FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC. 20549 (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2000 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from ___________________to___________ Commission file number 0-17077 PENNS WOODS BANCORP, INC. (exact name of registrant as specified in its charter) Pennsylvania 23-2226454 (State or other jurisdiction (IRS. Employer of incorporation or organization) Identification No.) 300 Market Street, P.O. Box 967 Williamsport, Pennsylvania 17703-0967 (Address of principal executive offices) (570) 322-1111 Registrant's telephone number, including area code Securities registered pursuant to Section 12(b) of the Act: None Title of each class None Name of each exchange which registered Securities to be registered pursuant to Section 12(g) of the Act: Common Stock, par value $10 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] State the aggregate market value of the voting stock held by non-affiliates of the registrant: $79,138,034 at March 6, 2001. Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at March 6, 2001 Common Stock, $10 Par Value 3,083,257 Shares DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement prepared in connection with its annual meeting of shareholders to be held on April 25, 2001 are incorporated by reference in Part III hereof. INDEX PART I ITEM PAGE Item 1. Business....................................... 4 Item 2. Properties..................................... 15 Item 3. Legal Proceedings.............................. 16 Item 4. Submission of Matters to a Vote of Security Holders........................................ 16 PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.................... 17 Item 6. Selected Financial Data........................ 18 Item 7. Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations.................................. 19 Item 8. Financial Statements and Supplementary Data.... 41 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure......... 79 PART III Item 10. Directors and Executive Officers of the Registrant..................................... 79 Item 11. Executive Compensation......................... 80 Item 12. Security Ownership and Certain Beneficial Owners and Management.......................... 80 Item 13. Certain Relationships and Related Transactions................................... 80 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................ 81 Signatures............................................... 84 PART I ITEM 1 BUSINESS A. General Development of Business and History On January 7, 1983, Penns Woods Bancorp, Inc. (the "Company") was incorporated under the laws of the Commonwealth of Pennsylvania as a bank holding company. The Jersey Shore State Bank (the "Bank") became a wholly-owned subsidiary of the Company, and each outstanding share of Bank common stock was converted into one share of Company common stock. This transaction was approved by the shareholders of the Bank on April 11, 1983 and was officially effective on July 12, 1983. The Company's business has consisted primarily of managing and supervising the Bank, and its principal source of income has been dividends paid by the Bank. The Company's two other wholly-owned subsidiaries are Woods Real Estate Development Co., Inc. and Woods Investment Co., Inc. The Bank is engaged in commercial and retail banking and the taking of time and regular savings and demand deposits, the making of commercial and consumer loans and mortgage loans, and safe deposit services. Auxiliary services, such as cash management, are provided to commercial customers. The Bank operates full banking services with ten branch offices and a Mortgage/Loan Center in Northcentral Pennsylvania. In October 2000, the Bank acquired The M Group, Inc. D/B/A The Comprehensive Financial Group("The M Group"). The M Group, which operates as a subsidiary of the Bank, offers insurance and securities brokerage services. Securities are offered by The M Group through Locust Street Securities, Inc., a registered broker-dealer. Neither the Company nor the Bank anticipates that compliance with environmental laws and regulations will have any material effect on capital expenditures, earnings, or on its competitive position. The Bank is not dependent on a single customer or a few customers, the loss of whom would have a material effect on the business of the Bank. The Bank employed approximately 154 persons as of December 31, 2000. The Company does not have any employees. The principal officers of the Bank also serve as officers of the Company. B. Regulation and Supervision The Company is also subject to the provisions of the Bank Holding Company Act of 1956, as amended (the "BHCA") and to supervision and examination by the Board of Governors of the Federal Reserve System (the "FRB"). The Bank is subject to the supervision and examination by the Federal Deposit Insurance Corporation (the "FDIC"), as its primary federal regulator and as the insurer of the Bank's deposits. The Bank is also regulated and examined by the Pennsylvania Department of Banking (the "Department"). The insurance activities of The M Group are subject to regulation by the insurance departments of the various states in which The M Group conducts business including principally the Pennsylvania Department of Insurance. The securities brokerage activities of The M Group are subject to regulation by federal and state securities commissions. The FRB has issued regulations under the BHCA that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the FRB, pursuant to such regulations, may require the Company to stand ready to use its resources to provide adequate capital funds to the Bank during periods of financial stress or adversity. The BHCA requires the Company to secure the prior approval of the FRB before it can acquire all or substantially all of the assets of any bank, or acquire ownership or control of 5% or more of any voting shares of any bank. Such a transaction would also require approval of the Department. A bank holding company is prohibited under the BHCA from engaging in, or acquiring direct or indirect control of, more than 5% of the voting shares of any company engaged in nonbanking activities unless the FRB, by order or regulation, has found such activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Under the BHCA, the FRB has the authority to require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon FRB's determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company. Bank holding companies are required to comply with the FRB's risk-based capital guidelines. The risk-based capital rules are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies and to minimize disincentives for holding liquid assets. Currently, the required minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least half of the total capital is required to be Tier 1 capital, consisting principally of common shareholders' equity, less certain intangible assets. The remainder ("Tier 2 capital") may consist of certain preferred stock, a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, 45% of net unrealized gains on marketable equity securities and a limited amount of the general loan loss allowance. The risk-based capital guidelines are required to take adequate account of interest rate risk, concentration of credit risk, and risks of nontraditional activities. In addition to the risk-based capital guidelines, the FRB requires each bank holding company to comply with the leverage ratio, under which the bank holding company must maintain a minimum level of Tier 1 capital to average total consolidated assets of 3% for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are expected to maintain a leverage ratio of at least 4% to 5%. The Bank is subject to similar capital requirements adopted by the FDIC. C. Regulation of the Bank From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions of, the business of the Bank. It cannot be predicted whether any such legislation will be adopted or how such legislation would affect the business of the Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, the Bank's business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business. Prompt Corrective Action - The FDIC has specified the levels at which an insured institution will be considered "well- capitalized," "adequately capitalized," "undercapitalized," and "critically undercapitalized." In the event an institution's capital deteriorates to the "undercapitalized" category or below, the Federal Deposit Insurance Act (the "FDIA") and FDIC regulations prescribe an increasing amount of regulatory intervention, including: (1) the institution of a capital restoration plan by a bank and a guarantee of the plan by a parent institution; and (2) the placement of a hold on increases in assets, number of branches or lines of business. If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and (in critically undercapitalized situations) appointment of a receiver. For well-capitalized institutions, the FDIA provides authority for regulatory intervention where the institution is deemed to be engaging in unsafe or unsound practices or receives a less than satisfactory examination report rating for asset quality, management, earnings or liquidity. Deposit Insurance - There are two deposit insurance funds administered by the FDIC - the Savings Association Insurance Fund ("SAIF") and the Bank Insurance Fund ("BIF"). The Bank's deposits are insured under the BIF; however, the deposits assumed by the Bank in connection with the merger of Lock Haven Savings Bank are treated and assessed as SAIF-insured deposits. The FDIC has implemented a risk-related premium schedule for all insured depository institutions that results in the assessment of premiums based on capital and supervisory measure. Under the risk-related premium schedule, the FDIC assigns, on a semiannual basis, each institution to one of three capital groups (well- capitalized, adequately capitalized or undercapitalized) and further assigns such institution to one of three subgroups within a capital group. The institution's subgroup assignment is based upon the FDIC's judgment of the institution's strength in light of supervisory evaluations, including examination reports, statistical analyses and other information relevant to gauging the risk posed by the institution. Only institutions with a total capital to risk-adjusted assets ratio of 10.0% or greater, a Tier 1 capital to risk-adjusted assets ratio of 6.0% or greater and a Tier 1 leverage ratio of 5.0% or greater, are assigned to the well-capitalized group. As of December 31, 2000, the Bank's ratios were well above required minimum ratios. Both the BIF and SAIF are presently fully funded at more than the minimum amount required by law. Accordingly, the BIF and SAIF assessment rates range from zero for those institutions with the least risk, to $0.27 for every $100 of insured deposits for institutions deemed to have the highest risk. The Bank is in the category of institutions that presently pay nothing for deposit insurance. The FDIC adjusts the rates every six months. While the Bank presently pays no premiums for deposit insurance, it is subject to assessments to pay the interest on Financing Corporation ("FICO") bonds. FICO was created by Congress to issue bonds to finance the resolution of failed thrift institutions. The annual FICO assessment for the Bank (and all banks) is $.0196 for each $100 of BIF deposits. New Banking Legislation Landmark legislation in the financial services area was signed into law by the President on November 12, 1999. The Gramm-Leach-Bliley Act dramatically changes certain banking laws that have been in effect since the early part of the 20th Century. The most radical changes are that the separation between banking and the securities businesses mandated by the Glass-Steagall Act has now been removed, and the provisions of any state law that prohibits affiliation between banking and insurance entities have been preempted. Accordingly, the new legislation now permits firms engaged in underwriting and dealing in securities, and insurance companies, to own banking entities, and permits bank holding companies (and in some cases, banks) to own securities firms and insurance companies. The provisions of federal law that preclude banking entities from engaging in non-financially related activity, such as manufacturing, have not been changed. For example, a manufacturing company cannot own a bank and become a bank holding company, and a bank holding company cannot own a subsidiary that is not engaged in financial activities, as defined by the regulators. The new legislation creates a new category of bank holding company called a "financial holding company". In order to avail itself of the expanded financial activities permitted under the new law, a bank holding company must notify the Federal Reserve that it elects to be a financial holding company. A bank holding company can make this election if it, and all its bank subsidiaries, are well capitalized, well managed, and have at least a satisfactory Community Reinvestment Act rating, each in accordance with the definitions prescribed by the Federal Reserve and the regulators of the subsidiary banks. Once a bank holding company makes such an election, and provided that the Federal Reserve does not object to such election by such bank holding company, the financial holding company may engage in financial activities (i.e. securities underwriting, insurance underwriting, and certain other activities that are financial in nature as to be determined by the Federal Reserve) by simply giving a notice to the Federal Reserve within thirty days after beginning such business or acquiring a company engaged in such business. This makes the regulatory approval process to engage in financial activities much more streamlined than it was under prior law. The Company believes it qualifies to become a financial holding company, but has not yet determined whether or not it will file to become treated as one. It is too early to tell what effect the Gramm-Leach-Bliley Act may have on the Company and the Bank. The intent and scope of the act is positive for the financial industry, and is an attempt to modernize federal banking laws and make U.S. institutions competitive with those from other countries. While the legislation makes significant changes in U.S. banking law, such changes may not directly affect the Company's business unless it decides to avail itself of new opportunities available under the new law. The Company does not expect any of the provisions of the Act to have a material adverse effect on our existing operations, or to significantly increase its costs. Separately from the Gramm-Leach-Bliley Act, Congress is often considering some financial industry legislation. The Company cannot predict how any new legislation, or new rules adopted by the federal banking agencies, may affect its business in the future. In addition to federal banking law, the Bank is subject to the Pennsylvania Banking Code. The Banking Code was amended in late 2000 to provide more complete "parity" in the powers of state-chartered institutions compared to national banks and federal savings banks doing business in Pennsylvania. Pennsylvania banks have all the same ability to form financial subsidiaries authorized by the Gramm-Leach-Bliley Act as do national banks. Environmental Laws Environmentally related hazards have become a source of high risk and potential liability for financial institutions relating to their loans. Environmentally contaminated properties owned by an institution's borrowers may result in a drastic reduction in the value of the collateral securing the institution's loans to such borrowers, high environmental clean up costs to the borrower affecting its ability to repay the loans, the subordination of any lien in favor of the institution to a state or federal lien securing clean up costs, and liability to the institution for clean up costs if it forecloses on the contaminated property or becomes involved in the management of the borrower. The Company is not aware of any borrower who is currently subject to any environmental investigation or clean up proceeding which is likely to have a material adverse effect on the financial condition or results of operations of the Company. Effect of Government Monetary Policies The earnings of the Company are and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States Government and its agencies. The monetary policies of the FRB have had, and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The FRB has a major effect upon the levels of bank loans, investments and deposits through its open market operations in the United States Government securities and through its regulation of, among other things, the discount rate on borrowing of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies. DESCRIPTION OF BANK a. History and Business Jersey Shore State Bank (Bank) was incorporated under the laws of the Commonwealth of Pennsylvania as a state bank in 1934 and became a wholly-owned subsidiary of the Company on July 12, 1983. As of December 31, 2000, the Bank had total assets of $385,592,000; total shareholders' equity of $39,566,000 and total deposits of $278,304,000. The Bank's deposits are insured by the Federal Deposit Insurance Corporation for the maximum amount provided under current law. Jersey Shore State Bank engages in business as a commercial bank, doing business at several locations in Lycoming, Clinton and Centre Counties, Pennsylvania. The Bank offers insurance and securities brokerage services through its wholly owned subsidiary, The M Group, Inc. D/B/A The Comprehensive Financial Group. Services offered by the Bank include accepting time, demand and savings deposits including Super NOW accounts, regular savings accounts, money market certificates, investment certificates, fixed rate certificates of deposit and club accounts. Its services also include making secured and unsecured commercial and consumer loans, financing commercial transactions, making construction and mortgage loans and the renting of safe deposit facilities. Additional services include making residential mortgage loans, revolving credit loans with overdraft protection, small business loans, etc. Business loans include seasonal credit collateral loans and term loans, as well as accounts receivable and inventory financing. The Bank's loan portfolio mix can be classified into four principal categories. They are real estate, agricultural, commercial and consumer. Real estate loans can be further segmented into construction and land development, farm land, one-to-four family residential, multi-family and commercial or industrial. Qualified borrowers are defined by policy or by industry underwriting standards. Owner provided equity requirements range from 20% to 30% with a first lien status required. Terms are restricted to between 10 and 20 years with the exception of construction and land development, which is limited to one to five years. Appraisals, verifications and visitations comply with industry standards. Financial information that is required on all commercial mortgages includes the most current three years' balance sheets and income statements and projections on income to be developed through the project. In the case of corporations and partnerships, the principals are often asked to indebt themselves personally as well. As regards residential mortgages, repayment ability is determined from information contained in the application and recent income tax returns. Emphasis is on credit, employment, income and residency verification. Broad hazard insurance is always required and flood insurance where applicable. In the case of construction mortgages, builders risk insurance is requested. Adjustable rate mortgages are not offered for residential mortgages. Agricultural loans for the purchase or improvement of real estate must meet the Bank's real estate underwriting criteria. The only permissible exception is when a Farmers Home Loan Administration guaranty is obtained. Agricultural loans made for the purchase of equipment are usually payable in five years, but never more than seven, depending upon the useful life of the purchased asset. Minimum borrower equity required is 20%. Livestock financing criteria depends upon the nature of the operation. A dairy herd could be financed over three years, but a feeder operation would require cleanup in intervals of less than one year. Agricultural loans are also made for crop production purposes. Such loans are structured to repay within the production cycle and not carried over into a subsequent year. General purpose working capital loans are also a possibility with repayment expected within one year. It is also a general policy to collateralize non-real estate loans with not only the asset purchased but also junior liens on all other available assets. Insurance and credit criteria is the same as mentioned previously. In addition, annual visits are made to our agricultural customers to determine the general condition of assets. Personal credit requirements are handled as consumer loans. Commercial loans are made for the acquisition and improvement of real estate, purchase of equipment and for working capital purposes on a seasonal or revolving basis. Criteria was discussed under real estate financing for such loans, but it is important to note that such loans may be made in conjunction with the Pennsylvania Industrial Development Authority. Caution is also exercised in taking industrial property for collateral by requiring, on a selective basis, environmental audits. Equipment loans are generally amortized over three to seven years, with an owner equity contribution required of at least 20% of the purchase price. Unusually expensive pieces may be financed for a longer period depending upon the asset's useful life. The increased cash flow resulting from the additional piece, through improved income or greater depreciation expense, serves in establishing the terms. Insurance coverage with the Bank as loss payee is required, especially in the case where the equipment is rolling stock. Seasonal and revolving lines of credit are offered for working capital purposes. Collateral for such a loan includes the pledge of inventory and/or receivables. Drawing availability is usually 50% of inventory and 75% of eligible receivables. Eligible receivables are defined as invoices less than 90 days delinquent. Exclusive reliance is very seldom placed on such collateral, therefore, other lienable assets are also taken into the collateral pool. Where reliance is placed on inventory and accounts receivable, the applicant must provide financial information including agings on a monthly basis. In addition, the guaranty of the principals is usually obtained. It is unusual for Jersey Shore State Bank to make unsecured commercial loans. But when such a loan is a necessity, credit information in the file must support that decision. Letter of Credit availability is limited to standbys where the customer is well known to the Bank. Credit criteria is the same as that utilized in making a direct loan and collateral is obtained in most cases, and whenever the expiration date is for more than one year. Consumer loan products include second mortgages, automobile financing, small loan requests, overdraft check lines and PHEAA referral loans. Our policy includes standards used in the industry on debt service ratios and terms are consistent with prudent underwriting standards and the use of proceeds. Verifications are made of employment and residency, along with credit history. Second mortgages are confined to equity borrowing and home improvements. Terms are generally ten years or less and rates are fixed. Loan to collateral value criteria is 80% or less and verifications are made to determine values. Automobile financing is generally restricted to four years and done on a direct basis. The Bank, as a practice, does not floor plan and therefore does not discount dealer paper. Small loan requests are to accommodate personal needs such as the purchase of small appliances or for the payment of taxes. Overdraft check lines are limited to $5,000 or less. The Bank's investment portfolio is analyzed and priced on a monthly basis. Investments are made in U.S. Treasuries, U.S. Agency issues, bank qualified municipal bonds, corporate bonds and corporate stocks which consist of Pennsylvania bank stocks. Bonds with BAA or better ratings are used, unless a local issue is purchased that has a lesser or no rating. Factors taken into consideration when investments are made include liquidity, the Company's tax position and the policies of the Asset/Liability Committee. The Bank has experienced deposit growth in the range of .96% to 8.83% over the last five years. This growth has primarily come in the form of core deposits. Although the Bank has regular opportunities to bid on pools of funds of $100,000 or more in the hands of municipalities, hospitals and others, it does not rely on these monies to fund loans on intermediate or longer term investments. Minor seasonal growth in deposits is experienced at or near the year end. It is the policy of Jersey Shore State Bank to generally maintain a rate sensitive asset (RSA) to rate sensitive liability (RSL) ratio of 200% of equity for a 6-month time horizon, 175% of equity for a 2-year time horizon and 150% of equity for a 5-year time horizon. The Bank operates 10 full service offices in Lycoming, Clinton, and Centre Counties, Pennsylvania, and a Mortgage/Loan Center in Centre County, Pennsylvania. The economic base of the region is developed around service, light manufacturing industries and agriculture. The banking environment in Lycoming, Clinton and Centre Counties, Pennsylvania is highly competitive. The Bank competes for loans and deposits with commercial banks, savings and loan associations and other financial institutions. The Bank has a relatively stable deposit base and no material amount of deposits is obtained from a single depositor or group of depositors (including federal, state and local governments). The Bank has not experienced any significant seasonal fluctuations in the amount of its deposits. b. Supervision and Regulation The earnings of the Bank are affected by the policies of regulatory authorities including the Federal Deposit Insurance Corporation and the Board of Governors of the Federal Reserve System. An important function of the Federal Reserve System is to regulate the money supply and interest rates. Among the instruments used to implement these objectives are open market operations in U.S. Government Securities, changes in reserve requirements against member bank deposits, and limitations on interest rates that member banks may pay on time and savings deposits. These instruments are used in varying combinations to influence overall growth and distribution of bank loans, investments on deposits, and their use may also affect interest rates charged on loans or paid for deposits. The policies and regulations of the Federal Reserve Board have had and will probably continue to have a significant effect on the Bank's deposits, loans and investment growth, as well as the rate of interest earned and paid, and are expected to affect the Bank's operation in the future. The effect of such policies and regulations upon the future business and earnings of the Bank cannot accurately be predicted. EXECUTIVE OFFICERS OF THE REGISTRANT: NAME AGE FIVE-YEAR ANALYSIS OF DUTIES Theodore H. Reich 62 Chairman of the Company; the Bank; Woods Real Estate Development Co., Inc Inc.; Woods Investment Company, Inc.; and The M Group, Inc. D/B/A The Comprehensive Financial Group. Ronald A. Walko 54 President and Chief Executive Officer of the Company; the Bank; The M Group, Inc. D/B/A The Comprehensive Financial Group; and Woods Investment Company, Inc.; Vice President of Woods Real Estate Development Co., Inc.; and Federal Bank examiner prior to 1986 for an eighteen-year period. Hubert A. Valencik 59 Senior Vice President of the Company; Senior Vice President and Operations Officer of the Bank; Vice President of Woods Real Estate Development Co. Inc.; Vice President - Operations of the M Group Inc., D/B/A The Comprehensive Financial Group; and Vice President with another bank prior to 1985 for a fourteen-year period. Sonya E. Scott 41 Secretary of the Company; Vice President and Controller of the Bank; Secretary and Treasurer of Woods Real Estate Development Co., Inc; Woods Investment Co., Inc; and The M Group Inc., D/B/A The Comprehensive Financial Group. ITEM 2 PROPERTIES The Company owns and leases its properties. Listed herewith are the locations of properties owned or leased, in which the banking offices and Mortgage/Loan Center are located; all properties are in good condition and adequate for the Bank's purposes: <TABLE> <CAPTION> Office Address <S> <C> <C> Main 115 South Main Street Owned P.O. Box 5098 Jersey Shore, Pennsylvania 17740 Bridge Street 112 Bridge Street Owned Jersey Shore, Pennsylvania 17740 DuBoistown 2675 Euclid Avenue Under Lease DuBoistown, Pennsylvania 17702 Williamsport 300 Market Street Owned P.O. Box 967 Williamsport, Pennsylvania 17703-0967 Montgomery RR 1, Box 493 Under Lease Montgomery, Pennsylvania 17752 Lock Haven 4 West Main Street Owned Lock Haven, Pennsylvania 17745 Mill Hall (Inside Wal-Mart), Under Lease 167 Hogan Boulevard Mill Hall, Pennsylvania 17751 Spring Mills Ross Hill Road, P.O. Box 66 Owned Spring Mills, Pennsylvania 16875 Centre Hall RR 2, Route 45 West Land Under Lease Centre Hall, Pennsylvania 16828 Zion 100 Cobblestone Road Under Lease Bellefonte, Pennsylvania 16823 Mortgage/Loan Center Under Lease State College 300 Allen Street State College, Pennsylvania 16801 The M Group, Inc. Under Lease D/B/A The Comprehensive 705 Washington Boulevard Financial Group Williamsport, Pennsylvania 17701 Financial Group </TABLE> ITEM 3 LEGAL PROCEEDINGS In the normal course of business, various lawsuits and claims arise against the Company and its subsidiary. There are no such legal proceedings or claims currently pending or threatened. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 2000. PART II ITEM 5 MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Registrant's Common Stock is traded locally. The following table sets forth (1) the quarterly high and low prices for a share of the Registrant's Common Stock during the periods indicated as reported by the management of the Registrant, and (2) quarterly dividends on a share of the Common Stock with respect to each quarter since January 1, 1998. The following quotations represent prices between buyers and sellers and do not include retail markup, markdown or commission. They may not necessarily represent actual transactions. Dividends HIGH LOW Declared 1998: First quarter $43.64 $29.44 $0.15 Second quarter $48.18 $42.73 $0.15 Third quarter $50.45 $49.09 $0.17 Fourth quarter $51.82 $48.64 $0.41 1999: First quarter $56.36 $51.82 $0.18 Second quarter $54.32 $48.00 $0.20 Third quarter $50.75 $44.75 $0.20 Fourth quarter $47.50 $40.00 $0.43 2000: First quarter $41.00 $29.00 $0.23 Second quarter $31.00 $26.00 $0.23 Third quarter $32.00 $26.00 $0.23 Fourth quarter $33.50 $28.00 $0.41 The stock prices and the dividends have been adjusted to reflect the issuance of a stock split effected in the form of a 100% stock dividend issued on January 15, 1998, and a 10% stock dividend on June 8, 1999. The stock prices and dividends have also been adjusted for the acquisition of the First National Bank of Spring Mills. The Bank has paid cash dividends since December 31, 1941. The Registrant has paid dividends since the effective date of its formation as a bank holding company. It is the present intention of the Registrant's Board of Directors to continue the dividend payment policy; however, further dividends must necessarily depend upon earnings, financial condition, appropriate legal restrictions and other factors relevant at the time the Board of Directors of the Registrant considers dividend policy. Cash available for dividend distributions to shareholders of the Registrant must initially come from dividends paid by the Bank to the Registrant. Therefore, the restrictions on the Bank's dividend payments are directly applicable to the Registrant. Under the Pennsylvania Business Corporation Law of 1988 a corporation may not pay a dividend, if after giving effect thereto, the corporation would be unable to pay its debts as they become due in the usual course of business and after giving effect thereto the total assets of the corporation would be less than the sum of its total liabilities plus the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of the shareholders whose preferential rights are superior to those receiving the dividend. As of March 6, 2000, the Registrant had approximately 1,215 shareholders of record. ITEM 6 SELECTED FINANCIAL DATA The following table sets forth certain financial data as of and for each of the years in the five-year period ended December 31, 2000. <TABLE> <CAPTION> As of and for the Years Ended December 31, 2000 1999 1998 1997 1996 (Dollars in thousands, except per share amounts) <S> <C> <C> <C> <C> <C> Consolidated Statement of Income Data: Interest income $ 28,454 $ 26,030 $ 25,096 $ 23,146 $ 22,074 Interest expense 12,778 10,518 10,529 9,324 8,985 -------- -------- -------- -------- -------- Net interest income 15,676 15,512 14,567 13,822 13,089 Provision for loan losses 286 286 305 274 137 -------- -------- -------- -------- -------- Net interest income after provision for loan losses 15,390 15,226 14,262 13,548 12,952 -------- -------- -------- -------- -------- Other income 2,358 3,527 3,435 5,921 2,611 Other expense 9,563 9,339 9,065 8,219 7,726 -------- -------- -------- -------- -------- Income before income taxes 8,185 9,414 8,632 11,250 7,837 Applicable income taxes 1,619 2,224 2,164 3,113 2,082 -------- -------- -------- -------- -------- Net Income $ 6,566 $ 7,190 $ 6,468 $ 8,137 $ 5,755 ======== ======== ======== ======== ======== Consolidated Balance Sheet at End of Period: Total assets $394,913 $373,742 $341,601 $314,562 $287,787 Loans 246,486 233,823 216,566 204,756 177,910 Allowance for loan losses (2,879) (2,823) (2,681) (2,579) (2,553) Deposits 278,134 255,573 253,134 242,806 224,356 Long-term debt -- other 31,778 27,278 22,778 3,500 2,260 Stockholders' equity 50,514 46,085 49,896 47,392 27,734 Per Share Data: Net income Earnings per share - basic $ 2.10 $ 2.30 $ 2.08 $ 2.62 $ 1.86 Earnings per share - diluted 2.10 2.30 2.07 2.61 1.86 Cash dividends declared 1.10 1.01 0.88 0.75 0.54 Book value 16.31 14.75 15.97 13.94 11.14 Number of shares outstanding, at end of period 3,097,293 3,123,372 2,837,167 1,545,250 1,539,769 Average number of shares outstanding 3,119,540 3,121,413 3,114,376 3,101,203 3,087,735 Selected financial ratios: Return on average stockholders' equity 13.77% 14.96% 13.06% 18.94% 16.37% Return on average total assets 1.74% 1.99% 1.94% 2.73% 2.06% Net interest income to average interest earning assets 4.35% 4.63% 4.77% 5.20% 5.05% Dividend payout ratio 52.18% 44.20% 42.59% 28.72% 29.11% Average stockholders' equity to average total assets 12.62% 13.81% 15.04% 14.51% 12.61% Loans to deposits, at end of period 88.62% 90.39% 84.49% 83.27% 78.16% </TABLE> Per share data and number of shares outstanding have been adjusted in each reporting period to give retroactive effect to a stock split effected in the form of a 100% stock dividend issued January 15, 1998, and a 10% stock dividend issued June 8, 1999. In addition, all financial data has been adjusted for the acquisition of the First National Bank of Spring Mills in 1999. ITEM 7 Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations RESULTS OF OPERATIONS NET INTEREST INCOME Net interest income is determined by calculating the difference between the yields earned on interest earning assets and the rates paid on interest bearing liabilities. 2000 vs 1999 Fully taxable equivalent net interest income increased $556,000 (3.4%) to $16,952,000 for the year ended December 31, 2000. Income related to volume increased $872,000 while income related to rates decreased $316,000. Total interest-earning average assets increased $25,281,000 from the year ended December 31, 1999 to the year ended December 31, 2000. The volume increases in total interest- earning average assets is comprised of a 7.4% or $16,629,000 increase in total average loans and a 7.8% or $8,652,000 increase in total average securities. The volume increases in interest-earning average assets accounts for $2,280,000 of the $2,816,000 increase in total interest income on earning assets. An increase of $536,000 was due to rate changes. Loans contributed $1,692,000 to the total income, $1,503,000 attributable to volume and $189,000 due to rate changes. Tax-exempt investment securities added $1,224,000 to interest income while net taxable investment securities reduced income $100,000. Total interest-bearing liabilities increased $22,010,000 or 8.4% during the year ended December 31, 2000. The expense related to the volume increases contributed $1,408,000 to the net interest expense increase of $2,260,000. The increase of $852,000 was due to rate increases. The volume increases of other time deposits, short-term borrowings and other borrowings explain $1,523,000 of the expense related to volume. A decline in the average balance of savings deposits reduced the expense by $115,000 due to volume. The $852,000 increase in expense related to rate changes is comprised of a $541,000 increase due to deposits and a $311,000 increase in borrowings. The effective interest differential fell 19 basis points to 4.71% in 2000. Amid inflation fears, the Federal Reserve increased the federal funds target rate in 2000. The rate increases have positively effected loan rates and interest income on earning assets by 22 basis points. Due to competitive deposit pricing, interest expense on interest-bearing deposits also increased 41 basis points. 1999 vs 1998 Taxable equivalent net interest income increased 5.2% or $804,000, to $16,396,000 from year end 1998 to year end 1999. The increase is mostly attributable to an increase in tax exempt investment securities volume of $1,618,000 and a $167,000 decline in the rate creating a net increase of $1,451,000. A net decrease in taxable investment securities of $511,000 and a $147,000 decrease in loans, moderates the increase of total interest-earning assets to $793,000. Total average interest-earning assets increased to $334,680,000 in 1999. The $29,488,000 increase over the previous year consisted of an $18,713,000 increase in total average securities and an increase of $10,775,000 in total average loans. Total average interest-bearing liabilities increased $23,577,000 during 1999. The increase was primarily due to an increase in other borrowings of $9,878,000. Other contributors include an increase in short-term borrowings of $8,442,000 and a $5,257,000 increase to total deposits. The effective interest differential declined 21 basis points during 1999. The decrease was due to the net effect of an interest rate decrease in total average earning assets and a rate increase in total average interest bearing liabilities. Competitive pressures and target interest rate increases by the Federal Reserve have resulted in upward interest rate pressure. AVERAGE BALANCES AND INTEREST RATES (INCOME AND RATES ON A FULLY TAXABLE EQUIVALENT BASIS) (IN THOUSANDS) <TABLE> <CAPTION> 2000 1999 1998 AVERAGE AVERAGE AVERAGE AVERATE AVERAGE AVERAGE BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> ASSETS: Interest-earning assets: Securities: U.S. Treasury and federal agency..................... $ 33,760 $ 2,361 6.99% $ 39,906 $ 2,513 6.30% $ 48,970 $ 3,186 6.51% State and political subdivisions.............. 59,085 4,577 7.75% 43,291 3,353 7.75% 22,134 1,902 8.59% Other....................... 27,147 1,082 3.99% 28,143 1,030 3.66% 21,523 868 4.03% Total securities.......... 119,992 8,020 6.68% 111,340 6,896 6.19% 92,627 5,956 6.43% LOANS: Tax-exempt loans................ 5,164 412 7.98% 6,157 487 7.91% 6,742 520 7.71% All other loans, net of discount where applicable...... 234,805 21,298 9.07% 217,183 19,531 8.99% 205,823 19,645 9.54% Total loans............... 239,969 21,710 9.05% 223,340 20,018 8.96% 212,565 20,165 9.49% Total interest-earning assets.................. 359,961 $29,730 8.26% 334,680 $26,914 8.04% 305,192 $26,121 8.56% Other assets.................... 18,027 21,096 25,308 TOTAL ASSETS............ $377,988 $355,776 $330,500 LIABILITIES AND SHAREHOLDERS' EQUITY: Interest-bearing liabilities: Deposits: Savings..................... $ 91,288 $ 1,907 2.09% $ 94,200 $ 1,965 2.09% $ 89,438 $ 2,475 2.77% Other time.................. 131,427 7,258 5.52% 118,461 5,933 5.01% 117,966 6,390 5.42% Total deposits............ 222,715 9,165 4.12% 212,661 7,898 3.71% 207,404 8,865 4.27% Short-term borrowings........... 31,813 1,866 5.87% 23,524 1,197 5.09% 15,082 771 5.11% Other borrowings................ 29,159 1,747 5.99% 25,492 1,423 5.58% 15,614 893 5.72% Total interest-bearing liabilities............. 283,687 $12,778 4.50% 261,677 $10,518 4.02% 238,100 $10,529 4.42% Demand deposits................. 42,765 41,071 36,592 Other liabilities............... 3,837 3,912 6,097 Shareholders' equity............ 47,699 49,116 49,711 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.. $377,988 $355,776 $330,500 Interest income/earning assets...................... $359,961 $29,730 8.26% $334,680 $26,914 8.04% $305,192 $26,121 8.56% Interest expense/earning assets...................... $359,961 12,778 3.55% $334,680 10,518 3.14% $305,192 10,529 3.45% Effective interest differential................ $16,952 4.71% $16,396 4.90% $15,592 5.11% </TABLE> 1. Fees on loans are included with interest on loans. 2. Information on this table has been calculated using average daily balance sheets to obtain average balances. 3. Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings. 4. Loan fees are included in interest income as follows: 2000, $411,000, 1999, $601,000, 1998, $623,000. 5. Income and rates on a fully taxable equivalent basis include an adjustment for the difference between annual income from tax-exempt obligations and the taxable equivalent of such income at the standard 34% tax rate (derived by dividing tax-exempt interest by .66). SUMMARY OF CHANGES IN INTEREST EARNED AND INTEREST PAID (IN THOUSANDS) Rate/Volume Analysis The table below sets forth certain information regarding changes in our interest income and interest expense for the periods indicated. For interest-earning assets and interest- bearing liabilities, information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by old rate); (ii) changes in rates (changes in rate multiplied by old average volume). Increases and decreases due to both rate and volume, which cannot be separated, have been allocated proportionally to the change due to volume and the change due to rate. <TABLE> <CAPTION> Year Ended December 31, 2000 vs 1999 1999 vs 1998 Increase (Decrease) Increase (Decrease) Due to Due to Volume Rate Net Volume Rate Net <S> <C> <C> <C> <C> <C> <C> Interest income: Taxable investment securities $ (446) $ 346 $ (100) $ (342) $ (169) $ (511) Tax-exempt investment securities 1,223 1 1,224 1,618 (167) 1,451 Loans 1,503 189 1,692 1,651 (1,798) (147) Total interest-earning assets $2,280 $ 536 $2,816 $2,927 $(2,134) $ 793 Interest expenses: Savings deposits $ (115) $ 57 $ (58) $ 142 $ (652) $ (510) Other time deposits 841 484 1,325 17 (474) (457) Short-term borrowings 467 202 669 430 (4) 426 Other borrowings 215 109 324 551 (21) 530 Total interest-bearing liabilities $1,408 $ 852 $2,260 $1,140 $(1,151) $ (11) Change in net interest income $ 872 $(316) $ 556 $1,787 $ (983) $ 804 </TABLE> PROVISION FOR LOAN LOSSES 2000 vs 1999 The allowance for loan losses increased 2.0% or $56,000 from fiscal 1999 after net charge-offs of $230,000 contributing to a year end allowance for loan losses of $2,879,000. This allotment recognized the prior year end allowance for loan losses balance, overall loan performance and anticipated recoveries. Each quarter management conducts comprehensive, detailed credit reviews of the loan portfolio to determine the adequacy of the provision. Supplementing the internal review is an external review. In so doing, management remains committed to an aggressive program of problem loan identification and resolution. 1999 vs 1998 The allowance for loan losses increased 5.3% or $142,000 from fiscal 1998 after net charge-offs of $144,000 contributing to a year end allowance for loan losses of $2,823,000. <TABLE> <CAPTION> Year Ended December 31, (In Thousands) 2000 1999 1998 1997 1996 <C> <C> <C> <C> <C> <C> Balance at beginning of period............... $2,823 $2,681 $2,579 $2,553 $2,473 Charge-offs: Domestic: Real estate............................ 165 50 - - 4 Commercial and industrial.............. 38 28 91 183 100 Installment loans to individuals....... 66 98 180 176 152 Total charge-offs.................... 269 176 271 359 256 Recoveries: Real estate............................ 8 4 - 2 - Commercial and industrial.............. 20 11 29 68 175 Installment loans to individuals....... 11 17 39 41 24 Total recoveries..................... 39 32 68 111 199 Net charge-offs............................ 230 144 203 248 57 Additions charged to operations............ 286 286 305 274 137 Balance at end of period................... $2,879 $2,823 $2,681 $2,579 $2,553 Ratio of net charge-offs during the period to average loans outstanding during the period............ 0.10% 0.06% 0.09% 0.14% 0.03% </TABLE> OTHER INCOME 2000 vs 1999 Total other income for the year ended December 31, 2000 decreased 33.1% or $1,169,000 from 1999. Most of the decrease resulted from securities gains taken during 2000 versus 1999. Securities gains realized during 2000 were $269,000 versus $1,946,000 realized in 1999. Market conditions in 1999 provided more opportunity for the Company to take security gains than in 2000. The Company also realized losses on debt securities in efforts to prudently position its assets and liabilities. Income on service charges increased $207,000 or 15.2% from 1999. The growth is mainly due to an increase in the fees collected on deposit accounts. Other operating income increased $301,000 to $524,000 in 2000. The substantial increase over 1999's other operating income of $223,000 was mostly due to commission income recognized from the sale of various financial products, sold by the Bank's newly acquired subsidiary, The M Group. 1999 vs 1998 Total other income at December 31, 1999 was $3,527,000 versus 1998's year end total of $3,435,000. This $92,000 increase resulted from the net effect of an increase in service charges collected of $258,000, a decrease in securities gains realized of $130,000 and a decrease in other operating income of $36,000. A significant portion of the increase in service charge income, of $105,000, is due to the growth in the deposit base and an increase in charges collected on deposit accounts. Other major factors include an increase of $153,000 in income based upon ATM and debit card usage. During 1999 securities gains realized amounted to $1,946,000 versus $2,076,000 realized in 1998. OTHER EXPENSES 2000 vs 1999 Other expenses at December 31, 2000 increased $224,000 or 2.4% from year end 1999. Expenses relating to salaries and employee benefits increased $144,000 or 3.0% from 1999 due to normal wage increases and the addition of the Bank's subsidiary, The M Group. Occupancy expense during 2000 increased $68,000 over 1999 expenses. The majority of this expense was due to the first full year's operation of the Zion branch and painting expense in the Williamsport branch. Furniture and equipment expense increased 10.0% in 2000 to $756,000. The $69,000 increase from 1999 year end amount of $687,000 resulted mostly from costs associated with the acquisition of additional computer equipment to accommodate the implementation of internet and telephone banking. Other operating expenses decreased $57,000 to $3,062,000 during 2000. Expenses relating to directors insurances represent the majority of the decrease. 1999 vs 1998 When comparing the year ended December 31, 1999 with the year ended December 31, 1998, there was a $274,000 or 3.0% increase in other expenses. Salaries and employee benefits expensed during 1999 increased by $72,000 over the amount expensed during 1998 due to normal wage increases. Occupancy, furniture and equipment expense decreased in 1999 by $11,000 compared to 1998. The net effect of a $39,000 increase in occupancy expense and a decrease of $50,000 in furniture and equipment expense account for this decrease. The increase in occupancy expense is related to the opening of a new branch office in Zion. The decrease in furniture and equipment expense is attributable to a decline in the monthly cost of the IBM computer lease offset by the increase in depreciation on new equipment. Other operating expenses, the final component of total other expenses increased by $213,000. The most significant increases occurred in bookkeeping and data processing, check imprinting, stationery and supplies and ATM expenses. Those increases were mainly due to the merger of the First National Bank of Spring Mills and the opening of the Zion branch. INCOME TAXES 2000 vs 1999 The provision for income taxes for the year ended December 31, 2000 resulted in an effective income tax rate of 19.8% compared to 23.6% for 1999. The 3.8% decline is attributable to the increase in tax-exempt interest earned when comparing 2000 to 1999. 1999 vs 1998 Income tax expense recognized in 1999 was $2,224,000 compared to $2,164,000 in 1998, resulting in an effective income tax rate of 23.6% and 25.1% for 1999 and 1998, respectively. The increase in tax-exempt income from 1998 to 1999 caused a 1.5% decline in the effective tax rate. FINANCIAL CONDITION INVESTMENTS 2000 The investment portfolio increased $2,831,000 or 2.4% in 2000. The increase is mostly attributable to an increase of $19,167,000 in the state and political subdivisions category and a decrease in the U.S. Government agencies category of $11,363,000 and corporate stock of $4,449,000. U.S. Treasury securities and other bonds, notes and debentures also decreased $524,000. The total investment portfolio at year end 2000 comprised of 22.7% U.S. Government agency and treasury securities, 57.5% state and political subdivisions, 18.6% equity securities and 1.2% other bonds, notes and debentures. Held to Maturity securities had a carrying value of $3,228,000. Available for sale securities occupied 97.3% of the total portfolio and had an amortized cost of $117,149,000 with an estimated market value of $115,922,000. The unrealized loss of $1,227,000 effected shareholders' equity by $(810,000), net of deferred taxes. 1999 The investment portfolio increased in 1999 by $10,918,000 due to net increases in U.S. Government agencies and state and political subdivisions of $19,135,000 and a decrease in U.S. Treasury securities, other bonds, notes and debentures and corporate stock of $8,217,000. The total investment portfolio at year end 1999 was comprised of 33.4% U.S. Government agency and treasury securities, 42.4% state and political subdivisions, 22.9% equity securities and 1.3% other bonds, notes and debentures. Held to maturity securities had a carrying value of $3,014,000. The largest portion of the portfolio is classified as available for sale and had an amortized cost of $117,740,000 with an estimated market value of $113,305,000. Due to the unrealized loss on available for sale securities of $4,435,000, shareholders' equity was effected by $(2,927,000), net of deferred taxes. Management has significantly increased holdings in tax free municipals which has served to increase its after- tax yield. The decrease in corporate stock is due to the net effect of purchases and sales in addition to the change in the net unrealized gain from year end 1998. The carrying amounts of investment securities at the dates indicated are summarized as follows ( in thousands): DECEMBER 31, 2000 1999 1998 U.S. Treasury securities: Held to maturity $ - $ - $ - Available for sale 3,046 3,504 10,866 U.S. Government agencies: Held to maturity 206 259 339 Available for sale 23,820 35,130 35,112 State and political subdivisions: Held to maturity 2,712 2,465 2,464 Available for sale 65,749 46,829 27,633 Other bonds, notes and debentures: Held to maturity 310 290 275 Available for sale 1,127 1,213 701 Total bonds, notes and debentures 96,970 89,690 77,390 Corporate stock -Available for sale 22,180 26,629 28,011 Total $119,150 $116,319 $105,401 The following table shows the maturities and repricing of investment securities at December 31, 2000 and the weighted average yields (for tax-exempt obligations on a fully taxable basis assuming a 34% tax rate) of such securities (in thousands): WITHIN AFTER ONE AFTER FIVE AFTER ONE BUT WITHIN BUT WITHIN TEN YEAR FIVE YEARS TEN YEARS YEARS U.S. Treasury securities: HTM Amount $ - $ - $ - $ - Yield - - - - AFS Amount - 2,989 - - Yield - 6.34% - - U.S. Government agencies: HTM Amount - - - 206 Yield - - - 8.83% AFS Amount - - 2,000 21,655 Yield - - 8.10% 7.50% State and political subdivisions: HTM Amount 890 250 532 1,040 Yield 6.68% 6.90% 7.84% 7.98% AFS Amount - 320 - 66,245 Yield - 9.63% - 5.85% Other bonds, notes and debentures: HTM Amount 25 185 100 - Yield 8.50% 7.56% 6.71% - AFS Amount - - - 1,139 Yield - - - 7.30% Total Amount $ 915 $3,744 $2,632 $90,285 Total Yield 6.73% 6.72% 8.00% 6.30% All yields represent weighted average yields expressed on a tax equivalent basis. They are calculated on the basis of the cost, adjusted for amortization of premium and accretion of discount and effective yields weighted for the scheduled maturity of each security. The taxable equivalent adjustment represents the difference between annual income from tax-exempt obligations and the taxable equivalent of such income at the standard 34% tax rate (derived by dividing tax-exempt interest by .66). LOAN PORTFOLIO 2000 At December 31, 2000, gross loans totaled $246,486,000, an increase of $12,663,000 or 5.4% over year end 1999. While commercial, agricultural and installment loans to individuals decreased from 1999, loans secured by real estate mortgages grew by $19,889,000 or 11.1%. Residential real estate mortgages increased $9,696,000 (7.9%). Commercial real estate mortgages grew by 17.8% or $9,177,000. Construction real estate mortgages increased $1,016,000 (27.2%). Commercial and agricultural loans decreased $5,264,000 (16.6%) and installment loans to individuals declined $1,962,000 or 8.3%. 1999 Gross loans totaled $233,823,000 at year end, an increase of $17,257,000 or 8.0% over fiscal 1998. Our commercial and agricultural loan portfolio declined $1,185,000 (3.6%) and installment loans to individuals declined $986,000 (4.0%). These reductions were offset by a $19,428,000 (12.2%) increase in our real estate secured portfolio. Contributing to this volume are increases of $11,687,000 (10.5%) in residential mortgages, $7,883,000 (18.1%) in commercial mortgages and a $142,000 (3.7%) decline in construction loans. A viable local economy and marketable lending practices are responsible for this overall increase. The amount of loans outstanding at the indicated dates are shown in the following table according to type of loan (in thousands): <TABLE> <CAPTION> December 31, 2000 1999 1998 1997 1996 <S> <C> <C> <C> <C> <C> Domestic: Commercial and agricultural $ 26,471 $ 31,735 $ 32,920 $ 38,631 $ 38,999 Real estate mortgage: Residential 133,088 123,392 111,705 109,767 98,069 Commercial 60,622 51,445 43,562 32,670 21,600 Construction 4,748 3,732 3,874 3,011 1,512 Installment loans to individuals 21,557 23,519 24,505 23,508 20,452 Gross loans $246,486 $233,823 $216,566 $207,587 $180,632 </TABLE> The amounts of domestic loans at December 31, 2000 are presented below by category and maturity (in thousands): <TABLE> <CAPTION> COMMERCIAL INSTALLMENT AND LOANS TO REAL ESTATE OTHER INDIVIDUALS TOTAL <S> <C> <C> <C> c> Loans with floating interest rates: 1 year or less $ 7,844 $ 7,067 $ 1,573 $ 16,484 1 through 5 years 2,305 683 10 2,998 5 through 10 years 6,949 1,160 182 8,291 After 10 years 22,297 220 114 22,631 Sub Total 39,395 9,130 1,879 50,404 Loans with predetermined interest rates: 1 year or less 3,849 1,308 2,062 7,219 1 through 5 years 16,599 8,692 14,442 39,733 5 through 10 years 35,722 4,218 1,686 41,626 After 10 years 102,893 3,123 1,488 107,504 Sub Total 159,063 17,341 19,678 196,082 Total $198,458 $26,471 $21,557 $246,486 </TABLE> (1) The loan maturity information is based upon original loan terms and is not adjusted for "rollovers". In the ordinary course of business, loans maturing within one year may be renewed, in whole or in part, as to principal amount at interest rates prevailing at the date of renewal. (2) Scheduled repayments are reported in maturity categories in which the payment is due. The Bank does not make loans that provide for negative amortization nor do any loans contain conversion features. The Bank does not have any foreign loans outstanding at December 31, 2000. ALLOWANCE FOR LOAN LOSSES 2000 At December 31, 2000, the allowance for loan losses stood at $2,879,000 or 1.2% of gross loans. This was a $56,000 (2.0%) increase over year end 1999. The adequacy of the loan loss allowance is determined quarterly in unison with management's comprehensive review of the loan portfolio credit quality. Reviews are further enhanced by analyses of recent and past economic conditions, portfolio trends and growth, peer comparisons and other factors impacting overall credit quality. Underwriting continues to emphasize the need for security and adequate collateral margins. Nonaccruing loans increased $493,000 (173.6%) to $777,000 from year end 1999. Overall nonperforming loans increased $279,000 (53.1%) to $804,000 from fiscal 1999. 1999 At December 31, 1999, the allowance for loan losses stood at $2,823,000 or 1.2% of gross loans. This was a $142,000 (5.3%) increase over year end 1998. The adequacy of the loan loss allowance is determined quarterly in unison with management's comprehensive review of the loan portfolio of credit quality. Reviews are further enhanced by analyses of recent and past economic conditions, portfolio trends and growth, peer comparisons and other factors impacting overall credit quality. Underwriting continues to emphasize the need for security and adequate collateral margins. Nonaccruing loans declined $362,000 (56.0%) to $284,000 from year end 1998. Overall nonperforming loans were reduced $181,000 (25.6%) to $525,000 from fiscal 1998. At December 31, 1999, 37.3% of nonaccruing loans were meeting contractual obligations and three of the five loans are real estate secured. The following table presents information concerning nonperforming loans. The accrual of interest will be discontinued when the principal or interest of a loan is in default for 90 days or more, or as soon as payment is questionable, unless the loan is well secured and in the process of collection. Consumer loans and residential real estate loans secured by 1 to 4 family dwellings shall ordinarily not be subject to those guidelines. The reversal of previously accrued but uncollected interest applicable to any loan placed in a nonaccrual status and the treatment of subsequent payments of either principal or interest will be handled in accordance with generally accepted accounting principles. Generally accepted accounting principles do not require a write-off of previously accrued interest if principal and interest are ultimately protected by sound collateral values. A nonperforming loan may be restored to an accruing status when: 1. Principal and interest is no longer due and unpaid. 2. It becomes well secured and in the process of collection. 3. Prospects for future contractual payments are no longer in doubt. TOTAL NONPERFORMING LOANS (IN THOUSANDS) 90 DAYS NONACCRUAL PAST DUE RENEGOTIATED 2000 $777 $ 27 -- 1999 $284 $241 -- 1998 $646 $ 60 -- 1997 $552 $430 -- 1996 $748 $278 -- If interest had been recorded at the original rate on nonaccrual loans, such income would have approximated $86,000, $48,000 and $98,000 for the years ended December 31, 2000, 1999 and 1998, respectively. Interest income on such loans, which is recorded when received, amounted to approximately $45,000, $38,000 and $50,000 for the years ended December 31, 2000, 1999 and 1998, respectively. The significant reduction in nonaccruing loans from 1996 to 1999 is attributed to a strengthening in underwriting standards and the successful culmination of several commercial loan workouts. The return of nonaccruing loans to the level experienced in years prior to 2000 is attributed to the various economic factors experienced both regionally and nationally. Overall the portfolio is well secured with a majority of the balance making regular payments or scheduled to be satisfied in the near future. Presently there are no significant amounts of loans where serious doubts exist as to the ability of the borrower to comply with the current loan payment terms which are not included in the nonperforming categories as indicated above. Management's judgment in determining the amount of the additions to the allowance charged to operating expense considers the following factors: 1. Economic conditions and the impact on the loan portfolio. 2. Analysis of past loan charge-offs experienced by category and comparison to outstanding loans. 3. Problem loans on overall portfolio quality. 4. Reports of examination of the loan portfolio by the Pennsylvania State Banking Department and the Federal Deposit Insurance Corporation. ALLOCATION IN THE ALLOWANCE FOR LOAN LOSSES (IN THOUSANDS) PERCENT OF LOANS IN EACH CATEGORY TO AMOUNT TOTAL LOANS DECEMBER 31, 2000: Balance at end of period applicable to: Domestic: Commercial and agricultural $ 541 10.7% Real estate mortgage: Residential 1,211 54.1% Commercial 723 24.6% Construction 71 1.9% Installment loans to individuals 306 8.7% Unallocated general allowance 27 - Total $2,879 100.0% DECEMBER 31, 1999: Balance at end of period applicable to: Domestic: Commercial and agricultural $ 531 13.5% Real estate mortgage: Residential 1,186 52.8% Commercial 710 22.0% Construction 70 1.6% Installment loans to individuals 300 10.1% Unallocated general allowance 26 - Total $2,823 100.0% DECEMBER 31, 1998: Balance at end of period applicable to: Domestic: Commercial and agricultural $ 505 15.2% Real estate mortgage: Residential 1,126 51.6% Commercial 673 20.1% Construction 67 1.8% Installment loans to individuals 284 11.3% Unallocated general allowance 26 - Total $2,681 100.0% DECEMBER 31, 1997: Balance at end of period applicable to: Domestic: Commercial and agricultural $ 485 18.6% Real estate mortgage: Residential 1,083 52.9% Commercial 647 15.7% Construction 65 1.5% Installment loans to individuals 273 11.3% Unallocated general allowance 26 - Total $2,579 100.0% DECEMBER 31, 1996: Balance at end of period applicable to: Domestic: Commercial and agricultural $ 480 21.6% Real estate mortgage: Residential 1,072 54.3% Commercial 641 12.0% Construction 64 0.8% Installment loans to individuals 271 11.3% Unallocated general allowance 25 - Total $2,553 100.0% DEPOSITS 2000 Overall average deposits increased $11,748,000 or 4.6% to $265,480,000 over 1999's average deposits of $253,732,000. Demand deposits grew slightly by $2,063,000 with noninterest and interest-bearing demand increasing $1,694,000 and $369,000, respectively. Savings deposits declined by $3,281,000. The majority of the decline was due to a shift from savings deposits to time deposits, with average time deposits increasing by $12,966,000 over 1999's average time deposits. The Bank's ability to offer competitive products during a period of rising interest rates attracted such deposits. 1999 All categories of deposits increased with demand deposits showing the most significant growth of 12.2%. Interest bearing deposits grew $5,257,000 while noninterest-bearing deposits increased $4,479,000. Together interest and noninterest-bearing deposits add $9,736,000 to the increase of total average deposits. Savings deposits increased $2,354,000 or 5.0% from year end 1998 to year end 1999. Time deposits remained stable, increasing only $495,000 in 1999. The reduction of growth in time deposits from 1998 to 1999 as compared to 1997 to 1998 is reflective of a highly competitive market for funds. Relatively high consumer spending ignited growth in transaction accounts. Time deposits of $100,000 or more totaled approximately $31,148,000 on December 31, 2000 and $24,308,000 on December 31, 1999. Interest expense related to such deposits was approximately $1,571,000, $1,242,000 and $1,238,000 for the years ended December 31, 2000, 1999 and 1998, respectively. Time deposits of $100,000 or more at December 31, 2000 mature as follows: 2001 - $27,110,000; 2002 - $3,014,000; 2003 - $524,000; beyond 2005 - $500,000. The average amount and the average rate paid on deposits are summarized below (in thousands): <TABLE> <CAPTION> 2000 1999 1998 AVERAGE AVERAGE AVERAGE AMOUNT RATE AMOUNT RATE AMOUNT RATE <S> <C> <C> <C> <C> <C> <C> DEPOSITS IN DOMESTIC BANK OFFICES: Demand deposits: Noninterest-bearing $ 42,765 0.00% $ 41,071 0.00% $ 36,592 0.00% Interest-bearing 45,464 2.17% 45,095 2.15% 42,687 2.56% Savings deposits 45,824 2.00% 49,105 2.03% 46,751 2.96% Time deposits 131,427 5.52% 118,461 5.01% 117,966 5.42% Total average deposits $265,480 $253,732 $243,996 </TABLE> SHAREHOLDERS' EQUITY 2000 Shareholders' equity is evaluated in relation to total assets and the risk associated with those assets. A company is more likely to meet its cash obligations and absorb unforeseen losses when the capital resources are greater. Total shareholders' equity at December 31, 2000 was $50,514,000, increasing $4,429,000 from the balance at December 31, 1999 of $46,085,000. Net income and the exercising of stock options contributed $6,566,000 and $74,000, respectively, to shareholders' equity. The unrealized appreciation on securities also added $2,117,000 to total equity. Reductions to shareholders' equity included $3,426,000 that was paid out in dividends and $902,000 for the purchase of treasury stock. 1999 Total shareholders' equity at December 31, 1999 was $46,085,000, decreasing by $3,811,000 from the balance at December 31, 1998 of $49,896,000. Net income and the exercising of stock options contributed $7,190,000 and $118,000, respectively, to shareholders' equity. The overall decline in total shareholders' equity is largely attributed to the decrease in the unrealized appreciation on securities. Additional reductions to shareholders' equity included $3,178,000 that was paid out in dividends and $56,000 for the purchase of treasury stock. Bank regulators have risk based capital guidelines. Under these guidelines, banks are required to maintain minimum ratios of core capital and total qualifying capital as a percentage of risk weighted assets and certain off-balance sheet items. At December 31, 2000, the Company's required ratios were well above the minimum ratios as follows: 2000 Minimum Company Standards Tier 1 capital ratio 20.05% 8.00% Total capital ratio 18.91% 4.00% For a more comprehensive discussion of these requirements, see "Regulations and Supervision" on the Form 10K. Management believes that the Company will continue to exceed regulatory capital requirements. RETURN ON EQUITY AND ASSETS: The ratio of net income to average total assets and average shareholders' equity and certain ratios are presented as follows: 2000 1999 1998 Percentage of net income to: Average total assets 1.74% 1.99% 1.94% Average shareholders' equity 13.77% 14.96% 13.06% Percentage of dividends declared per common share 52.18% 44.20% 42.59% Percentage of average shareholders' equity to average total assets 12.62% 13.81% 15.04% LIQUIDITY, INTEREST RATE SENSITIVITY AND MARKET RISK Fundamental objectives of the Company's asset/liability management process are to maintain adequate liquidity while minimizing interest rate risk. The maintenance of adequate liquidity provides the Company with the ability to meet its financial obligations to depositors, loan customers and stockholders. Additionally, it provides funds for normal operating expenditures and business opportunities as they arise. The objective of interest rate sensitivity management is to increase net interest income by managing interest sensitive assets and liabilities in such a way that they can be repriced in response to changes in market interest rates. Liquidity is generated from transactions relating to both the Company's assets and liabilities. Liquidity from assets is achieved primarily through temporary investments in Federal funds sold and time deposits with financial institutions. Cash receipts arising from normal customer loan payments provide another important source of asset related liquidity. On the liability side, deposit growth and temporary borrowings from the Federal Home Loan Bank of Pittsburgh's Open Repo Plus product provide liquidity. The liquidity provided by these sources is more than adequate to meet the Company's needs. Interest rate sensitivity, which is closely related to liquidity management, is a function of the repricing characteristics of the Company's portfolio of assets and liabilities. Asset/liability management strives to match maturities and rates between loan and investment security assets with the deposit liabilities and borrowings that fund them. Successful asset/liability management results in a balance sheet structure which can cope effectively with market rate fluctuations. The matching process is affected by segmenting both assets and liabilities into future time periods (usually 12 months, or less) based upon when repricing can be effected. Repriceable assets are subtracted from repriceable liabilities, for a specific time period to determine the "gap", or difference. Once known, the gap is managed based on predictions about future market interest rates. Intentional mismatching, or gapping, can enhance net interest income if market rates move as predicted. However, if market rates behave in a manner contrary to predictions, net interest income will suffer. Gaps, therefore, contain an element of risk and must be prudently managed. In addition to gap management, the Company has an asset liability management policy which incorporates a market value at risk calculation which is used to determine the effects of interest rate movements on shareholders' equity and a simulation analysis to monitor the effects of interest rate changes on the Company's balance sheets. INTEREST RATE SENSITIVITY The following table sets forth the Company's interest rate sensitivity as of December 31, 2000: <TABLE> <CAPTION> AFTER ONE AFTER TWO AFTER WITHIN BUT WITHIN BUT WITHIN FIVE ONE YEAR TWO YEARS FIVE YEARS YEARS <S> <C> <C> <C> <C> Earning assets:(1)(2) Investment securities(1) $ 15,214 $ 6,751 $ 13,558 $ 85,050 Loans(2) 87,604 35,751 101,362 21,770 Total earning assets $102,818 $ 42,502 $114,920 $106,820 Interest-bearing liabilities: Deposits(3) $121,401 $ 39,505 $ 43,013 $ 26,747 Borrowings 25,856 - 36,943 - Total interest-bearing liabilities $147,257 $ 39,505 $ 79,956 $ 26,747 Net noninterest-bearing funding(4) 7,360 7,360 22,079 36,796 Total net funding sources $154,617 $ 46,865 $102,035 $ 63,543 Excess assets (liabilities) (51,799) (4,363) 12,885 43,277 Cumulative excess assets (liabilities) (51,799) (56,162) (43,277) - </TABLE> (1) Investment balances reflect estimated prepayments on mortgage-backed securities. (2) Loan balances include annual repayment assumptions based on projected cash flow from the loan portfolio. The cash flow projections are based on the terms of the credit facilities and estimated prepayments on fixed rate mortgage loans. Loans include loans held for resale. (3) Adjustments to the interest sensitivity of Savings, NOW and MMDA account balances reflect managerial assumptions based on historical experience, expected behavior in future rate environments and the Company's positioning for these products. (4) Net noninterest-bearing funds is the sum of noninterest- bearing liabilities and shareholders' equity minus noninterest-earning assets and reflect managerial assumptions as to the appropriate maturity categories. In this analysis the Company examines the result of a 100 and 200 basis point change in market interest rates and the effect on net interest income. It is assumed that the change is instantaneous and that all rates move in a parallel manner. Assumptions are also made concerning prepayment speeds on mortgage loans and mortgage securities. The results of this rate shock are a useful tool to assist the Company in assessing interest rate risk inherent in its balance sheet. Below are the results of this rate shock analysis for the periods indicated: December 31, 2000 Net Interest Income Change Changes in (After Tax) Rates (In thousands) -200 $ 256 -100 $ 215 +100 $ (36) +200 $ (190) The model utilized to create the report presented above makes various estimates at each level of interest rate change regarding cash flow from principal repayment on loans and mortgage-backed securities and or call activity on investment securities. Actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change. In addition, the limits stated above do not necessarily represent the level of change under which management would undertake specific measure to realign its portfolio in order to reduce the projected level of change. Generally, management believes the Company is well positioned to respond expeditiously when the market interest rate outlook changes. INFLATION The asset and liability structure of a financial institution is primarily monetary in nature, therefore, interest rates rather than inflation have a more significant impact on the Corporation's performance. Interest rates are not always affected in the same direction or magnitude as prices of other goods and services, but are reflective of fiscal policy initiatives or economic factors which are not measured by a price index. COMPREHENSIVE INCOME Comprehensive income is a measure of all the changes in equity of a corporation. It excludes transactions with owners in their capacity as owners (i.e. Stock options granted or exercised, repurchase of treasury stock transactions, and dividends to shareholders). Other comprehensive income is the difference between net income and comprehensive income. The Company's other comprehensive income is composed of unrealized gains and losses on available for sale securities, net of deferred income tax. Comprehensive income is not a measure of net income. Net income would be affected by other comprehensive income only in the event that the entire securities portfolio was sold on the statement date. Unrealized gains or losses reflected in the Company's comprehensive income may vary widely at statement dates as a result of changing markets and/or interest rate movements. Other comprehensive income (loss) for the years ended December 31, 2000, 1999, 1998 were $2,117,000, $(7,885,000) and $(1,180,000), respectively. CAUTIONARY STATEMENT FOR PURPOSES OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This Report contains certain "forward-looking statements" including statements concerning plans, objectives, future events or performance and assumptions and other statements which are other than statements of historical fact. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, Penns Woods Bancorp, Inc. and its subsidiaries (the "Company") notes that a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of the Company's business include the following: general economic conditions and changes in interest rates including their impact on capital expenditures; business conditions in the banking industry; the regulatory environment; rapidly changing technology and evolving banking industry standards; the effect of changes in accounting policies and practices, including increased competition with community, regional and national financial institutions; new service and product offerings by competitors and price pressures; changes in the Company's organization, compensation and benefit plans; and similar items. ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors and Shareholders Penns Woods Bancorp, Inc. We have audited the accompanying consolidated balance sheet of Penns Woods Bancorp, Inc. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated statements of income, changes in shareholders' equity, and cash flows for the years ended December 31, 1998 were audited by other auditors whose report, dated January 15, 1999, expressed an unqualified opinion on those financial statements. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Penns Woods Bancorp, Inc. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. /s/ S.R. Snodgrass, A.C. Wexford, PA January 19, 2001 CONSOLIDATED BALANCE SHEET December 31, 2000 1999 ------------------ (in thousands) ASSETS Cash and due from banks . . . . . . . . . $ 15,318 $ 12,474 Securities available for sale . . . . . . 115,922 113,305 Securities held to maturity (market value of $3,261,000 and $2,992,000) . . 3,228 3,014 Loans, net of unearned discount . . . . . 246,486 233,823 Less allowance for loan losses. . . . . . 2,879 2,823 ------- ------- Loans, net. . . . . . . . . . . . . . 243,607 231,000 Bank premises and equipment, net. . . . . 4,727 4,888 Accrued interest receivable . . . . . . . 2,581 2,283 Bank owned life insurance . . . . . . . . 2,353 2,244 Other assets. . . . . . . . . . . . . . . 7,177 4,534 ------- ------- TOTAL . . . . . . . . . . . . . . . . . . $394,913 $373,742 ======= ======= LIABILITIES: Interest-bearing deposits . . . . . . . . $230,666 $212,528 Noninterest-bearing deposits. . . . . . . 47,468 43,045 -------- -------- TOTAL DEPOSITS. . . . . . . . . . . . . 278,134 255,573 Short-term borrowings . . . . . . . . . . 31,021 41,641 Other borrowings. . . . . . . . . . . . . 31,778 27,278 Accrued interest payable. . . . . . . . . 1,452 1,123 Other liabilities . . . . . . . . . . . . 2,014 2,042 -------- -------- TOTAL LIABILITIES . . . . . . . . . . . 344,399 327,657 -------- -------- SHAREHOLDERS' EQUITY: Common stock, par value $10; 10,000,000 shares authorized 3,130,844 and 3,128,332 shares issued . . . . . . . . 31,308 31,283 Additional paid-in capital. . . . . . . . 18,214 18,165 Retained earnings . . . . . . . . . . . . 2,974 (166) Accumulated other comprehensive loss. . . (810) (2,927) Less: Treasury stock, at cost 33,551 and 4,960 . . . . . . . . . . . . . . . (1,172) (270) ------- ------- TOTAL SHAREHOLDERS' EQUITY. . . . . . . 50,514 46,085 ------- ------ TOTAL . . . . . . . . . . . . . . . . . . $394,913 $373,742 ======= ======= CONSOLIDATED STATEMENT OF INCOME For the Years Ended December 31, 2000, 1999 and 1998 <TABLE> <CAPTION> (IN THOUSANDS EXCEPT SHARE DATA) 2000 1999 1998 <S> <C> <C> <C> INTEREST INCOME: Interest and fees on loans $21,570 $19,990 $19,770 Interest and dividends on investments: Taxable interest 3,751 3,555 3,395 Tax-exempt interest 2,205 1,664 1,223 Dividends 928 821 708 ------- ------ ------- TOTAL INTEREST INCOME 28,454 26,030 25,096 ------- ------- ------- INTEREST EXPENSE: Interest on deposits 9,165 7,898 8,865 Interest on short-term borrowings 1,866 1,197 771 Interest on other borrowings 1,747 1,423 893 ------- ------- ------- TOTAL INTEREST EXPENSE 12,778 10,518 10,529 ------- ------- ------- NET INTEREST INCOME 15,676 15,512 14,567 PROVISION FOR LOAN LOSSES 286 286 305 ------- ------- ------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 15,390 15,226 14,262 ------- ------- ------- OTHER INCOME: Service charges 1,565 1,358 1,100 Securities gains, net 269 1,946 2,076 Other operating income 524 223 259 ------- ------- ------- TOTAL OTHER INCOME 2,358 3,527 3,435 ------- ------- ------- OTHER EXPENSES: Salaries and employee benefits 5,004 4,860 4,788 Occupancy expense, net 741 673 634 Furniture and equipment expense 756 687 737 Other operating expenses 3,062 3,119 2,906 ------- ------- ------- TOTAL OTHER EXPENSES 9,563 9,339 9,065 ------- ------- ------- INCOME BEFORE INCOME TAX PROVISION 8,185 9,414 8,632 INCOME TAX PROVISION 1,619 2,224 2,164 ------- ------- ------- NET INCOME $ 6,566 $ 7,190 $ 6,468 ======= ======= ======= EARNINGS PER SHARE - BASIC $ 2.10 $ 2.30 $ 2.08 EARNINGS PER SHARE - DILUTED $ 2.10 $ 2.30 $ 2.07 </TABLE> CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY For the Years Ended December 31, 2000, 1999 and 1998 (IN THOUSANDS EXCEPT SHARE DATA) <TABLE> <CAPTION> Accumu- lated Other Stock Addi- Compre- Total Dividend tional hensive Share- ...Common Stock... Distri- Paid-In Retained Income Treasury Holders' Shares Amount butable Capital Earnings (Loss) Stock Equity <S> <C> <C> <C> <C> <C> <C> <C> <C> Balance, December 31, 1997 1,545,250 $15,453 $ 12,828 $ 4,712 $ 8,262 $ 6,138 - $47,393 Stock split effected in the form of a 100% stock dividend 1,282,779 12,828 (12,828) - Comprehensive income: Net income 6,468 6,468 Unrealized loss on securities, net of reclassification adjustments and tax benefit of $608 (1,180) (1,180) ------ Total comprehensive income 5,288 ------ Dividends declared, $0.88 (2,755) (2,755) Stock options exercised 12,794 128 56 184 Treasury stock acquired, 3,656 shares (214) (214) -------- ------- -------- ------- -------- --------- ------ ------ Balance, December 31, 1998 2,840,823 28,409 - 4,768 11,975 4,958 (214) 49,896 10 percent stock dividend 283,393 2,833 13,320 (16,153) - Comprehensive loss: Net income 7,190 7,190 Unrealized loss on securities, net of reclassification adjustments and tax benefit of $4,062 (7,885) (7,885) ------ Total comprehensive loss (695) ------ Dividends declared, $1.01 (3,178) (3,178) Stock options exercised 4,116 41 77 118 Treasury stock acquired, 1,304 shares (56) (56) -------- ------- -------- ------- -------- --------- ------ ------ Balance, December 31, 1999 3,128,332 31,283 - 18,165 (166) (2,927) (270) 46,085 Comprehensive income: Net income 6,566 6,566 Unrealized gain on securities, net of reclassification adjustments and tax of $1,091 2,117 2,117 ------- Total comprehensive income 8,683 ------- Dividends declared, $1.10 (3,426) (3,426) Stock options exercised 2,512 25 49 74 Treasury stock acquired, 28,591 shares (902) (902) -------- ------- -------- ------- -------- --------- ------ ------- Balance, December 31, 2000 3,130,844 $31,308 $ - $18,214 $ 2,974 $ (810) $(1,172) $50,514 ========= ======= ======== ======= ======= ========= ======== ======= </TABLE> <TABLE> <CAPTION> Components of comprehensive income (loss): 2000 1999 1998 ------ -------- ------- <S> <C> <C> <C> Change in net unrealized gain (loss) on investments available for sale $2,295 $(6,601) $ 190 Realized gains included in net income, net of tax $91, $662, and $706 $ (178) $(1,284) $(1,370) ------ -------- -------- Total $2,117 $(7,885) $(1,180) ====== ======= ======= </TABLE> CONSOLIDATED STATEMENT OF CASH FLOWS <TABLE> <CAPTION> For the years ended December 31, 2000 1999 1998 ------- -------- ------- (in thousands) <S> <C> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 6,566 $ 7,190 $ 6,468 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 551 512 431 Provision for loan losses 286 286 305 Accretion and amortization of investment security discounts and premiums (610) (156) (34) Securities gains, net (269) (1,946) (2,076) Loss (gain) on sale of foreclosed assets 29 (6) (12) Increase in all other assets (1,015) (999) (964) Increase (decrease) in all other liabilities 309 (121) (100) -------- -------- -------- Net cash provided by operating activities 5,847 4,760 4,018 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of securities available for sale (57,973) (78,020) (48,469) Proceeds from sale of securities available for sale 53,301 48,123 27,371 Proceeds from calls and maturities of securities available for sale 6,142 7,137 4,361 Purchase of securities held to maturity (273) (25) (323) Proceeds from calls and maturities of securities held to maturity 58 2,090 2,473 Net increase in loans (12,893) (17,502) (12,053) Acquisition of bank premises and equipment (390) (662) (713) Proceeds from the sale of foreclosed assets 168 80 47 Acquisition of a subsidiary (3,321) - - -------- -------- -------- Net cash used in investing activities (15,181) (38,779) (27,306) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in interest-bearing deposits 18,138 1,627 6,619 Net increase in noninterest-bearing deposits 4,423 812 3,709 Net increase (decrease) in short-term borrowings (10,620) 30,418 (5,087) Proceeds from other borrowings 5,000 5,000 20,528 Repayment of other borrowings (500) (500) (500) Dividends paid (3,426) (3,178) (2,755) Stock options exercised 65 40 56 Purchase of treasury stock (902) (23) (109) -------- -------- -------- Net cash provided by financing activities 12,178 34,196 22,461 -------- -------- -------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS 2,844 177 (827) CASH AND CASH EQUIVALENTS, BEGINNING 12,474 12,297 13,124 -------- -------- -------- CASH AND CASH EQUIVALENTS, ENDING $ 15,318 $ 12,474 $ 12,297 ======== ======== ======== </TABLE> SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: The Company paid approximately $12,449,000, $10,606,000, and $10,374,000 in interest on deposits and other borrowings during 2000, 1999, and 1998, respectively. The Company made income tax payments of approximately $2,008,000, $1,972,000, and $2,563,000 during 2000, 1999, and 1998, respectively. Transfers from loans to foreclosed assets held for sale amounted to approximately $294,000, $102,000, and $40,000 in 2000, 1999, and 1998, respectively. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The accompanying consolidated financial statements include the accounts of Penns Woods Bancorp, Inc. and its wholly-owned subsidiaries, Jersey Shore State Bank (the "Bank"), Woods Real Estate Development Co., Inc., Woods Investment Company, Inc. and The M Group Inc. D/B/A The Comprehensive Financial Group ("The M Group"), a wholly-owned subsidiary of the Bank (collectively, the "Company"). All significant intercompany balances and transactions have been eliminated. Nature of Business The Bank engages in a full-service commercial banking business, making available to the community a wide range of financial services including, but not limited to, installment loans, credit cards, mortgage and home equity loans, lines of credit, construction financing, farm loans, community development loans, loans to nonprofit entities and local government loans and various types of time and demand deposits including, but not limited to, checking accounts, savings accounts, clubs, money market deposit accounts, certificates of deposit and IRAs. Deposits are insured by the Federal Deposit Insurance Corporation (FDIC) to the extent provided by law. The financial service provided by the bank to individuals, partnerships, non-profit organizations and corporations through its ten offices and Mortgage/Loan Center located in Clinton, Lycoming, and Centre Counties, Pennsylvania. Woods Real Estate Development Co., Inc. engages in real estate transactions on behalf of Penns Woods Bancorp, Inc. and the Bank. Woods Investment Company, Inc. is engaged in investing activities. The M Group engages in securities brokerage and insurance activities. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired through, or in lieu of, foreclosure on settlement of debt. Investment Securities Investment securities are classified as held to maturity, available for sale, or trading. Securities held to maturity include bonds, notes, and debentures for which the Company has the positive intent and ability to hold to maturity and are reported at amortized cost. Trading account securities are recorded at their fair values. Unrealized gains and losses on trading account securities are included in other income. The Company has no trading account securities as of December 31, 2000 or 1999. Available for sale securities consist of bonds, notes, debentures, and certain equity securities not classified as trading securities nor as held to maturity securities. Unrealized holding gains and losses, net of tax, on available for sale securities are reported as a net amount in a separate component of shareholders' equity until realized. Gains and losses on the sale of all securities are determined using the specific-identification method. Declines in the fair value of individual securities held to maturity and available for sale below their cost that are other than temporary result in write-downs of the individual securities to their fair value and are included in earnings as realized losses. Premiums and discounts on all securities are recognized in interest income using the interest method over the period to maturity. The fair value of investments and mortgage-backed securities, except certain state and political securities, is estimated based on bid prices published in financial newspapers bid quotations received from securities dealers or in the case of equity securities, the closing price of the day as listed on the Internet. The fair value of certain state and political securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued. Loans Loans are stated at the principal amount outstanding, net of unearned discount, unamortized loan fees and costs, and the allowance for loan losses. Interest on loans is recognized as income when earned on the accrual method. The Company's general policy has been to stop accruing interest on loans when it is determined a reasonable doubt exists as to the collectibility of additional interest. Income is subsequently recognized only to the extent that cash payments are received provided the loan is not delinquent in payment and, in management's judgment, the borrower has the ability and intent to make future principal payments. Allowance for Loan Losses The allowance for loan losses represents the amount which management estimates is adequate to provide for potential losses in its portfolio. The allowance method is used in providing for loan losses. Accordingly, all loan losses are charged to the allowance and all recoveries are credited to it. The allowance for loan losses is established through a provision for loan losses charged to operations. The provision for loan losses is based on management's periodic evaluation of individual loans, economic factors, past loan loss experience, changes in the composition and volume of the portfolio, and other relevant factors. The estimates used in determining the adequacy of the allowance for loan losses, including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to changes in the near term. Impaired loans are commercial and commercial real estate loans for which it is probable the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. The Company individually evaluates such loans for impairment and does not aggregate loans by major risk classifications. The definition of "impaired loans" is not the same as the definition of "nonaccrual loans," although the two categories overlap. The Company may choose to place a loan on nonaccrual status due to payment delinquency or uncertain collectibility, while not classifying the loan as impaired if the loan is not a commercial or commercial real estate loan. Factors considered by management in determining impairment include payment status and collateral value. The amount of impairment for these types of impaired loans is determined by the difference between the present value of the expected cash flows related to the loan, using the original interest rate, and its recorded value, or as a practical expedient in the case of collateralized loans, the difference between the fair value of the collateral and the recorded amount of the loans. When foreclosure is probable, impairment is measured based on the fair value of the collateral. Mortgage loans on one-to-four family properties and all consumer loans are large groups of smaller-balance homogeneous loans and are measured for impairment collectively. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. Management determines the significance of payment delays on a case-by-case basis taking into consideration all circumstances surrounding the loan and the borrower including the length of the delay, the borrower's prior payment record, and the amount of shortfall in relation to the principal and interest owed. Foreclosed Assets Held for Sale Foreclosed assets held for sale are carried at the lower of fair value minus estimated costs to sell or cost. Prior to foreclosure, the value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for loan losses, if necessary. Any subsequent write-downs are charged against operating expenses. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in other expenses. Bank Premises and Equipment Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using straight-line and accelerated methods over the estimated useful lives of the related assets. Costs incurred for routine maintenance and repairs are expensed currently. Income Taxes Deferred tax assets and liabilities result from temporary differences in financial and income tax methods of accounting, and are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Earnings Per Share The Company provides dual presentation of basic and diluted earnings per share. Basic earnings per share is calculated utilizing net income as reported in the numerator and average shares outstanding in the denominator. The computation of diluted earnings per share differs in that the dilutive effects of any stock options are adjusted in the denominator. Stock Options The Company maintains a stock option plan for the Directors, officers and employees. When the exercise price of the Company's stock options is greater than or equal to the market price of the underlying stock on the date of the grant, no compensation expense is recognized in the Company's financial statements. Pro forma net income and earnings per share are presented to reflect the impact of the stock option plan assuming compensation expense had been recognized based on the fair value of the stock options granted under the plan. Comprehensive Income The Company is required to present comprehensive income in a full set of general-purpose financial statements for all periods presented. Other comprehensive income is comprised exclusively of unrealized holding gains (losses) on the available for sale securities portfolio. The Company has elected to report the effects of other comprehensive income as part of the Statement of Changes in Shareholders' Equity. Cash Flows The Company utilizes the net reporting of cash receipts and cash payments for deposit and lending activities. The Company considers amounts due from banks as cash equivalents. Pending Accounting Pronouncements Financial Accounting Standards Board ("FASB") Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" (Statement No. 133), as amended by FASB Statement No. 138, "Accounting for Derivative Instruments and Hedging Activities-Deferral of the Effective Date of Statement No. 133" (Statement No. 138), is effective in 2001, and requires measuring and recording the change in fair value of derivative instruments. Statement No. 133 is not expected to materially affect the Company's financial position or results of operations. In September 2000, the FASB issued Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The Statement replaces FASB Statement No. 125 and provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings based on a control- oriented "financial-components" approach. Under this approach, after a transfer of financial assets, and entity recognizes the financial and servicing assets it controls and liabilities it has incurred, derecognizes financial assets when control has been surrendered and derecognizes liabilities when extinguished. The provisions of Statement No. 140 are effective for transactions occurring after March 31, 2001. This Statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of the provisions of Statement No. 140 is not expected to have a material impact on financial position or results of operations. NOTE B - PER SHARE DATA There are no convertible securities which would affect the numerator in calculating basis and dilutive earnings per share, therefore, net income as presented on the consolidated statement of income will be used as the numerator. The following table sets forth the composition of the weighted average common shares (denominator) used in the basic and dilutive per share computation. The number of shares used in calculating basic and diluted earnings and cash dividends per share reflect the retroactive effect of stock dividends declared. <TABLE> <CAPTION> 2000 1999 1998 --------- ---------- --------- <S> <C> <C> <C> Weighted average common shares outstanding 3,130,178 3,125,292 3,114,396 Average treasury stock shares (10,638) (3,879) (20) --------- ---------- --------- Weighted average common shares and common stock equivalents used to calculate basic earnings per share 3,119,540 3,121,413 3,114,376 Additional common stock equivalents (stock options) used to calculate diluted earnings per share - 8,682 7,585 --------- ---------- --------- Weighted average common shares and common stock equivalents used to calculate diluted earnings per share 3,119,540 3,130,095 3,121,961 ========= ========= ========= </TABLE> NOTE C - CASH AND DUE FROM BANKS Banks are required to maintain reserves consisting of vault cash and deposit balances with the Federal Reserve Bank in their district. The reserves are based on deposit levels during the year and account activity and other services provided by the Federal Reserve Bank. Average daily currency, coin and cash balances with the Federal Reserve Bank needed to cover reserves against deposits for 2000 ranged from $3,526,000 to $4,394,000. For 1999, these balances ranged from $2,438,000 to $3,873,000. Average daily cash balances with the Federal Reserve Bank required to cover services provided to the Bank amounted to $800,000 throughout 2000 and 1999. Total balances restricted at December 2000 and 1999, respectively, were $4,819,000 and $4,384,000. NOTE D - INVESTMENT SECURITIES The amortized cost of investment securities and their approximate fair values at December 31, 2000 and 1999 were as follows (in thousands): <TABLE> <CAPTION> December 31, 2000 --------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- ------- <S> <C> <C> <C> <C> Securities available for sale: Equity securities $ 19,954 $ 1,917 $ (2,538) $ 19,333 U.S Government and agency securities 26,644 247 (25) 26,866 State and political securities 66,565 1,162 (1,978) 65,749 Restricted equity securities 2,847 - - 2,847 Other debt securities 1,139 3 (15) 1,127 --------- -------- -------- --------- $ 117,149 $ 3,329 $ (4,556) $ 115,922 ========= ======== ======== ========= Securities held to maturity: U.S Government and agency securities $ 206 $ 1 $ - $ 207 State and political securities 2,712 39 (7) 2,744 Other debt securities 310 - - 310 --------- -------- --------- --------- $ 3,228 $ 40 $ (7) $ 3,261 ========= ======== ======== ========= <CAPTION> December 31, 1999 ------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- ------- <S> <C> <C> <C> <C> Securities available for sale: Equity securities $ 23,718 $ 3,122 $ (3,058) $ 23,782 U.S Government and agency securities 39,722 5 (1,093) 38,634 State and political securities 50,224 66 (3,461) 46,829 Restricted equity securities 2,847 - - 2,847 Other debt securities 1,229 2 (18) 1,213 --------- -------- ---------- -------- $ 117,740 $ 3,195 $ (7,630) $113,305 ========= ======== ========= ======== Securities held to maturity: U.S Government and agency securities $ 259 $ 7 $ - $ 266 State and political securities 2,465 8 (37) 2,436 Other debt securities 290 - - 290 --------- -------- ---------- -------- $ 3,014 $ 15 $ (37) $ 2,992 ========= ======== ========= ======== </TABLE> The amortized cost and fair value of debt securities at December 31, 2000, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. <TABLE> <CAPTION> Securities Securities Held to Maturity Available for Sale Amoritized Fair Amoritized Fair Cost Value Cost Value ---------- ----- ---------- ----- <S> <C> <C> <C> <C> Due in one year or less $ 915 $ 915 $ - $ - Due after one year to five years 435 435 3,309 3,373 Due after five years to ten years 632 646 2,000 2,010 Due after ten years 1,246 1,265 89,039 88,359 -------- ------- -------- -------- Total $ 3,228 $ 3,261 $ 94,348 $ 93,742 ======== ======= ======== ======== </TABLE> Total gross proceeds from sales of securities available for sale, were $53,301,000 $48,123,000 and $27,371,000 for 2000, 1999 and 1998, respectively. The following table represents gross realized gains and gross realized losses on those transactions (in thousands): <TABLE> <CAPTION> 2000 1999 1998 ------- -------- ------- Gross realized gains: <S> <C> <C> <C> U.S Government and agency securities $ 36 $ 128 $ 72 State and political securities 170 364 - Equity securities 1,577 2,104 2,024 ------- ------- ------- $ 1,783 $ 2,596 $ 2,096 ======= ======= ======= Gross realized losses: U.S Government and agency securities $ 731 $ 416 $ 5 State and political securities 30 26 5 Equity securities 753 181 10 Other debt securities - 27 - ------- ------- ------- $ 1,514 $ 650 $ 20 ======= ======= ======= </TABLE> Investment securities with a carrying value of approximately $32,859,000 and $34,121,000 at December 31, 2000 and 1999, respectively, were pledged to secure certain deposits, security repurchase agreements, and for other purposes as required by law. There is no concentration of investments that exceed ten percent of shareholders' equity for any individual issuer, excluding those guaranteed by the U.S. Government. NOTE E - LOANS Major loan classifications loans are summarized as follows (in thousands): <TABLE> <CAPTION> December 31, 2000 -------------------------------------------------- Past Due Past Due 30 to 90 90 Days Non- Current Days or More Accrual Total --------- -------- ------- ------- --------- <S> <C> <C> <C> <C> <C> Commercial and agricultural $ 26,001 $ 241 $ - $ 229 $ 26,471 Real estate mortgage: Residential 130,532 2,366 22 168 133,088 Commercial 59,586 885 - 151 60,622 Construction 4,522 - - 226 4,748 Installment loans to individuals 21,252 297 5 3 21,557 ---------- ------- ------ ------- --------- $ 241,893 $ 3,789 $ 27 $ 777 246,486 ======= ====== ======= ========= Less: Allowance for loan losses 2,879 2,879 ---------- --------- Loans, net $ 239,014 $ 243,607 ========== ========= <CAPTION> December 31, 1999 -------------------------------------------------- Past Due Past Due 30 to 90 90 Days Non- Current Days or More Accrual Total --------- -------- ------- ------- --------- <S> <C> <C> <C> <C> <C> Commercial and agricultural $ 31,189 $ 482 $ 25 $ 39 $ 31,735 Real estate mortgage: Residential 120,668 2,518 201 5 123,392 Commercial 51,102 343 - - 51,445 Construction 3,493 3 - 236 3,732 Installment loans to individuals 23,141 359 15 4 23,519 ---------- ------- ------ ------ ---------- $ 229,593 $ 3,705 $ 241 $ 284 233,823 Less: Allowance for loan losses 2,823 ======= ====== ====== 2,823 ---------- ---------- Loans, net $ 226,770 $ 231,000 ========== ========== </TABLE> Loans on which the accrual of interest has been discontinued or reduced amounted to approximately $777,000 and $284,000 at December 31, 2000 and 1999, respectively. If interest had been recorded at the original rate on those loans, such income would have approximated $86,000, $48,000, and $98,000 for the years ended December 31, 2000, 1999, and 1998, respectively. Interest income on such loans, which is recorded as received, amounted to approximately $45,000, $38,000, and $50,000 for the years ended December 31, 2000, 1999, and 1998, respectively. Transactions in the allowance for loan losses are summarized as follows (in thousands): <TABLE> <CAPTION> Year Ended December 31, 2000 1999 1998 --------- ---------- ---------- <S> <C> <C> <C> Balance, beginning of year $ 2,823 $ 2,681 $ 2,579 Provision charged to operations 286 286 305 Loans charged off (269) (176) (271) Recoveries 39 32 68 -------- -------- -------- Balance, end of year $ 2,879 $ 2,823 $ 2,681 ======== ======== ======== </TABLE> The Company had no concentration of loans to borrowers engaged in similar businesses or activities which exceed five percent of total assets at December 31, 2000 or 1999. The Company grants commercial, industrial, residential, and installment loans to customers throughout Northcentral Pennsylvania. Although the Company has a diversified loan portfolio at December 31, 2000 and December 31,1999, a substantial portion of its debtors' ability to honor their contracts is dependent on the economic conditions within this region. NOTE F - BANK PREMISES AND EQUIPMENT Bank premises and equipment are summarized as follows (in thousands): December 31, 2000 1999 -------- -------- Land $ 566 $ 566 Bank premises 4,630 4,598 Furniture and equipment 5,129 4,813 Leasehold improvements 795 753 -------- ------- Total 11,120 10,730 Less accumulated depreciation 6,393 5,842 -------- ------- Net $ 4,727 $ 4,888 ======== ======= Depreciation expense for the years ended 2000, 1999 and 1998 was $551,000, $512,000, and $431,000, respectively. NOTE G - DEPOSITS Time deposits of $100,000 or more totaled approximately $31,148,000 on December 31, 2000 and $24,308,000 on December 31, 1999. Interest expense related to such deposits was approximately $1,571,000, $1,242,000, and $1,238,000 for the years ended December 31, 2000, 1999, and 1998, respectively. These time deposits at December 31, 2000 mature as follows: 2001 - - $27,110,000; 2002 - $3,014,000; 2003 - $524,000; beyond 2005 - $500,000. NOTE H - SHORT-TERM BORROWINGS Short-term borrowings consist of federal funds purchased, securities sold under agreements to repurchase, and FHLB advances which generally represent overnight or less than 30-day borrowings. The outstanding balances and related information for short-term borrowings are summarized as follows (in thousands): <TABLE> <CAPTION> 2000 1999 -------- -------- <S> <C> <C> Federal Home Loan Bank: Balance at year end $ - $ 2,000 Maximum amount outstanding at any month end $ 2,000 $ 2,000 Average balance outstanding during the year $ 1,394 $ 2,000 Weighted-average interest rate: At year end - 6.12% Paid during the year 6.45% 6.12% Open Repo Plus: Balance at year end $15,610 $23,590 Maximum amount outstanding at any month end $20,970 $23,590 Average balance outstanding during the year $14,009 $ 6,108 Weighted-average interest rate: At year end 6.63% 4.05% Paid during the year 6.49% 5.26% Repurchase Agreements: Balance at year end $15,411 $16,051 Maximum amount outstanding at any month end $20,724 $17,147 Average balance outstanding during the year $16,410 $15,416 Weighted-average interest rate: At year end 5.64% 4.62% Paid during the year 5.29% 4.62% </TABLE> NOTE I - OTHER BORROWINGS Other borrowings are comprised of advances from the FHLB. A schedule of other borrowings by maturity as of December 31, 2000 and 1999 is summarized as follows (in thousands): <TABLE> <CAPTION> Interest Description Maturity Rate 2000 1999 - -------------------------- -------- -------- ------ ------- <S> <C> <C> <C> <C> FHLB Borrowing October 29, 2000 5.21% $ - $ 500 FHLB Borrowing June 24, 2013 5.87% 528 528 Convertible Select Advance April 7, 2008 5.54% 10,000 10,000 Convertible Select Advance June 16, 2008 5.56% 10,000 10,000 Convertible Select Advance February 26, 2009 5.06% 5,000 5,000 FHLB Borrowing October 17, 2011 6.92% 500 500 FHLB Borrowing May 25, 2015 6.92% 750 750 Convertible Select Advance August 10, 2010 6.65% 5,000 - ------- ------ Total $31,778 $27,278 ======= ======= </TABLE> The Bank maintains a credit arrangement which includes a revolving line of credit with FHLB. Under this credit arrangement, the Bank has a remaining borrowing capacity of approximately $68,000,000 at December 31, 2000, is subject to annual renewal, and typically incurs no service charges. Under terms of a blanket agreement, collateral for the FHLB borrowings must be secured by certain qualifying assets of the Bank which consist principally of first mortgage loans. NOTE J - INCOME TAXES The following temporary differences gave rise to the net deferred tax asset at December 31, 2000 and 1999 (in thousands): <TABLE> <CAPTION> 2000 1999 -------- ------- <S> <C> <C> Deferred tax asset: Allowance for loan losses $ 634 $ 601 Deferred compensation 283 260 Contingencies 73 83 Pension 266 202 Loan fees and costs 184 169 Unrealized losses on available for sale securities 417 1,508 Stock option - 14 ------ ------ Total 1,857 2,837 ------ ------ Deferred tax liability: Bond accretion 17 20 Depreciation 127 124 ------- ------- Total 144 144 ------- ------- Deferred tax asset, net $ 1,713 $ 2,693 ======= ======= </TABLE> No valuation allowance was established at December 31, 2000 and 1999, in the view of the Company's ability to carry back to taxes paid in previous years and certain tax strategies, coupled with the anticipated future taxable income as evidenced by the Company's earning potential. The provision for income taxes is comprised of the following (in thousands): Year Ended December 31, 2000 1999 1998 ------- ------- ------- Currently payable $1,730 $2,422 $2,263 Deferred benefit (111) (198) (99) ------ ------ ------ Total provision $1,619 $2,224 $2,164 ====== ====== ====== The effective federal income tax rate for the years ended December 31, 2000, 1999, and 1998 was 19.8 percent, 23.6 percent, and 25.1 percent, respectively. A reconciliation between the expected income tax and rate and the effective income tax and rate on income before income tax provision follows (in thousands): <TABLE> <CAPTION> 2000 1999 1998 ---------------- ----------------- ---------------- Amount % Amount % Amount % ---------------- ----------------- ---------------- <S> <C> <C> <C> <C> <C> <C> Provision at expected rate $ 2,783 34.0% $ 3,201 34.0% $ 2,935 34.0% Decrease in tax resulting from: Tax-exempt income (837) (10.2) (677) (7.2) (416) (4.8) Other, net (327) (4.0) (300) (3.2) (355) (4.1) -------- ----- ------- ---- ------- ---- Effective income tax and rates $ 1,619 19.8% $ 2,224 23.6% $ 2,164 25.1% ======== ====== ======= ===== ======= ===== </TABLE> NOTE K - EMPLOYEE BENEFIT PLANS Defined Benefit Pension Plan The Company has a noncontributory defined benefit pension plan (the "Plan") for all employees meeting certain age and length of service requirements. Benefits are based primarily on years of service and the average annual compensation during the highest five consecutive years within the final ten years of employment. The following tables show the funded status and components of net periodic benefit cost from this defined benefit plan (in thousands): <TABLE> <CAPTION> 2000 1999 -------- ------- <S> <C> <C> CHANGE IN BENEFIT OBLIGATION: Benefit obligation at beginning of year $4,099 $3,459 Service cost 256 254 Interest cost 242 236 Actuarial adjustment (625) 253 Benefits paid (37) (103) ------ ------ Benefit obligation at end of year 3,935 4,099 ------ ------ CHANGE IN PLAN ASSETS: Fair value of plan assets at beginning of year 3,641 3,476 Actual return (loss) on plan assets (7) 268 Benefits paid (37) (103) ------ ------ Fair value of plan assets at end of year 3,597 3,641 ------ ------ Funded status (338) (458) ------ ------ Unrecognized net actuarial gain (646) (350) Unrecognized transition asset (30) (32) Unrecognized prior service cost 229 248 ------ ------ Accrued benefit cost $ (785) $ (592) ====== ====== WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31: Discount rate 7.00% 6.50% Expected return on plan assets 8.00% 8.00% Rate of compensation increase 5.00% 5.00% </TABLE> <TABLE> <CAPTION> 2000 1999 1998 -------- -------- -------- <S> <C> <C> <C> COMPONENTS OF NET PERIODIC BENEFIT COST: Service cost $ 256 $ 254 $ 222 Interest cost 242 236 213 Expected return on plan assets (291) (268) (224) Amortization of transition asset (3) (3) (3) Amortization of prior service cost 20 20 18 Recognized net actuarial gain (33) (15) (1) ------- ------- ------- Net periodic benefit cost $ 191 $ 224 $ 225 ======= ======= ======= </TABLE> 401(k) SAVINGS PLAN The Company also offers a 401(k) savings plan in which eligible participating employees may elect to contribute up to a maximum percentage allowable not to exceed the limits of Code Sections 401(k), 404, and 415. The company may make matching contributions equal to a discretionary percentage to be determined by the Company. Participants are at all times fully vested in their contributions and vest over a period of five years in the employer contribution. Contribution expense was approximately $67,000, $64,000, and $114,000 for the years ended December 31, 2000, 1999, and 1998, respectively. DEFERRED COMPENSATION PLAN The Company has a deferred compensation plan whereby participating directors elected to forego director's fees for a period of five years. Under this plan the Company will make payments for a ten-year period beginning at age 65 in most cases or at death, if earlier, at which time payments would be made to their designated beneficiaries. To fund benefits under the deferred compensation plan, the Company has acquired corporate-owned life insurance policies on the lives of the participating directors for which insurance benefits are payable to the Company. The total expense charged to other expenses was $66,000, $128,000 and $114,000 for the years ended December 31, 2000, 1999 and 1998, respectively. Benefits paid under the plan were approximately $53,000 in 2000 and $57,000 in 1999 and $45,000 in 1998. NOTE L - STOCK OPTIONS Prior to 1998, the Company granted a select group of its officers options to purchase shares of its common stock. These options, which are immediately exercisable, expire within three to ten years after having been granted. Also, in 1998, the Company adopted the "1998 Stock Option Plan" for key employees and directors. Incentive stock options and nonqualified stock options may be granted to eligible employees of the Bank and nonqualified options may be granted to directors of the Company. In addition, non-employee directors are eligible to receive grants of nonqualified stock options. Incentive nonqualified stock options granted under the 1998 Plan may be exercised not later than ten years after the date of grant. Each option granted under the 1998 Plan shall be exercisable only after the expiration of six months following the date of grant of such options. The Company applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for these options. Accordingly, compensation expense is recognized on the grant date, in amount equivalent to the intrinsic value of the options (stock price less exercise price, at measurement date). Had compensation costs for these options been determined based on the fair values at the grant dates for awards consistent with the method of SFAS No. 123, the effect on the Company's net income and earnings per share for 2000, 1999, and 1998 would have been insignificant. For purposes of the calculations required by SFAS No. 123, the fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants issued in 2000, 1999 and 1998, respectively: dividend yield of 1.03 percent, 1.85 percent, and 2.52 percent, respectively; risk-free interest rates of 4.95 percent, 6.75 percent, and 5.63 percent, respectively; expected option lives of three years and expected volatility of 23.81 percent, 18.73 percent, and 14.51 percent, respectively. A summary of the status of the Company's common stock option plans, adjusted to reflect a stock split effected in the form of a 100 percent stock dividend issued January 15, 1998 and a 10 percent stock dividend issued June 8, 1999, is presented below: <TABLE> <CAPTION> 2000 1999 1998 ------------------ ------------------- ------------------ Weighted- Weighted- Weighted- average average average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------- -------- ------ --------- ------ --------- <S> <C> <C> <C> <C> <C> <C> Outstanding, beginning of year 34,813 $ 38.52 28,479 $ 34.27 32,652 $ 18.70 Granted 10,000 32.63 10,450 42.00 9,900 53.18 Exercised 2,512 25.98 4,116 17.95 14,073 11.45 Forfeited - - - - - - ------ -------- ------ -------- ------ -------- Outstanding, end of year 42,301 $ 37.87 34,813 $ 38.52 28,479 $ 34.27 ====== ======== ====== ======== ====== ======== Options exercisable at year-end 32,301 $ 39.49 24,363 $ 37.03 18,579 $ 24.19 ====== ======== ====== ======== ====== ======== </TABLE> The following table summarizes information about nonqualified and incentive stock options outstanding at December 31, 2000: Exercise Number Remaining Number Prices Outstanding Contractual Life Exercisable -------- ----------- ---------------- ----------- $ 25.98 11,951 3 years 11,951 53.18 9,900 8 years 9,900 42.00 10,450 9 years 10,450 32.63 10,000 10 years - ------- ------ 42,301 32,301 ======= ====== NOTE M - RELATED PARTY TRANSACTIONS Certain directors and executive officers of the Company and the Bank, including their immediate families and companies in which they are principal owners (more than ten percent), are indebted to the Company. Such indebtedness was incurred in the ordinary course of business on the same terms and at those rates prevailing at the time for comparable transactions with others. A summary of loan activity with executive officers, directors, principal shareholders, and associates of such persons is listed below (in thousands): <TABLE> <CAPTION> Beginning Retired/ Charge- Ending Year Balance Additions Payments Resigned offs Balance ---- --------- --------- -------- -------- ------ ------- <S> <C> <C> <C> <C> <C> <C> 2000 $ 5,810 $ 1,387 $ 2,243 $ - $ - $ 4,954 1999 $ 2,452 $ 6,775 $ 3,417 $ - $ - $ 5,810 1998 $ 2,096 $ 1,642 $ 1,074 $ 212 $ - $ 2,452 </TABLE> NOTE N - COMMITMENTS AND CONTINGENT LIABILITIES The following schedule of future minimum rental payments under operating leases with noncancellable terms in excess of one year as of December 31, 2000 (in thousands): Year Ending December 31, 2001 $ 191 2002 142 2003 95 2004 71 2005 66 Thereafter 193 ------ Total $ 758 ====== Total rental expense for all operating leases for the years ended December 31, 2000, 1999, and 1998 approximated $208,000, $197,000, and $268,000, respectively. The Company is subject to lawsuits and claims arising out of its business. In the opinion of management, after review and consultation with counsel, any proceedings that may be assessed will not have a material adverse effect on the consolidated financial position of the Company. NOTE O - OFF-BALANCE SHEET RISK The Company is a party to financial instruments with off- balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit, interest rate or liquidity risk in excess of the amount recognized in the consolidated balance sheet. The contract amounts of these instruments express the extent of involvement the Company has in particular classes of financial instruments. The Company's exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Company May require collateral or other security to support financial instruments with off-balance sheet credit risk. Financial instruments whose contract amounts represent credit risk are as follows at December 31 (in thousands): 2000 1999 -------- -------- Commitments to extend credit $ 27,911 $ 25,917 Standby letters of credit $ 1,332 $ 1,564 Commitments to extend credit are legally binding agreements to lend to customers. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements. The Company evaluates each customer's credit worthiness on a case- by-case basis. The amount of collateral obtained, if deemed necessary by the Company, on extension of credit is based on management's credit assessment of the counterparty. Standby letters of credit are conditional commitments issued by the Company guaranteeing performance by a customer to a third party. Those guarantees are issued primarily to support public and private borrowing arrangements including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. NOTE P - CAPITAL REQUIREMENTS Federal regulations require the Company and the Bank to maintain minimum amounts of capital. Specifically, each is required to maintain certain minimum dollar amounts and ratios of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average total assets. In addition to the capital requirements, the Federal Deposit Insurance Corporation Improvement Act (FDICIA) established five capital categories ranging form "well capitalized" to "critically undercapitalized." Should any institution fail to meet the requirements to be considered "adequately capitalized," it would become subject to a series of increasingly restrictive regulatory actions. As of December 31, 2000 and 1999, the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be classified as a well capitalized financial institution, Total risk-based, Tier 1 risk-based and Tier 1 leverage capital ratios must be at least 10%, 6%, and 5%, respectively. The Company's and the Bank's actual capital ratios are presented in the following tables, which shows that both met all regulatory capital requirements. The Company's actual capital amounts and ratios are presented in the following table (in thousands). <TABLE> <CAPTION> 2000 1999 --------------------- --------------------- Amount Ratio Amount Ratio ---------- --------- ---------- --------- <S> <C> <C> <C> <C> Total Capital (to Risk-weighted Assets) - ---------------------------- Actual $ 50,533 20.1% $ 51,864 21.5% For Capital Adequacy Purposes 20,162 8.0 19,286 8.0 To Be Well Capitalized 25,202 10.0 24,108 10.0 Tier I Capital (to Risk-weighted Assets) - --------------------------- Actual $ 47,654 18.9% $ 49,012 20.3% For Capital Adequacy Purposes 10,081 4.0 9,643 4.0 To Be Well Capitalized 15,121 6.0 14,464 6.0 Tier I Capital (to Average Assets) - --------------------- Actual $ 47,654 12.4% $ 49,012 13.5% For Capital Adequacy Purposes 15,428 4.0 14,481 4.0 To Be Well Capitalized 19,285 5.0 18,102 5.0 </TABLE> The Bank's actual capital amounts and ratios are presented in the following table (in thousands). <TABLE> <CAPTION> 2000 1999 --------------------- --------------------- Amount Ratio Amount Ratio ---------- --------- ---------- --------- <S> <C> <C> <C> <C> Total Capital (to Risk-weighted Assets) - --------------------------- Actual $ 39,584 16.3% $ 38,572 16.8% For Capital Adequacy Purposes 19,416 8.0 18,332 8.0 To Be Well Capitalized 24,270 10.0 22,916 10.0 Tier I Capital (to Risk-weighted Assets) - --------------------------- Actual $ 36,705 15.1% $ 35,749 15.6% For Capital Adequacy Purposes 9,708 4.0 9,166 4.0 To Be Well Capitalized 14,562 6.0 13,749 6.0 Tier I Capital (to Average Assets) - --------------------- Actual $ 36,705 9.8% $ 35,749 10.5% For Capital Adequacy Purposes 15,059 4.0 13,607 4.0 To Be Well Capitalized 18,823 5.0 17,009 5.0 </TABLE> The Pennsylvania Banking Code restricts the availability of capital funds for payment of dividend by all state chartered banks to the additional paid in capital of the bank. Accordingly, at December 31, 2000, the balance in the additional paid in capital account totaling approximately $11,700,000 is unavailable for dividends. The Bank is subject to regulatory restrictions which limit its ability to loan funds to Penns Woods Bancorp, Inc. At December 31, 2000, the regulatory lending limit amounted to approximately $4,012,000. NOTE Q - ACQUISITION On October 1, 2000, the Bank acquired The M Group in a business acquisition accounted for as a purchase. The M Group is engaged in the insurance business. The results of operations of The M Group are included in the accompanying consolidated financial statements since the date of acquisition. The total cost of the acquisition was $3,321,000, which exceeds the fair value of the net assets of The M Group by $3,261,000 which was allocated to goodwill. On January 11, 1999 the Company completed the acquisition of all the outstanding common stock of the First National Bank of Spring Mills in exchange for 262,471 shares of the Company's common stock, in a business combination accounted for as a pooling of interest. As a result of this transaction, total consolidated assets increased approximately $31,834,000. Historical financial information has been restated to include the First National Bank of Spring Mills. NOTE R - STOCK DIVIDEND On April 28, 1999, the Board of Directors approved a ten percent stock dividend to shareholders of record as of May 10, 1999. As a result of the dividend, an additional 283,393 shares of the Company were issued, with fractional shares paid in cash. Average shares and all per share amounts included in the consolidated financial statements are based on the increased number of shares after giving retroactive effect to the stock dividend. NOTE S - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS "Disclosures about Fair Value of Financial Instruments," requires that the Company disclose estimated fair values for its financial instruments. Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Also, it is the Company's general practice and intention to hold most of its financial instruments to maturity and not to engage in trading or sales activities. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions can significantly affect the estimates. Estimated fair values have been determined by the Company using historical data and an estimation methodology suitable for each category of financial instruments. The estimated fair value of the Company's investment securities is described in Note A. The Company's fair value estimates, methods, and assumptions are set forth below for the Company's other financial instruments. As certain assets and liabilities, such as deferred tax assets, premises and equipment, and many other operational elements of the Company, are not considered financial instruments but have value, this estimated fair value of financial instruments would not represent the full market value of the Company. The estimated fair values of the Company's financial instruments are as follows: <TABLE> <CAPTION> 2000 1999 -------------------- --------------------- Carrying Fair Carrying Fair Value Value Value Value -------- ------ -------- ------ <S> <C> <C> <C> <C> Financial assets: Cash and due from banks $ 15,318 $ 15,318 $ 12,474 $ 12,474 Investment securities: Available for sale 115,922 115,922 113,305 113,305 Held to maturity 3,228 3,261 3,014 2,992 Loans, net of earned discount 246,486 246,403 233,823 233,923 Bank owned life insurance 2,353 2,353 2,244 2,244 Accrued interest receivable 2,581 2,581 2,283 2,283 -------- -------- -------- -------- Total $385,888 $385,838 $367,143 $367,221 ======== ======== ======== ======== Financial liabilities: Interest-bearing Deposits $230,666 $230,267 $212,528 $212,378 Noninterest-bearing Deposits 47,468 47,468 43,045 43,045 Short-term borrowings 31,021 31,021 41,641 41,641 Other borrowings 31,778 31,638 27,278 26,888 Accrued interest payable 1,452 1,452 1,123 1,123 -------- -------- -------- -------- Total $342,385 $341,846 $325,615 $325,075 ======== ======== ======== ======== </TABLE> Cash and due from banks, accrued interest receivable, short-term borrowings, and accrued interest payable: The fair value is equal to the carrying value. Investment securities: The fair value of investment securities available for sale and held to maturity is equal to the available quoted market price. If no quoted market price is available, fair value is estimated using the quoted market price for similar securities. Loans: Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage, credit card, and other consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories. The fair value of performing loans, except residential mortgage and credit card loans, is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. For performing residential mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discounted rates based on secondary market sources adjusted to reflect differences in servicing and credit costs. For credit card loans, cash flows and maturities are estimated based on contractual interest rates and historical experience and are discounted using secondary market rates adjusted for differences in servicing and credit costs. Fair value for significant nonperforming loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discounted rates are judgmentally determined using available market information and specific borrower information. Bank owned life insurance: The fair value is equal to the cash surrender value of life insurance policies. Deposits: The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings and NOW accounts, and money market and checking accounts, is equal to the amount payable on demand as of December 31, 2000 and 1999. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The fair value estimates above do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible. Other Borrowings: The fair value of other borrowings is based on the discounted value of contractual cash flows. Commitments to Extend Credit, Standby Letters of Credit, and Financial Guarantees Written: There is no material difference between the notional amount and the estimated fair value of off-balance sheet items at December 31, 2000 and 1999 respectively. NOTE T - PARENT COMPANY ONLY FINANCIAL STATEMENTS Condensed financial information for Penns Woods Bancorp, Inc. follows: CONDENSED BALANCE SHEET, DECEMBER 31, 2000 1999 --------- --------- (in thousands) ASSETS Cash $ 156 $ 27 Investment in subsidiaries: Bank 39,566 33,261 Nonbank 11,030 13,224 Other assets 11 27 --------- --------- Total Assets $ 50,763 $ 46,539 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Other liabilities $ 249 $ 454 Shareholders' equity 50,514 46,085 --------- --------- Total Liabilities and Shareholders' Equity $ 50,763 $ 46,539 ========= ========= CONDENSED STATEMENT OF INCOME, FOR THE YEARS ENDED DECEMBER 31, <TABLE> <CAPTION> 2000 1999 1998 ------- ------- ------- (in thousands) <S> <C> <C> <C> OPERATING INCOME Dividends from subsidiaries $6,220 $3,735 $3,789 Equity in undistributed net income of subsidiaries 443 3,583 2,691 Other income 2 1 - OPERATING EXPENSES (99) (129) (12) ------ ------ ------ NET INCOME $6,566 $7,190 $6,468 ====== ====== ====== </TABLE> CONDENSED STATEMENT OF CASH FLOWS, FOR THE YEARS ENDED DECEMBER 31, <TABLE> <CAPTION> 2000 1999 1998 -------- -------- -------- (in thousands) <S> <C> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 6,566 $ 7,190 $ 6,468 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of subsidiaries (443) (3,583) (2,691) Increase in income taxes payable 16 174 37 Increase (decrease) in liabilities 5 (24) (105) ------- ------ ------- Net cash provided by operating activities 6,144 3,757 3,709 ------- ------ ------- CASH FLOWS FROM INVESTING ACTIVITIES Additional investment in subsidiaries (1,752) (620) (1,105) ------- ------ ------- CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid 3,426) (3,178) (2,755) Proceeds from exercise of stock options 65 40 56 Purchase of treasury stock (902) (23) (109) ------- ------ ------- Net cash used in financing activities (4,263) (3,161) (2,808) ------- ------ ------- NET INCREASE (DECREASE) IN CASH 129 (24) (204) CASH, BEGINNING OF YEAR 27 51 255 ------- ------ ------- CASH, END OF YEAR $ 156 $ 27 $ 51 ======= ======= ======= </TABLE> NOTE U - CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) <TABLE> <CAPTION> FOR THE THREE MONTHS ENDED March June September December 2000 31, 30, 30, 31, - ----------------------------- --------- --------- --------- --------- <S> <C> <C> <C> <C> Interest income $ 6,819 $ 6,945 $ 7,252 $ 7,438 Interest expense 2,931 3,038 3,349 3,460 -------- -------- -------- -------- Net interest income 3,888 3,907 3,903 3,978 Provision for loan losses 78 52 78 78 Other income 412 477 461 739 Securities gains (losses), net 161 91 153 (136) Other expenses 2,371 2,402 2,319 2,471 -------- -------- -------- -------- Income before income tax provision 2,012 2,021 2,120 2,032 Income tax provision 466 417 399 337 -------- -------- -------- -------- Net income $ 1,546 $ 1,604 $ 1,721 $ 1,695 ======== ======== ======== ======== Earnings per share - basic $ 0.49 $ 0.52 $ 0.55 $ 0.54 Earnings per share - diluted $ 0.49 $ 0.52 $ 0.55 $ 0.54 </TABLE> <TABLE> <CAPTION> FOR THE THREE MONTHS ENDED March June September December 1999 31, 30, 30, 31, - ----------------------------- --------- --------- --------- --------- <S> <C> <C> <C> <C> Interest income $ 6,214 $ 6,368 $ 6,580 $ 6,868 Interest expense 2,524 2,536 2,610 2,848 -------- -------- -------- -------- Net interest income 3,690 3,832 3,970 4,020 Provision for loan losses 78 52 78 78 Other income 377 397 389 418 Securities gains, net 185 94 272 1,395 Other expenses 2,268 2,220 2,233 2,618 -------- -------- -------- -------- Income before income tax provision 1,906 2,051 2,320 3,137 Income tax provision 431 454 540 799 -------- -------- -------- -------- Net income $ 1,475 $ 1,597 $ 1,780 $ 2,338 ======== ======== ======== ======== Earnings per share - basic $ 0.52 $ 0.46 $ 0.57 $ 0.75 Earnings per share - diluted $ 0.52 $ 0.46 $ 0.57 $ 0.75 </TABLE> SCHEDULE 1 PENNS WOODS BANCORP, INC. INDEBTEDNESS OF RELATED PARTIES <TABLE> <CAPTION> Column A Column B Column C Column D Column E Deductions Beginning Retired/ Charge- Ending Year Name of Debtor Balance Additions Payments Resigned offs Balance <S> <C> <C> <C> <C> <C> <C> 2000 6 directors, 13 affiliated $5,810 $1,387 $2,243 $0 $0 $4,954 interests, and 2 officers 1999 6 directors, 15 affiliated $2,452 $6,775 $3,417 $0 $0 $5,810 interests, and 2 officers 1998 7 directors, 18 affiliated $2,096 $1,642 $1,074 $212 $0 $2,452 interests, and 3 officers </TABLE> ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On July 27, 1999, the board of Directors, upon the recommendation of its audit committee, engaged the accounting firm of S.R. Snodgrass, A.C. as independent accountants to audit the Company's financial statements for the fiscal year ended December 3, 1999. Concurrently with the engagement of S.R. Snodgrass, the Board of Directors dismissed Parente, Randolph, Orlando, Carey & Associates ("Parente") as the Company's independent auditors. During the fiscal years ended December 31, 1997 and 1998, there were no disagreements with Parente on any matter of accounting principles or practice, financial statement disclosure, or auditing scope or procedure or any reportable event. The reports on the financial statements of the Company for such years issued by Parente did not contain an adverse opinion or a disclaimer of opinion, and were not qualified or modified as to uncertainty, audit scope, or accounting principles PART III ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information appearing in the Proxy Statement under the caption "Election of Directors" is incorporated herein by reference. (a) Identification of directors. The information appearing under the caption "Election of Directors" in the Company's Proxy Statement dated March 27, 2001 (at page 5 thereto) is incorporated herein by reference. ITEM 11 EXECUTIVE COMPENSATION Information appearing under the caption "Executive Compensation" in the Company's Proxy Statement (at page 6 thereto) is incorporated herein by reference. ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information appearing under the caption "Principal Beneficial Owners of the Corporation's Common Stock" in the Company's Proxy Statement (at page 3 thereto) is incorporated herein by reference. ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS There have been no material transactions between the Company and the Bank, nor any material transactions proposed, with any Director or executive officer of the Company and the Bank, or any associate of the foregoing persons. The Company and the Bank have had, and intend to continue to have, banking and financial transactions in the ordinary course of business with Directors and Officers of the Company and the Bank and their associates on comparable terms and with similar interest rates as those prevailing from time to time for other customers of the Company and the Bank. Total loans outstanding from the Bank at December 31, 2000 to the Company's and the Bank's Officers and Directors as a group and members of their immediate families and companies in which they had an ownership interest of 10% or more was $4,954,000 or approximately 12.5% of the total equity capital of the Bank. Loans to such persons were made in the ordinary course of business, were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than the normal risk of collectability or present other unfavorable features. See also the information appearing in footnote M to the Consolidated Financial Statements included elsewhere in the Annual Report. PART IV ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Financial Statements. 1. The following consolidated financial statements and reports are set forth in Item 8: Report of Independent Certified Public Accountants Consolidated Balance Sheet Consolidated Statement of Income Consolidated Statement of Changes in Shareholders' Equity Consolidated Statement of Cash Flows Notes to the Consolidated Financial Statements 2. The following schedules are submitted herewith: I. Indebtedness of Related Parties (b) Reports on Form 8-K On January 26, 1999 Penns Woods Bancorp, Inc. filed a Form 8-K, reporting completion of the Company's acquisition of the First National Bank of Spring Mills. In addition, on September 23, 1999 Penns Woods Bancorp, Inc. filed a Form 8-K report under Item 4 of Form 8-K reporting a change in the registrant's independent certified public accountants. The schedules not included are omitted because the required matter or conditions are not present, the data is insignificant or the required information is submitted as part of the consolidated financial statements and notes thereto. (c) Exhibits: (3)(i) Articles of Incorporation of the Registrant, as presently in effect (incorporated herein by reference to Exhibit 3.1 of Registration Statement No. 333-65821 on Form S-4). (3)(ii) Bylaws of the Registrant as presently in effect (incorporated herein by reference to Exhibit 3.2 of Registration Statement No. 333-65821 on Form S-4). (10)(i) Employment Agreement, dated as of January 1, 1995, among Penns Woods Bancorp, Inc., Jersey Shore State Bank, and Theodore H. Reich (incorporated by reference to Exhibit 10.2 to Registration Statement No. 333-65821 on Form S-4)*. (10)(ii) Employment Agreement, dated August 29, 1991, between Jersey Shore State Bank and Ronald A. Walko (incorporated by reference to Exhibit 10.3 to Registration Statement No. 333-65821 on Form S-4)*. (10)(iii) Employment Agreement, dated November 5, 1984, between Jersey Shore State Bank and Hubert A. Valencik.* (10)(iv) Employment Severance Benefit Plan, dated May 30, 1996, between Jersey Shore State Bank and Ronald A. Walko (incorporated by reference to Exhibit 10.4 to Registration Statement No. 333-65821 on Form S-4)*. (10)(v) Employment Severance Benefit Plan, dated May 30, 1996, between Jersey Shore State Bank and Hubert A. Valencik.* (10)(vi) Penns Woods Bancorp, Inc. 1998 Stock Option Plan (incorporated by reference to Exhibit 10.1 to Registration Statement No. 333-65821 on Form S-4)*. (16) Letter re: change in certifying accountant (incorporated herein by reference to Exhibit 16.1 of the Registrant's Current Report on Form 8-K/A filed September 23, 1999). (21) Subsidiaries of the Registrant. (23) Consent of Parente, Randolph, Orlando, Carry & Associates. * Denotes compensatory plan or arrangement. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. March 13, 2001 PENNS WOODS BANCORP, INC. /s/Theodore H. Reich Theodore H. Reich, Chairman Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: /s/Theodore H. Reich Chairman March 13, 2001 Theodore H. Reich /s/Ronald A. Walko President, Chief March 13, 2001 Ronald A. Walko Executive Officer and Director /s/Sonya E. Scott Principal March 13, 2001 Sonya E. Scott Accounting Officer & Principal Financial Officer /s/Phillip H. Bower Director March 13, 2001 Phillip H. Bower /s/Lynn S. Bowes Director March 13, 2001 Lynn S. Bowes /s/Michael J. Casale, Jr. Director March 13, 2001 Michael J. Casale, Jr. /s/H. Thomas Davis, Jr. Director March 13, 2001 H. Thomas Davis, Jr. /s/William S. Frazier Director March 13, 2001 William S. Frazier /s/James M. Furey II Director March 13, 2001 James M. Furey II /s/Allan W. Lugg Director March 13, 2001 Allan W. Lugg /s/ Jay H. McCormick Director March 13, 2001 Jay H. McCormick /s/R. Edward Nestlerode, Jr. Director March 13, 2001 R. Edward Nestlerode, Jr. /s/James E. Plummer Director March 13, 2001 James E. Plummer /s/William H. Rockey Sr. Vice March 13, 2001 William H. Rockey President and Director EXHIBIT INDEX (10)(iii) Employment Agreement, dated November 5, 1984, between Jersey Shore State Bank and Hubert A. Valencik. (10)(v) Employment Severance Benefit Plan, dated May 30, 1996, between Jersey Shore State Bank and Hubert A. Valencik. (21) Subsidiaries of the Registrant. (23) Consent of Parente, Randolph, Orlando, Carry & Associates.