UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended SEPTEMBER 30, 2005 -------------------------------- Commission file number 0-11783 ACNB CORPORATION - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) PENNSYLVANIA 23-2233457 - ------------------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 16 LINCOLN SQUARE, GETTYSBURG, PENNSYLVANIA 17325-3129 - ------------------------------------------- ------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (717) 334-3161 -------------- COMMON STOCK, PAR VALUE $2.50 PER SHARE - -------------------------------------------------------------------------------- (Title of class) 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 Exchange Act Rule 12b-2). Yes [X] No [ ] The aggregate market value of the voting stock held by nonaffiliates of the Registrant at September 30, 2005 was approximately $117,778,000. The number of shares of Registrant's Common Stock outstanding on September 30, 2005 was 5,436,101.
PART I ACNB CORPORATION ITEM I FINANCIAL INFORMATION CONSOLIDATED STATEMENTS OF CONDITION <TABLE> <CAPTION> UNAUDITED UNAUDITED SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31, 2005 2004 2004 ------------- ------------- ------------ <S> <C> <C> <C> DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA ASSETS Cash and due from banks $ 21,645 $ 25,224 $ 21,757 Interest-bearing deposits in banks 892 932 938 --------- --------- --------- Cash and Cash Equivalents 22,537 26,156 22,695 Securities available for sale 357,717 410,796 381,383 Securities held to maturity, fair value $20,217; $27,846; $25,089 20,101 27,192 24,560 Loans held for sale 470 604 511 Loans, net of allowance for loan losses $4,226; $4,170; $3,938 473,935 425,525 436,631 Premises and equipment 14,798 9,691 11,992 Restricted investment in bank stocks 9,137 10,927 10,271 Investment in bank owned life insurance 20,922 19,034 19,198 Investments in low income housing partnerships 5,794 5,542 6,153 Intangible asset 3,356 -- -- Foreclosed real estate -- 513 -- Goodwill 2,186 -- -- Other assets 12,427 9,155 10,794 --------- --------- --------- TOTAL ASSETS $ 943,380 $ 945,135 $ 924,188 ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits: Non-interest bearing $ 81,616 $ 76,520 $ 74,667 Interest bearing 598,487 578,010 572,205 --------- --------- --------- Total Deposits 680,103 654,530 646,872 Short-term borrowings 55,721 79,589 64,966 Long-term borrowings 125,839 132,000 132,000 Other liabilities 7,460 5,382 5,829 --------- --------- --------- TOTAL LIABILITIES 869,123 871,501 849,667 --------- --------- --------- STOCKHOLDERS' EQUITY Common stock, $2.50 par value; 20,000,000 shares authorized; 13,590 13,590 13,590 5,436,101 shares issued and outstanding Retained earnings 65,297 61,664 63,127 Accumulated other comprehensive loss (4,630) (1,620) (2,196) --------- --------- --------- TOTAL STOCKHOLDERS' EQUITY 74,257 73,634 74,521 --------- --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 943,380 $ 945,135 $ 924,188 ========= ========= ========= </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS. 2
ACNB CORPORATION CONSOLIDATED STATEMENTS OF INCOME <TABLE> <CAPTION> UNAUDITED UNAUDITED THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------- ---------------------- 2005 2004 2005 2004 -------- -------- -------- -------- <S> <C> <C> <C> <C> DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA INTEREST INCOME Loans, including fees $ 6,965 $ 6,016 $ 19,892 $ 17,785 Securities: Taxable 3,423 3,714 10,298 9,472 Tax-exempt 229 229 687 688 Dividends 61 37 214 104 Other 24 8 64 75 -------- -------- -------- -------- TOTAL INTEREST INCOME 10,702 10,004 31,155 28,124 -------- -------- -------- -------- INTEREST EXPENSE Deposits 3,084 2,375 8,212 7,128 Short-term borrowings 301 221 838 537 Long-term debt 1,063 895 3,145 1,980 -------- -------- -------- -------- TOTAL INTEREST EXPENSE 4,448 3,491 12,195 9,645 -------- -------- -------- -------- NET INTEREST INCOME 6,254 6,513 18,960 18,479 PROVISION FOR LOAN LOSSES 168 75 348 225 -------- -------- -------- -------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 6,086 6,438 18,612 18,254 -------- -------- -------- -------- OTHER INCOME Service charges on deposit accounts 453 453 1,287 1,335 Income from fiduciary activities 206 196 567 557 Earnings on investment in bank owned life insurance 200 210 561 507 Gains (losses) on sales of securities 8 243 (264) 1,014 Losses on foreclosed real estate -- -- (87) (11) Service charges on ATM and debt card transactions 192 81 540 429 Commissions from insurance sales 1,035 -- 3,074 -- Other 273 294 993 735 -------- -------- -------- -------- TOTAL OTHER INCOME 2,367 1,477 6,671 4,566 -------- -------- -------- -------- OTHER EXPENSES Salaries and employee benefits 3,148 2,485 9,672 7,687 Net occupancy expense 419 204 1,083 724 Equipment expense 617 464 1,743 1,544 Professional services 187 127 693 364 Other tax expense 244 235 760 731 Supplies and postage 246 142 595 491 Other operating 1,420 956 4,042 2,590 -------- -------- -------- -------- TOTAL OTHER EXPENSES 6,281 4,613 18,588 14,131 -------- -------- -------- -------- INCOME BEFORE INCOME TAXES 2,172 3,302 6,695 8,689 PROVISION FOR INCOME TAXES 388 863 1,100 2,311 -------- -------- -------- -------- NET INCOME $ 1,784 $ 2,439 $ 5,595 $ 6,378 ======== ======== ======== ======== PER SHARE DATA Basic earnings $ 0.33 $ 0.45 $ 1.03 $ 1.17 ======== ======== ======== ======== Cash dividends paid $ 0.21 $ 0.21 $ 0.63 $ 0.63 ======== ======== ======== ======== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS. 3
ACNB CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 <TABLE> <CAPTION> ACCUMULATED OTHER TOTAL COMMON RETAINED COMPREHENSIVE STOCKHOLDERS' STOCK EARNINGS INCOME (LOSS) EQUITY -------- -------- ------------- ------------- <S> <C> <C> <C> <C> DOLLARS IN THOUSANDS BALANCE - DECEMBER 31, 2003 $ 13,590 $ 58,711 $ 442 $ 72,743 -------- Comprehensive income: Net income -- 6,378 -- 6,378 Change in net unrealized losses on securities available for sale, net of reclassification adjustment and taxes -- -- (2,062) (2,062) -------- TOTAL COMPREHENSIVE INCOME 4,316 -------- Cash dividends declared -- (3,425) -- (3,425) -------- -------- -------- -------- BALANCE - SEPTEMBER 30, 2004 $ 13,590 $ 61,664 $ (1,620) $ 73,634 ======== ======== ======== ======== BALANCE - DECEMBER 31, 2004 $ 13,590 $ 63,127 $ (2,196) $ 74,521 Comprehensive income: Net income -- 5,595 -- 5,595 Change in net unrealized losses on securities available for sale, net of reclassification adjustment and taxes -- -- (2,434) (2,434) -------- TOTAL COMPREHENSIVE INCOME 3,161 -------- Cash dividends declared -- (3,425) -- (3,425) -------- -------- -------- -------- BALANCE - SEPTEMBER 30, 2005 $ 13,590 $ 65,297 $ (4,630) $ 74,257 ======== ======== ======== ======== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS. 4
ACNB CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> UNAUDITED NINE MONTHS ENDED SEPTEMBER 30, ------------------------ 2005 2004 --------- --------- <S> <C> <C> IN THOUSANDS CASH FLOWS FROM OPERATING ACTIVITIES Interest and dividends received $ 32,109 $ 28,858 Fees and commissions received 6,374 5,043 Interest paid (12,151) (9,718) Cash paid to suppliers and employees (18,840) (14,189) Income tax (benefit) paid 1,517 (1,955) Loans originated for sale (13,236) (6,445) Proceeds from mortgage loans sold 13,277 5,927 --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES 9,050 7,521 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturities of investment securities held-to-maturity 4,289 14,991 Proceeds from maturities of investment securities available-for-sale 30,610 98,572 Proceeds from sales of securities available-for-sale 22,761 170,163 Purchase of investment securities available-for-sale (34,813) (337,768) Purchase of restricted investment in bank stocks (2,849) (3,380) Proceeds from sales of restricted investments in bank stocks 3,983 -- Purchase of bank owned life insurance (1,200) (4,400) Net increase in loans (37,652) (14,666) Cash paid for purchase of Russell Insurance Group, Inc., net of cash acquired (5,542) -- Investments in low income housing partnerships (78) (1,683) Capital expenditures (3,809) (3,276) Proceeds from sales of property and foreclosed real estate 692 37 --------- --------- NET CASH USED IN INVESTING ACTIVITIES (23,608) (81,410) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase in demand deposits, NOW accounts, and savings accounts 6,949 8,546 Net increase in time certificates of deposit 26,282 6,597 Net increase (decrease) in short-term borrowings (9,245) 9,913 Dividends paid (3,425) (3,425) Proceeds from long-term borrowings 51,000 45,000 Repayments on long-term borrowings (57,161) -- --------- --------- NET CASH PROVIDED BY FINANCING ACTIVITIES 14,400 66,631 --------- --------- NET DECREASE IN CASH AND CASH EQUIVALENTS (158) (7,258) CASH AND CASH EQUIVALENTS - BEGINNING 22,695 33,414 --------- --------- CASH AND CASH EQUIVALENTS - ENDING $ 22,537 $ 26,156 ========= ========= RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES Net income $ 5,595 $ 6,378 Adjustments to reconcile net income to net cash provided by operating activities: (Gains) losses on sales of loans, property and foreclosed real estate (138) 11 Earnings on investment in bank owned life insurance (561) (507) (Gains) losses on sales of securities 264 (1,014) Deferred income taxes (569) 146 Depreciation and amortization 1,104 638 Provision for loan losses 348 225 Net amortization of investment securities premiums 1,269 2,073 Decrease in taxes payable -- 211 Decrease in accrued expenses -- 750 (Increase) in interest receivable (315) (935) Increase (decrease) in interest payable 44 (73) (Increase) decrease in mortgage loans held for sale 41 (518) (Increase) decrease in other assets 381 64 Increase in other liabilities 1,587 72 --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES $ 9,050 $ 7,521 ========= ========= </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL STATEMENTS. 5
ACNB CORPORATION ITEM 1 - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly ACNB Corporation's financial position as of September 30, 2005 and 2004, and the results of its operations, changes in stockholders' equity and cash flows for the three months and nine months ended September 30, 2005 and 2004. All such adjustments are of a normal recurring nature. The accounting policies followed by the Corporation are set forth in Note A to the Corporation's financial statements in the 2004 ACNB Corporation Annual Report and Form 10-K, filed with the SEC on March 15, 2005. The results of operations for the three month and nine month periods ended September 30, 2005 are not necessarily indicative of the results to be expected for the full year. For comparative purposes, the September 30, 2004 balances have been reclassified to conform with the 2005 presentation. Such reclassifications had no impact on net income. 2. EARNINGS PER SHARE Earnings per share are based on the weighted average number of shares of stock outstanding during each period. Weighted average shares outstanding for the three month and nine month periods ended September 30, 2005 and 2004 were 5,436,101. The Corporation does not have dilutive securities outstanding. 3. COMPONENTS OF NET PERIODIC BENEFIT COST The components of net periodic benefit costs for the three month and nine month periods ended September 30 were as follows: <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ----------------- 2005 2004 2005 2004 ----- ----- ----- ----- <S> <C> <C> <C> <C> Service cost $ 134 $ 109 $ 402 $ 327 Interest cost 206 195 618 587 Expected return on plan assets (219) (185) (657) (555) Recognized net actuarial loss 38 18 114 56 Other, net 13 16 39 46 ----- ----- ----- ----- NET PERIODIC BENEFIT COST $ 172 $ 153 $ 516 $ 461 ===== ===== ===== ===== </TABLE> The Corporation previously disclosed in its financial statements for the year ended December 31, 2004 that it expected to contribute $1,250,000 to its pension plan in 2005. As of September 30, 2005, $1,250,000 of contributions have been made. 6
ACNB CORPORATION ITEM 1 - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. GUARANTEES The Corporation does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit are written conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Generally, all letters of credit, when issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as those that are involved in extending loan facilities to customers. The Corporation, generally holds collateral and/or personal guarantees supporting these commitments. The Corporation had $4,615,000 in standby letters of credit, as of September 30, 2005. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees should be sufficient to cover the potential amount of future payment required under the corresponding guarantees. The current amount of the liability, as of September 30, 2005 for guarantees under standby letters of credit issued is not material. 5. COMPREHENSIVE INCOME The Corporation's other comprehensive income items are unrealized gains (losses) on securities available for sale and unfunded pension liability. There was no change in the unfunded pension liability during the three month and nine month periods ended September 30, 2005 and 2004. The components of total comprehensive income for the three month and nine month periods ended September 30 were as follows: <TABLE> <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------- -------------------- 2005 2004 2005 2004 ------- ------- ------- ------- <S> <C> <C> <C> <C> Unrealized holding gains (losses) on available for sale securities arising during the period $ (992) $ 4,427 $(4,009) $(2,158) Reclassification of gains (losses) realized in net income 8 243 (264) 1,014 ------- ------- ------- ------- NET UNREALIZED GAINS (LOSSES) (1,000) 4,184 (3,745) (3,172) TAX EFFECT Tax effect 350 (1,391) 1,311 1,110 ------- ------- ------- ------- OTHER COMPREHENSIVE INCOME $ (650) $ 2,793 $(2,434) $(2,062) (LOSS) ======= ======= ======= ======= </TABLE> 7
ACNB CORPORATION ITEM 1 - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. ACQUISITION OF RUSSELL INSURANCE GROUP, INC. On November 19, 2004, the Corporation, through its acquisition subsidiary, entered into a definitive agreement to purchase Russell Insurance Group Inc. ("RIG"). Under the terms of the definitive agreement, the Corporation agreed to pay $4,750,000 in cash to acquire Russell Insurance Group Inc. Additional consideration of up to $2,882,000 is subject to performance criteria for payment over the next three years. In addition, the Corporation through its acquisition subsidiary has entered into a three-year employment contract with Frank Russell, Jr., the President of Russell Insurance Group Inc. On January 5, 2005, the acquisition was completed. The purchase price of $5,663,000, which includes closing costs of $220,000, has been allocated as follows (in thousands): Cash $ 628 Intangible asset 3,230 Goodwill 2,186 Other assets 1,197 Other liabilities (1,578) ------- $ 5,663 ======= The intangible asset, representing the customer base, is being amortized over 10 years. Goodwill will not be amortized but will be analyzed annually for impairment. Amortization on goodwill and the intangible asset will be deductible for tax purposes. During the nine months ended 2005, RIG acquired two additional books of business with an aggregate purchase price of $368,000. This amount is being amortized over 10 years. 7. NEW ACCOUNTING STANDARDS EITF 03-1 In January 2003, the FASB's Emerging Issues Task Force (EITF) issued EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investors" ("EITF 03-1"), and in March 2004, the EITF issued an update. EITF 03-1 addresses the meaning of other-than-temporary impairment and its application to certain debt and equity securities. EITF 03-1 aids in the determination of impairment of an investment and gives guidance as to the measurement of impairment loss and the recognition and disclosures of other-than-temporary investments. EITF 03-1 also provides a model to determine other-than-temporary impairment using evidence-based judgment about the recovery of the fair value up to the cost of the investment by considering the severity and duration of the impairment in relation to the forecasted recovery of the fair value. In July 2005, FASB adopted the recommendation of its staff to nullify key parts of EITF 03-1. The staff's recommendations were to nullify the guidance on the determination of whether an investment is impaired as set forth in paragraphs 10-18 of Issue 03-1 and not to provide additional guidance on the meaning of other-than temporary impairment. Instead, the staff recommends that entities recognize other-than-temporary impairments by applying existing accounting literature such as paragraph 16 of SFAS 115. 8
ACNB CORPORATION ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION AND FORWARD-LOOKING STATEMENTS INTRODUCTION The following is management's discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for ACNB Corporation (the Corporation or ACNB), a financial holding company. The consolidated financial statements include its wholly-owned subsidiaries, Adams County National Bank, Russell Insurance Group Inc. and Pennbanks Insurance Company. Please read this discussion in conjunction with the consolidated financial statements and disclosures included herein. Current performance does not guarantee or assure and is not necessarily indicative of similar performance in the future. FORWARD-LOOKING STATEMENTS In addition to historical information, this Form 10-Q contains forward-looking statements. Examples of forward-looking statements include, but are not limited to, (a) projections or statements regarding future earnings, expenses, net interest income, other income, earnings or loss per share, asset mix and quality, growth prospects, capital structure and other financial terms, (b) statements of plans and objectives of management or the board of directors, and (c) statements of assumptions, such as economic conditions in the Corporation's market areas. Such forward-looking statements can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "intends," "will," "should," "anticipates," or the negative of any of the foregoing or other variations thereon or comparable terminology, or by discussion of strategy. Forward-looking statements are subject to certain risks and uncertainties. Actual results may differ materially from those projected in the forward-looking statements. We caution readers not to place undue reliance on these forward-looking statements. They only reflect management's analysis, as of this date. The Corporation does not revise or update these forward-looking statements to reflect events or changed circumstances. Please carefully review the risk factors described in other documents the Corporation files from time-to-time with the Securities and Exchange Commission, including the Quarterly Reports on Form 10-Q, filed by the Corporation and any Current Reports on Form 8-K filed by the Corporation. CRITICAL ACCOUNTING POLICIES The accounting policies that the Corporation's management deems to be most important to the portrayal of its financial condition and results of operations, and that require management's most difficult, subjective or complex judgment, often result in the need to make estimates about the effect of such matters which are inherently uncertain. The following policies are deemed to be critical accounting policies by management: The allowance for loan losses represents management's estimate of probable losses inherent in our loan portfolio. Management makes numerous assumptions, estimates and adjustments in determining an adequate allowance. The Corporation assesses the level of potential loss associated with its loan portfolio and provides for that exposure through an Allowance for Loan Losses. The allowance is established through a provision for loan losses charged to earnings. The allowance is an estimate of the losses inherent in the loan portfolio as of the end of each reporting period. The Corporation assesses the adequacy of its allowance on a quarterly basis. The evaluation of securities for other than temporary impairment requires a significant amount of judgment. In estimating other than temporary impairment losses, management considers various factors, including length of time the fair value has been below cost, the financial condition of the issuer and the intent and ability of the corporation to hold the securities until recovery. Declines in fair value that are determined to be other than temporary are charged against earnings. 9
CRITICAL ACCOUNTING POLICIES (CONTINUED) The evaluation of goodwill and intangibles for impairment requires a significant amount of judgment, and includes consideration of various factors, including estimates of future income from the customer base. Impairment would be recognized through a charge to earnings. RESULTS OF OPERATIONS Net income totaled $5,595,000 during the nine months ended September 30, 2005. Earnings per share totaled $1.03 for the same period. Net income during the nine months ended September 30, 2004 totaled $6,378,000 and earnings per share totaled $1.17. The decrease in net income and earnings per share was primarily driven by a lack of realized gains on securities and increases in occupancy, equipment, and professional services expense. The downward trend in income will continue through the fourth quarter because of a flat yield curve and a large shortfall in tax credits. Historical tax credits were used in the fourth quarter of 2004 but will drop from approximately $800,000 in 2004 to $-0- in 2005. Net interest income totaled $18,960,000 during the nine month period ended September 30, 2005 compared to $18,479,000 for the same period in 2004. The increase in net interest income during 2005 was primarily related to an increase in interest rates. The net interest spread during the first nine months of 2005 was 2.66% compared to 2.70% during the same period in 2004. The yield on interest earning assets increased by 0.33% and cost of interest bearing liabilities increased by 0.37% during 2005. The net interest margin was 2.90% for the first nine months of 2005 compared to 2.93% for the same period in 2004. Average earning assets were $871,654,000 during 2005, an increase of $30,800,000 over the 2004 average of $840,854,000. Average interest bearing liabilities were $768,142,000 in 2005, up from $732,519,000 in 2004. PROVISION FOR LOAN LOSSES The provision for loan losses charged against earnings was $348,000 for the first nine months of 2005 compared to $225,000 for the same period in 2004. The provision for loan losses totaled $168,000 for the third quarter of 2005 as compared to $75,000 for the third quarter of 2004. The increase was primarily a result of loan growth and strengthening of the reserve as ACNB continues to emphasize commercial lending. ACNB adjusts the provision for loan losses periodically as necessary to maintain the allowance at a level deemed to meet the risk characteristics of the loan portfolio. 10
OTHER INCOME During the first nine months of 2005, total other income was $6,671,000, a $2,105,000 increase from 2004. The increase was primarily the result of commissions from insurance sales totaling $3,074,000 recognized by the Corporation's new subsidiary, Russell Insurance Group, Inc. (see footnote 6), partially offset by a decrease in gains on sales of securities of $1,278,000. Total other income during the third quarter of 2005 was $2,367,000 as compared to $1,477,000 during the second quarter of 2004. The increase was primarily the result of commissions from insurance sales totaling $1,035,000. Income from fiduciary activities, which includes both institutional and personal trust management services and brokerage service fees, totaled $567,000 for the first nine months of 2005, as compared to $557,000 during 2004. During the third quarter of 2005, income totaled $206,000 as compared to $196,000 during the third quarter of 2004. Other income was $906,000 for the nine months ended September 30, 2005, as compared to income of $735,000 during the same period in 2004. The major factor in the increase was the sale of two bank properties for a gain of $220,000, partially offset by a loss on sale of foreclosed real estate of $88,000. OTHER EXPENSES The largest component of other expenses is salaries and employee benefits, which increased $1,985,000, or 26%, to $9,672,000 during the first nine months of 2005 as compared to the same period a year ago. Salaries and employee benefits totaled $3,148,000 during the third quarter of 2005 as compared to $2,485,000 during the third quarter of 2004. The increase in salary and employee benefits was the result of: o Salaries and benefits included expenses related to Russell Insurance Group, Inc. totaling $1,513,000 and $502,000 during the first nine months of 2005 and the third quarter of 2005, respectively. o Normal merit increases to employees; o Increases in administrative personnel expense as the bank's strategic direction continues to focus on greater growth; and, o Increases in employee benefit costs, particularly health and welfare benefit plans, consistent with the rising health care cost trend noted nationwide and increased net periodic pension costs due to the underperformance of investments in the pension plan. Net occupancy expense totaled $1,083,000 and equipment expense totaled $1,743,000 during the nine month period ended September 30, 2005 as compared to $724,000 and $1,544,000 during the same period in 2004, respectively. During the third quarter of 2005, net occupancy expense totaled $419,000 and equipment expense totaled $617,000 as compared to $204,000 and $464,000, respectively, during the third quarter of 2004. The increases were the result of additional operational expenses and maintenance associated with the overall bank growth and more sophisticated delivery channels offered to the bank's customer base as well as additional expenses relating to the New Oxford branch opened in early 2005 and the new operations center which was placed into service in May 2005. Professional services expense totaled $693,000 during the first nine months of 2005, as compared to $364,000 for the same period in 2004. During the third quarter of 2005, professional services expense totaled $187,000 as compared to $127,000 during the second quarter of 2004. The increase was primarily a result of internal audit services and expenses relating to Sarbanes-Oxley ss. 404 compliance. 11
Other operating expenses totaled $4,042,000 during the nine month period ended September 30, 2005, compared to $2,590,000 during the same period in 2004. During the third quarter of 2005, other operating expenses totaled $1,420,000 as compared to $956,000 during the third quarter of 2004. Significant expense components in this category include marketing and advertising and expenses incurred by Russell Insurance Group, Inc., which totaled $1,048,000 and $593,000 during the first nine months and third quarter of 2005, respectively. INCOME TAX EXPENSE During the nine month period ended September 30, 2005, ACNB recognized income taxes of $1,100,000, or 16.4% of pretax income as compared to $2,311,000, or 26.6% of pre-tax income during the same period in 2004. The effective tax rate during the third quarter of 2005 was 17.9% as compared to 26.1% during the third quarter of 2004. The variances from the federal statutory rate of 35% are generally due to tax-exempt income and investments in low-income housing partnerships (which qualify for federal tax credits). The effective tax rate during the periods ended September 30, 2005 and 2004 included historical and low income housing tax credits of $593,000 and $213,000, respectively, associated with low income housing projects. FINANCIAL CONDITION Average earning assets during the nine months ended September 30, 2005 increased to $871,654,000 from $840,854,000 during the same period in 2004. Average funding sources, or interest bearing liabilities, increased in 2005 to $768,142,000 from $732,519,000 in 2004. INVESTMENT SECURITIES ACNB uses investment securities to generate interest and dividend income, to manage interest rate risk, and to provide liquidity. Much of the investment activity focused on U.S. Government agencies, tax-free municipal, and corporate securities. These securities provide the appropriate characteristics with respect to yield and maturity relative to the management of the overall balance sheet. At September 30, 2005, the securities balance included a net unrealized loss on available for sale securities of $4,630,000, net of taxes, versus a net unrealized loss of $2,196,000, net of taxes at December 31, 2004. The increase in interest rates during 2004 and 2005 led to the depreciation in the fair value of securities during 2005. Management has not recognized other than temporary impairment on any of the securities and believes the losses are solely related to changes in interest rates. LOANS Loans outstanding increased $48,332,000 from September 30, 2004 to September 30, 2005 and $37,551,000 from December 31, 2004 to September 30, 2005. The growth in loans is consistent with a stable local economy and lending to support existing customers. The commercial loan growth experienced in 2005, which totaled $14,558,000, is the result of actively marketing to local businesses. Additionally, ACNB has been able to participate with other institutions on larger loans. Most of the Corporation's activities are with customers located within the south central Pennsylvania and northern Maryland region of the country. The Corporation does not have any significant concentrations greater than 10% of loans to any one industry or customer. 12
ALLOWANCE FOR LOAN LOSSES The allowance for loan losses at September 30, 2005 was $4,226,000 or 0.88% of loans, as compared to $4,170,000 or 0.97% of loans at the end of the third quarter of 2004 and $3,938,000 or 0.89% at December 31, 2004. Loans past due 90 days and still accruing were $255,000 and non-accrual loans were $6,931,000 as of September 30, 2005. The ratio of non-performing loans plus foreclosed assets to total assets was 0.77% at September 30, 2005 as compared to 0.64% at September 30, 2004 and 0.91% at December 31, 2004. Loans past due 90 days and still accruing were $160,000 at December 31, 2004, while non-accruals were $8,054,000. Nonaccrual and impaired loans include three commercial loan relationships. Payments on these loans were current as of December 31, 2004 and September 30, 2005, however, cash flows reported to the Bank by each of the related companies are not sufficient to service the debt. As a result, the loans have been classified as impaired. The loans were also classified as nonaccrual as a result of a banking regulatory requirement to stop accruing interest on loans for which full payment of principal and interest is not expected. All three of the loans are collateralized by real estate. No additional funds are committed to be advanced in connection with impaired loans. The bank considers a loan impaired when, based on current, information and events it is probable that a lender will be unable to collect all amounts due. We measure impaired loans based on the present value of expected future cash flows, discounted at the loan's effective interest rate, or as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. If the measure of the impaired loan is less than its recorded investment a lender must recognize an impairment by creating, or adjusting, a valuation allowance with a corresponding charge to loan loss expense. The corporation uses the cash basis method to recognize interest income on loans that are impaired. PREMISES AND EQUIPMENT The increase in premises and equipment from $9,691,000 at September 30, 2004 to $14,798,000 at September 30, 2005 and $11,992,000 from December 31, 2004 to September 30, 2005 is primarily related to the Corporation's new Operations Center, which was completed in the second quarter in 2005. DEPOSITS ACNB continues to rely on deposit growth as the primary source of funds for lending activities. Deposits increased $25,573,000 from September 30, 2004 to September 30, 2005 and $33,231,000 from December 31, 2004 to September 30, 2005. Deposits have grown as the bank has continued to expand its market area. ACNB will continue to explore new products for its customers, to attract and retain other funds seeking safe havens. However, ACNB's ability to maintain and add to its deposit base may experience additional competitive pressures from the stock market and/or other alternative investment products offered by the insurance industry and others. BORROWINGS Short-term borrowings are comprised primarily of securities sold under agreements to repurchase, and overnight borrowings at the Federal Home Loan Bank in Pittsburgh (FHLB). As of September 30, 2005, short-term borrowings were $55,721,000, as compared to $64,966,000 at December 31, 2004 and $79,589,000 at September 30, 2004. Long-term debt consists primarily of advances from the Federal Home Loan Bank to fund ACNB's growth in its securities portfolio. Long-term debt totaled $125,839,000 at September 30, 2005, versus $132,000,000 at December 31, 2004. Borrowings include a $6,000,000 borrowing from a local institution to fund the purchase of Russell Insurance Group, Inc. The borrowing was dated January 5, 2005 and will mature on January 5, 2020. The interest rate is fixed at 6.5% for the first ten years at which time it will convert to a variable rate based upon the Wall Street Prime rate. 13
CAPITAL The management of capital in a regulated financial services industry must properly balance return on equity to stockholders while maintaining sufficient capital levels and related risk-based capital ratios to satisfy regulatory requirements. Capital management must also consider growth opportunities that may exist, and the resulting need for additional capital. ACNB's capital management strategies have been developed to provide attractive rates of returns to stockholders, while maintaining its "well-capitalized" position. The primary source of additional capital to ACNB is earnings retention, which represents net income less dividends declared. During 2005, ACNB retained $2,170,000, or 39%, of its net income as compared to $2,953,000 or 46% during the same period in 2004. ACNB Corporation is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on ACNB Corporation. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, ACNB Corporation must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and reclassifications are also subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy requires ACNB Corporation to maintain minimum amounts and ratios of total and Tier 1 capital to average assets. Management believes, as of September 30, 2005, that ACNB Corporation's banking subsidiary met all minimum capital adequacy requirements to which they are subject and are categorized as "well-capitalized." There are no conditions or events since the notification that management believes have changed the subsidiary bank's category. RISKED-BASED CAPITAL ACNB Corporation's capital ratios are as follows: <TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, 2005 2004 ------------- ------------ <S> <C> <C> Tier 1 leverage ratio (to average assets) 8.06% 8.34% Tier 1 risk-based capital ratio (to risk-weighted assets) 13.79 13.91 Total risk-based capital ratio 14.55 14.64 </TABLE> LIQUIDITY Effective liquidity management ensures the cash flow requirements of depositors and borrowers, as well as the operating cash needs of ACNB are met. ACNB's funds are available from a variety of sources, including assets that are readily convertible to such as cash and federal funds sold, maturities and repayments from the securities portfolio, scheduled repayments of loans receivable, the core deposit base, and the ability to borrow from the FHLB. At September 30, 2005, ACNB could borrow approximately $428,079,000 from the FHLB of which $278,084,000 was available. Another source of liquidity is securities sold under repurchase agreement to customers of ACNB's banking subsidiary totaling $25,726,000 and $27,166,000 at September 30, 2005 and December 31, 2004, respectively. The liquidity of the parent company also represents an important aspect of liquidity management. The parent company's cash outflows consist principally of dividends to stockholders and corporate expenses. The main source of funding for the parent company is the dividends it receives from its banking subsidiary. Federal and state banking regulations place certain restrictions on dividends paid to the parent company from the subsidiary banks. The total amount of dividends that may be paid from the subsidiary bank to ACNB were $7,337,000 at September 30, 2005. 14
ACNB CORPORATION ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Management monitors and evaluates changes in market conditions on a regular basis. Based upon the most recent review management has determined that there have been no material changes in market risks since year end. For further discussion of year end information, refer to the quarterly report. ITEM 4 - CONTROLS AND PROCEDURES As of the end of the period covered by this report, the Corporation carried out an evaluation, under the supervision and with the participation of the Corporation's management, including the Corporation's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the corporation's disclosure controls and procedures pursuant to the Securities Exchange Act of 1934 (" Exchange Act") Rule 13a-15e. Based upon that evaluation, the Corporation's Chief Executive Officer along with the Corporation's Chief Financial Officer concluded that the Corporation's disclosure controls and procedures are not effective, as a result of a material weakness identified during the Corporation's assessment of internal control over financial reporting as of December 31, 2004, in timely alerting them to material information relating to the Corporation (including its consolidated subsidiaries) required to be included in the Corporation's internal controls or in other factors which could significantly affect these controls subsequent to the date the Corporation carried out its evaluation. The material weakness is described as follows: ineffective controls over the application of generally accepted accounting principles to certain significant, complex, non-routine transactions and the related statement disclosures. The Corporation intends to actively search for experienced financial personnel to enhance the Corporation's financial reporting capabilities and expects to engage outside consultants to provide expertise on non-routine matters when they arise. Disclosure controls and procedures are corporation controls and other procedures that are designed to ensure that information required to be disclosed by the Corporation in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms. There was no change in our internal control over financial reporting during our fiscal quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 15
PART II ACNB CORPORATION OTHER INFORMATION ITEM 1 - LEGAL PROCEEDINGS Management is not aware of any litigation that would have a material adverse effect on the consolidated financial position of the Corporation. There are no proceedings pending other than the ordinary routine litigation incident to the business of the Corporation and its subsidiaries. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Corporation and its subsidiaries by government authorities. ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS - NOTHING TO REPORT ITEM 3 - DEFAULTS UPON SENIOR SECURITIES - NOTHING TO REPORT ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - NOTHING TO REPORT ITEM 5 - OTHER INFORMATION - NOTHING TO REPORT. ITEM 6 - EXHIBITS The following Exhibits are included in this Report: Exhibit 3(i) Articles of Incorporation of ACNB Corporation, as amended (Incorporated by Reference to Exhibit 3(i) of the Registrant's Annual Report on Form 10K for the year ended December 31, 2004, filed with the Commission on March 15, 2005). Exhibit 3(ii) Bylaws of Registrant; a copy of the Bylaws, as amended (Incorporated by Reference to Exhibit 99 of the Registrant's Report of Form 8K, filed with the Commission on December 19, 2003). Exhibit 10.1 Executive Employment Agreement Dated as of January 1, 2000 between Adams County National Bank, ACNB Corporation and Thomas A. Ritter (Incorporated by Reference to Exhibit 99 of the Registrant's Current Report on Form 8K, filed with the Commission on March 26, 2001). Exhibit 10.2 ACNB Corporation, ACNB Acquisition Subsidiary LLC, Russell Insurance Group, Inc. Stock Purchase Agreement. (Incorporated by reference to Exhibit 10.2 of the Registrant's Annual Report on Form 10K for the year ended December 31, 2004, filed with the Commission on March 15, 2005.) Exhibit 10.3 Salary Continuation Agreement - applicable to Thomas A. Ritter, Lynda L. Glass, John W. Krichten, John M. Kiehl, Carl L. Ricker and Ronald L. Hankey. (Incorporated by reference to Exhibit 10.3 of the Registrant's Annual Report on Form 10K for the year ended December 31, 2004, filed with the Commission on March 15, 2005.) Exhibit 10.4 Executive Supplemental Life Insurance Plan - applicable to Gary Bennett, Lynda L. Glass, Ronald L. Hankey, John M. Kiehl, John W. Krichten, Carl L. Ricker and Thomas A. Ritter. (Incorporated by reference to Exhibit 10.4 of the Registrant's Annual Report on Form 10K for the year ended December 31, 2004, filed with the Commission on March 15, 2005.) 16
Exhibit 10.5 Director Supplemental Life Insurance Plan - applicable to Philip P. Asper, Frank Elsner, III, D. Richard Guise, Wayne E. Lau, William B. Lower, Daniel W. Potts, Marian B. Schultz, Jennifer L. Weaver and Harry L. Wheeler. (Incorporated by reference to Exhibit 10.5 of the Registrant's Annual Report on Form 10K for the year ended December 31, 2004, filed with the Commission on March 15, 2005.) Exhibit 10.6 Director Deferred Fee Agreement - applicable to Frank Elsner, III, D. Richard Guise, Marian B. Schlutz, Jennifer L. Weaver and Harry L. Wheeler. (Incorporated by reference to Exhibit 10.6 of the Registrant's Annual Report on Form 10K for the year ended December 31, 2004, filed with the Commission on March 15, 2005.) Exhibit 10.7 Adams County National Bank Salary Savings Plan. (Incorporated by reference to Exhibit 10.7 of the Registrant's Annual Report on Form 10K for the year ended December 31, 2004, filed with the Commission on March 15, 2005.) Exhibit 10.8 Group Pension Plan for Employees of Adams County National Bank. (Incorporated by reference to Exhibit 10.8 of the Registrant's Annual Report on Form 10K for the year ended December 31, 2004, filed with the Commission on March 15, 2005.) Exhibit 14 Code of Ethics (incorporated by reference to Exhibit 14 of the registrants annual report on Form 10K for the year ended December 31, 2003, filed with the Commission on March 12, 2004) Exhibit 16.1 Letter re Change in Certifying Accountant (Incorporated by reference to Exhibit 16.1 of the Registrant's annual report on Form 10K for the year ended December 31, 2003, filed with the Commission March 12, 2004) Exhibit 23 Consent of Stambaugh Ness, P.C. (Incorporated by reference to Exhibit 23 of the Registrant's annual report on Form 10K for the year ended December 31, 2004, filed with the Commission on March 15, 2005). Exhibit 31.1 Chief Executive Officer Certification of quarterly report on Form 10Q Exhibit 31.2 Chief Financial Officer Certification of quarterly report on Form 10Q Exhibit 32.1 Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350 as Added by Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 32.2 Chief Financial Officer certification pursuant to 18 U.S.C. Section 1350 as Added by Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 99 Independent Auditors' Report for the consolidated statement of condition of ACNB Corporation and subsidiaries as of December 31, 2003 and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the two-year period ended December 31, 2003. (Incorporated by reference to Exhibit 99 of the Registrant's annual report on Form 10K for the year ended December 31, 2004, filed with the Commission on March 15, 2005). 17
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NOVEMBER 7, 2005 /S/ THOMAS A. RITTER - ---------------- ----------------------------------------- Thomas A. Ritter, Chief Executive Officer /S/ JOHN W. KRICHTEN ----------------------------------------- John W. Krichten, Chief Financial Officer 18