<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________________ TO __________________
COMMISSION FILE NUMBER 0-17894
SIGNAL CORP
(Exact name of registrant as specified in its charter)
Ohio 34-1622711
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
135 EAST LIBERTY STREET, WOOSTER, OHIO 44691
(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code (330) 264-8001
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
COMMON STOCK, $1.00 PAR VALUE 11,810,000
(Class) (Shares Outstanding at October 31, 1998)
THIS FORM 10-Q CONTAINS 18 PAGES.
(NO EXHIBIT INDEX)
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<TABLE>
<CAPTION>
SIGNAL CORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Consolidated Balance Sheets as of September 30, 1998 and
December 31, 1997 3
Consolidated Statements of Income for the Three and Nine Months
Ended September 30, 1998 and 1997 4
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1998 and 1997 5
Notes to Consolidated Financial Statements 6
Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
PART II. OTHER INFORMATION
Signatures 17
Exhibit 27 Financial Data Schedule 18
</TABLE>
2
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<TABLE>
<CAPTION>
SIGNAL CORP
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS ($000's)
(unaudited)
September 30 December 31
1998 1997
----------- -----------
<S> <C> <C>
ASSETS:
Cash and due from banks $ 30,147 $ 34,393
Securities available for sale (a) 363,983 348,468
Securities held to maturity (b) 78,115 70,959
Other short term investments 17,745 32,795
Loans held for sale 54,180 90,379
Loans and leases:
Residential mortgage loans 638,127 676,129
Commercial loans 109,219 64,808
Commercial mortgage loans 102,862 101,582
Commercial lease financing 54,312 41,909
Finance contracts 17,175 4,585
Manufactured housing loans 240,683 110,827
Consumer loans 178,862 175,871
Allowance for credit losses (9,801) (8,773)
----------- -----------
Net loans and leases 1,331,439 1,166,938
Premises and equipment, net 23,130 21,073
Intangible assets 33,847 32,062
Other assets 50,362 35,320
----------- -----------
Total assets $ 1,982,948 $ 1,832,387
=========== ===========
LIABILITIES:
Deposits:
Non-interest bearing demand $ 54,587 $ 52,545
Interest bearing 1,263,563 1,204,351
----------- -----------
Total deposits 1,318,150 1,256,896
Short term borrowings 109,531 124,275
Long term debt 304,581 270,693
Company obligated mandatorily redeemable preferred
securities 50,000 --
Other liabilities 39,507 27,926
----------- -----------
Total liabilities 1,821,769 1,679,790
SHAREHOLDERS' EQUITY:
Preferred stock (c) 9,671 9,917
Common stock (d) 11,802 9,748
Additional paid-in capital 59,113 64,276
Retained earnings 80,046 75,947
Treasury stock, at cost (1,271) (8,535)
Accumulated other comprehensive income 1,818 1,244
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 161,179 152,597
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,982,948 $ 1,832,387
=========== ===========
<FN>
(a) Amortized cost of $360,806 as of September 30, 1998 and $346,613 as of
December 31, 1997.
(b) Market value of $78,660 as of September 30, 1998 and $71,059 as of December 31, 1997.
(c) Preferred stock, no par value; authorized 1,500,000 shares; Series B 419,242 and 429,892 issued and outstanding,
respectively.
(d) Common stock, $1.00 par value; authorized 40,000,000 shares; 11,802,101 (net of 103,675 treasury shares),
11,754,620 (net of 821,083 treasury shares), respectively.
</TABLE>
See accompanying notes to Consolidated Financial Statements.
3
<PAGE> 4
<TABLE>
<CAPTION>
SIGNAL CORP
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
($000's except per share data)
(unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------------------------------------------
1998 1997 1998 1997
---------------------------------------------------------------
INTEREST INCOME:
<S> <C> <C> <C> <C>
Loans and leases $ 27,994 $ 23,754 $ 80,669 $ 63,851
Securities available for sale 5,713 6,959 17,931 17,195
Securities held to maturity 1,443 1,221 3,520 3,949
Other 298 512 1,696 1,363
---------------------------------------------------------------
Total interest income 35,448 32,446 103,816 86,358
INTEREST EXPENSE:
Deposits 15,140 12,277 44,348 33,747
Short-term borrowings 1,449 3,432 4,222 9,128
Long-term debt and mandatorily
redeemable preferred securities 5,995 5,286 17,405 12,826
---------------------------------------------------------------
Total interest expense 22,584 20,995 65,975 55,701
---------------------------------------------------------------
NET INTEREST INCOME 12,864 11,451 37,841 30,657
Provision for credit losses 706 461 3,940 1,118
---------------------------------------------------------------
NET INTEREST INCOME AFTER PROVISION FOR
CREDIT LOSSES 12,158 10,990 33,901 29,539
Non-interest income
Manufactured housing income 1,117 4,100 6,675 12,739
Mortgage banking income 4,642 1,761 7,838 3,050
Customer service fee income 2,527 1,156 6,341 3,541
Net securities gains 360 279 400 353
Other 633 1,522 3,265 1,754
---------------------------------------------------------------
Total non-interest income 9,279 8,818 24,519 21,437
NON-INTEREST EXPENSE:
Personnel 5,787 5,399 18,055 13,607
Net occupancy expense 1,142 1,114 3,833 2,786
Outside services, data processing and
communications 1,481 1,214 4,020 2,903
Professional fees 579 457 2,065 1,067
Amortization of intangibles 806 354 2,112 1,019
Other 3,090 3,095 8,239 6,776
Nonrecurring expenses -- 1,209 7,336 1,209
---------------------------------------------------------------
Total non-interest expense 12,885 12,842 45,660 29,367
---------------------------------------------------------------
INCOME BEFORE INCOME TAXES 8,552 6,966 12,760 21,609
Provision for income taxes 2,980 2,582 4,811 7,620
---------------------------------------------------------------
NET INCOME $ 5,572 $ 4,384 $ 7,949 $ 13,989
===============================================================
Net income applicable to common stock $ 5,398 $ 3,994 $ 7,427 $ 12,790
NET INCOME PER COMMON SHARE:
Basic $ 0.46 $ 0.42 $ 0.65 $ 1.45
Diluted $ 0.43 $ 0.35 $ 0.63 $ 1.17
</TABLE>
See accompanying notes to Consolidated Financial Statements.
4
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<TABLE>
<CAPTION>
SIGNAL CORP
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
For the Nine Months Ended September 30: ($000's) 1998 1997
--------- ----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 7,949 $ 13,989
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for credit losses 3,940 1,118
Depreciation and amortization 5,727 2,839
Employee stock ownership expense 1,593 225
Net securities gains (400) (353)
Net gain on sales of loans (8,920) (7,534)
Proceeds from sales of loans held for sale 433,585 231,416
Originations of loans held for sale (388,466) (215,164)
Increase in other assets (13,298) (26,748)
Increase in other liabilities 11,581 3,556
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 53,291 3,344
INVESTING ACTIVITIES:
Proceeds from calls, paydowns and maturities of
securities available for sale 175,293 56,519
Proceeds from sales of securities available for sale 32,809 30,375
Purchases of securities available for sale (228,880) (198,949)
Purchases of securities held to maturity (25,000) (592)
Proceeds from maturities of securities held to maturity 17,844 11,321
(Increase) decrease in other short-term investments 15,050 (25,511)
Increase in loans and leases (168,441) (48,544)
Purchases of premises and equipment, net (5,650) (3,896)
Cash paid in acquisitions of subsidiary -- (2,000)
Net assets acquired in branch acquisitions -- (27,914)
Net cash from purchases of subsidiaries and other
acquisitions -- 2,556
--------- ---------
NET CASH USED BY INVESTING ACTIVITIES (186,975) (206,635)
FINANCING ACTIVITIES:
Increase in core deposits 61,254 34,443
Acquisitions of deposits -- 150,844
Net change in short-term borrowings (14,744) 17,126
Proceeds from issuance of mandatorily redeemable
preferred securities 50,000 --
Net change in long-term debt 33,888 9,856
Cash dividends paid (3,850) (3,494)
Purchases of treasury stock -- (722)
Proceeds from common stock transactions 2,313 700
Other, net 577 1,821
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 129,438 210,574
--------- ---------
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS (4,246) 7,283
CASH AND DUE FROM BANKS AT BEGINNING OF YEAR 34,393 27,830
--------- ---------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 30,147 $ 35,113
========= =========
</TABLE>
See accompanying notes to Consolidated Financial Statements.
5
<PAGE> 6
SIGNAL CORP
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(1) BASIS OF PRESENTATION
The accompanying unaudited Consolidated Financial Statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions to Form 10-Q. It is assumed
that the readers of these interim financial statements have read or have access
to the 1997 Annual Report on Form 10-K of Signal Corp ("Signal Corp" or the
"Company"). Therefore, only material changes in financial condition and results
of operations are discussed in Management's Discussion and Analysis. The
interim consolidated financial statements include the accounts of Signal Corp
and its subsidiaries. All significant intercompany transactions have been
eliminated.
The interim Consolidated Financial Statements reflect the Company's
June 29, 1998 merger with First Shenango Bancorp, Inc. The merger was completed
with the exchange of approximately 3,087,000 common shares of Signal Corp for
all 2,161,000 of the outstanding shares of First Shenango. The merger has been
treated as a pooling of interests and accordingly all prior period data has
been restated to reflect the consolidation of First Shenango. Pursuant to the
transaction the Company recorded $9.2 million ($6.3 million after-tax) in
nonrecurring merger related charges in the quarter ended June 30, 1998. In
addition, the three months ended September 30, 1997 reflect nonrecurring merger
charges of $1.2 million ($1.0 million after-tax) incurred pursuant to the
Company's July 8, 1997 acquisition of Summit Bank, N.A.
In the opinion of management, the Consolidated Financial Statements
contain all adjustments (consisting only of normal recurring adjustments except
as discussed above) necessary to present fairly the financial condition of
Signal Corp as of September 30, 1998 and December 31, 1997, the results of its
operations for the three and nine months ended September 30, 1998 and 1997, and
its cash flows for the nine months ended September 30, 1998 and 1997. The
results of operations for the interim period reported herein are not
necessarily indicative of results of operations to be expected for the entire
year. Certain financial statement reclassifications have been made for 1997 to
conform to classifications used in 1998.
(2) EARNINGS PER SHARE
Earnings per share is calculated by dividing net income available to
common shareholders for the period by the weighted average number of shares of
common stock outstanding during the period. The assumed conversion of
convertible preferred stock and the exercise of stock options have been
included in the calculation of diluted earnings per share.
6
<PAGE> 7
<TABLE>
<CAPTION>
A reconciliation of basic earnings per share to diluted earnings per
share is as follows:
THREE MONTHS ENDED SEPTEMBER 30
-------------------------------
1998 1997
----------------------------------------------------------------------------------
(000's) Per Per
Share Share
except per share Income Shares Amount Income Shares Amount
- ---------------- ------ ------ ------ ------ ------ ------
data
- ----
<S> <C> <C> <C> <C> <C> <C>
BASIC EPS
Net income
available to
common shareholders $5,398 11,780 $ 0.46 $3,994 9,597 $ 0.42
EFFECT OF DILUTIVE
SECURITIES
Stock options 149 0.01 106 0.01
Convertible
Preferred
Stock 174 892 0.02 390 2,758 0.06
------------------------------------------------------------------------------------
DILUTED EPS
Net income
available to
common
shareholders
plus assumed
conversions $5,572 12,821 $ 0.43 $4,384 12,461 $ 0.35
- ----------------------------------------------------------------------------------------------------------------------------
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30
------------------------------
1998 1997
----------------------------------------------------------------------------------
(000's) Per Per
Share Share
except per share Income Shares Amount Income Shares Amount
- ---------------- ------ ------ ------ ------ ------ ------
data
- ----
<S> <C> <C> <C> <C> <C> <C>
BASIC EPS
Net income available
to common
shareholders $ 7,427 11,486 $ 0.65 $12,790 8,832 $ 1.45
EFFECT OF DILUTIVE
SECURITIES
Stock options 145 0.01 324 0.05
Convertible
Preferred
Stock 522 898 0.01 1,199 2,808 0.23
------------------------------------------------------------------------------------
DILUTED EPS
Net income available
to common
shareholders
plus assumed
conversions $ 7,949 12,529 $ 0.63 $13,989 11,964 $ 1.17
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
(3) DIVIDENDS ON COMMON AND PREFERRED STOCK
On April 23, 1998, the Company's Board of Directors declared a
five-for-four stock split, effecting a 25% stock dividend to shareholders of
record on May 4, 1998. All prior period per share data has been restated to
reflect this dividend.
On July 22, 1998 the Company's Board declared a cash dividend of $0.11
per common share. The cash dividend was paid on August 21, 1998 to shareholders
of record at August 3, 1998. The Board of Directors also declared a cash
dividend of $0.40625 per share on the 6 1/2% Cumulative Convertible Preferred
Stock, Series B. The dividend was paid on September 1, 1998 to shareholders of
record at August 10, 1998.
7
<PAGE> 8
On October 19, 1998 the Company's Board of Directors declared cash
dividends on its common and Series B preferred shares. The dividend payment on
the common stock will be $0.11 per common share payable on November 20, 1998 to
shareholders of record as of November 2, 1998. The Board declared a dividend of
$0.40625 per share on the Cumulative Convertible, Series B, Preferred Stock.
The dividends will be paid on December 1, 1998 to shareholders of record as of
November 10, 1998.
(4) Recently Issued Accounting Standards
The Company has adopted SFAS No. 130 "Reporting Comprehensive Income."
The Statement requires additional reporting of items that affect comprehensive
income but not net income. Items relevant to the Company include unrealized
gains and losses on securities. Comprehensive income was as follows ($000's):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
------------------------------------------------------------------
1998 1997 1998 1997
------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income $5,572 $4,384 $7,949 $13,989
Unrealized gain on securities
available for sale, net of tax 881 1,364 574 1,821
------------------------------------------------------------------
Comprehensive income $6,453 $5,748 $8,523 $15,810
==================================================================
</TABLE>
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" was issued in June, 1997 and is effective for fiscal years
beginning after December 15, 1997. The provisions of this statement do not
apply to interim periods in the year of adoption. The statement requires
financial disclosure and descriptive information about reportable operating
segments and will result in additional financial statement disclosures.
In June, 1998 SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities", was issued. The statement establishes accounting and
reporting standards for derivative instruments and for hedging activities.
Items relevant to the Company include interest rate swap agreements, and
certain hedges related to manufactured housing loans, both of which are
periodically utilized by the Company. Management has not as yet fully analyzed
the impact of this statement on the Company's Consolidated Financial
Statements. The statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999 with earlier adoption encouraged.
In October, 1998 SFAS No. 134, "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise" was issued. The statement provides accounting
and reporting standards for mortgage backed securities retained after the
securitization of mortgage loans held for sale. The statement is effective for
the first quarter of 1999 and is not expected to have a material impact on the
Company's financial statements.
(5) LOANS HELD FOR SALE
Loans held for sale amounted to $54.2 million of residential mortgage
loans as of September 30, 1998 compared to $90.4 million at December 31, 1997
consisting of $40.4 million of residential mortgage loans and $50 million of
manufactured housing loans.
(6) ACQUISITION
On June 29, 1998, the Company completed its acquisition of First
Shenango Bancorp, Inc. ("First Shenango") by exchanging approximately 3,087,000
common shares of Signal Corp for all 2,161,000 of the outstanding shares of
First Shenango. The merger has been treated as a pooling of interests. All
prior period data has been restated. Pursuant to the transaction the Company
has incurred $9.2 million ($6.3 million after-tax) in nonrecurring merger
related costs in the second quarter of 1998. The costs are primarily for 1)
transactions costs of $1.8 million ($1.5 million after-tax) for financial
advisory services, and legal and accounting fees, 2) estimated operational
costs of $5.6 million ($3.6 million after-tax) to integrate First Shenango into
Signal including systems conversions, product conversions/introductions and the
8
<PAGE> 9
elimination of certain duplicated operations, and 3) an additional provision
for credit risk of $1.8 million ($1.2 million after-tax).
(7) DEFINITIVE MERGER AGREEMENT
On August 10, 1998, the Company entered into a merger agreement with
FirstMerit Corporation (Nasdaq:FMER). Under the terms of the agreement the
Company will merge with and into FirstMerit. Shareholders will receive 1.32
shares of FirstMerit's common stock in exchange for each share of Signal Corp's
common stock and one share of FirstMerit 6 1/2% Cumulative Convertible
Preferred Stock for each share of Signal 6 1/2% Cumulative Convertible
Preferred Stock, Series B. Based on FirstMerit's August 10, 1998 closing price
of $28.19 the transaction is valued at approximately $470 million. FirstMerit
is a bank holding company with approximately $6.2 billion in assets. The
transaction, which is intended to be accounted for as a pooling of interests,
is subject to regulatory and shareholder approval and other customary
conditions of closing, and is expected to be completed in the first quarter of
1999.
(8) SIGNAL TRUST
In February 1998, the Company formed Signal Capital Trust One ("Signal
Trust"),a Delaware business trust. Signal Trust was formed for the purpose of
(i) issuing and selling $50 million of its 8.67% Capital Securities, Series A
(the "Capital Securities"), referred to in the Consolidated Balance Sheet as
"company obligated mandatorily redeemable preferred securities", and common
securities (the "Common Securities"), (ii) investing the proceeds thereof in
the 8.67% Junior Subordinated Deferrable Interest Debentures, Series A, issued
by the Company (the "Signal Corp Debentures") and (iii) engaging in certain
other limited activities. The Capital Securities were issued and sold to
investors in a private placement exempt from the Securities Act of 1933 on
February 10, 1998. The Company registered the Capital Securities with the
Securities and Exchange Commission in June of 1998.
(9) MANUFACTURED HOUSING
The Company, through its subsidiary Mobile Consultants, Inc. (MCi)
sells certain manufactured housing finance contracts (MHF contracts) to various
financial institutions while retaining collection and recovery aspects of
servicing.
The Company's subsidiary, Signal Bank, N.A., purchases MHF contracts
from MCi, a portion of which are periodically packaged in asset-backed
securitizations (ABS pools) and sold to investors. Sales and securitizations
totaled $100 million in the nine months ended September 30, 1998 and $150
million in the nine months ended September 30, 1997. It is anticipated that
there will be no additional sales and securitizations in 1998. The aggregate
amount of ABS pools serviced by the Company totaled $264.2 million at September
30, 1998 and $186.2 million at December 31, 1997.
At the time of sale the Company records an asset, "retained interest
in securitized assets" which represents the discounted cash flows to be
received by the Company for 1) servicing income from ABS pools, 2) principal
and interest payments on MHF contracts contributed to the ABS pools as a credit
enhancement, referred to as overcollateralization, and 3) excess interest
spread. These cash flows are projected and discounted over the expected life of
the ABS pools using assumptions for credit risk, estimated prepayments and
interest rates. The cash flows are subject to volatility that could materially
affect operating results. Prepayments resulting from increased competition,
obligor mobility, general and regional economic conditions and prevailing
interest rates, as well as actual losses incurred, may vary from the
performance the Company projects. Actual cash flow from the Company's six ABS
pools have been less than originally projected. The original projections
reflect assumed credit loss experience at a constant rate per year throughout
the term of the pools. Actual credit loss experience typically occurs in ABS
pools in the second through the fourth years at a rate in excess of the assumed
constant annual rate resulting in lower than projected cash flows during these
months. At September 30, 1998 management has determined that there is no
permanent impairment that would require adjustment to the carrying value of the
retained interest in securitized assets. Management continues to review the
cash flow and actual performance of the ABS pools on a quarterly basis.
9
<PAGE> 10
The Company classifies the retained interest in securitized assets in
two components on the Company's Consolidated Balance Sheet, 1) securities held
for sale and 2) excess servicing included in the balance sheet as other assets.
Total retained interest in securitized assets and excess servicing were $44.4
million and $27.0 million at September 30, 1998 and December 31, 1997,
respectively.
The components of manufactured housing income were as follows:
<TABLE>
<CAPTION>
Nine Months
Three Months Ended Ended
September 30 September 30
----------------------------------------------------------------
($000's) 1998 1997 1998 1997
----------------------------------------------------------------
<S> <C> <C> <C> <C>
Gain on sale of ABS pools -- $1,562 $2,650 $5,464
Manufactured housing brokerage fees $512 1,241 1,714 3,477
Servicing income on brokered MHF contracts 333 1,200 1,666 3,600
Servicing income on ABS pools 272 97 645 198
Total manufactured housing income $1,117 $4,100 $6,675 $12,739
================================================================
</TABLE>
(10) MORTGAGE BANKING INCOME
The Company has sold certain residential mortgage loans to various
investors while retaining servicing rights. Loans serviced for others totaled
$596 million at September 30, 1998 and $521 million at December 31, 1997 and
are not included in the accompanying Consolidated Financial Statements.
The components of mortgage banking income were as follows:
<TABLE>
<CAPTION>
Nine Months
Three Months Ended Ended
September 30 September 30
---------------------------------------------------------------
($000's) 1998 1997 1998 1997
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Gain on sale of mortgage loans $3,643 $1,305 $6,270 $2,070
Mortgage servicing fees, net of amortization 999 456 1,568 980
Total mortgage banking income $4,642 $1,761 $7,838 $3,050
===============================================================
</TABLE>
10
<PAGE> 11
SIGNAL CORP
AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS
The Company's earnings for the quarter ended September 30, 1998
amounted to $5.6 million or $0.43 per share on a diluted basis. This compares
favorably to earnings of $4.4 million or $0.35 per share on a diluted basis for
the three month period ended September 30, 1997. Included in the quarter ended
September 30, 1997 was $1.2 million ($1.0 million after-tax) in nonrecurring
merger related costs pursuant to the Company's July 1997 acquisition of Summit
Bank, N.A. Excluding the nonrecurring charges, earnings for the third quarter
of 1997 amounted to $5.4 million or $0.43 per share on a diluted basis.
The increased earnings were principally the result of higher net
interest income of $1.4 million reflecting strong asset growth and enhanced
asset yields and higher noninterest income of $0.5 million due to higher
mortgage banking income and higher customer service fee income partially offset
by lower manufactured housing income.
Return on average assets (ROA) for the quarter ended September 30,
1998 was 1.14% as compared to 1.23 % for the comparable period of 1997
excluding the impact of the nonrecurring merger costs. Return on average
shareholders' equity (ROE) was 14.06% as compared to 14.85%, excluding
nonrecurring merger costs, for the comparable period in 1997. The Company's
ratio of shareholders' equity to total assets decreased from 8.33% at December
31, 1997 to 8.13% at September 30, 1998, reflecting asset growth and improved
leverage in 1998.
Net interest income for the quarter increased $1.4 million to $12.9
million as compared to $11.5 million in the third quarter of 1997. This
increase reflects growth in average loan and lease balances of $230 million
partially offset by a $44 million decrease in average securities balances for
the three month period ended September 30, 1998 compared to 1997. The increase
in loan and lease balances are primarily due to higher manufactured housing and
commercial loans. The Company is continuing the strategic diversification of
its balance sheet by selling new residential mortgage loan production. The
decline in the average securities balance is further reflective of the
Company's efforts to increase its mix of higher yielding assets.
The net interest margin of 2.84% for the quarter ended September 30,
1998 compares favorably to 2.73% for the third quarter of 1997. Yields on
interest earning assets averaged 7.84% compared to 7.73% for the quarter ended
September 30, 1997 reflecting a favorable change in the mix of loans and leases
to higher yielding assets.
The provision for credit losses was $706,000 compared to $461,000 in
the third quarter of 1997. The increased provision reflects the continued
growth in commercial and manufactured housing loan originations which
inherently have a higher credit risk level than residential mortgage loans. Net
chargeoffs as a percentage of average loans and leases for the third quarter of
1998 were 34 basis points (annualized) and 7 basis points (annualized) for the
comparable quarter of 1997. Net charge-offs for the three months ended
September 30, 1998 amounted to $1,096,000 which compares to charge-offs of
$175,000 for the three months ended September 30, 1997. The increase in
charge-offs is principally the result of the growth in manufactured housing
loans. Nonperforming assets as a percentage of total assets were .42% at
September 30, 1998 and .47% at December 31, 1997.
Noninterest income increased $0.5 million for the third quarter of
1998 versus third quarter 1997 primarily due to increases of $2.9 million in
mortgage banking income and of $1.4 million in customer service fee income,
partially offset by lower manufactured housing income of $3.0 million. The
increase in mortgage banking income reflects higher originations. Mortgage loan
originations were $138.1 million in the three months ended September 30, 1998
which compares to $72.7 million in the three months ended September 30, 1997.
The decline in manufactured housing income reflects the sale and securitization
of manufactured housing loans in the third quarter of 1997. The Company did not
securitize and sell manufactured housing loans in the third quarter of 1998.
The Company anticipates increasing its portfolio of manufactured housing loans
for the remainder of 1998 and does not plan to sell or securitize these loans.
11
<PAGE> 12
Noninterest expense, excluding 1997 nonrecurring merger charges,
increased $1.3 million for the quarter ended September 30, 1998 as compared to
the third quarter of 1997. The increase is comprised primarily of higher
compensation expense, increased occupancy costs and other expenses necessary to
support higher asset originations. In addition the third quarter of 1998
reflects a full three months of expense for seven new banking offices acquired
in September 1997. Mortgage and manufactured housing loan originations amounted
to $138.1 million and $93.4 million, respectively for the three months ended
September 30, 1998 as compared to $72.7 million and $96.8 million, respectively
in the three months ended September 30, 1997. Moreover, the Company has
continued to grow its network of manufactured housing sales territories and has
expanded into seven new states in 1998. The Company's efficiency ratio of 54.55%
for the third quarter of 1998 compares favorably to 55.65% for the comparable
quarter of 1997 and 62.50% for the second quarter of 1998.
Net income for the nine months ended September 30, 1998 amounted to
$7.9 million or $0.63 per share on a diluted basis which compares to $14.0
million or $1.17 per share on a diluted basis for the nine months ended
September 30, 1997. Included in both 1998 and 1997 were nonrecurring merger
related expenses incurred pursuant to acquisitions. Nonrecurring expenses
amounted to $6.3 million on an after-tax basis in 1998 related to the June 29,
1998 acquisition of First Shenango Bancorp, Inc. and $1.0 million on an
after-tax basis in 1997 related to the July 8, 1997 acquisition of Summit Bank,
N.A. Excluding nonrecurring charges, net income and diluted earnings per share
were $14.3 million and $1.14, respectively for the nine months ended September
30, 1998 and $15.0 million and $1.25, respectively for the nine months ended
September 30, 1997.
Net interest income increased $7.2 million in the nine months ended
September 30, 1998 as compared to the nine months ended September 30, 1997
principally as a result of an increase in average interest earning assets of
approximately $265 million primarily reflecting growth in the Company's
manufactured housing and commercial loan portfolio and higher investment
securities. As a result of the asset growth, asset yield and net interest
margin increased in 1998 to 7.76% and 2.83%, respectively as compared to 7.58%
and 2.69%, respectively in 1997.
The Company's provision for credit losses increased $2.8 million
reflecting $1.8 million in additional provision pursuant to the Company's
acquisition of First Shenango Bancorp and a higher recurring provision
reflecting the higher mix of manufactured housing loans and commercial loans
which inherently have higher credit risk than residential mortgage loans. Net
chargeoffs amounted to $2.9 million for the nine months ended September 30,
1998 which compares to $0.6 million for the comparable period of a year ago.
Noninterest income increased to $24.5 million in the year-to-date
period ended September 30, 1998 from $21.4 million for the year-to-date period
ended September 30, 1997. The increase is primarily due to higher mortgage
banking income of $4.8 million reflecting increased loan originations and
higher customer service fee income of $2.8 million partially offset by lower
manufactured housing income primarily due to lower gains on securitizations.
Noninterest expense increased $16.3 million in the nine months ended
September 30, 1998 as compared to the nine months ended September 30, 1997
primarily due to higher nonrecurring merger related costs of $6.1 million and
additional investments in asset origination capacity. The results for 1998
include incremental noninterest expenses of approximately $6.5 million pursuant
to the Company's 1997 acquisitions of Summit Bank, N.A., Alpha Equipment Group,
Inc., and Alliance Corporate Resources as well as the acquisition or
construction of eleven new banking offices.
Certain aspects of the Company's financial condition during 1998 are
as follows ($000's):
<TABLE>
<CAPTION>
SEPTEMBER 30 December 31 Increase
1998 1997 (Decrease)
---------------- ------------------- -----------------
<S> <C> <C> <C>
Securities available for sale $363,983 $348,468 $15,515
Loans available for sale 54,180 90,379 (36,199)
Net loans and leases 1,331,439 1,166,938 `164,501
Deposits 1,318,150 1,256,896 61,254
Borrowings 464,112 394,968 69,144
</TABLE>
12
<PAGE> 13
The $15.5 million increase in securities available for sale reflects
the February 1998 issuance of and investment of the proceeds of $50 million in
8.67% trust preferred securities partially offset by accelerated prepayments on
mortgage related securities.
Net loans and leases increased $164.5 million comparing September 30,
1998 to December 31, 1997 reflecting a $130 million increase in manufactured
housing loans and a $58 million increase in commercial loans and leases
partially offset by lower residential mortgages of $38 million reflecting the
impact of mortgage loan sales and prepayments. The Company securitized and sold
$50 million of manufactured housing finance contracts in both the first and
second quarter of 1998. For the nine months ended September 30, 1998
originations of residential mortgage loans and manufactured housing contracts
totaled $361 million and $243 million, respectively compared to $208 million
and $227 million, respectively, for the comparable period of a year ago.
Borrowings in 1998 have increased $69.1 million reflecting the
necessity for additional funding given the combination of the rapid pace of
asset originations and the Company's decision not to securitize and sell
manufactured housing loans in the third quarter of 1998. Included in the
increase is $50 million in 8.67% trust preferred securities issued in February
1998.
Deposits increased $61.3 million comparing September 30, 1998 to
December 31, 1997, reflecting the favorable results of sales and marketing
efforts as well as increased balances in existing customer accounts.
CREDIT RISK
The Company provides as an expense an amount for expected credit
losses. The provision is based on the growth of the loan and lease portfolio
and on recent loss experience. Actual losses on loans and leases are charged
against the allowance for loan losses. The Company's provision for loan losses
was $706,000 in the three months ended September 30, 1998 as compared to
$461,000 in the three months ended September 30, 1997 and $3.9 million in the
nine months ended September 30, 1998 as compared to $1.1 million in the nine
months ended September 30, 1997. The increases in the provision reflect the
shift in the mix of loans on the Company's balance sheet from traditional
residential mortgages to commercial loans and manufactured housing loans both
of which inherently have higher credit risk. Charge-offs, net of recoveries
were $1.1 million and $175,000 for the three months ended September 30, 1998
and 1997, respectively. Net charge-offs as a percentage of average loans and
leases were 34 basis points annualized in the three months ended September 30,
1998 as compared to 7 basis points annualized for the comparable period of
1997. Net charge-offs for the nine months ended September 30, 1998 amounted to
$2.9 million which compares to net charge-offs of $618,000 for the nine months
ended September 30, 1997.
The Company defines underperforming assets as 1) nonaccrual loans and
leases on which the ultimate collectibility of the full amount of interest is
uncertain, 2) loans and leases which have been renegotiated to provide for a
reduction or deferral of interest or principal because of deterioration in the
financial position of the borrower, 3) loans and leases past due 90 days or
more as to principal or interest and 4) other real estate owned.
Underperforming assets, including nonaccrual loans of $6.4 million and $7.1
million, were $8.3 million and $8.5 million at September 30, 1998 and December
31, 1997, respectively.
Impaired loans are measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate or the fair
value of the underlying collateral. Impaired loans have been defined as all
nonaccrual loans.
LIQUIDITY AND CAPITAL RESOURCES
The maintenance of an adequate level of liquidity is necessary to
ensure that sufficient funds are available to meet customers' loan demand and
deposit withdrawals. The banking subsidiaries' liquidity sources consist
primarily of short-term marketable securities, maturing loans and selected
sales of loan assets. Liquidity has also been obtained through liabilities such
as customer-related core deposits, funds borrowed, certificates of deposit and
public funds deposits. The Company has additional borrowing capacity with both
the Federal Home Loan Bank of Cincinnati and the
13
<PAGE> 14
Federal Home Loan Bank of Pittsburgh and additional collateral eligible for
repurchase agreements in the event internally generated funds are insufficient
to meet liquidity needs. In the absence of the sale and securitization of
manufactured housing loans, the Company expects to augment its liquidity with
additional deposit growth, sales of mortgage loans and wholesale borrowings.
The Company anticipates that it has adequate liquidity and additional sources
of funds to meet all of its foreseeable commitments.
At September 30, 1998, shareholders' equity was $161.2 million,
compared to $152.6 million at December 31, 1997, an increase of $8.6 million
primarily reflecting net income for the nine months ended September 30, 1998.
Shareholders' equity as a percentage of total assets as of September 30, 1998
was 8.13% compared to 8.33% as of December 31, 1997. The Federal Reserve Board
has adopted risk-based capital guidelines which assign risk weightings to
assets and off-balance sheet items and also define and set minimum capital
requirements (risk-based capital ratios). The guidelines also define "well
capitalized" ratios of Tier 1, total capital and leverage as 6%, 10% and 5%
respectively. The Company's subsidiary banks, Signal Bank N.A., Summit Bank
N.A., and First Federal Savings of New Castle exceeded the minimum guidelines
for well capitalized institutions at September 30, 1998. At September 30, 1998,
the Company had a Tier 1 risk-based capital ratio of 11.70%, a total risk-based
capital ratio of 18.49% and a leverage ratio of 9.26%. At December 31, 1997, the
Company had Tier 1 risk-based capital ratio of 8.18%, a total risk-based capital
ratio of 12.89% and a leverage ratio of 5.23%.
In February 1998, the Company issued $50 million of 8.67% Capital
Securities which was used to pay down short term borrowings, provide funds for
loan originations and as a source of additional capital to support future
growth activities. Interest on the Capital Securities is payable semi-annually
beginning in August 1998. The Capital Securities are redeemable at the option
of the Company after February 2008 until its maturity in February 2028.
DEFINITIVE MERGER AGREEMENT
On August 10, 1998, the Company entered into a merger agreement with
FirstMerit Corporation (Nasdaq:FMER). Under the terms of the agreement the
Company will merge with and into FirstMerit. Shareholders will receive 1.32
shares of FirstMerit's common stock in exchange for each share of Signal Corp's
common stock and one share of FirstMerit 6 1/2% Cumulative Convertible
Preferred Stock for each share of Signal 6 1/2% Cumulative Convertible
Preferred Stock, Series B. Based on FirstMerit's August 10, 1998 closing price
of $28.19 the transaction is valued at approximately $470 million. FirstMerit
is a bank holding company with approximately $6.2 billion in assets. The
transaction, which is anticipated to be accounted for as a pooling of interests,
is subject to regulatory and shareholder approval and other customary conditions
of closing, and is expected to be completed in the first quarter of 1999.
IMPACT OF THE YEAR 2000
The Year "2000" issue arises from computer programs that were written
using two digits rather than four to define the applicable year. As a result
computer systems and date-sensitive software may have a difficult time
distinguishing between the year 2000 and the year 1900, causing potential
disruptions of operations, including, among other things, potential
miscalculations or an inability to process transactions.
The Company has based its response to the Year 2000 issue on
regulatory guidelines published by the Federal Financial Institutions
Examinations Council (FFIEC). The FFIEC considers five general phases:
awareness, assessment, renovation, validation and implementation. The Company
has essentially completed the awareness, assessment, and renovation phases.
The awareness phase involves defining the Year 2000 problem and
establishing an overall strategy to address the problem. The Company defines
Year 2000 compliance as accurately processing date/time data including
calculating, comparing and sequencing from, into, and between the twentieth and
twenty-first centuries. The Company began the assessment phase in 1997, has
executive sponsorship and has assigned a project manager to manage the
development and implementation of the Company's plan.
The assessment phase defines the size and complexity of the problem
and determines the resources necessary to address the Year 2000 issues. During
this phase
14
<PAGE> 15
the Company has conducted a comprehensive review of its computer systems to
identify systems and applications that could be adversely affected by the "Year
2000". The Company's data processing for its banking subsidiaries is performed
primarily utilizing outside vendors, consequently the Company is very dependent
on those vendors to conduct its business. To date, the Company has been
informed that its primary service providers anticipate that all reprogramming
efforts will be completed by December 31, 1998. The computer systems of the
Company's manufactured housing loan origination subsidiary, Mobile Consultants,
Inc. (MCi) were developed and are maintained internally. As of September 30,
1998 MCi had completed its assessment and was in the process of renovating and
testing its various processes. MCi's applications and systems are expected to
be substantially Year 2000 compliant by December 31, 1998. In addition the
Company has reviewed substantially all of its computer hardware for Year 2000
compliance. The Company has also completed its assessment of possible Year 2000
issues related to its non-information technology systems including cash vaults,
alarm systems, and HVAC and has determined that these systems are essentially
Year 2000 compliant. Lastly, the Company has begun to assess the Company's Year
2000 risks related to its customers including both commercial borrowers and
commercial depositors. Surveys have been sent to all commercial borrowers and
the Company is in process of reviewing the results and responding to potential
issues.
The purpose of the renovation phase is to ensure all date routines have
been corrected to properly address Year 2000 issues. Given the Company's
reliance on third party vendors for its mission critical functions the Company
is working closely with its three main service providers. The service provider
of the Company's largest subsidiary, Signal Bank, N.A., has begun testing
mission critical applications with Company data and has found the tested
systems to be Year 2000 compliant. The Company's other banking subsidiaries,
Summit Bank, N.A. (Summit), and First Federal Savings of New Castle (New Castle)
utilize service providers that have not as yet begun testing their systems with
Company data. The Company expects these providers to provide Year 2000 compliant
systems in a timely manner however there can be no assurance. In the event these
providers fail to show the necessary progress the Company will covert the
systems of Summit and New Castle to the service provider for Signal Bank.
The validation and implementation phases encompass testing the
renovated systems to ensure compliance as well as the conversion of the
validated systems to production or "live" systems.
Management does not expect Year 2000 costs to have a significant
impact on its financial position or results of operations however, there can be
no assurance that third party vendors systems will meet the Company's
compliance definition which could result in additional unexpected costs to the
Company.
Total Year 2000 costs to the Company are expected to amount to
approximately $2.0 million principally in the form of capital expenditures to
replace noncompliant hardware and software. Year 2000 expenditures through
September 30, 1998 were approximately $300,000. It is expected that all Year
2000 costs will be funded through operating cash flows.
FORWARD LOOKING STATEMENTS
When used in this filing and in future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases or other
public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases "would be,"
"will allow," "intends to," "will likely result," "are expected to," "will
continue," "is anticipated," "estimate," "project," or similar expressions are
intended to identify "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Such statements are subject
to risks and uncertainties, including but not limited to changes in economic
conditions in the Company's market area, changes in policies by regulatory
agencies, fluctuations in interest rates, demand for loans in the Company's
market area and competition, all or some of which would cause actual results to
differ materially from historical earnings and those presently anticipated or
projected.
The Company wishes to caution readers not to place undue reliance on
any such forward-looking statements, which speak only as of the date made, and
advises readers that various factors, including regional and national economic
conditions, substantial changes in levels of market interest rates, credit and
other risks of lending and investment activities and competitive and regulatory
factors, could affect the Company's financial performance and could cause the
Company's actual results for future
15
<PAGE> 16
periods to differ materially from those anticipated or projected.
The Company does not undertake, and specifically disclaims any
obligation, to update any forward-looking statements to reflect occurrences or
unanticipated events or circumstances after the date of such statements.
16
<PAGE> 17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Management considers interest rate risk to be the Company's most
significant market risk. Interest rate risk is the exposure to adverse changes
in the net interest income of the Company as a result of changes in interest
rates. Consistency in the Company's earnings is largely dependent on the
effective management of interest rate risk.
There have been no significant changes to the Company's interest rate
risk position or to the practices used by the Company to manage interest rate
risk since December 31, 1997.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K
- One report on Form 8-K was filed on July 8, 1998
with respect to the announcement of the consummation
of the Company's acquisition of First Shenango
Bancorp, Inc.
- One report on Form 8-K was filed on August 14,
1998 with respect to the Company entering into a
definitive merger agreement with FirstMerit.
- One report on Form 8-K/A was filed on August 31,
1998 with respect to the required Financial
Statements and Pro Forma Financial Information
pursuant to the Company's June 29, 1998 acquisition
of First Shenango Bancorp, Inc.
All other items have been omitted as not required and not applicable under the
instructions.
17
<PAGE> 18
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.
SIGNAL CORP
(Registrant)
Date: November 13, 1998 /s/ GARY G. CLARK
Gary G. Clark
Chairman and Chief Executive Officer
(Duly Authorized Representative)
Date: November 13, 1998 /s/ JON W. PARK
Jon W. Park
Chief Financial Officer (Principal
Financial and Accounting Officer)
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
REGISTRANT'S CONSOLIDATED CONDENSED BALANCE SHEET AND STATEMENT OF INCOME FOR
THE THREE MONTHS ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 30,147
<INT-BEARING-DEPOSITS> 17,745
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 363,983
<INVESTMENTS-CARRYING> 78,115
<INVESTMENTS-MARKET> 54,180
<LOANS> 1,331,439
<ALLOWANCE> 9,801
<TOTAL-ASSETS> 1,982,948
<DEPOSITS> 1,318,150
<SHORT-TERM> 109,531
<LIABILITIES-OTHER> 39,507
<LONG-TERM> 304,581
50,000
9,671
<COMMON> 11,802
<OTHER-SE> 139,706
<TOTAL-LIABILITIES-AND-EQUITY> 1,982,948
<INTEREST-LOAN> 27,994
<INTEREST-INVEST> 7,156
<INTEREST-OTHER> 298
<INTEREST-TOTAL> 35,448
<INTEREST-DEPOSIT> 15,140
<INTEREST-EXPENSE> 22,584
<INTEREST-INCOME-NET> 12,864
<LOAN-LOSSES> 706
<SECURITIES-GAINS> 360
<EXPENSE-OTHER> 12,885
<INCOME-PRETAX> 8,552
<INCOME-PRE-EXTRAORDINARY> 5,572
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,572
<EPS-PRIMARY> 0.46
<EPS-DILUTED> 0.43
<YIELD-ACTUAL> 2.84
<LOANS-NON> 8,324
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 10,191
<CHARGE-OFFS> 1,163
<RECOVERIES> 67
<ALLOWANCE-CLOSE> 9,801
<ALLOWANCE-DOMESTIC> 9,801
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
