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, 1999 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, 1999 - -------------------------- ------------------- Common Stock, no par value 1,493,867 HILLS BANCORPORATION Index to Form 10-Q Part I FINANCIAL INFORMATION Page Number Item 1. Financial Statements Consolidated balance sheets, September 30, 1999 (unaudited) and December 31, 1998 Consolidated statements of income, (unaudited) for three and nine months ended September 30, 1999 and 1998 Consolidated statements of comprehensive income, (unaudited) for three and nine months ended September 30, 1999 and 1998. Consolidated statements of stockholders' equity, (unaudited) for nine months ended September 30, 1999 and 1998 Consolidated statements of cash flows (unaudited) for nine months ended September 30, 1999 and 1998 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) September 30, 1999 December 31, Unaudited 1998* --------------------------- ASSETS Cash and due from banks .................................. $ 17,344 $ 16,427 Investment securities: Available for sale (amortized cost September 30, 1999 $131,702; December 31, 1998 $121,974) ......................... 131,036 123,835 Held to maturity (fair value September 30, 1999 $19,273; December 31, 1998 $21,740) .......................... 19,114 21,168 Stock of Federal Home Loan Bank ....................... 4,931 4,347 Federal funds sold ....................................... 206 36,811 Loans, net ............................................... 536,397 460,911 Property and equipment, net .............................. 11,605 11,193 Accrued interest receivable .............................. 6,584 5,885 Deferred income taxes, net ............................... 2,836 1,838 Other assets ............................................. 8,515 7,372 --------- --------- $ 738,568 $ 689,787 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Noninterest-bearing deposits ............................. $ 63,010 $ 68,100 Interest-bearing deposits ................................ 485,813 466,051 --------- --------- Total deposits ........................................ $ 548,823 $ 534,151 Federal funds purchased and securities sold under agreements to repurchase ................... 26,689 10,554 Federal Home Loan Bank notes ............................. 88,700 75,732 Accrued interest payable ................................. 1,978 2,048 Other liabilities ........................................ 2,910 1,549 --------- --------- $ 669,100 $ 624,034 --------- --------- REDEEMABLE COMMON STOCK HELD BY EMPLOYEE STOCK OWNERSHIP PLAN (ESOP) ................................................ $ 10,911 $ 9,301 --------- --------- STOCKHOLDERS' EQUITY Capital stock, common, no par value; authorized 10,000,000 shares; issued September 30, 1999 - 1,493,867 shares; December 31, 1998 - 1,469,443 shares .................. $ 9,785 $ 9,140 Retained earnings ........................................ 60,103 55,428 Accumulated other comprehensive income, unrealized gains (losses) on investment securities, net (420) 1,185 --------- --------- $ 69,468 $ 65,753 Less, maximum cash obligation related to ESOP shares ........................................... 10,911 9,301 --------- --------- $ 58,557 $ 56,452 --------- --------- $ 738,568 $ 689,787 ========= ========= * Derived from audited financial statements. See Notes to Financial Statements. HILLS BANCORPORATION UNAUDITED CONSOLIDATED STATEMENTS OF INCOME Three and Nine Months Ended September 30, 1999 and 1998 (In Thousands, Except Per Share Data) Three Months Ended Nine Months Ended 1999 1998 1999 1998 -------------------- ------------------- Interest Income: Interest and fees on loans ........................ $ 10,746 $ 9,566 $ 30,624 $ 28,108 Interest on investment securities: Taxable ......................................... 1,788 1,698 5,315 5,064 Non-taxable ..................................... 394 354 1,157 1,019 Interest on federal funds sold .................... 78 350 435 893 -------- -------- -------- -------- Total interest income ............................. $ 13,006 $ 11,968 $ 37,531 $ 35,084 -------- -------- -------- -------- Interest Expense: Interest on deposits .............................. $ 5,220 $ 5,185 $ 15,498 $ 15,253 Interest on securities sold under Interest on FHLB borrowings ....................... 1,296 1,106 3,415 3,277 -------- -------- -------- -------- Total interest expense ............................ $ 6,629 $ 6,379 $ 19,221 $ 18,787 -------- -------- -------- -------- Net interest income ............................... $ 6,377 $ 5,589 $ 18,310 $ 16,297 Provision for loan losses ............................ 204 304 612 712 -------- -------- -------- -------- Net interest income after provision for loan losses ................................. 6,173 5,285 17,698 15,585 -------- -------- -------- -------- Other income: Loan origination fees ............................. $ 121 $ 166 $ 525 $ 500 Trust fees ........................................ 457 403 1,483 1,266 Deposit account charges and fees .................. 605 458 1,589 1,351 Net gains (losses) on sale of investment securities (214) (214) -- Other fees and charges ............................ 464 348 1,382 1,079 -------- -------- -------- -------- $ 1,433 $ 1,375 $ 4,765 $ 4,196 -------- -------- -------- -------- Other expenses: Salaries and employee benefits .................... $ 2,429 $ 2,133 $ 7,244 $ 6,366 Occupancy ......................................... 330 284 920 859 Furniture and equipment ........................... 453 421 1,363 1,249 Office supplies and postage ....................... 290 293 814 882 Other operating ................................... 1,045 954 3,050 2,792 -------- -------- -------- -------- $ 4,547 $ 4,085 $ 13,391 $ 12,148 -------- -------- -------- -------- Income before income taxes ........................ $ 3,059 $ 2,575 $ 9,072 $ 7,633 Federal and state income taxes ....................... 941 756 2,794 2,237 -------- -------- -------- -------- Net income ........................................ $ 2,118 $ 1,819 $ 6,278 $ 5,396 ======== ======== ======== ======== Earning per common share: Basic ............................................ $ 1.41 $ 1.24 $ 4.20 $ 3.68 Diluted ......................................... 1.40 1.22 4.17 3.62 HILLS BANCORPORATION UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Three and Nine Months Ended September 30, 1999 and 1998 (In Thousands, Except Per Share Data) Three Months Ended Nine Months Ended September 30, September 30, ------------------ ------------------ 1999 1998 1999 1998 ------------------ ------------------ Net Income ...................................... $ 2,118 $ 1,819 $ 6,278 $ 5,396 Other comprehensive income: Unrealized gains (losses) on debt securities . (371) 1,147 (2,527) 1,209 Income tax effect of unrealized gains (losses) 138 (426) 922 (450) ------- ------- ------- ------- Comprehensive Income ............................ $ 1,885 $ 2,540 $ 4,673 $ 6,155 ======= ======= ======= ======= HILLS BANCORPORATION UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Nine Months Ended September 30, 1999 and 1998 (In Thousands) Less Maximum Accumulated Cash Other Obligation Capital Retained Comprehensive To ESOP Stock Earnings Income Shares Total ------------------------------------------------------- Balance, January 1, 1999 ................ $ 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 ======================================================= Balance, January 1, 1998 ................ $ 9,070 $49,627 $ 485 $ (7,682) $ 51,500 Net income .............................. - - - 5,396 - - - - - - 5,396 Change related to ESOP shares ........... - - - - - - - - - (1,120) (1,120) Cash dividends ($1.20 per share) ........ - - - (1,763) - - - - - - (1,763) Other comprehensive income .............. - - - - - - 759 - - - 759 Tax savings on restricted stock issued .. - - - 78 - - - - - - 78 ------------------------------------------------------- Balance, September 30, 1998 ............. $ 9,070 $ 53,338 $ 1,244 $ (8,802) $ 54,850 ======================================================= See Notes to Financial Statements. HILLS BANCORPORATION UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months Ended September 30, 1999 and 1998 (In Thousands) 1999 1998 -------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income ..................................................................... $ 6,278 $ 5,396 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation ............................................................... 1,071 987 Provision for loan losses .................................................. 612 712 Net gains (losses) on disposition of investment securities ................. 214 - - - Deferred income taxes ...................................................... (56) - - - Compensation paid by issuance of common stock .............................. 20 - - - (Increase) decrease in accrued interest receivable ......................... (699) (500) Amortization of bond discount .............................................. 339 216 (Increase) in other assets ................................................. (1,401) (910) Amortization of intangibles ................................................ 258 258 Increase in accrued interest and other liabilities ......................... 1,291 (106) -------------------- Net cash provided by operating activities .................................. $ 7,927 $ 6,053 -------------------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from maturities of investment securities: Available for sale ......................................................... $ 26,837 $ 19,599 Held to maturity ........................................................... 2,055 2,286 Proceeds from sale of available-for-sale securities ............................ 9,003 - - - Purchase of investment securities, available for sale .......................... (46,726) (29,785) Federal funds sold, net ........................................................ 36,605 (17,349) Loans made to customers, net of collections .................................... (76,098) (24,968) Purchases of property and equipment ............................................ (1,483) (2,173) -------------------- Net cash (used in) investing activities .................................... $(49,807) $(52,390) -------------------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase (decrease) in deposits ........................................ $ 14,672 $ 22,478 Net increase (decrease) in fed funds purchased and securities sold under agreements to repurchase .......................... 16,135 (682) Borrowings from FHLB ....................................................... 25,000 40,000 Payments on FHLB notes ......................................................... (12,032) (15,032) Stock options exercised .................................................... 625 - - - Income tax benefits on stock options exercised ............................. 308 78 Dividends paid ............................................................. (1,911) (1,762) -------------------- Net cash provided by financing activities ............................... $ 42,797 $ 45,080 -------------------- (Decrease) in cash and due from banks ................................... $ 917 $ (1,257) CASH AND DUE FROM BANKS Beginning .................................................................. 16,427 15,508 -------------------- Ending ..................................................................... $ 17,344 $ 14,251 ==================== SUPPLEMENTAL DISCLOSURES Cash payments for: Interest paid to depositors and others .................................. $ 15,568 $ 15,309 Interest paid on other obligations ...................................... 3,723 3,534 Non-cash financing transactions: Increase in maximum cash obligation related to ESOP shares ......................................................... 1,610 1,120 Net unrealized gains (losses) on debt securities ........................ (2,557) 1,209 See Notes to Financial Statements. HILLS BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Note 1. nterim 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. 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 --------------------------- 1999 1998 --------------------------- Agricultural ............................... $ 29,394 $ 33,946 Commercial and financial ................... 40,046 36,523 Real estate, construction .................. 39,706 24,512 Real estate, mortgage ...................... 406,420 330,525 Loans to individuals ....................... 30,058 29,994 --------- --------- $ 545,624 $ 455,500 Less allowance for loan losses ............. (9,227) (8,483) --------- --------- $ 536,397 $ 447,017 ========= ========= Transactions in the allowance for loan losses are as follows: (In thousands) Nine Months Ended September 30 ------------------------ 1999 1998 ------------------------ Balance, beginning ........................... $ 8,856 $ 8,010 Provision charged to expense ............... 612 712 Net charge-offs ............................ (241) (239) ------- ------- Balance, ending .............................. $ 9,227 $ 8,483 ======= ======= The following summarizes the Company's nonaccrual, past due, restructured and impaired loans: (In thousands) September 30 ---------------- 1999 1998 ---------------- Nonaccrual .................................... $- - - $- - - Accruing loans, past due 90 days or more ...... 1,083 1,825 Restructured loan ............................. - - - - - - Impaired loans ................................ 9,343 7,996 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 The consolidated balance sheet of Hills Bancorporation as of September 30, 1999 reflects total assets of $738.6 million, which is an increase of $48.8 million from December 31, 1998 and $84.3 million from September 40, 1998. Net loans as of September 30, 1998 totaled $536.4 million, which represents an increase of $75.5 million from December 31, 1998 and $89.4 million from September 30, 1998. The major portion of the loan increase was in real estate loans secured by 1-4 family properties. The local and national economy continues to be strong which, coupled with moderate interest rates, have aided in the increase in loans outstanding. Investment securities as of September 30, 1999 totaled $155.1 million, an increase of $5.1 million from December 31, 1998 and $8.2 million from September 30, 1998. The growth in loans and investment securities since December 31, 1998 was funded by a combination of an increase in total deposits, securities sold under agreements to repurchase, federal funds purchased, and Federal Home Loan Bank borrowings. In addition, federal funds sold as of December 31, 1998 decreased $36.6 million and these funds were used to fund loan growth. 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. In January 1999, Hills Bancorporation paid a dividend of $1.30 per share, a 8.33% increase from the $1.20 paid in January 1998. The total dividend of $1,911,000 is deducted from stockholders' equity and is reflected in the resulting stockholders' equity as of September 30, 1999 of $58,557,000. Stockholders' equity at September 30, 1999 and December 31, 1998 reflects an adjustment for unrealized gain (losses) on debt securities, net of income taxes. The total stockholders' equity of Hills Bancorporation as of September 30, 1999 before the reduction for the ESOP shares, as a percent of total assets is 9.40%. Under risk-based capital rules, total capital is 14.52% of risk adjusted assets, compared to the current 8% requirement. Net income for the quarter and nine months ended September 30, 1999 increased $299,000 and $882,000, respectively, from the prior year periods. For both periods the changes were primarily the result of significant increases in net interest income resulting primarily from increases in average earning assets. Average earning assets were approximately $66.4 million higher for the nine months ended September 30, 1999 compared to the same period in 1998. Other income increased over the prior year by $58,000 for the three months ended September 30, 1999 and $569,000 for the nine month period shown. Loan origination fees were $45,000 less in the third quarter and are $525,000 for the nine months of 1999 compared to $500,000 in 1998. The decrease in origination fees is due primarily to reduced loan originations for the secondary market. Trust fees increased $217,000 for the nine months to $1,483,000, primarily attributable to growth of trust assets under management. Deposit account charges and fees increased $147,000 and $238,000 for the three and nine months ended September 30, 1999 compared to the same periods one year ago. Also other income was reduced for the quarter by $214,000, which represented investments securities losses taken to replace lower yielding securities with higher yielding securities of similar risk and maturity. Other expenses for the nine months ended September 30, 1999 were $13,391,000 or an increase of $1,243,000 from the period ended September 30, 1998. Salaries and employee benefits accounted for $878,000 of the increase, attributable to new staff additions in 1999, salary adjustments in January 1999, and increases in medical insurance claims over 1998 claims. All other expenses increased from $5,782,000 at September 30, 1998 to $6,147,000 at September 30, 1999 or $365,000, which was an increase of 6.31%. The major category that increased was furniture and equipment, which was $1,249,000 in 1998 and $1,363,000 in 1999 and was the result of major computer hardware and software additions in 1998. Earnings per share, both basic and diluted, increased for both the quarter and the nine months ending September 30, 1999 compared to 1998. For the period ending September 30, 1999 basic and diluted earnings per share were $1.41 and $1.40 in comparison to $1.24 and $1.22 for the quarter ending September 30, 1998. The earnings per share for the nine months ended September 30, 1999 and September 30, 1998 were $4.20 and $3.68 for basic earnings per share and $4.17 and $3.62 for diluted earnings per share, respectively. The Company's principal sources of funds continue to be prepayment of loan principal and current amortized loan payments. In addition, funds are provided from current operations. All of the funds are used to fulfill loan commitments, make short-term investments, and fund any deposit withdrawals needed. The Company has no material commitments or plans which will materially affect its liquidity or capital resources. The acquisition of property and equipment may be in cash purchases, or they may be financed if favorable terms are available. Year 2000 The Year 2000 poses an important business issue regarding how existing application software programs and operating systems can accommodate this date value. Many computer programs that can only distinguish the final two digits of the year entered are expected to read entries for the Year 2000 as the Year 1900. Like most financial service providers, the Company may be significantly affected by the Year 2000 issues due to the nature of financial information. Software, hardware and equipment both within and outside the Company's direct control and with whom the Company electronically or operationally interfaces are likely to be affected. If computer systems are not adequately changed to identify the Year 2000, many computer applications could fail or create erroneous results. As a result, may calculations that rely on the data field information, such as interest, payment or due dates and other operating functions, may generate results that could be significantly misstated, and the Company could experience a temporary inability to process transactions and engage in normal business activities. All of the significant computer programs of the Company that could be affected by this issue are provided by major third-party vendors. In 1998, the Company completed the replacement/upgrading of most of its computer systems and programs, as well as most equipment, in order to provide cost-effective and efficient delivery of services to customers, information to management, and to provide additional capacity for processing information and transactions due to acquisitions. The third-party vendors have advised the Company that all such computer systems and programs either are or shortly will be Year 2000 compliant. The Company completed off-site testing of its major applications in 1998. The total cost of the Company's Year 2000 efforts over a two year period was approximately $1,180,000 for capitalized hardware and software and an additional $88,000 in expenses charged to earnings in 1998. A substantial portion of the costs capitalized were normal upgrades, and all abandoned hardware and software had previously been fully depreciated. Management estimates the expenses of the remediation effort to make the Company's systems Year 2000 ready will total approximately $40,000 in 1999, and an estimated $105,000 to be capitalized in the last quarter of 1999. In addition, it is estimated that 2,000 man hours will be incurred by Company personnel in 1999 related to Year 2000 issues at an approximate cost of $40,000. The Company has completed a Year 2000 contingency plan that addresses, among other issues, critical operations and potential failures thereof, and strategies for business continuation. The contingency plan includes back up power sources, off-site processing of data and a detailed listing of responsibilities among various employees of their contingency plan duties. The plan was finalized during the third quarter of 1999. The Company could incur losses if loan payments are delayed due to Year 2000 problems affecting significant borrowers. The Company is communicating with such parties to assess their progress in evaluating and implementing any corrective measures required by them to be Year 2000 ready. To date, the Company has been advised by such parties that they have plans in place to address and correct the issues associated with the Year 2000 problem; however, no assurance can be given as to the adequacy of such plans or to the timeliness of their implementation. As part of the current credit approval process, new and renewed loans are evaluated as to the borrower's Year 2000 readiness. Management does not anticipate significant loan losses related to this issue. Although management believes the Company's computer systems and service providers will be Year 2000 ready, there can be no assurance that these systems, or those systems of other companies on which the Company's systems rely, will be fully functional in the Year 2000. Such failure could have a significant adverse impact on the financial condition and results of operations of the Company. In addition, there could be a material effect to the financial statements if there are significant interruptions in basic services, such as the electric power grid, telephone services or the banking system. These risks cannot be estimated. 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. 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 ending September 30, 1999. 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, 1999. 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) 11/12/1999 /s/ Dwight O. Seegmiller - ---------------------------- ------------------------------------------- Date Dwight O. Seegmiller, President (Duly authorized officer of the registrant) /s/ James G. Pratt ------------------------------------------- James G. Pratt, Treasurer (Principal Financial Officer)