UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2006 Commission file # 0-28388 CNB CORPORATION (Exact name of registrant as specified in its charter) Michigan 38-2662386 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 303 North Main Street, Cheboygan MI 49721 (Address of principal executive offices, including Zip Code) (231) 627-7111 (Registrant's telephone number, including area code) 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 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): Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X] Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). Yes [ ] No [X] As of May 3, 2006 there were 1,237,582 shares of the issuer's common stock outstanding. CNB CORPORATION Index PART I - FINANCIAL INFORMATION Item 1 - Financial Statements (Condensed): Consolidated Balance Sheets - March 31, 2006 and December 31, 2005............................... 3 Consolidated Statements of Income - Three Months Ended March 31, 2006 and 2005................... 4 Consolidated Statements of Cash Flows - Three Months Ended March 31, 2006 and 2005............... 5 Notes to Consolidated Financial Statements....................................................... 6 - 7 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations............ 8 - 11 Item 3 - Quantitative and Qualitative Disclosures About Market Risk....................................... 11 Item 4 - Controls and Procedures.......................................................................... 11 PART II - OTHER INFORMATION Item 1 - Legal Proceedings................................................................................ 12 Item 1A - Risk Factors.................................................................................... 12 Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds...................................... 12 Item 3 - Defaults Upon Senior Securities.................................................................. 12 Item 4 - Submission of Matters to a Vote of Security Holders.............................................. 12 Item 5 - Other Information................................................................................ 12 Item 6 - Exhibits and Reports on Form 8-K................................................................. 12 Signatures................................................................................................ 13 - 16 Exhibit Index............................................................................................. 17 2 PART I - FINANCIAL INFORMATION ITEM 1-FINANCIAL STATEMENTS (CONDENSED) CONSOLIDATED BALANCE SHEETS (dollars in thousands, except per share data) March 31, December 31, 2006 2005 (Unaudited) ASSETS Cash and due from banks $ 7,553 $ 6,586 Interest-bearing deposits with other financial institutions 5 - Federal funds sold 4,663 5,357 ---------- ------------ Total cash and cash equivalents 12,221 11,943 Securities available for sale 65,589 69,315 Securities held to maturity (market value of $3,712 in 2006 and $4,128 in 2005) 3,690 4,117 Other securities 1,053 1,053 Loans, held for sale 365 51 Loans, net of allowance for loan losses of $1,465 in 2006 and $1,456 in 2005 157,340 154,811 Premises and equipment, net 5,674 5,443 Other assets 6,427 5,998 ---------- ------------ Total assets $ 252,359 $ 252,731 ========== ============ LIABILITIES Deposits Noninterest-bearing $ 36,224 $ 38,943 Interest-bearing 186,986 184,494 ---------- ------------ Total deposits 223,210 223,437 Other liabilities 4,378 4,795 ---------- ------------ Total liabilities 227,588 228,232 SHAREHOLDERS' EQUITY Common stock - $2.50 par value; 2,000,000 shares authorized; and 1,237,582 and 1,237,418 shares issued and outstanding in 2006 and 2005 3,094 3,094 Additional paid-in capital 20,434 20,430 Retained earnings 1,751 1,576 Accumulated other comprehensive loss, net of tax (508) (601) ---------- ------------ Total shareholders' equity 24,771 24,499 ---------- ------------ Total liabilities and shareholders' equity $ 252,359 $ 252,731 ========== ============ See accompanying notes to consolidated financial statements. 3 CONSOLIDATED STATEMENTS OF INCOME (dollars in thousands, except per share data) Three months ended March 31, 2006 2005 (Unaudited) INTEREST INCOME Loans, including fees $ 2,822 $ 2,449 Securities Taxable 456 508 Tax exempt 127 152 Other interest income 102 52 ---------- --------- Total interest income 3,507 3,161 INTEREST EXPENSE ON DEPOSITS 995 653 ---------- --------- NET INTEREST INCOME 2,512 2,508 Provision for loan losses 30 30 ---------- --------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 2,482 2,478 ---------- --------- NONINTEREST INCOME Service charges and fees 225 220 Net realized gains from sales of loans 50 52 Loan servicing fees, net of amortization 29 22 Other income 40 55 ---------- --------- Total noninterest income 344 349 NONINTEREST EXPENSES Salaries and employee benefits 880 793 Deferred compensation 81 75 Pension 64 78 Hospitalization 141 129 Occupancy 269 212 Supplies 34 43 Legal and professional 98 94 Other expenses 323 259 ---------- --------- Total noninterest expense 1,890 1,683 ---------- --------- INCOME BEFORE INCOME TAXES 936 1,144 Income tax expense 242 339 ---------- --------- NET INCOME $ 694 $ 805 ========== ========= TOTAL COMPREHENSIVE INCOME $ 787 $ 519 ========== ========= Return on average assets (annualized) 1.08% 1.25% Return on average equity (annualized) 11.21% 13.32% Basic earnings per share $ 0.56 $ 0.65 Diluted earnings per share $ 0.56 $ 0.65 Dividends declared per share $ 0.42 $ 0.40 See accompanying notes to consolidated financial statements. 4 CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands). Three months ended March 31, 2006 2005 (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 694 $ 805 Adjustments to reconcile net income to net cash from operating activities Depreciation, amortization and accretion, net (84) 226 Provision for loan losses 30 30 Loans originated for sale (2,528) (2,809) Proceeds from sales of loans originated for sale 2,237 2,240 Gain on sales of loans (50) (52) Increase in other assets (415) (270) Increase in other liabilities 315 550 ----------- --------- Total adjustments (495) (85) ----------- --------- Net cash provided by operating activities 199 720 CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturities of securities available for sale 8,800 4,513 Purchase of securities available for sale (4,697) (6,186) Proceeds from maturities of securities held to maturity 427 413 Proceeds from maturities of other securities - 40 Purchase of other securities - (9) Net change in portfolio loans (2,594) (714) Premises and equipment expenditures (383) (108) ----------- --------- Net cash provided by (used in) investing activities 1,553 (2,051) CASH FLOWS FROM FINANCING ACTIVITIES Net increase(decrease) in deposits (227) 525 Dividends paid (1,251) (1,238) Net proceeds from exercise of stock options 8 4 Purchases of common stock (4) (10) ----------- --------- Net cash used in financing activities (1,474) (719) ----------- --------- Net change in cash and cash equivalents 278 (2,050) Cash and cash equivalents at beginning of year 11,943 12,695 ----------- --------- Cash and cash equivalents at end of period $ 12,221 $ 10,645 =========== ========= Cash paid during the period for: Interest $ 977 $ 631 Income taxes - 24 Non-cash transactions: Transfer from loans to other real estate owned 35 148 See accompanying notes to consolidated financial statements. 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1-Basis of Presentation The consolidated financial statements include the accounts of CNB Corporation ("Company") and its wholly owned subsidiary, Citizens National Bank of Cheboygan ("Bank") and the Bank's wholly owned subsidiary CNB Mortgage Corporation. All significant intercompany accounts and transactions are eliminated in the consolidation process. The statements have been prepared by management without an audit by independent certified public accountants. However, these statements reflect all adjustments (consisting of normal recurring accruals) and disclosures which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented and should be read in conjunction with the notes to the consolidated financial statements included in the CNB Corporation's Form 10-K for the year ended December 31, 2005. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. Because the results of operations are so closely related to and responsive to changes in economic conditions, the results for any interim period are not necessarily indicative of the results that can be expected for the entire year. Stock Compensation: Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 123(R), Share-Based Payment, which requires companies to record compensation expense for stock options provided to employees in return for employee service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employee's service period, which is normally the vesting period of the options. This will apply to awards granted or modified after adoption and for prior grants that vest after the date of adoption. As of and for the three months ended March 31, 2006 there was no unrecognized compensation expense or recorded compensation expense as there were no unvested options during this period or as of March 31, 2006. The effect on future results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted at such future date, as well as the vesting periods provided, and so cannot currently be predicted. Prior to December 31, 2005 stock-based compensation was accounted for using the intrinsic value method prescribed in Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees, and related interpretations. Accordingly, compensation cost of stock options was measured as the excess, if any, of the fair value of our stock at the date of grant over the grant price and no stock-based employee compensation cost was reflected in the income statements for the periods ended prior to December 31, 2005. The effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123, was less than $.01 per share for the three months ended March 31, 2005. There is no proforma effect for the three months ended March 31, 2006 since previously all awards were recorded under the intrinsic value method of APB Opinion No. 25, Accounting for Stock Issued to Employees. There were no stock options granted during the three months ended March 31, 2006 and 2005. The Company adopted a stock option plan in May 1996 under which the options may be issued at market prices to employees. Stock options are used to reward certain officers and provide them with an additional equity interest. Options are issued for 10 year periods and have varying vesting schedules. The exercise price of options granted is equivalent to the market value of underlying stock at the grant date. The Company has a policy of issuing new shares to satisfy option exercises. There were no modification of awards during the periods ended March 31, 2006 and 2005. 6 Information about options available for grant, options outstanding and options exercisable follows: Weighted Options Weighted Average Outstanding Average Remaining Aggregate Available and Exercise Contractual Intrinsic For Grant Exercisable Price Term Value Balance at January 1, 2006 9,952 25,932 $ 47.35 Options exercised (264) 33.62 ----- ------ Balance at March 31, 2006 9,952 25,668 $ 47.49 4.3 years $ 36,000 ----- ------ The aggregate intrinsic value of options exercised for the three months ended March 31, 2006 and 2005 was approximately $4,000 and $0, respectively. There were no shares vested for the same periods. Cash received from option exercises for the periods ending March 31, 2006 and 2005 was approximately $8,000 and $4,000, respectively. There were no tax benefits realized from option exercises during the same periods. There have been no significant changes in the Company's critical accounting policies since December 31, 2005. Note 2-Earnings Per Share Basic earnings per share are calculated solely on weighted-average common shares outstanding. Diluted earnings per share will reflect the potential dilution of stock options and other common stock equivalents. For the three month period ending March 31, 2006 the weighted average shares outstanding in calculating basic earnings per share was 1,237,435 while the weighted average number of shares for diluted earnings per share was 1,239,494. As of March 31, 2006 there were 19,392 shares not considered in the earnings per share calculation because they were antidilutive. For the three month period ending March 31, 2005 the weighted average shares outstanding in calculating basic earnings per share were 1,237,854 while the weighted average number of shares for diluted earnings per share was 1,240,702. 7 ITEM 2-MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion provides information about the consolidated financial condition and results of operations of CNB Corporation ("Company") and its wholly owned subsidiary, Citizens National Bank of Cheboygan ("Bank") and the Bank's wholly owned subsidiary CNB Mortgage Corporation for the three month period ending March 31, 2006. FINANCIAL CONDITION The Company's balances of cash and cash equivalents increased $278,000 or 2.3%. During the three month period ending March 31, 2006, $199,000 in cash was provided by operating activities. Investing activities provided $1.6 million during the three months ended March 31, 2006, primarily due to proceeds of maturing securities and financing activities utilized $1.5 million. SECURITIES The securities portfolio decreased $4.2 million since December 31, 2005. The available for sale portfolio increased to 93.3% of the investment portfolio up from 93.1% at year-end. The fair values and related unrealized gains and losses for securities available for sale were as follows, in thousands of dollars: Gross Gross Fair Unrealized Unrealized Value Gains Losses ------------ ---------- ---------- Available for Sale MARCH 31, 2006 U.S. Government agency $ 47,849 $ 3 $ (618) Mortgage-backed 7,715 0 (196) State and municipal 10,025 71 (30) ------------ ---------- ---------- $ 65,589 $ 74 $ (844) ============ ========== ========== DECEMBER 31, 2005 U.S. Government agency $ 49,099 $ - $ (717) Mortgage-backed 8,140 - (180) State and municipal 12,076 38 (52) ------------ ---------- ---------- $ 69,315 $ 38 $ (949) ============ ========== ========== The carrying amount, unrecognized gains and losses, and fair value of securities held to maturity were as follows, in thousand of dollars: Gross Gross Carrying Unrecognized Unrecognized Fair Amount Gains Losses Value -------- ------------ ------------ --------- Held to Maturity MARCH 31, 2006 State and municipal $ 3,690 $ 39 $ (17) $ 3,712 ======== ============ ============ ========= DECEMBER 31, 2005 State and municipal $ 4,117 $ 37 $ (26) $ 4,128 ======== ============ ============ ========= 8 The carrying amount and fair value of securities by contractual maturity at March 31, 2006 are shown below, in thousands of dollars. Available for sale Held to Maturity Fair Carrying Fair Value Amount Value ----------- --------- ---------- Due in one year or less $ 37,019 $ 1,225 $ 1,226 Due from one to five years 27,003 736 750 Due from five to ten years 718 1,729 1,736 Due after ten years 849 - - ----------- --------- ---------- $ 65,589 $ 3,690 $ 3,712 =========== ========= ========== LOANS Net loans at March 31, 2006 increased $2.5 million from December 31, 2005. The table below shows total loans outstanding by type, in thousands of dollars, at March 31, 2006 and December 31, 2005 and their percentages of the total loan portfolio. All loans are domestic. A quarterly review of loan concentrations at March 31, 2006 indicates the pattern of loans in the portfolio has not changed significantly. There is no individual industry with more than a 10% concentration. However, all tourism related businesses, when combined, total 13.2% of total loans. March 31, 2006 December 31, 2005 Balance % of total Balance % of total ----------- ---------- ----------- ---------- Portfolio loans: Residential real estate $ 82,002 51.64% $ 83,183 53.23% Consumer 9,866 6.21% 9,922 6.35% Commercial real estate 55,936 35.22% 53,133 34.00% Commercial 11,007 6.93% 10,037 6.42% ----------- ------ ----------- ------ 158,811 100.00% 156,275 100.00% ====== ====== Deferred loan origination fees, net (7) (8) Allowance for loan losses (1,464) (1,456) ----------- ----------- Loans, net $ 157,340 $ 154,811 =========== =========== ALLOWANCE AND PROVISION FOR LOAN LOSSES An analysis of the allowance for loan losses, in thousands of dollars, for the three months ended March 31, follows: 2006 2005 --------- --------- Beginning balance $ 1,456 $ 1,350 Provision for loan losses 30 30 Charge-offs (34) (2) Recoveries 13 6 --------- --------- Ending balance $ 1,465 $ 1,384 --------- --------- The Company had no impaired loans during the first three months of 2006 or 2005. Since December 31, 2005 commercial mortgages have increased $2.8 million while consumer mortgages have decreased $1.2 million. This is primarily due to a slow down in residential refinancing and a stronger emphasis on commercial lending. There has been no change in the bank's lending policies. The lending staff continues to be well-trained and experienced. The trend and volume of past due loans continues to be well-controlled and in 9 line with peer averages. In response to the change in portfolio composition and loan growth management recorded a provision of $30,000 in the first three months of 2006 and 2005. CREDIT QUALITY The Company maintains a high level of asset quality as a result of actively managing delinquencies, nonperforming assets and potential loan problems. The Company performs an ongoing review of all large credits to watch for any deterioration in quality. Nonperforming loans are comprised of: (1) loans accounted for on a nonaccrual basis; (2) loans contractually past due 90 days or more as to interest or principal payments (but not included in nonaccrual loans in (1) above); and (3) other loans whose terms have been renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower (exclusive of loans in (1) or (2) above). The aggregate amount of nonperforming loans is shown in the table below. March 31, December 31, 2006 2005 (dollars in thousands) Nonaccrual $ - $ - Loans past due 90 days or more 512 255 Troubled debt restructurings - - ---------- ------------ Total nonperforming loans $ 512 $ 255 ========== ============ Percent of total loans 0.33% 0.16% DEPOSITS Deposits at March 31, 2006 decreased $227,000 since December 31, 2005. Interest-bearing deposits increased $2.5 million or 1.4% for the three months ended March 31, 2006, while noninterest-bearing deposits decreased $2.7 million or 7.0%. This change in the deposit mix can be attributed to the changing rate environment and the increased rates paid on certificates of deposit. LIQUIDITY AND FUNDS MANAGEMENT As of March 31, 2006, the Company had $4.7 million in federal funds sold, $65.6 million in securities available for sale and $1.2 million in held to maturity securities maturing within one year. These sources of liquidity are supplemented by new deposits and loan payments received by customers. These short-term assets represent 28.3% of total deposits as of March 31, 2006. Total equity of the Company at March 31, 2006 was $24.8 million compared to $24.5 million at December 31, 2005. RESULTS OF OPERATIONS CNB Corporation's 2006 net income for the first three months was $694,000, a decrease of $111,000 compared to 2005 results. This decrease in net income can be attributed to an increase in noninterest expense resulting from the increase in depreciation expense on new equipment and increased salary expense over 2005. Basic and diluted earnings per share were $0.56 for 2006 compared to $0.65 for 2005. The return on assets was 1.08% for the first three months of the year versus 1.25% for the same period in 2005. The return on equity was 11.21% compared to 13.32% for the same period last year. For the first three months of 2006, net interest income was $2.5 million representing an increase of less than 1.0% from the same period in 2005. The fully taxable equivalent net interest margin increased to 4.30% for the three month period ending March 31, 2006 compared to 4.25% for the same period ending March 31, 2005. This change can be attributable to an increase in overall interest rates from 2005 to 2006. 10 In response to the change in the loan portfolio composition and loan growth, management recorded a provision expense of $30,000 in the first three months in 2006 and 2005. Noninterest income for the three months ending March 31, 2006 was $344,000, a decrease of $5,000 or 1.4% from the same period last year. Noninterest expense for the first three months of 2006 was $1.9 million compared to $1.7 million for the same period in 2005. This increase can largely be attributed to increases in depreciation expense due to the purchase of new processing equipment and new branch facilities in Cheboygan and Indian River. Also, an increase in salary and benefit expenses as the Company increased its number of employees from 74 full-time equivalent employees at March 31, 2005 to 77.5 full-time equivalent employees at March 31, 2006. This increase in employees is due to increased branch hours and a new branch facility, both of which require additional staffing. Also during 2006, the Company has recognized $51,000 of expense due to the loss on sale or write-down of other real estate properties owned. The provision for federal income tax was 25.9% of pretax income for the three months ended March 31, 2006 as compared to 29.6% for the same period in 2005. The difference between the tax rates for the two periods is due to the increase in our noninterest expense in 2006 from 2005 as mentioned earlier. The difference between the effective tax rate and the federal corporate tax rate of 34% is generally due to tax-exempt interest earned on investments and loans and other tax-related items. ITEM 3-QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The primary source of market risk for the financial instruments held by the Company is interest rate risk. That is, the risk that a change in market rates will adversely affect the market value of the instruments. Generally, the longer the maturity, the higher the interest rate risk exposure. While maturity information does not necessarily present all aspects of exposure, it may provide an indication of where risks are prevalent. All financial institutions assume interest rate risk as an integral part of normal operations. Managing and measuring interest rate risk is a dynamic, multi-faceted process that ranges from reducing the exposure of the Company's net interest margin to swings in interest rates, to assuring sufficient capital and liquidity to support future balance sheet growth. The Company manages interest rate risk through the Asset Liability Committee. The Asset Liability Committee is comprised of bank officers from various disciplines. The Committee reviews policies and establishes rates which lead to prudent investment of resources, the effective management of risks associated with changing interest rates, the maintenance of adequate liquidity, and the earning of an adequate return of shareholders' equity. Management believes that there has been no significant changes to the interest rate sensitivity since the presentation in the December 31, 2005 Management Discussion and Analysis appearing in the December 31, 2005 10K. ITEM 4-CONTROLS AND PROCEDURES The term "disclosure controls and procedures" is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the "Exchange Act"). These rules refer to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed summarized and reported within required time periods. Our Chief Executive Officer and Treasurer, who serves as the Company's CFO have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report (the "Evaluation Date"), and have concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective in providing them with material information relating to the Corporation which is required to be included in our periodic reports filed under the Exchange Act. There have been no significant changes in the Company's internal controls over financial reporting or in other factors that could significantly affect internal controls over financial reporting. 11 PART II-OTHER INFORMATION ITEM 1-LEGAL PROCEEDINGS None ITEM 1A.-RISK FACTORS None ITEM 2- UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None ITEM 3-DEFAULTS UPON SENIOR SECURITIES None ITEM 4-SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5-OTHER INFORMATION None ITEM 6-EXHIBITS AND REPORTS OF FORM 8-K a.) Exhibits 31.1 Certification of Chief Executive Officer 31.2 Certification of Chief Financial Officer 32.1 Certification pursuant to section 906 of the Sarbanes-Oxley Act of 2002 b.) Reports on Form 8-K None 12 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. CNB Corporation ------------------------------------- (Registrant) /s/ James C. Conboy, Jr. Date: May 11, 2006 ------------------------------------- James C. Conboy, Jr. President and Chief Executive Officer /s/ Susan A. Eno Date: May 11, 2006 ------------------------------------- Susan A. Eno Executive Vice President 13 EXHIBIT INEDX Number Exhibit 31.1 Certification of Chief Executive Officer 31.2 Certification of Chief Financial Officer 32.1 Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002