KNBT Bancorp 10-Q 2007
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
For the transition period from ____________ to ____________
Registrant’s Telephone Number, Including Area Code: 610-861-5000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act. YES oNOx
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: As of August 3, 2007, 26,243,968 shares of the Registrant’s common stock were outstanding.
KNBT BANCORP, INC. AND SUBSIDIARIES
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
KNBT BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
KNBT BANCORP, INC. AND SUBSIDIARIES
KNBT Bancorp, Inc. (“KNBT” or the “Company”) is a Pennsylvania corporation headquartered in Bethlehem, Pennsylvania. The Company is the registered bank holding company for Keystone Nazareth Bank & Trust Company (the “Bank”), a Pennsylvania-chartered savings bank.
The accompanying consolidated financial statements were prepared in accordance with instructions to Form 10-Q, and therefore, do not include information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles used in the United States (“GAAP”). However, all normal, recurring adjustments that, in the opinion of management, are necessary for a fair presentation of these financial statements have been included. These financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto for the Company for the year ended December 31, 2006, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 (the “Form 10-K”). The results for the interim periods presented are not necessarily indicative of the results that may be expected for the year ended December 31, 2007.
The financial information presented herein is unaudited; however, in the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present fairly the unaudited financial information have been made. The Company has prepared its accompanying consolidated financial statements in accordance with GAAP as applicable to the banking industry. Certain amounts in prior years are reclassified for comparability to the current year’s presentation. Such reclassifications, when applicable, have no effect on net income. The consolidated financial statements include the balances of the Company and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation. References to the Company include the Bank and both the Bank’s and the Company’s subsidiaries unless otherwise noted.
In preparing the consolidated financial statements, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of financial condition and revenue and expense for the period. The principal estimates that are particularly susceptible to significant change in the near term relate to the allowance for loan losses, the evaluation of impairment of goodwill and the evaluation of deferred tax asset. The evaluation of the adequacy of the allowance for loan losses includes an analysis of the individual loans and overall risk characteristics and size of the different loan portfolios, and takes into consideration current economic and market conditions, the capability of specific borrowers to pay specific loan obligations, as well as current loan collateral values. However, actual losses on specific loans, which also are encompassed in the analysis, may vary from estimated losses.
In addition to the Bank, KNBT’s subsidiaries include KNBT Inv. I and KNBT Inv. II, and the Bank’s wholly owned subsidiaries KLVI, Inc., KLV, Inc., KNBT Settlement Services, LLC, Caruso Benefits Group, Inc. (“Caruso”), Higgins Insurance Associates, Inc. (“Higgins”), and KNBT Securities, Inc.
The Trust Company of Lehigh Valley
On February 28, 2006, the Bank completed its acquisition of Paragon Group, Inc. (“Paragon”), the parent holding company for the Trust Company of Lehigh Valley (“TCLV”), a Pennsylvania-chartered non-depository bank located in Allentown, Pennsylvania. TCLV provided estate, personal trust and investment management services, estate and financial planning and employee retirement benefits administration and had approximately $400 million in assets under administration and management at the time of its acquisition by the Bank. Paragon and TCLV were merged into the Bank in connection with the completion of the acquisition. The results of the acquired trust operations have been included in KNBT’s results since March 1, 2006.
Under the terms of the definitive merger agreement, the Bank acquired all of the capital stock of Paragon for a purchase price of $5.3 million in cash of which $4.3 million was paid at time of closing and $1.0 million was held in escrow. As a result of satisfaction of certain conditions set forth in the merger agreement, 50% of the escrow including interest earned was disbursed on February 28, 2007. Assuming the remaining conditions are met, the balance will be paid upon the eighteenth-month anniversary of the completion of the acquisition of Paragon.
The acquisition price resulted in the recording of $2.6 million in goodwill, which is the excess cost of the entity over the net of the amounts assigned to assets acquired and liabilities assumed and $2.6 million of other intangible assets. The intangible assets consist of $1.7 million for Paragon’s customer list, $610,000 for a restrictive covenant agreement with the principals of Paragon and $280,000 for employment agreements with the principals of Paragon. The amortization periods for the intangible assets are 15 years, 5 years and 2.7 years, respectively. Amortization expense relating to these assets was $91,000 and $43,000 for the three month periods ended June 30, 2007 and 2006, respectively, and $181,000 and $58,000 for the six month periods ended June 30, 2007 and 2006, respectively.
Caruso Benefits Group, Inc.
On April 1, 2005, the Bank acquired Caruso, a benefits management firm based in Bethlehem, Pennsylvania. Caruso specializes in benefits management with an emphasis on group medical, life and disability. Caruso’s results of operations have been included in KNBT’s results since the date of acquisition. Caruso operates as a wholly owned subsidiary of the Bank.
Under the terms of the stock purchase agreement, the Bank acquired all of the capital stock of Caruso for a purchase price of $28.0 million in cash of which $20.0 million was paid at the time of closing with the remaining $8.0 million payable over a three-year period, subject to Caruso maintaining certain levels of profitability. Caruso has exceeded profitability targets in each of the first two years. KNBT paid $2.7 million to Caruso during the second quarter of 2006 and $2.9 million during the second quarter of 2007 that represents the aggregate obligation through June 30, 2007. The payments were made pursuant to the terms of the stock purchase agreement relating to the purchase price contingency.
The acquisition resulted in the recording of approximately $13.1 million of goodwill. KNBT also recorded an identifiable intangible asset for Caruso’s customer list of $9.9 million that is being amortized on a straight line basis over 15 years. The expense related to the amortization of the identifiable intangible asset arising from the Caruso acquisition totaled $165,000 and $331,000 for the three and six-month periods ended June 30, 2007 and 2006, respectively.
Additional information and disclosures concerning the Paragon and Caruso acquisitions can be found in the Company’s Form 10-K for the year ended December 31, 2006.
The Company calculates earnings per share as provided by the provisions of SFAS No. 128, “Earnings Per Share” (SFAS No. 128). Basic and diluted earnings per share for the three and six months ended June 30, 2007 and 2006 were calculated as follows:
KNBT had outstanding stock options for the three and six months ended June 30, 2007 to purchase 1,712,980 and 1,690,648 shares of common stock, respectively, with exercise prices ranging from $15.41 to $16.56 per share that were anti-dilutive. These options were not included in the computation of diluted earnings per share for the three and six months ended June 30, 2007 because the option exercise price was greater than the average market price. KNBT also had outstanding stock options for the three and six months ended June 30, 2006, to purchase 1,290,400 and 1,266,528 shares of common stock, respectively, at $16.50 to $16.56 per share that were anti-dilutive.
Common stock outstanding for the purpose of calculating basic earnings per share does not include 773,518 and 821,119 unallocated shares held by the Employee Stock Ownership Pan (“ESOP”) at June 30, 2007 and June 30, 2006, respectively. The exclusion of these unallocated shares held by the ESOP is in accordance with the provisions of Statement of Position (“SOP”) 93-6, “Employer’s Accounting for Employee Stock Ownership Plans”, issued by the Accounting Standards Division of the American Institute of Certified Public Accountants (“AICPA”).
Unearned and uncommitted shares of common stock held in the Management Recognition and Retention Plan (“MRRP”) are not considered to be outstanding for basic earnings per share calculations. At June 30, 2007, unearned MRRP shares totaled 378,600 and uncommitted MRRP shares totaled 55,147. At June 30, 2006, unearned MRRP shares totaled 379,700 and uncommitted MRRP shares totaled 176,547.
The amortized cost, unrealized gains and losses and fair value of KNBT’s investment securities held-to-maturity and available-for-sale at June 30, 2007 (unaudited) and December 31, 2006 are as follows:
Stock Option Plans
KNBT maintains the 2004 Stock Option Plan (“2004 Plan”), as well as the stock option plans assumed in prior acquisitions. The 2004 Plan allows KNBT to grant options covering up to an aggregate of 2,020,118 shares of common stock to key employees and directors. The options have a term of up to ten years when they are issued and typically vest over a five-year period, except for some options granted to directors that vest over an eight-year period. The exercise price of each option is the market price of KNBT’s stock on the date of grant.
On January 1, 2006, KNBT adopted SFAS No. 123(R) (revised 2004), “Share-Based Payment”. Statement 123(R) replaces SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”. SFAS No. 123(R) established accounting and disclosure requirements using a fair-value based method of accounting for stock-based employee compensation plans. Prior to January 1, 2006, KNBT accounted for stock options using APB Opinion No. 25 and included disclosures of pro forma net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been used. KNBT elected the modified prospective transition method for adopting SFAS No. 123(R). Under SFAS No. 123(R), all forms of share-based payments to employees, including stock options, are treated the same as other forms of compensation by recognizing the related cost in the income statement. The provisions apply to all awards granted after the required effective date as well as existing awards not vested, or which are modified, repurchased, or canceled after that date.
As of January 1, 2006, KNBT began to expense these grants as required by SFAS No. 123(R). Stock-based employee compensation cost pertaining to stock options is reflected in net income with the fair value of each option being estimated as of the date of grant using the Black-Scholes option valuation model. The Black-Scholes model incorporates variable assumptions, which include: the expected volatility, which is based on the historical volatility of KNBT’s traded stock and peer group comparisons; the expected term calculated using the simplified method; the expected dividend yield based on historical patterns and peer group performance; and the risk free interest rate, based on the U.S. Treasury yield curve at the time of the grant. KNBT used historical data to estimate option exercises and forfeitures within the valuation model. KNBT used the following assumptions:
During the three-month periods ended June 30, 2007 and 2006, KNBT did not grant any new options. For the six-month periods ended June 30, 2007 and 2006, KNBT granted 180,050 and 217,400 new options to certain employees and directors under the 2004 Plan. These options vest ratably over a five-year period.
A summary of all of the stock option plans as of June 30, 2007 and 2006 and changes during the quarters are as follows:
The following table summarizes information concerning KNBT’s stock options outstanding and exercisable at June 30, 2007:
The aggregate intrinsic value of the options outstanding as of June 30, 2007 and 2006 was $3.8 million and $5.1 million, respectively. The aggregate intrinsic value represents the total pre-tax intrinsic value (the difference between KNBT’s closing stock price on the last trading day of the quarter ended and the exercise price, multiplied by the number of options outstanding). The aggregate intrinsic value of options currently exercisable as of June 30, 2007 was $3.8 million compared to $4.9 million as of June 30, 2006. The weighted average remaining contractual life is 6.02 years for exercisable options outstanding at June 30, 2007. The total intrinsic value of stock options exercised during the quarters ended June 30, 2007 and 2006 was $55,662 and $196,291, respectively.
Compensation cost is generally recognized over the stated vesting period as provided in terms of the option grants. As of June 30, 2007, there was $4.2 million of unrecognized compensation cost related to unvested stock options that is expected to be recognized over a weighted-average period of approximately 2.29 years.
Management Recognition and Retention Plan
The MRRP, which is a stock-based incentive plan, provides for the ability to grant up to 808,047 restricted shares of KNBT’s common stock to the Company’s directors, advisory directors, officers and employees. KNBT, for the benefit of the MRRP Trust, purchased 808,047 shares of KNBT common stock at an average price of $16.44 per share, which was treated as a reduction of additional paid-in-capital. Shares awarded to date under the MRRP are generally earned by recipients at a rate of 20% per year beginning on the first anniversary date of the grant. (Certain grants made in 2006 vest 60% on the third anniversary and 20% per year thereafter.) On May 6, 2004, 638,000 restricted shares were awarded. For the year ended December 31, 2005, 10,000 additional MRRP shares were awarded. On January 26, 2007, 35,000 additional MRRP shares were awarded. Since the inception of the MRRP, awards covering 29,100 shares were forfeited and made available for future grants. Except as discussed below, compensation expense for this plan is being recorded over the vesting period and is based on the market value of KNBT’s stock as of the date the awards were made. The remaining unearned compensation cost of the MRRP shares granted is $4.2 million and the periodic amortization of such cost is recorded as an increase in shareholders’ equity. Expense under this plan for the three month periods ended June 30, 2007 and 2006 was $531,000 and $534,000, respectively. Expense under this plan for both the six month periods ended June 30, 2007 and 2006 was $1.1 million.
The MRRP also provides for the ability to issue performance-based restricted share awards. There were no performance-based restricted shares awarded for the six month period ended June 30, 2007. During the year ended December 31, 2006, the Board of Directors awarded performance-based restricted share awards covering 85,000 shares subject to increase as described below. These shares are earned if certain defined corporate performance targets are achieved for fiscal year 2008. If the targets are achieved, on the third anniversary of the date of grant, 60% of the shares granted will be earned with the remaining 40% being earned pro rata on the fourth and fifth anniversary dates of the grant assuming the recipient remains employed by KNBT at each of such dates. Furthermore, if the Company exceeds the performance targets for fiscal year 2008, the awards will increase in the aggregate by 14,000 shares. The grants specifically exclude accelerated vesting in the event of a change in control. To date, KNBT has not recorded any compensation expense related to these performance-based restricted share awards.
In January 2007, upon further consideration of the grants of the performance-based restricted share awards, the grantees agreed to forfeit any right to receive 40% of the shares subject to the performance-based MRRP grants made in 2006 that would vest on the fourth and fifth anniversary of the grant of such awards (assuming the performance targets are met). In return for such forfeitures, each grantee agreed to receive a cash bonus in an amount equal to the fair market value of the remaining unvested restricted shares on the third anniversary of the grant date of the performance-based restricted share awards. Such amount will be paid in a lump sum within five days of the third anniversary of the grant date of the performance-based restricted share awards.
A summary of KNBT’s loans receivable at June 30, 2007 (unaudited) and December 31, 2006 is as follows:
The following table shows the amounts of KNBT’s non-performing assets, defined as non-accruing loans, accruing loans 90 days or more past due and other real estate owned at June 30, 2007 (unaudited) and December 31, 2006.
KNBT’s recorded investment in impaired loans was $1.0 million at June 30, 2007 and $1.6 million at December 31, 2006. The valuation allowance related to impaired loans is a part of the allowance for loan losses and was $253,000 at June 30, 2007 and $323,000 at December 31, 2006. The average impaired loan balance for the six months ended June 30, 2007 was $1.1 million and $2.1 million for the six months ended June 30, 2006. During the six months ended June 30, 2007 and 2006, KNBT received principal payments on impaired loans of $297,000 and $584,000, respectively. Income on impaired loans is recognized by KNBT on a cash basis. KNBT recognized $39,000 in interest income on impaired loans for the six month period ended June 30, 2007, and $5,000 for the six month period ended June 30, 2006.
The following table shows the (unaudited) activity in KNBT’s allowance for loan losses during the periods indicated:
KNBT participates in a multiple employer defined benefit pension plan, which covered substantially all employees who had 1,000 hours of service during the plan year ended October 2003. On October 1, 2003, KNBT froze the future accrual of benefits under this plan. KNBT continues to contribute to this plan for benefits accrued prior to October 2003. KNBT’s contribution to this plan in the six months ended June 30, 2007 and 2006 was $462,000 and $183,000, respectively, which is included in compensation and employee benefits expense.
As part of the Northeast Pennsylvania Financial Corp., (“NEPF”) merger, KNBT assumed the multiple employer defined benefit pension plan of NEPF. This plan covered all employees who were age 21 or older and had one year of service at the time the plan was frozen. NEPF had amended the plan and froze the benefits for the then current participants of the plan. For the six months ended June 30, 2007 and 2006, KNBT contributed approximately $249,000 and $239,000, respectively, to the NEPF pension plan, which is included in compensation and employee benefits expense.
KNBT expects to contribute an additional $230,000 in the aggregate to the two pension plans through December 31, 2007.
KNBT, as a part of previous acquisitions, assumed the deferred compensation plan for certain former directors of First Colonial. This Plan has been subsequently frozen and no future deferrals are permitted. The plan requires annual payments for periods of five to fifteen years beginning at age 65 or death. The annual benefit is based upon the amount deferred plus interest. KNBT has recorded the deferred compensation liabilities using the present value method. The net periodic defined benefit expense for the six months ended June 30, 2007 and June 30, 2006 was as follows: