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 September 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 October 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, September 30, 2000 (unaudited) and December 31, 1999 Consolidated statements of income, (unaudited) for three and nine months ended September 30, 2000 and 1999 Consolidated statements of comprehensive income, (unaudited) for three and nine months ended September 30, 2000 and 1999 Consolidated statements of stockholders' equity, (unaudited) for three and nine months ended September 30, 2000 and 1999 Consolidated statements of cash flows (unaudited) for nine months ended September 30, 2000 and 1999 Notes to consolidated financial statements Item 2. Management's discussion and analysis of financial condition and results of operations Part II OTHER INFORMATION Item 1. Legal proceedings Item 2. Changes in securities 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 Except Shares) September 30, 2000 December 31, Unaudited 1999* --------------------------- ASSETS Cash and due from banks .................................. $ 21,381 $ 21,765 Investment securities: Available for sale (amortized cost September 30, 2000 $134,989; December 31, 1999 $133,516) ......................... 134,337 131,961 Held to maturity (fair value September 30, 2000 $16,675; December 31, 1999 $18,362) .......................... 16,577 18,307 Stock of Federal Home Loan Bank ....................... 7,927 5,930 Federal funds sold ....................................... 5,510 206 Loans, net ............................................... 622,574 565,381 Property and equipment, net .............................. 14,338 11,646 Accrued interest receivable .............................. 7,647 6,376 Deferred income taxes, net ............................... 3,473 3,954 Other assets ............................................. 8,014 8,440 --------- --------- $ 841,778 $ 773,966 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Noninterest-bearing deposits ............................. $ 73,872 $ 66,794 Interest-bearing deposits ................................ 547,532 495,292 --------- --------- Total deposits ........................................ $ 621,404 $ 562,086 Federal funds purchased and securities sold under agreements to repurchase ................... 12,377 26,714 Federal Home Loan Bank notes ............................. 125,669 108,700 Accrued interest payable ................................. 2,535 2,040 Other liabilities ........................................ 3,237 3,209 --------- --------- $ 765,222 $ 702,749 --------- --------- REDEEMABLE COMMON STOCK HELD BY EMPLOYEE STOCK OWNERSHIP PLAN (ESOP) ................................................ $ 11,735 $ 10,953 --------- --------- STOCKHOLDERS' EQUITY Capital stock, common, no par value; authorized 10,000,000 shares; issued September 30, 2000 - 1,495,941 shares; December 31, 1999 - 1,495,941 shares .................. $ 10,214 $ 10,214 Retained earnings ........................................ 66,754 61,984 Accumulated other comprehensive income, unrealized gains (losses) on investment securities, net (412) (981) --------- --------- $ 76,556 $ 71,217 Less, maximum cash obligation related to ESOP shares ........................................... 11,735 10,953 --------- --------- $ 64,821 $ 60,264 --------- --------- $ 841,778 $ 773,966 ========= ========= <FN> * Derived from audited financial statements. </FN> See Notes to Financial Statements. HILLS BANCORPORATION UNAUDITED CONSOLIDATED STATEMENTS OF INCOME Three and Nine Months Ended September 30, 2000 and 1999 (In Thousands, Except Per Share Data) Three Months Ended Nine Months Ended ------------------ ----------------- September 30 September 30 ----------------- ----------------- 2000 1999 2000 1999 ------------------------------------- Interest income: Interest and fees on loans .......... $12,950 $10,746 $36,813 $30,624 Interest on investment securities: Taxable ........................... 1,832 1,788 5,567 5,315 Non-taxable ....................... 439 394 1,284 1,157 Interest on federal funds sold ...... 79 78 346 435 ------- ------- ------- ------- Total interest income ............... $15,300 $13,006 $44,010 $37,531 ------- ------- ------- ------- Interest expense: Interest on deposits ................ $ 6,536 $ 5,220 $17,870 $15,498 Interest on securities sold under agreements to repurchase .......... 162 113 424 308 Interest on FHLB borrowings ......... 1,854 1,296 5,704 3,415 ------- ------- ------- ------- Total interest expense .............. $ 8,552 $ 6,629 $23,998 $19,221 ------- ------- ------- ------- Net interest income ................. $ 6,748 $ 6,377 $20,012 $18,310 Provision for loan losses .............. 237 204 711 612 ------- ------- ------- ------- Net interest income after provision for loan losses ................... $ 6,511 $ 6,173 $19,301 $17,698 ------- ------- ------- ------- Other income: Loan origination fees ............... $ 110 $ 121 $ 222 $ 525 Trust fees .......................... 590 457 1,757 1,483 Deposit account charges and fees .... 652 605 1,851 1,589 Net losses on sale of investment securities ........................ - - (214) - - (214) Other fees and charges .............. 534 464 1,710 1,382 ------- ------- ------- ------- $ 1,886 $ 1,433 $ 5,540 $ 4,765 ------- ------- ------- ------- Other expenses: Salaries and employee benefits ...... $ 2,659 $ 2,429 $ 7,939 $ 7,244 Occupancy ........................... 414 330 1,085 920 Furniture and equipment ............. 517 453 1,512 1,363 Office supplies and postage ......... 254 290 754 814 Other operating ..................... 1,183 1,045 3,514 3,050 ------- ------- ------- ------- $ 5,027 $ 4,547 $14,804 $13,391 ------- ------- ------- ------- Income before income taxes .......... $ 3,370 $ 3,059 $10,037 $ 9,072 Federal and state income taxes ......... 1,034 941 3,098 2,794 ------- ------- ------- ------- Net income .......................... $ 2,336 $ 2,118 $ 6,939 $ 6,278 ======= ======= ======= ======= Earning per common share: Basic ............................. $ 1.56 $ 1.41 $ 4.63 $ 4.20 Diluted ........................... 1.55 1.40 4.60 4.17 HILLS BANCORPORATION UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Three and Nine Months Ended September 30, 2000 and 1999 (In Thousands) Three Months Ended Nine Months Ended September 30 September 30 ------------------- ------------------ 2000 1999 2000 1999 ------- ------- ------- ------- Net Income ..................................... $ 2,336 $ 2,118 $ 6,939 $ 6,278 ------- ------- ------- ------- Other comprehensive income: Unrealized gains (losses) on debt securities 1,133 (371) 903 (2,527) Income tax effect of unrealized gains losses) (419) 138 (334) 922 ------- ------- ------- ------- $ 714 $ (233) $ 569 $(1,605) ------- ------- ------- ------- Comprehensive Income ........................ $ 3,050 $ 1,885 $ 7,508 $ 4,673 ======= ======= ======= ======= See Notes to Financial Statements. HILLS BANCORPORATION UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Nine Months Ended September 30, 2000 and 1999 (In Thousands) Less Maximum Accumulated Cash Other Obligation Capital Retained Comprehensive To ESOP Stock Earnings Income Shares Total -------- -------- ------------- ----------- -------- Balance, December 31, 1999 ................. $ 10,214 $ 61,984 $ (981) $(10,953) $ 60,264 Net income ............................... - - - 6,939 - - - - - - 6,939 Change related to ESOP shares ............ - - - - - - - - - (782) (782) Cash dividends ($1.45 per share) ......... - - - (2,169) - - - - - - (2,169) Other comprehensive income ............... - - - - - - 569 - - - 569 -------- -------- ------ -------- -------- Balance, September 30, 2000 ................ $ 10,214 $ 66,754 $ (412) $(11,735) $ 64,821 ======== ======== ====== ======== ======== Less Maximum Accumulated Cash Other Obligation Capital Retained Comprehensive To ESOP Stock Earnings Income Shares Total -------- -------- ------------- -------- -------- Balance, December 31, 1998 ................. $ 9,140 $55,428 $ 1,185 $ (9,301) $ 56,452 Net income ............................... - - - 6,278 - - - - - - 6,278 Change related to ESOP shares ............ - - - - - - - - - (1,610) (1,610) Cash dividends ($1.30 per share) ......... - - - (1,911) - - - - - - (1,911) Other comprehensive income ............... - - - - - - (1,605) - - - (1,605) Issuance of 24,424 shares of common stock 645 - - - - - - - - - 645 Income tax benefit related to stock options exercised ................ - - - 308 - - - - - - 308 ------- ------- -------- -------- ------- Balance, September 30, 1999 ................ $ 9,785 $60,103 $ (420) $(10,911) $ 58,557 ======= ======= ======== ======== ======== See Notes to Financial Statements. HILLS BANCORPORATION UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months Ended September 30, 2000 and 1999 (In Thousands) 2000 1999 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net income ..................................................................... $ 6,939 $ 6,278 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation ............................................................... 1,020 1,071 Provision for loan losses .................................................. 711 612 Net losses on disposition of investment securities ......................... - - - 214 Deferred income taxes ...................................................... 147 (56) Compensation paid by issuance of common stock .............................. - - - 20 (Increase) decrease in accrued interest receivable ......................... (1,271) (699) Amortization of bond discount .............................................. 52 339 (Increase) in other assets ................................................. 168 (1,401) Amortization of intangibles ................................................ 258 258 Increase in accrued interest and other liabilities ......................... 523 1,291 -------- -------- Net cash provided by operating activities .................................. $ 8,547 $ 7,927 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturities of investment securities: Available for sale ......................................................... $ 21,531 $ 26,837 Held to maturity ........................................................... 1,651 2,055 Proceeds from sales of available for sale securities ....................... - - - 9,003 Purchase of available for sale investment securities ....................... (24,974) (46,726) Federal funds sold, net .................................................... (5,304) 36,605 Loans made to customers, net of collections ................................ (57,904) (76,098) Purchases of property and equipment ........................................ (3,712) (1,483) -------- -------- Net cash (used in) investing activities .................................... $(68,712) $(49,807) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposits ................................................... $ 59,318 $ 14,672 Net increase (decrease) in fed funds purchased and securities sold under agreements to repurchase .......................... (14,337) 16,135 Borrowings from FHLB ....................................................... 40,000 25,000 Payments on FHLB notes ..................................................... (23,031) (12,032) Stock options exercised .................................................... - - - 625 Income tax benefits on stock options exercised ............................. - - - 308 Dividends paid ............................................................. (2,169) (1,911) -------- -------- Net cash provided by financing activities ............................... $ 59,781 $ 42,797 -------- -------- Increase (decrease) in cash and due from banks .......................... $ (384) $ 917 CASH AND DUE FROM BANKS Beginning .................................................................. 21,765 16,427 -------- -------- Ending ..................................................................... $ 21,381 $ 17,344 ======== ======== SUPPLEMENTAL DISCLOSURES Cash payments for: Interest paid to depositors and others .................................. $ 17,375 $ 15,568 Interest paid on other obligations ...................................... 6,128 3,723 Non-cash financing transaction, increase in maximum cash obligation related to ESOP shares ..................................... 782 1,610 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) September 30 -------------------------- 2000 1999 --------- --------- Agricultural ................................ $ 29,090 $ 29,394 Commercial and financial .................... 37,292 40,046 Real estate, construction ................... 44,340 39,706 Real estate, mortgage ....................... 489,453 406,420 Loans to individuals ........................ 32,447 30,058 --------- --------- $ 632,622 $ 545,624 Less allowance for loan losses .............. 10,048 9,227 --------- --------- $ 622,574 $ 536,397 ========= ========= Transactions in the allowance for loan losses are as follows: (In thousands) Nine Months Ended September 30 ------------------------- 2000 1999 -------- -------- Balance, beginning ........................... $ 9,750 $ 8,856 Provision charged to expense ............... 711 612 Net charge-offs ............................ (413) (241) -------- -------- Balance, ending .............................. $ 10,048 $ 9,227 ======== ======== The following summarizes the Company's nonaccrual, past due, restructured and impaired loans: (In thousands) September 30 ----------------- 2000 1999 ------ ------ Nonaccrual ..................................... $ 98 $- - - Accruing loans, past due 90 days or more ....... 2,215 1,083 Restructured loan .............................. - - - - - - Impaired loans ................................. $8,908 9,343 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 nine months of 2000 the Company expanded to a new market and two significant construction projects were started in Hills and Coralville, respectively. In February the Company opened a new office in downtown Cedar Rapids, Iowa, our tenth location. The construction of the new operations center in Hills, began in March 2000, and continues to be on schedule with a completion expected by December of 2000. The total cost of the project is expected to be approximately $3.1 million, plus capitalized interest cost during construction. Also construction began in June, 2000 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 September 30, 2000 are $841.8 million and represent a $103.2 million increase in assets from one year ago. This increase in assets included an increase in net loans from September 30, 1999 to September 30, 2000 of $86.2 million, with primarily all the loan growth attributable to real estate loans, consistent with loan growth over the last 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 $72.6 million, while federal funds purchased and securities sold under agreements to repurchase decreased by $14.3 million and a net increase in Federal Home Loan Bank note advances of $37.0 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. The Company believes it 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 September 30, 2000 totaled $64,821,000. The total stockholders' equity of Hills Bancorporation as of September 30, 2000 before the reduction for the ESOP shares, totaled 9.09% of total assets. Under risk-based capital rules, our total risk based capital is 13.70% of risk adjusted assets, and substantially in excess of required minimums. Results of Operations Net income for the quarter and nine months ended September 30, 2000 compared to the same periods in 1999 had increases of $218,000 and $661,000, 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 $100 million higher for the nine months ended September 30, 2000 compared to the same period in 1999. Total other income increased over the prior year by $453,000 for the three months ended September 30, 2000 and $775,000 for the nine month period then ended. Loan origination fees for the nine months in 2000 are $303,000 less than 1999 as a result of fewer real estate loan refinancings in 2000. Trust fees, deposit account charges and other fees increased $250,000 for the three months and $864,000 for the nine months and were the direct results of volume increased in trust assets and deposit accounts opened. During the third quarter of 1999 the Company had a reduction of other income by $214,000, which represented investment securities losses taken to replace lower yielding securities with higher yielding securities of similar risk and maturity. For the year 2000 no gains and losses on sale of investment securities have occurred. Other expenses increased $480,000 and $1,413,000 for the two periods represented. Of the increase, salaries and benefits accounted for $695,000, occupancy and furniture and equipment expense $314,000 and all other expenses $404,000. The salaries and employee benefits increase were the direct result of salary adjustments in the first quarter of 2000 and the two new offices added during the last sixteen months. The Eastside location of Hills Bank and Trust Company opened in June of 1999 and the Cedar Rapids office of Hills Bank opened in February of 2000. The two new locations also accounted for a portion of the increase in occupancy expense and other expense increases in marketing and business promotion. Also during the year 2000 the banks have introduced an on-line banking product and incurred increased promotion expense for this product. Earnings per share, both basic and diluted, increased for the quarter ended September 30, 2000 compared to 1999. For the quarter ended September 30, 2000 basic and diluted earnings per share were $1.56 and $1.55 in comparison to $1.41 and $1.40 for the quarter ended September 30, 1999. The earnings per share for the nine months ended September 30, 2000 and 1999 were $4.63 and $4.20 for basic earnings per share and $4.60 and $4.17 for diluted earnings per share. 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. Our objective 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 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 No matters were submitted to a vote of security holders during the quarter ended September 30, 2000. 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 September 30, 2000. 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) November 14, 2000 /s/ Dwight O. Seegmiller - ------------------ ------------------------------------------- Date Dwight O. Seegmiller, President (Duly authorized officer of the registrant) November 14, 2000 /s/ James G. Pratt - ----------------- ------------------------------------------- Date James G. Pratt, Treasurer (Principal Financial Officer)