
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Demand deposit accounts ............................................ $ 54,894 $ 52,684
Money market deposit accounts ...................................... 73,911 77,924
Savings accounts ................................................... 28,400 29,174
Time deposits ...................................................... 214,899 214,962
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Total deposits .................................................. 372,104 374,744
Borrowed money ..................................................... 63,577 55,772
Deferred compensation .............................................. 5,158 5,850
Other liabilities .................................................. 738 201
------------- -------------
Total liabilities ............................................... 441,577 436,567
Common stock, $0.01 par value, 20,000,000 shares authorized,
9,062,727 shares issued and outstanding at March 31, 2005
and December 31, 2004 ............................................. 91 91
Additional paid-in-capital ......................................... 68,381 68,381
Unallocated common stock held by Employee Stock Ownership Plan ..... (1,750) (1,796)
Unearned compensation related to Recognition and Retention Plan .... (1,628) (1,698)
Retained earnings, substantially restricted ........................ 30,191 29,765
Accumulated unrealized loss on securities available-for-sale,
net of tax ........................................................ (1,341) (419)
Treasury stock of 1,815,283 shares at March 31, 2005, and
1,630,683 shares at December 31, 2004, at cost .................... (24,433) (21,930)
------------- -------------
Total stockholders' equity ...................................... 69,511 72,394
------------- -------------
Total liabilities and stockholders' equity ...................... $ 511,088 $ 508,961
============= =============
See accompanying notes to consolidated financial statements.
1
CITIZENS SOUTH BANKING CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(in thousands, except per share data)
THREE MONTHS ENDED
MARCH 31,
--------------------------
2005 2004
----------- -----------
INTEREST INCOME:
Loans ..................................................... $ 4,632 $ 3,872
Investment securities ..................................... 396 485
Interest-bearing deposits ................................. 35 20
Mortgage-backed and related securities .................... 737 778
----------- -----------
Total interest income ................................... 5,800 5,155
INTEREST EXPENSE:
Deposits .................................................. 1,696 1,426
Borrowed funds ............................................ 475 445
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Total interest expense .................................. 2,171 1,871
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Net interest income ....................................... 3,629 3,284
Provision for loan losses ................................. 150 30
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Net interest income after provision for loan losses ....... 3,479 3,254
NONINTEREST INCOME:
Fee income on deposit accounts ............................ 544 603
Income on mortgage banking and other lending activities ... 113 102
Dividends on FHLB stock ................................... 37 23
Increase in cash value of bank-owned life insurance ....... 161 140
Fair value adjustment on deferred compensation assets ..... (47) 72
Gain on sale of assets .................................... 131 290
Other noninterest income .................................. 110 96
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Total noninterest income ................................ 1,049 1,326
NONINTEREST EXPENSE:
Compensation and benefits ................................. 1,666 1,738
Fair value adjustment on deferred comp. obligations ....... (47) 72
Occupancy and equipment expense ........................... 485 376
Professional services ..................................... 151 130
Amortization of intangible assets ......................... 87 111
Loss on sale of assets .................................... 64 -
Other noninterest expense ................................. 843 770
----------- -----------
Total noninterest expense ............................... 3,249 3,197
Income before income taxes ................................ 1,279 1,383
Provision for income taxes ................................ 377 412
----------- -----------
Net income ................................................ $ 902 $ 971
=========== ===========
Basic earnings per share .................................. $ 0.13 $ 0.12
Diluted earnings per share ................................ $ 0.13 $ 0.12
Basic average common shares outstanding ................... 7,084,471 8,268,233
Diluted average common shares outstanding ................. 7,202,704 8,342,431
See accompanying notes to consolidated financial statements.
2
CITIZENS SOUTH BANKING CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)
(dollars in thousands)
THREE MONTHS ENDED
MARCH 31,
-------------------
2005 2004
-------- --------
Net income ......................................................... $ 902 $ 971
Other comprehensive income, net of tax:
Unrealized gains on securities available for sale:
Unrealized holding gains (losses) arising during period ........ (898) 563
Reclassification adjustment for (gains) included in net income . (24) (186)
-------- --------
Other comprehensive income ....................................... (922) 377
-------- --------
Comprehensive income (loss) ........................................ $ (20) $ 1,348
======== ========
See accompanying notes to consolidated financial statements.
3
CITIZENS SOUTH BANKING CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited)
(dollars in thousands)
THREE MONTHS ENDED
MARCH 31,
---------------------
2005 2004
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COMMON STOCK:
At beginning of period ..................................................... $ 91 $ 91
Issuance of common stock ................................................... - -
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At end of period ........................................................... 91 91
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ADDITIONAL PAID-IN-CAPITAL:
At beginning of period ..................................................... 68,381 68,280
Allocation from shares purchased with loan from ESOP ....................... - -
Exercise of options ........................................................ - -
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At end of period ........................................................... 68,381 68,280
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UNALLOCATED COMMON STOCK HELD BY ESOP:
At beginning of period ..................................................... (1,796) (1,979)
Allocation from shares purchased with loan from ESOP ....................... 46 46
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At end of period ........................................................... (1,750) (1,933)
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UNEARNED COMPENSATION RELATED TO RECOGNITION AND RETENTION PLAN:
At beginning of period ..................................................... (1,698) (1,979)
Vesting of shares for plan ................................................. 70 186
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At end of period ........................................................... (1,628) (1,793)
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RETAINED EARNINGS, SUBSTANTIALLY RESTRICTED:
At beginning of period ..................................................... 29,765 28,824
Net income ................................................................. 902 971
Cash dividends declared on common stock .................................... (476) (515)
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At end of period ........................................................... 30,191 29,280
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ACCUMULATED UNREALIZED GAIN ON SECURITIES AVAILABLE FOR SALE, NET OF TAX:
At beginning of period ..................................................... (419) (40)
Other comprehensive results, net of tax .................................... (922) 377
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At end of period ........................................................... (1,341) 337
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TREASURY STOCK:
At beginning of period ..................................................... (21,930) (5,528)
Repurchase of common stock ................................................. (2,503) (3,300)
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At end of period ........................................................... (24,433) (8,828)
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See accompanying notes to consolidated financial statements.
4
CITIZENS SOUTH BANKING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(dollars in thousands)
THREE MONTHS ENDED
MARCH 31,
-------------------
2005 2004
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ......................................................................... $ 902 $ 971
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses ...................................................... 150 30
Depreciation ................................................................... 296 207
Net gain on sale of investments, available for sale ............................ (36) (290)
Net gain on sale of other assets ............................................... (31) -
Deferred loan origination fees ................................................. (165) (9)
Allocation of shares to the ESOP ............................................... 46 46
Vesting of shares for the Recognition and Retention Plan ....................... 70 186
Decrease in accrued interest receivable ........................................ (41) 200
Amortization of intangible assets .............................................. 87 111
Decrease in other assets ....................................................... 111 664
Decrease in other liabilities .................................................. (344) (105)
-------- --------
Net cash provided by operating activities .................................... 1,045 2,011
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in loans receivable ........................................ (10,458) 1,765
Proceeds from the sale of investment securities .................................... 5,517 1,258
Proceeds from the sale of mortgage-backed securities ............................... 1,563 6,432
Proceeds from the sale of other assets ............................................. 450 25
Maturities and prepayments of investment securities ................................ 4,045 9,375
Maturities and prepayments of mortgage-backed securities ........................... 4,616 4,323
Purchases of investments ........................................................... - (3,325)
(Purchase) sale of FHLB stock ...................................................... (388) 365
Capital expenditures for premises and equipment .................................... (91) (1,312)
-------- --------
Net cash provided by investment activities ................................... 5,254 18,906
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits ................................................ (2,640) 8,074
Dividends paid to stockholders ..................................................... (476) (515)
Repurchase of common stock ......................................................... (2,503) (3,300)
Net increase (decrease) in borrowed money .......................................... 7,805 (6,862)
Increase in advances from borrowers for insurance and taxes ........................ 190 244
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Net cash provided by (used for) financing activities ......................... 2,376 (2,359)
Net decrease in cash and cash equivalents ............................................ 8,675 18,558
Cash and cash equivalents at beginning of period ..................................... 11,590 8,214
-------- --------
Cash and cash equivalents at end of period ........................................... $ 20,265 $ 26,772
======== ========
See accompanying notes to consolidated financial statements.
5
CITIZENS SOUTH BANKING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
In management's opinion, the accompanying consolidated financial
statements, which are unaudited, reflect all adjustments, consisting solely of
normal recurring accruals, necessary for a fair presentation of the financial
information as of and for the three-month periods ended March 31, 2005 and 2004,
in conformity with accounting principles generally accepted in the United States
of America. Results for the three months ended March 31, 2005, are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2005.
The consolidated financial statements include the accounts of Citizens
South Banking Corporation (the "Company") and the Company's wholly owned
subsidiary, Citizens South Bank (the "Bank").
The organization and business of the Company, accounting policies
followed, and other related information are contained in the notes to the
consolidated financial statements of the Company as of December 31, 2004 and
2003, and for the years ended December 31, 2004, 2003, and 2002, filed as part
of the Company's annual report on Form 10-K. These consolidated financial
statements should be read in conjunction with the annual consolidated financial
statements.
CRITICAL ACCOUNTING POLICIES
The accounting and financial policies of the Company and its
subsidiaries are prepared in accordance with accounting principles generally
accepted in the United States and conform to general practices in the banking
industry. We consider accounting policies that require significant judgment and
assumptions by management that have, or could have, a material impact on the
carrying value of certain assets or on income to be critical accounting
policies. Changes in underlying factors, assumptions or estimates could have a
material impact on our future financial condition and results of operations.
Based on the size of the item or significance of the estimate, the allowance for
loan losses is considered critical to our financial results. The allowance for
loan losses is calculated with the objective of maintaining an allowance
sufficient to absorb estimated probable loan losses. Management's determination
of the adequacy of the allowance is based on quarterly evaluations of the loan
portfolio and other relevant factors. However, this evaluation is inherently
subjective, as it requires an estimate of the loss for each type of loan and for
each impaired loan, an estimate of the amounts and timing of expected future
cash flows, and an estimate of the value of the collateral.
Management has established a systematic method for periodically
evaluating the credit quality of the loan portfolio in order to establish an
allowance for loan losses. The methodology is set forth in a formal policy and
includes a review of all loans in the portfolio on which full collectibility may
or may not be reasonably assured. The loan review considers among other matters,
the estimated fair value of the collateral, economic conditions, historical loan
loss experience, our knowledge of inherent losses in the portfolio that are
probable and reasonably estimable and other factors that warrant recognition in
providing an appropriate loan loss allowance. Specific allowances are
established for certain individual loans that management considers impaired
under Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting
by Creditors for Impairment of a Loan." The remainder of the portfolio is
segmented into groups of loans with similar risk characteristics for evaluation
and analysis. In originating loans, we recognize that losses will be experienced
and that the risk of loss will vary with, among other things, the type of loan
being made, the creditworthiness of the borrower, the term of the loan, general
economic conditions, and in the case of a secured loan, the quality of the
collateral. We increase our allowance for loan losses by charging provisions for
loan losses against our current period income. Management's periodic evaluation
of the adequacy of the allowance is consistently applied and is based on our
past loan loss experience, particular risks inherent in the different kinds of
lending that we engage in, adverse situations that may affect the borrower's
ability to repay, the estimated value of any underlying collateral, current
economic conditions, and other relevant internal and external factors that
affect loan collectibility. Management believes this is a critical accounting
policy because this evaluation involves a high degree of complexity and requires
us to make subjective judgments that often require assumptions or estimates
about various matters.
6
STOCK OPTION EXPENSE DISCLOSURE
In accordance with the Statement of Financial Accounting Standards ("SFAS") No.
123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148,
Accounting for Stock-Based Compensation - Transition and Disclosure - An
Amendment of FASB Statement No. 123, the Company has adopted the disclosure-only
option and elected to apply the provisions of APB No. 25 for financial statement
purposes. As such, no stock-based employee compensation cost is reflected in net
income for the Company's stock option plans. Pro forma information regarding net
income and earnings per share have been determined as if the Company had
accounted for its employee stock options using the fair value method, and is
presented in the following table.
Three months ended
March 31,
-------------------
2005 2004
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Net income (in thousands):
As reported $ 902 $ 971
Deduct: Total stock-based employee
compensation cost determined under
the fair value method, net of tax 20 32
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Pro forma $ 882 $ 939
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Basic earnings per share:
As reported $ 0.13 $ 0.12
Pro forma $ 0.12 $ 0.11
Diluted earnings per share:
As reported $ 0.13 $ 0.12
Pro forma $ 0.12 $ 0.11
The fair value of each option grant is estimated on the date of the
grant using the Black-Scholes option-pricing model with the following weighted
average assumptions used for the three-month periods ended March 31, 2005 and
2004: dividend yield of 2.0%, expected volatility of 30%, risk-free investment
rate of 3.5%, and expected lives of seven years.
NOTE 2 - USE OF ESTIMATES
The financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America which require
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
7
NOTE 3 - EARNINGS PER SHARE
Earnings per share has been determined under the provisions of SFAS No.
128, Earnings Per Share. The only potential stock of the Company, as defined in
SFAS No. 128, Earnings Per Share, is stock options granted to various directors
and officers of the Bank. The following is a summary of the diluted earnings per
share calculation for the three months ended March 31, 2005 and 2004 (dollars in
thousands, except per share data):
Three Months Ended
March 31,
---------------------------
2005 2004
------------ ------------
Net income .......................... $ 902 $ 971
Weighted average outstanding shares.. 7,084,471 8,268,233
Dilutive effect of stock options .... 118,233 74,198
------------ ------------
Weighted average diluted shares ..... 7,202,704 8,342,431
Diluted earnings per share .......... $ 0.13 $ 0.12
NOTE 4 - DIVIDEND DECLARATION
On April 18, 2005, the Board of Directors of the Company approved and
declared a regular cash dividend of seven cents per share of common stock to
stockholders of record as of May 1, 2005, and payable on May 15, 2005.
NOTE 5 - STOCK REPURCHASE PROGRAMS
On February 28, 2005, the Board of Directors of the Company authorized
the repurchase of up to 370,000 shares, or approximately 5%, of the Company's
then outstanding shares of common stock. These repurchases may be carried out
through open market purchases, block trades, and negotiated private
transactions. The stock may be repurchased on an ongoing basis and will be
subject to the availability of stock, general market conditions, the trading
price of the stock, alternative uses for capital, and the Company's financial
performance. As of March 31, 2005, management had repurchased a total of 95,600
shares at an average price of $13.43 per share and had 274,400 shares remaining
to be repurchased under this plan. Management will consider repurchasing
additional shares of common stock of the Company at prices management considers
to be attractive and in the best interests of both the Company and its
stockholders. Any repurchased shares will be held as treasury stock and will be
available for general corporate purposes.
On May 17, 2004, the Board of Directors of the Company authorized the
repurchase of up to 815,000 shares, or approximately 10%, of the Company's
outstanding shares of common stock. This stock repurchase program was completed
in March 2005, with the repurchase of 815,000 shares at an average price of
$13.09. In October 2003, the Company authorized the repurchase of up to 879,900
shares, or approximately 10%, of the outstanding shares. This repurchase program
was completed in May 2004, with the repurchase of 877,235 shares at an average
price of $13.80. Also, in March 2003 the Company authorized the repurchase of up
to 343,027 shares, or approximately 3.8% of the outstanding shares. This program
was completed in September 2003, with the repurchase of 342,200 shares at an
average price of $13.66.
8
NOTE 6 - IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS) No. 123 (revised), Share
Based Payment which establishes standards for the accounting for transactions in
which an entity exchanges its equity instruments for goods or services. It also
addresses transactions in which an entity incurs liabilities in exchange for
goods or services that are based on the fair value of the entity's equity
instruments or that may be settled by the issuance of those equity instruments.
The primary focus of this statement is on accounting for transactions in which
an entity obtains employee services in exchange for share-based payment
transactions. As a result of a recent SEC ruling, this Statement is now
effective for the beginning of the first annual reporting period that begins
after June 15, 2005. SFAS No. 123 (revised) will be adopted by the Company
beginning with the first quarter ending March 31, 2006. Based on the unvested
options outstanding at March 31, 2005, the Company expects that the adoption of
SFAS 123 (revised) will result in additional compensation expense of
approximately $125,000 during 2006.
In March 2005, the SEC released Staff Accounting Bulletin No. 107,
"Share-Based Payment," (SAB 107). SAB 107 express views of the SEC staff
regarding the application of Statement of Financial Accounting Standards
Statement No. 123 (revised 2004), Share-Based Payment (Statement 123R). Among
other things, SAB 107 provides interpretive guidance related to the interaction
between Statement 123R and certain SEC rules and regulations, as well as
provides the staff's views regarding the valuation of share-based payment
arrangements for public companies.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
From time to time, the Company may publish forward looking statements
relating to such matters as anticipated financial performance, business
prospects, technological developments, new products, and similar matters. The
Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward looking statements provided that the Company notes that a variety of
factors could cause the Company's actual results to differ materially from the
anticipated results expressed in the Company's forward looking statements.
Factors that may cause actual results to differ materially from those projected
in the forward looking statements include, but are not limited to, general
economic conditions that are less favorable than expected, changes in market
interest rates that result in reduced interest margins, risks in the loan
portfolio, including prepayments, that are greater than expected, legislation or
regulatory changes that have a less than favorable impact on the business of the
Company are enacted, and competitive pressures increase significantly.
Statements included in this report should be read in conjunction with the
Company's Annual Report on Form 10-K, which is incorporated into this discussion
by this reference. Forward looking statements speak only as of the date they are
made and the Company does not undertake to update forward looking statements to
reflect circumstances or events that occur after the date of the forward looking
statements or to reflect the occurrence of unanticipated events. Accordingly,
past results and trends should not be used by investors to anticipate future
results or trends.
COMPARISON OF FINANCIAL CONDITION
Assets. Total assets of the Company increased by $2.1 million, or 0.4%,
from $509.0 million as of December 31, 2004, to $511.1 million as of March 31,
2005. Loans receivable increased by $10.5 million, or 3.3%, to $324.6 million at
March 31, 2005. This loan growth was primarily fueled by an $8.5 million, or
5.7%, increase in the commercial real estate portfolio to $157.1 million.
Commercial nonmortgage loans increased by $2.6 million, or 18.7%, during the
period to $16.6 million. A large portion of the growth in our commercial
mortgage and commercial business loan portfolios was attributable to the
staffing of a new loan production office in Cornelius, North Carolina, which was
started during the fourth quarter of 2004, and the hiring of several experienced
commercial bankers over the past six months to assist the Company in meeting its
loan growth objectives. The Company's consumer and mortgage loan portfolios were
flat during the period, with consumer loans totaling $61.4 million at March 31,
2005, and residential loans totaling $92.5 million on the same date. Prepayments
on residential loans have slowed down, allowing new originations to offset
prepayments and normal amortization of the residential portfolio. Additional
growth in the residential portfolio is expected due to the recent hiring of two
mortgage loan originators and an expanded product offering for our residential
portfolio. Consumer loan pricing has become increasingly competitive. However,
we have been able to maintain our existing portfolio. Modest growth is expected
in our consumer loan portfolio for the remainder of the year due to the expected
opening of our twelfth full-service office in Belmont, North Carolina, in the
third quarter of 2005.
Management will seek to continue to grow the loan portfolio in a safe
and sound manner with an emphasis on adjustable-rate loans and shorter-term
fixed rate loans. As of March 31, 2005, approximately $181.9 million, or 55% of
the Company's loan portfolio, was scheduled to price each month. This
sensitivity to rising interest rates has been a driving factor in the Company's
margin expansion over the past several quarters as the prime interest rate has
steadily increased.
Cash and cash equivalents increased by $8.7 million, or 74.6%, from
$11.6 million at December 31, 2004, to $20.3 million at March 31, 2005. This
increase was largely due to a $7.8 million increase in borrowed money. These
funds will primarily be used to fund loan growth and repurchase the common stock
of the Company. Also during the three-month period, mortgage-backed securities
decreased $7.1 million, or 8.8%, to $74.0 million and investment securities
decreased by $10.1 million, or 19.2%, to $42.3 million. These decreases were
largely due to the sale of $1.6 million in mortgage-backed securities,
maturities and prepayments of $4.6 million in mortgage-backed securities, sales
of $5.5 million of investment securities, and maturities of $4.0 million in
investment
10
securities during the period. The cash flows generated from these
mortgage-backed and investment securities were primarily used to fund loan
growth and stock repurchases during the period. Management expects the
investment and mortgage-backed securities portfolios to continue to decrease as
a percentage of total assets as the cash flows generated from these investments
are reinvested into the loan portfolio.
Other real estate owned, which consists of five residential properties
acquired by the Company through foreclosure, decreased by 47.5% from $806,000 at
December 31, 2004, to $423,000 at March 31, 2005. This decrease was due to the
sale of eleven residential properties during the first quarter of 2005 for
$427,000. Management will continue to aggressively market these properties for a
timely disposition. All foreclosed properties are located in the Company's
primary lending area.
Allowance for loan losses and nonperforming assets. The Company has
established a systematic methodology for determining the adequacy of the
allowance for loan losses. This methodology is set forth in a formal policy and
considers all loans in the portfolio. Specific allowances are established for
certain individual loans that management considers impaired. The remainder of
the portfolio is segmented into groups of loans with similar risk
characteristics for evaluation and analysis. Management's periodic evaluation of
the allowance is consistently applied and based on inherent losses in the
portfolio, past loan loss experience, risks inherent in the different types of
loans, the estimated value of any underlying collateral, current economic
conditions, the borrower's financial position, and other relevant internal and
external factors that may affect loan collectibility. The allowance for loan
losses is increased by charging provisions for loan losses against income. As of
March 31, 2005, the allowance for loan losses was $3.2 million. Management
believes that this amount meets the requirement for losses on loans that
management considers to be impaired, for known losses, and for incurred losses
inherent in the remaining loan portfolio. Although management believes that it
uses the best information available to make such determinations, future
adjustments to the allowance for loan losses may be necessary and results of
operations could be significantly adversely affected if circumstances differ
substantially from the assumptions used in making the determinations. The
following table presents an analysis of changes in the allowance for loan losses
for the periods and information with respect to nonperforming assets at the
dates indicated.
11
AT AND FOR THE THREE
MONTHS ENDED MARCH 31,
-----------------------
2005 2004
---------- ----------
(dollars in thousands)
ALLOWANCE FOR LOAN LOSSES:
Beginning of period ............... $ 3,029 $ 2,969
Add:
Provision for loan losses ..... 150 30
Recoveries .................... 5 1
Less:
Charge-offs ................... - 2
---------- ----------
End of period ..................... $ 3,184 $ 2,998
Nonaccrual loans .................. $ 1,419 $ 513
Real estate owned ................. 423 24
---------- ----------
Nonperforming assets .............. $ 1,842 $ 537
Allowance for loan losses as a
percentage of total loans ........ 0.97% 1.00%
Nonperforming loans to
total loans ...................... 0.43% 0.17%
Nonperforming assets to
total assets ..................... 0.36% 0.11%
Liabilities. Total liabilities increased by $5.0 million, or 1.2%, from
$436.6 million as of December 31, 2005, to $441.6 million as of March 31, 2005.
This increase was primarily due to a $7.8 million, or 14.0%, increase in
borrowed money, the effects of which were partly offset by a $2.6 million, or
0.7%, decrease in total deposits. Demand deposit accounts (checking accounts)
increased by $2.2 million, or 4.2%, during the three-month period to $54.9
million. This was primarily due to a continued emphasis on increasing the
Company's number of retail and business checking account customers. The decrease
in other deposits was largely due to the loss of price sensitive customers as a
result of aggressive pricing from competitors. Management has always focused on
increasing deposits by building customer relationships and typically avoids
growing deposits by offering the highest rates in the market. Also, during the
three-month period, the Company increased its outstanding borrowed funds by $7.8
million. This increase was primarily due to the addition of two $5.0 million
adjustable rate Federal Home Loan Bank advances. These funds were used to repay
an existing daily rate Federal Home Loan Bank advance, to fund loan growth, and
to repurchase common stock during the period.
Stockholders' Equity. Total stockholders' equity decreased by $2.9
million, or 4.0%, from $72.4 million as of December 31, 2004, to $69.5 million
as of March 31, 2005. The decrease in stockholders' equity was primarily due to
the repurchase of 184,600 shares of common stock for $2.5 million, at an average
cost of $13.56 per share. In February 2005, the Board of Directors authorized
the repurchase of up to 370,000 shares, or approximately 5%, of the outstanding
shares of common stock. As of March 31, 2005, management had repurchased a total
of 95,600 shares under the current program at an average price of $13.43 per
share and had 274,400 shares remaining to be repurchased. Management will
consider repurchasing additional shares of common stock of the Company at prices
that management considers to be attractive and in the best interests of both the
Company and its stockholders. Any repurchased shares will be held as treasury
stock and will be available for general corporate purposes. In addition, the
Company paid cash dividends totaling $477,000 during the nine-month period,
representing $0.065 per share, and posted a $923,000 increase in unrealized
losses on available for sale securities due to an increase in market interest
rates. These decreases in equity were partially offset by $902,000 in earnings
during the period.
12
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2005
AND 2004
General. Net income for the three months ended March 31, 2005, amounted
to $902,000, or $0.13 per diluted share, as compared to $971,000, or $0.12 per
diluted share, for the three months ended March 31, 2004. This represents an
8.3% increase in earnings per share.
Net interest income. Net interest income increased by $344,000, or
10.5%, to $3.6 million for the three months ended March 31, 2005. Interest
income increased by $646,000, or 12.5%, primarily as a result of an $8.7
million, or 2.0%, increase in the average outstanding balance of
interest-earning assets to $448.4 million for the three months ended March 31,
2005. The increase in average interest-earning assets was primarily the result
of a $21.8 million, or 7.4%, increase in average outstanding loans to $317.9
million. The Company's average yield on earning assets increased by 53 basis
points to 5.27% for the quarter ended March 31, 2005. Interest expense increased
by $301,000, or 16.1%, for the comparable quarters. This increase in interest
expense was due to a 20 basis point increase in the average cost of funds to
2.16%. In addition, the Company experienced a $24.5 million, or 6.4%, increase
in the average balance of interest-bearing liabilities to $407.5 million.
Average interest-bearing liabilities increased primarily as a result of a $19.5
million, or 16.6%, increase in average core deposits (checking accounts, savings
accounts and money market accounts), coupled with a $4.7 million, or 9.1%,
increase in borrowed money. The net interest margin improved 25 basis points, or
8.4%, to 3.24% for the quarter ended March 31, 2005, compared to 2.99% for the
quarter ended March 31, 2004. This increase in the net interest margin was
primarily the result of increased yields on prime-based consumer and commercial
loans due to steady 25 basis point increases in the prime-lending rate since
June 30, 2004. Approximately 55% of the Company's loans have interest rates that
are tied to short-term rate indexes such as the prime-lending rate.
Provision for loan losses. The provision for loan losses amounted to
$150,000 for the three months ended March 31, 2005, compared to $30,000 for the
three months ended March 31, 2004. The increase in the provision for loan losses
was primarily attributable to the increase in outstanding loans during the
respective quarters ($10.5 million increase in outstanding loans during the
quarter ended March 31, 2005, compared t o a $1.8 million decrease in
outstanding loans during the quarter ended March 31, 2004). The allowance for
loan losses was $3.2 million, or 0.97% of total loans, as of March 31, 2005,
compared to $3.0 million, or 1.00% of total loans, as of March 31, 2004. While
the Company continues to emphasize commercial loans and consumer loans that are
generally secured by real estate, in addition to residential mortgage loans, the
Company's ratio of nonperforming loans to total loans remains below our peer
group average, at 0.43% of total loans on March 31, 2005, compared to 0.17% of
total loans on March 31, 2004. Most of the Company's nonperforming loans at
March 31, 2005, were secured by real estate.
Noninterest income. Noninterest income decreased by $278,000, or 20.9%,
to $1.0 million for the three months ended March 31, 2005, as compared to $1.3
million for the three months ended March 31, 2004. This decrease was primarily
due to a $159,000, or 54.8 %, decrease in gains on sale of assets and an
$119,000 decrease in the fair value adjustment on deferred compensation assets,
the effects of which are offset by a decrease in compensation expense. Fee
income on deposit accounts decreased by $59,000, or 9.9%, due to fewer NSF
charges generated from overdrawn checking accounts. Management expects that this
trend of decreasing NSF fee income will continue throughout the remainder of the
year. However, the effects of this decrease should be partially offset by a
growth in service charges arising from an increasing number of transaction
accounts. These decreases in noninterest income were partially offset by
increases in fee income on mortgage banking and other lending activities,
commissions on the sale of financial products, dividends on FHLB stock,
increases in cash value of bank owned life insurance, and other income. Fee
income generated from mortgage brokerage and other lending activities increased
by $11,500, or 11.3%, due to higher levels of residential loan originations.
Residential loan origination activity is expected to decline when longer term
interest rates begin to increase. Dividends on FHLB stock increased by $14,000,
or 58.8%, due to an increase in the number of shares owned and an increase in
the dividend rate.
13
During the quarter ended March 31, 2005, the Company recognized a gain
of $131,000 on the sale of assets. These gains were generated from the sale of
$5.5 million in investment securities, $1.6 million in mortgage-backed
securities, and the sale of a vacant lot located adjacent to one of the
Company's branch offices for $111,000. During the quarter ended March 31, 2004,
the Company recognized a gain of $290,000 from the sale of $1.3 million in
investment securities and $6.4 million in mortgage-backed securities.
Noninterest expense. Noninterest expense increased by $51,000, or 1.6%,
to $3.2 million for the quarter ended March 31, 2005. The Company experienced
increases in office occupancy and equipment, professional services, and other
expenses. Occupancy and equipment expense increased by $109,000, or 28.9%,
primarily due to expenses associated with constructing a new building to be used
as the corporate headquarters and a full-service office. The Company plans to
open its twelfth full-service office in Belmont, North Carolina, in the third
quarter of 2005. The Company experienced a $20,000, or 15.1% increase, in
professional services, primarily as a result of new regulations and laws that
require additional assistance from outside professionals. Other expense
increased $159,000, or 24.8%, due in part to the upgrading of the Company's
technological capabilities in the areas of online banking, cash management,
document imaging, and core processing. These improvements in the Company's
infrastructure should enable the Company to pursue additional growth both
internally through offering improved products and services and externally
through acquisitions in order to enhance the franchise value of the Company.
These increases in noninterest expense were partially offset by decreases in
compensation and benefits, advertising, amortization of intangible assets, and
fair value adjustments on deferred compensation obligations. Compensation and
benefits decreased by $72,000, or 4.1%, due to an $116,000 decrease in stock
benefit expense. Advertising expense decreased by $85,000, or 65.2%, due to
higher costs incurred in 2004 in preparing for the Company's 100th Anniversary
celebration. The amortization of intangible assets decreased by $24,000, or
21.8%, due mainly to normal reductions in the amortization expense of the core
deposit intangible associated with a seven year accelerated depreciation
schedule. Losses on the sale of assets amounted to $64,000 for the quarter ended
March 31, 2005. These losses were primarily attributable to the sale of eleven
foreclosed residential properties at a loss of $58,000. For the quarter ended
March 31, 2004, the Company recognized no losses from the sale of assets.
Income taxes. Income taxes amounted to $377,000, or 29.5% of taxable
income, for the quarter ended March 31, 2005, as compared to $412,000, or 29.8%
of taxable income for the quarter ended March 31, 2004. The decrease in income
tax expense during the first quarter of 2005 was primarily due to a $103,000
decrease in net income before taxes. The effective tax rate was fairly flat
between the two periods. The Company invests in tax-advantaged sources of income
to reduce its overall tax burden. These tax-advantaged sources include
investments such as municipal securities and bank-owned life insurance. As the
Company continues to increase the amount of income derived from interest income
on loans and fee income on deposits, the effective tax rate is expected to
increase.
LIQUIDITY, MARKET RISK, AND CAPITAL RESOURCES
The objectives of the Company's liquidity management policy include
providing adequate funds to meet the cash needs of both borrowers and
depositors, to provide for the on-going operations of the Company, and to
capitalize on opportunities for expansion. Liquidity management addresses the
Company's ability to meet deposit withdrawals on demand or at contractual
maturity, to repay borrowings as they mature, and to fund new loans and
investments as opportunities arise. The primary sources of internally generated
funds are principal and interest payments on loans receivable, increases in
local deposits, cash flows generated from operations, and cash flows generated
by investments. If the Company requires funds beyond its internal funding
capabilities, it may rely upon external sources of funds such as brokered
deposits and Federal Home Loan Bank of Atlanta ("FHLB") advances. The Company
has $65.0 million in additional advances available from its line of credit from
the FHLB. The FHLB functions as a central reserve bank providing credit for
member financial institutions. As a member of the FHLB, we are required to own
capital stock in the FHLB and we are authorized to apply for advances on the
security of such stock and certain of our mortgage loans and other assets
(principally securities that are obligations of, or guaranteed by, the U.S.
Government) provided certain creditworthiness standards have been met. Advances
are made pursuant to several different credit programs. Each credit program has
its own interest rate and range of maturities. Depending on the program,
limitations on the amount of advances are based on the financial condition of
the member institution and the adequacy of
14
collateral pledged to secure the credit. The Company may also solicit brokered
deposits for providing funds for asset growth; however, to date, the Company has
not used such deposits to supplement its liquidity position. The Company
believes that it has sufficient sources of liquidity to fund the cash needs of
both borrowers and depositors, to provide for the on-going operations of the
Company, and to capitalize on opportunities for expansion.
In the normal course of business, various commitments are outstanding
that are not reflected in the consolidated financial statements. Commitments to
extend credit and undisbursed advances on customer lines of credit are
agreements to lend to a customer as long as there is no violation of any
condition established in the contract. The funding of these commitments and
previously approved undisbursed lines of credit could affect the Company's
liquidity position. At March 31, 2005, the Company had loan commitments of $17.5
million, unused lines of credit of $66.2 million, and undisbursed construction
loan proceeds of $5.0 million. The Company believes that it has adequate
resources to fund loan commitments and lines of credit as they arise. The
Company does not have any special purpose entities or other similar forms of
off-balance sheet financing.
The Company's most significant form of market risk is interest rate
risk, as the Company's assets and liabilities are sensitive to changes in
interest rates. The Company's Asset / Liability Committee ("ALCO") is
responsible for monitoring its level of interest rate risk and ensuring
compliance with Board-adopted limits. There were no changes in the Company's
asset or liability composition that could result in a material change in the
Company's analysis of interest rate sensitivity as discussed in the Company's
Annual Report on Form 10-K for the year ended December 31, 2004.
The Bank is subject to various regulatory capital requirements
administered by the banking regulatory agencies. As of March 31, 2005, Citizens
South Bank's capital exceeded all applicable regulatory requirements. Citizens
South Bank's Tier I capital was $60.9 million, or 12.1% of adjusted total
assets. The minimum Tier I capital ratio is 4.00%. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly discretionary
actions by the regulators that, if undertaken, could have a direct material
effect on the Bank's financial statements. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and classifications
are subject to qualitative judgments by the regulators about components,
risk-weightings, and other factors.
15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is included above in Item 2,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, under the caption "Liquidity, Market Risk, and Capital Resources."
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, the Company has evaluated the effectiveness of the design and operation
of its disclosure controls and procedures (as defined in Rule 13a-15(e) and
15d-15(e) under the Exchange Act) as of the end of the period covered by this
report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this
report, the Company's disclosure controls and procedures were effective to
ensure that information required to be disclosed in the reports that the Company
files or submits under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SEC's rules and forms and in
timely alerting them to material information relating to the Company (or its
consolidated subsidiaries) required to be filed in its periodic SEC filings.
There has been no change in the Company's internal control over
financial reporting identified in connection with the quarterly evaluation that
occurred during the Company's last fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the Company's internal control
over financial reporting.
PART II. OTHER INFORMATION
LEGAL PROCEEDINGS
There are various claims and lawsuits in which the Bank is periodically
involved incidental to the Company's business. In the opinion of management, no
material loss is expected from any of such pending claims or lawsuits.
CHANGES IN SECURITIES AND USE OF PROCEEDS
During the three-month period ended March 31, 2005, the Company
repurchased 184,600 shares of common stock for $2.5 million, at an average cost
of $13.56 per share as detailed in the following table:
MAXIMUM NUMBER
TOTAL TOTAL NUMBER OF OF SHARES THAT
NUMBER OF AVERAGE SHARES PURCHASED AS MAY BE PURCHASED
SHARES PRICE PAID PART OF THE CURRENT UNDER CURRENT
PERIOD PURCHASED PER SHARE REPURCHASE PLAN REPURCHASE PLAN
- -------- -------------- -------------- -------------------- --------------------
January 0 $ 0.00 0 370,000
February 67,800 $ 13.73 0 370,000
March 116,800 $ 13.46 95,600 274,400
Total 184,600 $ 13.56 95,600 274,400
On February 28, 2005, the Board of Directors of the Company authorized
the repurchase of up to 370,000 shares, or approximately 5%, of the Company's
outstanding shares of common stock. These repurchases may be carried out through
open market purchases, block trades, and negotiated private transactions. The
stock may be repurchased on an ongoing basis and will be subject to the
availability of stock, general market conditions, the trading price of the
stock, alternative uses for capital, and the Company's financial performance. As
of March 31, 2005, management had repurchased a total of 95,600 shares at an
average price of $13.43 per share and had
16
274,400 shares remaining to be repurchased under this plan. Management will
consider repurchasing additional shares of common stock of the Company at prices
management considers to be attractive and in the best interests of both the
Company and its stockholders. Any repurchased shares will be held as treasury
stock and will be available for general corporate purposes.
On May 17, 2004, the Board of Directors of the Company authorized the
repurchase of up to 815,000 shares, or approximately 10%, of the Company's
outstanding shares of common stock. This stock repurchase program was completed
in March 2005, with the repurchase of 815,000 shares at an average price of
$13.09. In October 2003, the Company authorized the repurchase of up to 879,900
shares, or approximately 10%, of the outstanding shares. This repurchase program
was completed in May 2004, with the repurchase of 877,235 shares at an average
price of $13.80. Also, in March 2003 the Company authorized the repurchase of up
to 343,027 shares, or approximately 3.8% of the outstanding shares. This program
was completed in September 2003, with the repurchase of 342,200 shares at an
average price of $13.66.
DEFAULTS UPON SENIOR SECURITIES
Not applicable.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no meetings of the shareholders during the quarter ended
March 31, 2005.
17
EXHIBITS
Exhibits:
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Written statement of Chief Executive Officer furnished pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Written statement of Chief Financial Officer furnished pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
CITIZENS SOUTH BANKING CORPORATION
Date: May 5, 2005 By: /s/ Kim S. Price
----------------------------
Kim S. Price
President and
Chief Executive Officer
Date: May 5, 2005 By: /s/ Gary F. Hoskins
----------------------------
Gary F. Hoskins
Executive Vice President,
Chief Financial Officer
and Treasurer
19