10-Q 1 r10q_063003.txt FORM 10-Q FOR JUNE 30, 2003 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 2003 Commission File No. 33-12756-B COMMUNITY BANCORP, INC. A Massachusetts Corporation IRS Employer Identification No. 04-2841993 17 Pope Street, Hudson, Massachusetts 01749 Telephone - (978)568-8321 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 [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ] Common Stock $2.50 par value 5,863,314 shares outstanding as of June 30, 2003 PART I - FINANCIAL INFORMATION ------------------------------ COMMUNITY BANCORP, INC. Item 1. CONSOLIDATED BALANCE SHEETS (Unaudited)

-2- COMMUNITY BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

-3- COMMUNITY BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME (CONTINUED) (Unaudited)

-4- COMMUNITY BANCORP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)

-5- COMMUNITY BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

-7- COMMUNITY BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2003 ----------------------------------------------------------------------------- 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted 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. The results of operations for any interim period are not necessarily indicative of results expected for the full year. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company's Annual Report to shareholders and Form 10-K for the year ended December 31, 2002. 2. STOCK OPTIONS Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation", ("SFAS No. 123") requires stock-based compensation to be either recorded or disclosed at its fair value. As permitted by SFAS No. 123, the Company has elected to account for stock-based compensation under Accounting Principles Board Opinion No. 25. Had compensation cost for awards made in 2003 and 2002 under the Company's stock option plans been determined based on the fair value at the grant dates, consistent with the method set forth under SFAS No. 123, the Company's pro forma net income and earnings per share would have been adjusted to the pro forma amounts indicated below. Pro forma compensation expense for options granted is reflected over the vesting period. Therefore, future pro forma compensation expense may be greater as additional options are granted. The table below is for the six month and three month periods ending June 30, 2003 and 2002, respectively.

3. MERGER AGREEMENT On July 30, 2003, the Company and Citizens Financial Group ("Citizens") entered into an Agreement and Plan of Merger (the "Agreement") by and among Citizens -8- Bank of Massachusetts ("Citizens Bank"), a wholly owned subsidiary of Citizens, Citizens and the Company. Under the terms of the Agreement, Citizens will acquire the Company in a cash merger transaction for $19.75 per share. Pursuant to the Agreement, Community National Bank will become a part of Citizens Bank. The acquisition is subject to customary conditions, including shareholder and regulatory approval, and is expected to close in the fourth quarter of 2003. -9- PART I - FINANCIAL INFORMATION ------------------------------ Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Summary ------- The Company recorded net income of $2,829,000 for the six months ended June 30, 2003, representing a decrease of $19,000 or 0.7% from net income of $2,848,000 reported for the same period in 2002. Basic earnings per share of $0.49 for the current period represented an increase of $0.01 from basic earnings per share of $0.48 reported for the six months ended June 30, 2002. Diluted earnings per share of $0.48 for the current period remained unchanged from one year ago. While net income for the six months ended June 30, 2003 remained relatively unchanged compared to the six month period ending June 30, 2002, net interest income decreased from one year ago and noninterest expense increased from a year ago and both were offset by an increase in noninterest income and a decrease in tax expense. Deposits of $348.5 million at June 30, 2003 decreased by $5.8 million or 1.6% from $354.3 million at December 31, 2002. The decrease in deposits occurred in the noninterest-bearing, and interest-bearing categories. Loans of $219.5 million at June 30, 2003 increased by $18.1 million or 9.0% from $201.4 million at December 31, 2002. This increase took place in the commercial loan and 1-4 family real estate loan categories. Noncurrent loans (nonaccrual loans and loans 90 days or more past due but still accruing) totaled $510,000 and $245,000 at June 30, 2003 and December 31, 2002, respectively. Assets of $457.3 million at June 30, 2003 represented a $21.5 million or 4.9% increase from $435.8 million at December 31, 2002. Six Months Ended June 30, 2003 As Compared To Six Months Ended June 30, 2002 --------------------------------------------- Interest and Dividend Income ---------------------------- Interest and dividend income for the six months ended June 30, 2003 was $10,850,000 representing a decrease of $484,000 or 4.3% from $11,334,000 for the six months ended June 30, 2002, primarily due to lower interest rates in 2003, partially offset by an increase in average loan and securities balances in 2003. Interest expense was $2,500,000, representing a decrease of $417,000 or 14.3% from $2,917,000 for the six months ended June 30, 2002, primarily due to lower interest rates in 2003, partially offset by higher average interest bearing deposit and borrowing balances in 2003. Net interest income for the six months ended June 30, 2003 was $8,270,000, representing a decrease of $57,000 or 0.7% from $8,327,000 for the six months ended June 30, 2002. Noninterest Income and Expense ------------------------------ Noninterest income for the six months ended June 30, 2003 was $2,790,000 representing an increase of $325,000 or 13.2% from $2,465,000 for the six months ended June 30, 2002. This increase was primarily the result of an increase in service charges, gains on sales of loans and gains on sales of securities, partially offset by a decrease in merchant credit card assessments. The increases in service charges, loan sales and securities sales were primarily the result of the low interest rate environment. -10- Service charges increased due to a lower earnings credit applied to business DDA balances, gains on sale of loans increased due to increased residential mortgage originations, and the low interest rate environment enabled the bank to sell securities available for sale that mature within one year and invest the proceeds of those sales in longer-term securities and in the loan portfolio. The decrease in merchant credit card assessments resulted from lower merchant sales volumes attributable to the weaker economic environment. Noninterest expense for the six months ended June 30, 2003 of $6,809,000 was up $377,000 or 5.9% from $6,432,000 for the corresponding period in 2002 as the result of increases in salaries and benefits, and professional fees. The increase in salaries and benefits occurred due to merit salary increases, minor additions to staff and increases in employee benefit expense. Professional fees increased primarily due to legal fees and expenses related to correspondent banking. Provision for Loan Losses ------------------------- The provision for loan losses for the six months ended June 30, 2003 was $80,000, compared to $90,000 for the six months ended June 30, 2002. This change was a result of changes in the inherent risk of the loan portfolio. Income Taxes ------------ Income tax expense for the six months ended June 30, 2003 was $1,422,000, compared to $1,512,000 for the corresponding period in 2002. The company's effective tax rate was approximately 34% for both periods. Three Months Ended June 30, 2003 As Compared To Three Months Ended June 30, 2002 ----------------------------------------------- Interest and Dividend Income ---------------------------- Interest and dividend income for the three months ended June 30, 2003 was $5,385,000 representing a decrease of $353,000 or 6.2% from $5,738,000 for the three months ended June 30, 2002, primarily due to lower interest rates in 2003, partially offset by an increase in average loan and securities balances in 2003. Interest expense was $1,232,000, representing a decrease of $204,000 or 14.2% from $1,436,000 for the three months ended June 30, 2002, primarily due to lower interest rates in 2003, partially offset by higher average interest bearing deposit and borrowing balances in 2003. Net interest income for the three months ended June 30, 2003 was $4,118,000, representing a decrease of $139,000 or 3.3% from $4,257,000 for the three months ended June 30, 2002. Noninterest Income and Expense ------------------------------ Noninterest income for the three months ended June 30, 2003 was $1,403,000 representing an increase of $175,000 or 14.3% from $1,228,000 for the three months ended June 30, 2002. This increase was primarily the result of an increase in service charges, gains on sales of loans and gains on sales of securities. The decrease in merchant credit card assessments resulted from lower merchant sales volumes attributable to the weaker economic environment. Noninterest expense for the three months ended June 30, 2003 was $3,379,000 representing an increase of $185,000 or 5.8% from $3,194,000 for the three months ended June 30, 2002. This increase was primarily the result of an increase in salaries and benefits, information technology, occupancy, professional fees, and other expense. The increase in salaries and benefits occurred due to merit salary increases, minor additions to staff and increases in employee benefit expense. Occupancy expense increased as a result of the -11- bank's approval to sell insurance products. Prior to receiving this approval, insurance commissions and annuity sales were booked as rental income offsetting occupancy expense. This rental income totaled $43,000 during the first six months of 2002. During 2003, this income in the amount of $26,000 has been booked in noninterest income in other charges, commissions and fees. Provision for Loan Losses ------------------------- The provision for loan losses for the three months ended June 30, 2003 was $35,000, compared to $45,000 for the three months ended June 30, 2002. Management believes the allowance for loan losses is adequate, and it will continue its on going assessment of the allowance and may adjust the provision if necessary. Income Taxes ------------ Income tax expense was $713,000 for the three months ended June 30, 2003, compared to $801,000 for the same period in 2002. The company's effective tax rate was approximately 34% for both periods. Allowance for Loan Losses ------------------------- The allowance for loan losses is based on management's estimate of the amount required to reflect the risks in the loan portfolio, based on circumstances and conditions known or anticipated at each reporting date. The methodology for assessing the appropriateness of the allowance consists of a review of the following three key elements: * The valuation allowance for loans specifically identified as impaired * The formula allowance for the various loan portfolio classifications * The imprecision allowance The valuation allowance reflects specific estimates of potential losses on individually impaired loans. When each impaired loan is evaluated, if the net present value of the expected cash flows (or fair value of the collateral if the loan is collateral-dependent) is lower than the recorded loan balance, the difference represents the valuation allowance for that loan. The formula allowance is a percentage-based estimate based on historical loss experience and assigns required allowance allocations by loan classification based on fixed percentages of all outstanding loan balances. The formula allowance employs a risk-rating model that grades loans based on their general characteristics of credit quality and relative risk. When a loan's credit quality becomes suspect, it is placed on the Company's internal "watch list" and its allowance allocation is increased. For the remainder of the loan portfolio, appropriate allowance levels are estimated based on judgments regarding the type of loan, economic conditions and trends, potential exposure to loss and other factors. Losses are charged against the allowance when management believes the collectibility of principal is doubtful. In addition to the valuation allowance and the formula allowance, there is an imprecision allowance that is determined based on the totals of the valuation and formula allowances. The imprecision allowance reflects the measurement imprecision inherent in determining the valuation allowance and the formula allowance. Per the Company's internal policy, the imprecision allowance should represent 15% - 25% of the valuation and formula allowances, depending on management's evaluation of various conditions, the effects of which are not directly measured in determining the valuation and formula allowances. -12- The evaluation of the inherent loss resulting from these conditions involves a higher level of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection with the imprecision allowance include the following: * Levels of and trends in delinquencies and impaired loans * Levels of and trends in charge-offs and recoveries * Trends in loan volume and terms * Effects of changes in credit concentrations * Effects of and changes in risk selection and underwriting standards, and other changes in lending policies, procedures and practices * National and local economic conditions * Trends and duration of the present business cycle * Findings of internal and external credit review examiners When an evaluation of these conditions signifies a change in the level of risk, the Company adjusts the formula allowance. Periodic credit reviews enable further adjustment to the formula allowance through the risk rating of loans and the identification of loans requiring a valuation allowance. In addition, the formula allowance model is designed to be self-correcting by taking into consideration recent actual loss experience. Securities ---------- The Company's securities portfolio consists of obligations of U.S. Government sponsored agencies, mortgage-backed securities, obligations of various municipalities, and corporate bonds. Those assets are used in part to secure public deposits and as collateral for repurchase agreements. Total securities were $189.4 million at June 30, 2003, representing an increase of $8.5 million or 4.7% from $180.9 million at December 31, 2002. Securities classified as available for sale were $49.8 million and $64.8 million at June 30, 2003 and December 31, 2002, respectively. During the first six months of 2003, the Company sold $9.2 million in short-term available for sale bonds. The sales took place in order to take advantage of current interest rate conditions and improve investment earnings. Liquidity and Capital Resources ------------------------------- The Company's primary sources of liquidity are customer deposits, amortization and pay-offs of loan principal and maturities of securities. These sources provide funds for loan originations, the purchase of securities and other activities. Deposits are considered a relatively stable source of funds. At June 30, 2003 and December 31, 2002, deposits were $348.5 million and $354.3 million, respectively. As a nationally chartered member of the Federal Reserve System, the Bank has the ability to borrow funds from the Federal Reserve Bank of Boston by pledging certain of its securities as collateral. Also, the Bank is a member of the Federal Home Loan Bank which provides additional borrowing opportunities. Bank regulatory authorities have established a capital measurement tool called "Tier 1" leverage capital. A 4.00% ratio of Tier 1 capital to assets now constitutes the minimum capital standard for most banking organizations. At June 30, 2003, the Company's Tier 1 leverage capital ratio was 8.73%. Regulatory authorities have also implemented risk-based capital guidelines requiring a minimum ratio of Tier 1 capital to risk weighted assets of 4.00% and a minimum ratio of total capital to risk-weighted assets of 8.00%. At June 30, 2003 the Company's Tier 1 and total risk-based capital ratios were 15.62% and 16.71%, respectively. The Bank is categorized as "well capitalized" under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). -13- Asset/Liability Management -------------------------- The Company has an asset/liability management committee which oversees all asset/liability activities of the Company. The committee establishes general guidelines each year and meets regularly to review the Company's operating results and to make strategic changes when necessary. It is the Company's general policy to reasonably match the rate sensitivity of its assets and liabilities. A common benchmark of this sensitivity is the one year gap position, which is a reflection of the difference between the speed and magnitude of rate changes of interest rate sensitive liabilities as compared with the Bank's ability to adjust the rates of it's interest rate sensitive assets in response to such changes. The Company's positive one-year cumulative gap position at June 30, 2003, representing the excess of repricing assets versus repricing liabilities within a one year time frame, was 0.4% expressed as a percentage of total assets. Cautionary Statement Regarding Forward-Looking Information ---------------------------------------------------------- This Quarterly Report on Form 10-Q, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains, in addition to historical information, "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. When used in this and other Reports filed by the Company, the words "anticipate", "estimate", "expect", "objective", and similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to a variety of risks and uncertainties. In addition to any assumptions and other factors referred to specifically in connection with such forward-looking statements, risk factors that could cause the Company's actual results to differ materially from those contemplated in any forward-looking statement include, but are not limited to, changes in political and economic conditions, interest rate fluctuations, competitive product and pricing pressures, adverse changes in asset quality, increased inflation, and adverse legislative or regulatory changes. Item 4. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures ------------------------------------------------ Within the 90 day period prior to the filing of this report, an evaluation was carried out under the supervision and with the participation of the Company's management, including the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of our disclosure controls and procedures. Based on that evaluation, the CEO and CFO have concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Subsequent to the date of their evaluation, there were no significant changes in the Company's internal controls or in other factors that could significantly affect the disclosure controls, including any corrective actions with regard to significant deficiencies and material weaknesses. -14- PART II - OTHER INFORMATION --------------------------- Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. The Annual Meeting of Shareholders was held on April 8, 2003. At that meeting, two (2) matters were put before the shareholders for vote. The results of the voting were as follows: 1. To fix the number of Directors who shall constitute the full Board of Directors at eleven. Votes for: 4,283,968 Votes against: 2,204 2. To elect as Directors the four individuals listed as nominees in the Proxy Statement, who, together with the seven Directors whose terms of office did not expire at this meeting, constitute the full Board of Directors. Director Votes For Votes Against -------- --------- ------------- Jennie Lee Colosi 4,276,968 9,204 Edward M. Durkin 4,276,968 9,204 Antonio Frias 4,276,968 9,204 Dennis F. Murphy, Jr. 4,276,968 9,204 Item 5. OTHER INFORMATION On June 17, 2003, the Company's Board of Directors declared a second quarter 2003 cash dividend of $.085 per share of common stock to shareholders of record at June 1, 2003, payable on July 15, 2003. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 10.1 Amendment to Change in Control Agreement between the Company and John P. Galvani, dated July 29, 2003. 99.1 Certification of Financial Statements by Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification of Financial Statements by Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.3 Form of Stockholder Agreement (b) Reports on Form 8-K The Company filed a Form 8-K on April 15, 2003 pursuant to the Company's condensed consolidated financial statements for the three months ended March 31, 2003, which were mailed to shareholders on that date. -15- SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMMUNITY BANCORP, INC. Date: August 12, 2003 By: /s/ James A. Langway ---------------------------- James A. Langway President & Chief Executive Officer Principal Executive Officer Date: August 12, 2003 By: /s/ Donald R. Hughes, Jr. ---------------------------- Donald R. Hughes, Jr. Treasurer and Clerk, Principal Financial Officer and Principal Accounting Officer -16- CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 ---------------------------------------------------- I, James A. Langway, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Community Bancorp, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. -17- DATE: August 12, 2003 /s/ James A. Langway ------------------------- James A. Langway President and Chief Executive Officer CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 ---------------------------------------------------- I, Donald R. Hughes, Jr., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Community Bancorp, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and -18- 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. DATE: August 12, 2003 /s/ Donald R. Hughes, Jr. ------------------------- Donald R. Hughes, Jr. Treasurer and Clerk and Chief Financial Officer -19- EXHIBIT INDEX ------------- EXHIBIT DESCRIPTION ------- ----------- 10.1 Amendment to Change in Control Agreement between the Company and John P. Galvani, dated July 29, 2003. 99.1 Certification of Financial Statements by Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification of Financial Statements by Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.3 Form of Stockholder Agreement -20-

COMMUNITY BANCORP INC /MA/ 10-Q