FORM 10-Q - QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (As last amended in Rel. No. 34-26589, eff. 4/12/93.) UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2000 Commission file number: 0-12668 Hills Bancorporation Incorporated in Iowa I.R.S. Employer Identification No. 42-1208067 131 MAIN STREET, HILLS, IOWA Telephone number: (319) 679-2291 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. [X] Yes [ ] No APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. SHARES OUTSTANDING CLASS AT July 31, 2000 - -------------------------- ------------------- Common Stock, no par value 1,495,941 HILLS BANCORPORATION Index to Form 10-Q Part I FINANCIAL INFORMATION Page Number Item 1. Financial Statements Consolidated balance sheets, June 30, 2000 (unaudited) and December 31, 1999 Consolidated statements of income, (unaudited) for three and six months ended June 30, 2000 and 1999 Consolidated statements of comprehensive income, (unaudited) for three and six months ended June 30, 2000 and 1999. Consolidated statements of stockholders' equity, (unaudited) for six months ended June 30, 2000 and 1999 Consolidated statements of cash flows (unaudited) for six months ended June 30, 2000 and 1999 Notes to consolidated financial statements (unaudited) Item 2. Management's discussion and analysis of financial condition and results of operations Item 3. Quantitative and Qualitative Disclosures About Market Risk The information appearing on page 11 of item 2 under the heading "Market Risk Management" is incorporated herein by reference. Part II OTHER INFORMATION Item 1. Legal proceedings Item 2. Changes in securities and use of proceeds Item 3. Defaults upon senior securities Item 4. Submission of matters to vote of security holders Item 5. Other information Item 6. Exhibits and reports on Form 8-K COMPUTATION OF EARNINGS PER SHARE SIGNATURES HILLS BANCORPORATION CONSOLIDATED BALANCE SHEETS (In Thousands) June 30, 2000 December 31, Unaudited 1999* ------------------------ ASSETS Cash and due from banks .................................. $ 24,321 $ 21,765 Investment securities: Available for sale (amortized cost June 30, 2000 $134,634; December 31, 1999 $133,516) ................ 132,849 131,961 Held to maturity (fair value June 30, 2000 $16,692; December 31, 1999 $18,362) .......................... 16,687 18,307 Stock of Federal Home Loan Bank ....................... 7,789 5,930 Federal funds sold ....................................... 200 206 Loans, net ............................................... 605,334 565,381 Property and equipment, net .............................. 13,203 11,646 Accrued interest receivable .............................. 7,116 6,376 Deferred income taxes, net ............................... 3,878 3,954 Other assets ............................................. 7,890 8,440 --------- --------- $ 819,267 $ 773,966 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Noninterest-bearing deposits ............................. $ 72,965 $ 66,794 Interest-bearing deposits ................................ 525,912 495,292 --------- --------- Total deposits ........................................ $ 598,877 $ 562,086 Federal funds purchased and securities sold under agreements to repurchase ................... 15,753 26,714 Federal Home Loan Bank notes ............................. 125,700 108,700 Accrued interest payable ................................. 2,253 2,040 Other liabilities ........................................ 3,178 3,209 --------- --------- $ 745,761 $ 702,749 --------- --------- REDEEMABLE COMMON STOCK HELD BY EMPLOYEE STOCK OWNERSHIP PLAN (ESOP) ................................................ $ 11,344 $ 10,953 --------- --------- STOCKHOLDERS' EQUITY Capital stock, common, no par value; authorized 10,000,000 shares; issued June 30, 2000 - 1,495,941 shares; December 31, 1999 - 1,495,941 shares .................. $ 10,214 $ 10,214 Retained earnings ........................................ 64,418 61,984 Accumulated other comprehensive income, unrealized gains (losses) on investment securities, net ................. (1,126) (981) --------- --------- $ 73,506 $ 71,217 Less, maximum cash obligation related to ESOP shares ........................................... 11,344 10,953 --------- --------- $ 62,162 $ 60,264 --------- --------- $ 819,267 $ 773,966 ========= ========= <FN> * Derived from audited financial statements. </FN> See Notes to Financial Statements. HILLS BANCORPORATION UNAUDITED CONSOLIDATED STATEMENTS OF INCOME Three and Six Months Ended June 30, 2000 and 1999 (In Thousands, Except Per Share Data) Three Months Ended Six Months Ended ------------------ ----------------- June 30 June 30 ----------------- ----------------- 2000 1999 2000 1999 ----------------- ----------------- Interest Income: Interest and fees on loans .......... $12,225 $10,215 $23,863 $19,878 Interest on investment securities: Taxable ........................... 1,902 1,776 3,735 3,527 Non-taxable ....................... 429 384 845 763 Interest on federal funds sold ...... 95 96 267 357 ----------------- ----------------- Total interest income ............... $14,651 $12,471 $28,710 $24,525 ----------------- ----------------- Interest Expense: Interest on deposits ................ $ 5,928 $ 5,188 $11,334 $10,278 Interest on securities sold under Interest on FHLB borrowings ......... 1,897 1,042 3,850 2,119 ----------------- ----------------- Total interest expense .............. $ 7,954 $ 6,324 $15,446 $12,592 ----------------- ----------------- Net interest income ................. $ 6,697 $ 6,147 $13,264 $11,933 Provision for loan losses .............. 201 204 474 408 ----------------- ----------------- Net interest income after provision Other income: Loan origination fees ............... $ 65 $ 205 $ 112 $ 404 Trust fees .......................... 578 500 1,167 1,026 Deposit account charges and fees .... 630 532 1,199 984 Other fees and charges .............. 592 440 1,176 918 ----------------- ----------------- $ 1,865 $ 1,677 $ 3,654 $ 3,332 ----------------- ----------------- Other expenses: Salaries and employee benefits ...... $ 2,620 $ 2,473 $ 5,280 $ 4,815 Occupancy ........................... 331 297 671 590 Furniture and equipment ............. 509 459 995 910 Office supplies and postage ......... 259 258 500 524 Other operating ..................... 1,163 1,110 2,331 2,005 ----------------- ----------------- $ 4,882 $ 4,597 $ 9,777 $ 8,844 ----------------- ----------------- Income before income taxes .......... $ 3,479 $ 3,023 $ 6,667 $ 6,013 Federal and state income taxes ......... 1,080 942 2,064 1,853 ----------------- ----------------- Net income .......................... $ 2,399 $ 2,081 $ 4,603 $ 4,160 ================= ================= Earning per common share: Basic ............................. $ 1.60 $ 1.40 $ 3.08 $ 2.82 Diluted ........................... 1.59 1.39 3.05 2.79 HILLS BANCORPORATION UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Three and Six Months Ended June 30, 2000 and 1999 (In Thousands, Except Per Share Data) Three Months Ended Six Months Ended June 30 June 30 ------------------- ------------------ 2000 1999 2000 1999 ------------------ ------------------ Net Income ...................................... $ 2,399 $ 2,081 $ 4,603 $ 4,160 Other comprehensive income: Unrealized gains (losses) on debt securities . 137 (1,301) (230) (2,156) Income tax effect of unrealized gains (losses) (51) 483 85 798 ------------------ ------------------ Comprehensive Income ......................... $ 2,485 $ 1,263 $ 4,458 $ 2,802 ================== ================== HILLS BANCORPORATION UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Six Months Ended June 30, 2000 and 1999 (In Thousands) Less Maximum Accumulated Cash Other Obligation Capital Retained Comprehensive To ESOP Stock Earnings Income Shares Total ------------------------------------------------------- Balance, January 1, 2000 .......................... $10,214 $61,984 $ (981) $(10,953) $60,264 Net income ........................................ - - 4,603 - - - - 4,603 Change related to ESOP shares ..................... - - - - - - (391) (391) Cash dividends ($1.45 per share) .................. - - (2,169) - - - - (2,169) Other comprehensive income ........................ - - - - (145) - - (145) ------------------------------------------------------- Balance, June 30, 2000 ............................ $10,214 $64,418 $(1,126) $(11,344) $ 62,162 ======================================================= Balance, January 1, 1999 ......................... $ 9,140 $55,428 $ 1,185 $ (9,301) $ 56,452 Net income ........................................ - - 4,160 - - - - 4,160 Change related to ESOP shares ..................... - - - - - - (968) (968) Cash dividends ($1.30 per share) .................. - - (1,911) - - - - (1,911) Other comprehensive income ........................ - - - - (1,372) - - (1,372) Issuance of 24,424 shares of common stock ......... 645 - - - - - - 645 Income tax benefit related to stock options exercised ......................... - - 308 - - - - 308 -------------------------------------------------------- Balance, June 30, 1999 ............................ $ 9,785 $ 57,985 $ (187) $(10,269) $ 57,314 ======================================================== See Notes to Financial Statements. HILLS BANCORPORATION UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30, 2000 and 1999 (In Thousands) 2000 1999 -------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income ..................................................................... $ 4,603 $ 4,160 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation ............................................................... 680 714 Provision for loan losses .................................................. 474 408 Deferred income taxes ...................................................... 161 (60) Compensation paid by issuance of common stock .............................. - - 20 (Increase) decrease in accrued interest receivable ......................... (740) (774) Amortization of bond discount .............................................. 33 245 (Increase) in other assets ................................................. 378 (849) Amortization of intangibles ................................................ 172 172 Increase in accrued interest and other liabilities ......................... 182 1,046 -------------------- Net cash provided by operating activities .................................. $ 5,943 $ 5,082 -------------------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturities of investment securities: Available for sale ......................................................... $ 13,531 $ 19,637 Held to maturity ........................................................... 1,568 2,241 Purchase of investment securities, available for sale ........................ (16,489) (26,689) Federal funds sold, net ...................................................... 6 24,895 Loans made to customers, net of collections .................................. (40,427) (48,877) Purchases of property and equipment .......................................... (2,237) (1,210) -------------------- Net cash (used in) investing activities .................................... $(44,048) $(30,003) -------------------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase (decrease) in deposits ........................................ $ 36,791 $ 10,857 Net increase (decrease) in fed funds purchased and securities sold under agreements to repurchase ................................................. (10,961) (2,065) Borrowings from FHLB ....................................................... 40,000 25,000 Payments on FHLB notes ..................................................... (23,000) (7,000) Stock options exercised .................................................... - - 625 Income tax benefits on stock options exercised ............................. - - 308 Dividends paid ............................................................. (2,169) (1,911) -------------------- Net cash provided by financing activities ............................... $ 40,661 $ 25,814 -------------------- Increase in cash and due from banks ..................................... $ 2,556 $ 893 CASH AND DUE FROM BANKS Beginning .................................................................. 21,765 16,427 -------------------- Ending ..................................................................... $ 24,321 $ 17,320 ==================== SUPPLEMENTAL DISCLOSURES Cash payments for: Interest paid to depositors and others .................................. $ 11,121 $ 10,282 Interest paid on other obligations ...................................... 4,112 2,314 Non-cash financing transaction, increase in maximum cash obligation related to ESOP shares ................................................. 391 968 See Notes to Financial Statements. HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Note 1. Interim Financial Statements Interim consolidated financial statements have not been examined by independent public accountants, but include all adjustments (consisting only of normal recurring accruals) which, in the opinion of management, are necessary for a fair presentation of the results for these periods. The results of operation for the interim periods are not necessarily indicative of the results for a full year. In reviewing these financial statements, reference should be made to the Notes to Financial Statements contained in the Financial Statements for the year ended December 31, 1999. There were no changes in accounting policies which had a significant effect on the interim consolidated financial statements for the periods presented. For purposes of reporting cash flows, cash and due from banks includes cash on hand and amounts due from banks (including cash items in process of clearing). Cash flows from demand deposits, NOW accounts, savings accounts, and federal funds purchased and sold are reported net since their original maturities are less than three months. Cash flows from loans and time deposits are presented as net increases or decreases. Note 2. Loans The following tables set forth the composition of loans and the allowance for loan losses: (In thousands) June 30 ------------------------- 2000 1999 ------------------------- Agricultural ................................. $ 30,131 $ 27,997 Commercial and financial ..................... 35,927 34,300 Real estate, construction .................... 40,417 38,634 Real estate, mortgage ........................ 477,892 382,741 Loans to individuals ......................... 30,927 34,935 -------- -------- $615,294 $518,607 Less allowance for loan losses ............... 9,960 9,227 -------- -------- $605,334 $509,380 ======== ======== Transactions in the allowance for loan losses are as follows: (In thousands) Six Months Ended June 30 ------------------------- 2000 1999 ------------------------- Balance, beginning ........................... $ 9,750 $ 8,856 Provision charged to expense ............... 474 408 Net charge-offs ............................ (264) (37) ------- ------- Balance, ending .............................. $ 9,960 $ 9,227 ======= ======= The following summarizes the Company's nonaccrual, past due, restructured and impaired loans: (In thousands) June 30 -------------------- 2000 1999 -------------------- Nonaccrual .......................................... $ - - $ - - Accruing loans, past due 90 days or more ............ 2,172 1,749 Restructured loan ................................... - - - - Impaired loans ...................................... 8,837 9,413 Note 3. Earnings Per Share Basic net income per share amounts are computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed by dividing net income by the weighted average number of common shares outstanding during the period plus the number of potential dilutive common shares attributable to the Company's stock option plan. PART I, ITEM 2. HILLS BANCORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward Looking Information Forward looking information relating to the financial results or strategies of the Company are made in the Management's Discussion and Analysis. The following paragraphs identify forward looking statements and the risks that need to be considered when reading those statements. Forward looking statements include such words as believe, expect, anticipate, target, goal, objective and other words with similar meaning. The Company is under no obligation to update such statements. The risks involved in the operations and strategies of the Company include competition from other financial institutions, changes in interest rates, changes in economic or market conditions and changes in regulatory factors. These risks, which are not all inclusive, cannot be estimated. Recent Activities During the first six months of 2000 the Company expanded to a new market and two significant construction projects were started. In February we opened a new office in downtown Cedar Rapids, Iowa, our tenth location. At the end of the six months our consolidated total assets exceeded $819 million, reflecting continued growth at all locations. The construction of our new operations center in Hills, began in March 2000, and continues to be on schedule with a completion expected by February of 2001. The total cost of the project is expected to be approximately $3.1 million, plus capitalized interest cost during constuction. Also we began construction of a 6,000 square foot addition to the Coralville office, which will be primarily for retail banking services in the growing Coralville market. The Coralville project also includes a substantial remodeling of the existing two story Coralville office. Total project costs are estimated to be approximately $2.1 million. Financial Position Total assets at June 30, 2000 totaled $819.3 million and represent a $99.8 million increase in assets from one year ago. This increase in assets includes an increase in net loans from June 30, 1999 to June 30, 2000 of $96.0 million, with primarily all the loan growth attributable to real estate loans, consistent with our loan growth of the past few years. The local and national economy continues to be strong despite recent increases in interest rates. Our asset growth was funded primarily by deposit growth of $53.9 million, federal funds purchased and securities sold under agreements to repurchase of $7.3 million and a net increase in Federal Home Loan Bank note advances of $32.0 million. Due to the continued loan demand and challenges for funding sources, asset-liability management continues to be very important. The asset-liability management encompasses both the management of interest rate sensitivity and the maintenance of adequate liquidity. Interest rate sensitivity management attempts to provide the optimal level of net interest income while managing exposure to risks associated with interest rate movements. Liquidity management involves planning to meet anticipated funding needs. Management monitors the rate sensitivity and liquidity positions on an on-going basis and, when necessary, appropriate action is taken to minimize any adverse effects of rapid interest rate movements or any unexpected liquidity concerns. We believe that we will be able to maintain sufficient liquidity. In January 2000, Hills Bancorporation paid a dividend of $2,169,000 or $1.45 per share, an 11.54% increase from the $1.30 paid in January 1999. After payment of the dividend and adjustment for accumulated other comprehensive income, stockholders' equity as of June 30, 2000 totaled $62,162,000. The total stockholders' equity of Hills Bancorporation as of June 30, 2000 before the reduction for the ESOP shares, totaled 8.97% of total assets. Under risk-based capital rules, our total risk based capital is 14.13% of risk adjusted assets, and substantially in excess of required miniumums. Results of Operations Net income for the quarter and six months ended June 30, 2000 compared to the same periods in 1999 had increases of $318,000 and $443,000, respectively. For both periods the changes were primarily the result of significant increases in net interest income which was the result of increases in average earning assets from the prior year. Average earning assets were approximately $102.5 million higher for the six months ended June 30, 2000 compared to the same period in 1999. Other income increased over the prior year by $188,000 for the three month period ended June 30 and $322,000 for the six month period then ended. Loan origination fees for the quarter and six months decreased $140,000 and $292,000, respectively as interest rates increased significantly from the rates prevailing during the first six months of 1999 and this directly affected the volume of loans sold in the secondary market. Trust fees, deposit account charges and other fees increased $328,000 for the three months and $614,000 for the six months which were the direct results of volume increases in trust assets and deposit accounts opened, respectively. Other expenses increased $285,000 and $933,000 for the three and six month periods presented. For the $933,000 increase, salaries and benefits accounted for $465,000, occupancy and furniture and equipment expense $166,000 and all other expenses $302,000. The salaries and employee benefits increased as the result of salary adjustments in the first quarter of 2000 and the addition of employees at the new Cedar Rapids office. The East Iowa City branch of Hills Bank and Trust Company was opened in June 1999 and the Cedar Rapids office of Hills Bank opened in February 2000. The two new locations accounted for a portion of the increase in occupancy expense and other expense increases in marketing and business promotion. Also early in 2000 the banks introduced on-line banking services and incurred increased promotion expenses. The usage of on-line service has exceeded our expectations and we look forward to continued increased usage. Earnings per share, both basic and diluted, increased for the quarter ended June 30, 2000 compared to 1999. For the quarter ended June 30, 2000 basic and diluted earnings per share totaled $1.60 and $1.59 in comparison to $1.40 and $1.39 for the quarter ended June 30, 1999. For the six month period ended in June 2000, basis and diluted earning per share totaled $3.08 and $3.05 compared to $2.82 and $2.79 for the same period in 1999. Market Risk Management Market risk is the risk of earnings volatility that results from adverse changes in interest rates and market prices. The Company's market risk is comprised primarily of interest rate risk arising form its core banking activities of lending and deposit taking. Interest rate risk is the risk that changes in market interest rates may adversely affect the Company's net interest income. Management continually develops and applies strategies to mitigate this risk. Management does not believe that the Company's primary market risk exposures and how those exposures have been managed to-date in 2000 changed significantly when compared to 1999. Asset/Liability Management The Company has a fully integrated asset/liability management system to assist in managing the balance sheet. The process, which is used to project the results of alternative investment decisions, includes the development of simulations that reflect the effects of various interest rate scenarios on net interest income. Management analyzes the simulations to manage interest rate risk, the net interest margin and levels of net interest income. The goal is to structure the balance sheet so that net interest margin fluctuates in a narrow range during periods of changing interest rates. The Company currently believes that net interest income would fall by less than 4 percent if interest rates increased or decreased by 300 basis points over a one-year time horizon. This is within the Company's policy limits. To improve net interest income and lessen interest rate risk, management continues its strategy of de-emphasizing fixed-rate portfolio residential real estate loans with long repricing periods. The Company continues to focus on reducing interest rate risk by emphasizing growth in variable-rate consumer and commercial loans. Other actions include the use of fixed-rate Federal Home Loan Bank (FHLB) advances as alternatives to certificates of deposit, active management of the available for sale investment securities portfolio to provide for cash flows that will facilitate interest rate risk management. The highly competitive banking environment in Iowa also greatly impacts the Company's net interest margin. The effect of competition on net interest income is difficult to predict. HILLS BANCORPORATION PART II - OTHER INFORMATION Item 1. Legal Proceedings There are no material pending legal proceedings. Item 2. Changes in Securities and use of Proceeds There were no changes in securities. Item 3. Defaults upon Senior Securities Hills Bancorporation has no senior securities. Item 4. Submission of Matters to a Vote of Security Holders At the Annual Meeting held on April 17, 2000, the security holders approved the following: 1. Election of Michael E. Hodge to a one year term to the Board of Directors expiring at the 2001 Annual Meeting. 2. Election of Willis M. Bywater, Thomas J. Gill, D.D.S., Donald H. Gringer and Dwight O. Seegmiller to three-year terms to the Board of Directors expiring at the 2003 Annual Meeting. 3. Approved the Hills Bancorporation 2000 Stock Option and Incentive Plan. Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibit See exhibit II - Statement Re Computation of Earnings Per Common Share (b) Reports on Form 8-K No reports on Form 8-K have been filed during the quarter ended June 30, 2000. HILLS BANCORPORATION EXHIBIT II COMPUTATION OF EARNINGS PER COMMON SHARE Three months ended Six months ended June 30 June 30 -------------------- ------------------- 2000 1999 2000 1999 --------------------- -------------------- Weighted average numbe of shares outstanding (basic) ................... 1,495,941 1,484,525 1,495,941 1,476,139 Weighted average of potential dilutive shares attributable to stock options granted computed under the treasury stock method .......................... 12,677 11,871 12,631 16,217 --------------------------------------------- Weighted average number of shares (diluted) ............................. 1,508,618 1,496,396 1,508,572 1,492,356 ============================================= Earnings Per Share: Net income (in thousands) ............. $ 2,399 $ 2,081 $ 4,603 $ 4,160 Earnings per common share: Basic ............................... $ 1.60 $ 1.40 $ 3.08 $ 2.82 Diluted ............................. 1.59 1.39 3.05 2.79 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned and thereunto duly authorized. HILLS BANCORPORATION (Registrant) August 14, 2000 /s/ Dwight O. Seegmiller - -------------------- ------------------------------------------- Date Dwight O. Seegmiller, President (Duly authorized officer of the registrant) August 14, 2000 /s/ James G. Pratt - -------------------- ------------------------------------------- Date James G. Pratt, Treasurer (Principal Financial Officer)