SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended March 31, 2003, [ ] Transition report pursuant to Section 13 or 15 (d) of the Exchange Act for the Transition Period from _______________ to _______________. No. 0-17077 (Commission File Number) PENNS WOODS BANCORP, INC. (Exact name of Registrant as specified in its charter) PENNSYLVANIA 23-2226454 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 300 Market Street, Williamsport, Pennsylvania 17701 (Address of principal executive offices) (Zip Code) (570) 322-1111 Registrant's telephone number, including area code 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 Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [ X ] NO[ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) YES [ X ] NO[ ] On May 13, 2003 there were 3,030,129 of the Registrant's common stock outstanding. 1 PENNS WOODS BANCORP, INC. INDEX TO QUARTERLY REPORT ON FORM 10-Q Page Number ------ Part I Financial Information Item 1. Financial Statements Consolidated Balance Sheet (unaudited) as of March 31, 2003 and December 31, 2002 3 Consolidated Statement of Income (unaudited) for the Three Months ended March 31, 2003 and 2002 5 Consolidated Statement of Comprehensive Income (unaudited) For the Three Months ended March 31, 2003 and 2002 7 Consolidated Statement of Changes in Shareholders' Equity (unaudited) for the Three Months ended March 31, 2003 8 Consolidated Statement of Cash Flows (unaudited) for the Three Months ended March 31, 2003 and 2002 9 Notes to Consolidated Financial Statements 11-16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 17-24 Item 3. Quantitative and Qualitative Disclosure About Market Risk 24 Item 4. Controls and Procedures 24 Part II Other Information 24 Signatures 26 2 Item 1. Financial Statements PENNS WOODS BANCORP, INC. CONSOLIDATED BALANCE SHEET (UNAUDITED) March 31, December 31, 2003 2002 --------- ------------ (in thousands) ASSETS: Cash and due from banks $ 17,898 $ 11,731 Investment securities available for sale 199,173 176,436 Investment securities held to maturity (market value of $1,210 and $1,289) 1,176 1,181 Loans held for sale 2,072 2,651 Loans, net of unearned discount of $793 and $769 251,240 257,845 Allowance for loan losses (3,018) (2,953) -------- -------- Loans, net 248,222 254,892 Bank premises and equipment, net 4,731 4,856 Accrued interest receivable 2,351 2,460 Bank-owned life insurance 8,607 8,537 Goodwill 3,032 3,032 Other assets 6,940 6,430 -------- -------- TOTAL ASSETS $494,202 $472,206 ======== ======== LIABILITIES: Demand deposits $ 59,994 $ 67,061 Interest-bearing demand deposits 82,181 78,590 Savings deposits 64,332 60,417 Time deposits 134,267 133,780 -------- -------- Total deposits $340,774 $339,848 Short-term borrowings 13,417 13,563 Other borrowings 70,878 51,778 Accrued interest payable 983 1,092 3 Other liabilities 3,310 2,783 -------- -------- Total liabilities 429,362 409,064 -------- -------- SHAREHOLDERS' EQUITY: Common stock, par value $10; 10,000,000 shares authorized; 3,137,832 and 3,136,832 shares issued $ 31,378 $ 31,368 Additional paid-in capital 18,314 18,291 Retained earnings 13,028 11,749 Accumulated other comprehensive income 5,617 5,145 Less: Treasury stock at cost, 107,703 and 105,503 (3,497) (3,411) -------- -------- Total shareholders' equity $ 64,840 $ 63,142 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $494,202 $472,206 ======== ======== See accompanying notes to the unaudited consolidated financial statements. 4 PENNS WOODS BANCORP, INC. CONSOLIDATED STATEMENT OF INCOME (UNAUDITED) Three Months Ended March 31, ---------------------- 2003 2002 --------- ---------- (in thousands except per share data) INTEREST INCOME: Interest and fees on loans $4,995 $5,270 Interest and dividends on investments: Taxable 1,199 982 Tax-exempt 863 785 Other dividend and interest income 35 39 --------- --------- Total interest and dividend income 7,092 7,076 --------- --------- INTEREST EXPENSE: Interest on deposits 1,633 2,037 Interest on short-term borrowings 72 117 Interest on other borrowings 681 565 --------- --------- Total interest expense 2,386 2,719 --------- --------- Net interest income 4,706 4,357 Provision for loan losses 90 105 --------- --------- Net interest income after provision for loan losses 4,616 4,252 --------- --------- OTHER INCOME: Service charges 465 390 Securities gains(losses), net 101 (119) Earnings on bank-owned life insurance 104 100 Insurance commissions 358 572 Other operating income 255 339 --------- --------- Total other operating income 1,283 1,282 --------- --------- OTHER EXPENSES: Salaries and employee benefits 1,635 1,628 Occupancy expense, net 233 195 Furniture and equipment expense 285 207 5 Other expenses 986 922 --------- --------- Total other operating expenses 3,139 2,952 --------- --------- INCOME BEFORE INCOME TAX PROVISION 2,760 2,582 APPLICABLE INCOME TAX PROVISION 573 485 --------- --------- NET INCOME $2,187 $2,097 ========= ========= EARNINGS PER SHARE - BASIC $ 0.72 $ 0.69 EARNINGS PER SHARE - DILUTED $ 0.72 $ 0.69 BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 3,030,357 3,037,934 DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 3,031,910 3,040,468 See accompanying notes to the unaudited consolidated financial statements. 6 PENNS WOODS BANCORP, INC. CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (UNAUDITED) Three Months Ended March 31, ------------------ 2003 2002 ------ ------- (in thousands) Net Income $2,187 $2,097 Other comprehensive income (loss): Unrealized gains (losses) on available for sale securities $ 816 $ (566) Less: Reclassification adjustment for gain (loss) included in net income 101 (119) ------ ------ Other comprehensive income (loss) before tax 715 (447) Income tax expense (benefit) related to other comprehensive income 243 (152) Other comprehensive income (loss), net of tax 472 (295) ------ ------ Comprehensive income $2,659 $1,802 ====== ====== See accompanying notes to the unaudited consolidated financial statements. 7 PENNS WOODS BANCORP, INC. CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) (in thousands except per share data) <table> <caption> ACCUMULATED COMMON STOCK ADDITIONAL OTHER TOTAL ------------------- PAID-IN RETAINED COMPREHENSIVE TREASURY SHAREHOLDERS' SHARES AMOUNT CAPITAL EARNINGS INCOME STOCK EQUITY --------- ------- ---------- -------- ------------- -------- ------------- <s> <c> <c> <c> <c> <c> <c> <c> Balance, December 31, 2002 3,136,832 $31,368 $18,291 $11,749 $5,145 $(3,411) $63,142 Net income for the three months ended March 31, 2003 2,187 2,187 Dividends declared, $0.30 (908) (908) Treasury Stock acquired (2,200 shares) (86) (86) Net change in unreal- ized gain on invest- ments available for sale, net of tax of $243 472 472 Stock options exercised 1,000 10 23 33 --------- ------- ------- ------- ------ -------- ------- Balance, March 31, 2003 3,137,832 $31,378 $18,314 $13,028 $5,617 $ (3,497) $64,840 ========= ======= ======= ======= ====== ======== ======= </table> See accompanying notes to the unaudited consolidated financial statements. 8 PENNS WOODS BANCORP, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) <table> <caption> Three Months Ended March 31, --------------------- 2003 2002 --------- --------- (in thousands) <s> <c> <c> OPERATING ACTIVITIES: Net Income $ 2,187 $ 2,097 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 201 138 Provision for loan losses 90 105 Accretion and amortization of investment security discounts and premiums (142) (248) Securities losses (gains), net (101) 119 Originations of loans held for sale (2,258) (3,919) Proceeds of loans held for sale 2,837 5,408 Earnings on bank-owned life insurance 104 100 Decrease in all other assets 161 99 Increase in all other liabilities 418 458 -------- -------- Net cash provided by operating activities $ 3,497 $ 4,357 -------- -------- INVESTING ACTIVITIES: Investment securities available for sale: Proceeds from sales 3,703 11,540 Proceeds from calls and maturities 8,182 2,795 Purchases (33,664) (24,808) Investment securities held to maturity: Proceeds from calls and maturities 29 28 Purchases (24) (6) Net decrease in loans 6,580 5,464 Acquisition of bank premises and equipment (76) (37) Proceeds from the sale of foreclosed assets - 64 Gross proceeds from redemption of regulatory stock - 505 Gross purchases of regulatory stock (979) (705) -------- -------- Net cash used in investing activities $(16,249) $ (5,160) FINANCING ACTIVITIES: Net increase in interest-bearing deposits 7,993 5,054 Net decrease in noninterest-bearing deposits (7,067) (4,091) Net increase (decrease) in short-term borrowings (146) 1,699 Proceeds from other borrowings 19,100 - Dividends paid (908) (819) Stock options exercised 33 - Purchase of Treasury Stock (86) (197) -------- -------- Net cash provided by financing activities 18,919 1,646 -------- -------- 9 NET INCREASE IN CASH AND CASH EQUIVALENTS 6,167 843 CASH AND CASH EQUIVALENTS, BEGINNING 11,731 14,844 -------- -------- CASH AND CASH EQUIVALENTS, ENDING $ 17,898 $ 15,687 ======== ======== </table> The Company paid approximately $2,495,000 and $2,846,000 interest on deposits and other borrowings during the first quarter of 2003 and 2002, respectively. See accompanying notes to the unaudited consolidated financial statements. 10 PENNS WOODS BANCORP, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1. Basis of Presentation The consolidated financial statements include the accounts of Penns Woods Bancorp, Inc. (the "Company") and its wholly-owned subsidiaries Woods Investment Company, Inc., Woods Real Estate Development Company, Inc., and Jersey Shore State Bank (the "Bank") and its wholly-owned subsidiary The M Group, Inc. D/B/A The Comprehensive Financial Group ("The M Group"). All significant inter-company balances and transactions have been eliminated in the consolidation. The interim financial statements are unaudited but, in the opinion of management, reflect all adjustments necessary for the fair presentation of results for such periods. All of those adjustments are of a normal, recurring nature. The results of operations for any interim period are not necessarily indicative of results for the full year. These financial statements should be read in conjunction with financial statements and notes thereto contained in the Company's annual report for the year ended December 31, 2002. Recent Accounting Pronouncements In August 2001, the Financial Accounting Standards Board ("FASB") issued FAS No. 143, Accounting for Asset Retirement Obligations, which requires that the fair value of a liability be recognized when incurred for the retirement of a long-lived asset and the value of the asset be increased by that amount. The statement also requires that the liability be maintained at its present value in subsequent periods and outlines certain disclosures for such obligations. The adoption of this statement, which was effective January 1, 2003, did not have a material effect on the Company's financial position or results of operations. In April 2002, the FASB issued FAS No. 145, Rescission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. FAS No. 145 rescinds FAS No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB Opinion No. 30 will now be used to classify those gains and losses. This statement also amends FAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. This statement also makes technical corrections to existing pronouncements, which are not substantive but in 11 some cases may change accounting practice. The provisions of this statement related to the rescission of FAS No. 4 shall be applied in fiscal years beginning after May 15, 2002. Any gain or loss on extinguishments of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in APB Opinion No. 30 for classification as an extraordinary item shall be reclassified. Early adoption of the provisions of this statement related to FAS No. 13 shall be effective for transactions occurring after May 15, 2002. All other provisions of this statement shall be effective for financial statements issued on or after May 15, 2002. The adoption of this statement did not have a material effect on the Company's financial position or results of operations. In July 2002, the FASB issued FAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. This statement replaces EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring). The new statement is effective for exit or disposal activities initiated after December 31, 2002. The adoption of this statement did not have a material effect on the Company's financial position or results of operations. On December 31, 2002, the FASB issued FAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, which amends FAS No. 123, Accounting for Stock-Based Compensation. FAS No. 148 amends the disclosure requirements of FAS No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock- based compensation. Under the provisions of FAS No. 123, companies that adopted the preferable, fair value based method were required to apply that method prospectively for new stock option awards. This contributed to a "ramp-up" effect on stock-based compensation expense in the first few years following adoption, which caused concern for companies and investors because of the lack of consistency in reported results. To address that concern, FAS No. 148 provides two additional methods of transition that reflect an entity's full complement of stock-based compensation expense immediately upon adoption, thereby eliminating the ramp-up effect. FAS No. 148 also improves the clarity and prominence of disclosures about the pro forma effects of using the fair value based method of accounting for stock-based compensation for all companies-regardless of the accounting method used-by requiring that the data be presented more prominently and in a more user-friendly format in the footnotes to the financial statements. In addition, the statement improves the timeliness of those disclosures by requiring that this information be included in interim as well as annual financial statements. The transition guidance and annual 12 disclosure provisions of FAS No. 148 are effective for fiscal years ending after December 15, 2002, with earlier application permitted in certain circumstances. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The adoption of this statement did not have a material effect on the Company's financial statements. In April 2003, the FASB issued FAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under FAS No. 133. The amendments set forth in FAS No. 149 improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. In particular, this statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative as discussed in FAS No. 133. In addition, it clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. FAS No. 149 amends certain other existing pronouncements. Those changes will result in more consistent reporting of contracts that are derivatives in their entirety or that contain embedded derivatives that warrant separate accounting. This statement is effective for contracts entered into or modified after June 30, 2003, except as stated below and for hedging relationships designated after June 30, 2003. The guidance should be applied prospectively. The provisions of this statement that relate to FAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. In addition, certain provisions relating to forward purchases or sales of when-issued securities or other securities that do not yet exist, should be applied to existing contracts as well as new contracts entered into after June 30, 2003. In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. This interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. This interpretation clarifies that a guarantor is required to disclose (a) the nature of the guarantee, including the approximate term of the guarantee, how the guarantee arose, and the events or circumstances that would require the guarantor to perform under the guarantee; (b) the maximum potential amount of future payments under the guarantee; (c) the carrying amount of the liability, if any, for the guarantor's obligations under the guarantee; and (d) the nature and extent of any recourse provisions or available collateral that would enable the guarantor to recover the amounts paid under the guarantee. This 13 interpretation also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the obligations it has undertaken in issuing the guarantee, including its ongoing obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur. The objective of the initial measurement of that liability is the fair value of the guarantee at its inception. The initial recognition and initial measurement provisions of this interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor's fiscal year-end. The disclosure requirements in this interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The adoption of this interpretation did not have a material effect on the Company's financial position or results of operations. In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, in an effort to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. The objective of this interpretation is not to restrict the use of variable interest entities but to improve financial reporting by companies involved with variable interest entities. Until now, one company generally has included another entity in its consolidated financial statements only if it controlled the entity through voting interests. This interpretation changes that by requiring a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. The consolidation requirements of this interpretation apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The adoption of this interpretation has not and is not expected to have a material effect on the Company's financial position or results of operations. 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 14 Three Months Ended March 31, ----------------------- 2003 2002 ---------- ---------- Weighted average common shares outstanding 3,137,316 3,131,644 Average treasury stock shares (106,959) (93,710) --------- --------- Weighted average common shares and common stock equivalents used to calculate basic earnings per share 3,030,357 3,037,934 Additional common stock equivalents (stock options)used to calculate diluted earnings per share 1,553 2,534 --------- --------- Weighted average common shares and common stock equivalents used to calculate diluted earnings per share 3,031,910 3,040,468 ========= ========= Options to purchase 20,350 shares of common stock at prices from $42.00 to $53.18 were outstanding during the three months ended March 31, 2003 and 2002, but were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive. Reclassification of Comparative Amounts Certain comparative amounts for the prior periods have been reclassified to conform to current period presentations. Such reclassifications had no effect on net income or stockholders' equity. 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 Company wishes to caution readers that the following important factors, among others, may have affected and could in the future affect the Company's actual results and could cause the Company's actual results for subsequent periods to differ materially from those expressed 15 in any forward-looking statement made by or on behalf of the Company herein: (i) the effect of changes in laws and regulations, including federal and state banking laws and	 regulations, which the Company must comply, and the associated costs of compliance with such laws and regulations either currently or in the future as applicable; (ii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board, or of changes in the Company's organization, compensation and benefit plans; (iii) the effect on the Company's competitive position within its market area of the increasing consolidation within the banking and financial services industries, including the increased competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services; (iv) the effect of changes in interest rates; and (v) the effect of changes in the business cycle and downturns in the local, regional or national economies. 16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation EARNINGS SUMMARY Comparison of the Three Months Ended March 31, 2003 and 2002 Interest Income For the three months ended March 31, 2003, total interest income increased by $16,000 compared to the first three months of 2002. Total interest and dividends on investments increased $295,000 and interest and fees on loans decreased $275,000. Other dividend and interest income decreased $4,000. Overall, the increase in total interest income of $16,000 is the result of an increase in the volume of investment securities average balance held for the period relative to the same period a year ago offset by a decrease in the return on loans. Interest income generated from the net increase in volume of interest earning assets was offset by a general decline in rates. On a tax equivalent basis, investment security interest income increased $329,000 for the first quarter of 2003 compared to the first quarter of 2002. The increase of taxable interest is due to the significant purchase of U.S. Government Agency securities over the past year. US Treasury and Agency securities average balance increased interest income $673,000 while the decrease in the average of S&P securities decreased interest income $293,000. Management has repositioned the investment portfolio from longer term assets to shorter term assets to take advantage of the cash flow opportunities for reinvestment. Interest earned on other securities decreased $51,000. The net growth in the volume of investment holdings has generated additional interest that has offset the 79 basis point negative impact of lower rates. Historically low rates have negatively affected interest income collected on variable and new loans compared to a year ago. The average Prime rate during the quarter was the lowest it has been for over thirty years. A 54 basis point decrease of the tax equivalent return on loans, partially offset by an increase in the average balance of $2.8 million, caused a decrease of $291,000 to interest income. Interest Expense For the three months ended March 31, 2003, total interest expense decreased by $333,000 or 12% compared to the first three months of 2002. Historically low interest rates have positively impacted interest expense. 17 Lower rates for all deposit accounts contribute the most substantial decrease in interest expense. The rate on interest paid on deposits declined 88 basis points. Interest expense on savings deposits decreased $75,000 and interest expense on time deposits decreased $329,000. Favorable long-term borrowing rates offer opportunities to reduce interest expenses over the coming years. The rate paid for interest on borrowings decreased 77 basis points. Interest paid on short-term borrowings decreased $45,000. The Company borrowed an additional $20 million in long term advances through the FHLB during the first quarter of 2003 to minimize future borrowing costs and to enhance asset and liability positioning. The $116,000 increase in expense on other borrowings is the result of the additional advances offset by the 32 basis point decline in the resulting weighted average rate. Provision for Loan Losses The provision for loan losses is based upon management's quarterly review of the loan portfolio. The purpose of the review is to assess loan quality, identify impaired loans, analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets served. An external independent loan review is also performed annually for the Bank. Management remains committed to an aggressive program of problem loan identification and resolution. The allowance is calculated by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined. Loss factors are based on management's consideration of the nature of the portfolio segments, changes in mix and volume of the loan portfolio, and historical loan loss experience. In addition, management considers industry standards and trends with respect to nonperforming loans and its knowledge and experience with specific lending segments. Although management believes that it uses the best information available to make such determinations and that the allowance for loan losses is adequate at March 31, 2003, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations. A downturn in the local economy, employment and delays in receiving financial information from borrowers could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions and reductions in income. Additionally, as an integral part of the examination process, bank regulatory agencies periodically review the Bank's loan loss allowance. The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination. 18 The allowance for loan losses increased from $2,953,000 at December 31, 2002 to $3,018,000 at March 31, 2003. At March 31, 2003 allowance for loan losses was 1.2% of total loans compared to 1.1% of total loans at December 31, 2002. This percentage is consistent with the Bank's historical experience and peer banks. Management's conclusion is that the allowance for loan losses is adequate to provide for probable losses inherent in its loan portfolio as of the balance sheet date. The provision for loan losses totaled $90,000 for the three months ended March 31, 2003. The provision for the same period in 2002 was $105,000. For the three month period ending March 31, 2003, charge-offs exceeded recoveries by $25,000 compared to the same period ended March 31, 2002, when charge-offs exceeded recoveries by $74,000. An overall decrease was experienced in non-performing loans from the December 31, 2002 total of $2,096,000 to $1,205,000 on March 31, 2003. This decline consisted of a commercial and industrial loans decrease of $34,000, a real estate secured loans decrease of $848,000 and an installment loans decrease of $9,000. The real estate secured loan has been paying to the original agreed upon terms and has been deemed by management to meet the classification of a performing loan. Based upon this analysis as well as the others noted above, senior management has concluded that the allowance for loan losses remains at a level adequate to provide for probable losses inherent in its loan portfolio. Other Operating Income Other operating income for the three months ended March 31, 2003 increased $1,000. Excluding net security gains, other income decreased $219,000. Service charges increased $75,000 due to the increase of both the fee charged for overdrafts and the quantity of overdrafts. Insurance commissions earned by the Bank's subsidiary, The M Group, decreased $214,000 while earnings on bank-owned life insurance increased $4,000 from the same period in 2002. Other income decreased $84,000. Management has analyzed its equity portfolio for impairment that would qualify as other than temporary. Impairment is determined using factors such as length of time and the extent to which the market value is less than cost; the financial condition and the near-term prospects of the issuer; and the intent and ability of the Company to retain its investment to allow for the market to recover. In doing so, management has identified securities within the equity portfolio that have an other than temporary decline in market value. Management has reserved an additional 19 $289,000, which was charged to security gains and losses, to provide for this decline. Extracting the $289,000 charge, security gains increased $509,000. The Company sold securities that were determined to have attained their maximum long-term potential value which thereby resulted in gains on securities. Other Operating Expense For the three months ended March 31, 2003 total other operating expenses increased $187,000 over the same period in 2002. Occupancy expense increased $38,000 and furniture and equipment expense increased $78,000. Occupancy expenses experienced an overall increase due to rent, maintenance, and utilities for the new State College Wal-Mart Branch. The increase in furniture and equipment expense is a result of the purchase of a Wide Area Network system. Salary expense increased $7,000 due to the standard cost of living salary increases offset by the decline in commissions earned by The M Group and the retirement of an executive officer. An overall increase in other expenses totaled $64,000 and is the result of normal operational increases. Provision for Income Taxes The provision for income taxes for the three months ended March 31, 2003 resulted in an effective income tax rate of 20.76% compared to 18.78% for the corresponding period in 2002. This increasing effective tax rate is the result of management's repositioning of the investment portfolio from tax-exempt securities to taxable securities. The tax effects of the repositioning were examined by management a part of the strategic plan. ASSET/LIABILITY MANAGEMENT Assets At March 31, 2003, total assets were $494.2 million compared to $472.2 million at December 31, 2002. Cash and due from banks increased $6.2 million during the first three months of 2003. Investment securities totaled $200.3 million at March 31, 2003 or a net increase of $22.7 million over the corresponding balance at December 31, 2002. During this period, net loans decreased by $6.7 million to $248.2 million. Loans held for resale decreased $579,000 to $2.1 million. Loan growth has been affected by businesses and consumers reluctant to borrow in an uncertain economic environment. The investment growth is largely attributed to management's strategic plan to benefit from the low borrowing rates by taking advantage of over a 200 basis point interest rate spread of investments with similar maturity periods. 20 Deposits At March 31, 2003 total deposits amounted to $340.8 million representing an increase of $1 million, from total deposits at December 31, 2002. Non-interest bearing demand deposits decreased $7.1 million while interest-bearing demand deposits increased $3.6 million. Savings increased $3.9 million and time deposits increased $487,000. Capital The adequacy of the Company's capital is reviewed on an ongoing basis with reference to the size, composition and quality of the Company's resources and regulatory guidelines. Management seeks to maintain a level of capital sufficient to support existing assets and anticipated asset growth, maintain favorable access to capital markets and preserve high quality credit ratings. Bank holding companies are required to comply with the Federal Reserve Board'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. Specifically, each is required to maintain certain minimum dollar amounts and ratios of Total risk-based, Tier I risk-based and Tier I leverage capital requirements. In addition to the capital requirements, the Federal Deposit Insurance Corporation Improvements Act (FDICIA) established five capital categories ranging from "well capitalized" to "critically undercapitalized." To be classified as "well capitalized, "Total risk-based, Tier I risked-based and Tier I leverage capital ratios must be at least 10%, 6%, and 5% respectively. At March 31, 2003 the Company was "well capitalized" with a total capital ratio of 22.61%, a Tier I capital ratio of 21.01% and a Tier I leverage ratio of 12.32% Liquidity and Interest Rate Sensitivity The asset/liability committee addresses the liquidity needs of the Bank to see that sufficient funds are available to meet credit demands and deposit withdrawals as well as to the placement of available funds in the investment portfolio. In assessing liquidity requirements, equal consideration is given to the current position as well as the future outlook. The following liquidity measures are monitored and kept within the limits cited. 1. Net Loans to Total Assets, 70% maximum 21 2. Net Loans to Total Deposits, 92.5% maximum 3. Net Loans to Core Deposits, 100% maximum 4. Investments to Total Assets, 40% maximum 5. Investments to Total Deposits, 50% maximum 6. Total Liquid Assets to Total Assets, 25% minimum 7. Total Liquid Assets to Total Liabilities, 25% minimum 8. Net Core Funding Dependence, 35% maximum 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. The Company, like other financial institutions, must have sufficient funds available to meet its liquidity needs for deposit withdrawals, loan commitments and expenses. In order to control cash flow, the bank estimates future flows of cash from deposits and loan payments. The primary sources of funds are deposits, principal and interest payments on loans and mortgage-backed securities, as well as Federal Home Loan Bank borrowings. Funds generated are used principally to fund loans and purchase investment securities. Management believes the Company has adequate resources to meet its normal funding requirements. Management monitors the Company's liquidity on both a long and short- term basis thereby, providing management necessary information to react to current balance sheet trends. Cash flow needs are assessed and sources of funds are determined. Funding strategies consider both customer needs and economical cost. Both short and long term funding needs are addressed by maturities and sales of available for sale investment securities, loan repayments and maturities, and liquidating money market investments such as federal funds sold. The use of these resources, in conjunction with access to credit provides core ingredients to satisfy depositor, borrower and creditor needs. 22 Management monitors and determines the desirable level of liquidity. Consideration is given to loan demand, investment opportunities, deposit pricing and growth potential as well as the current cost of borrowing funds. The Company has a current borrowing capacity at the Federal Home Loan Bank of $219.2 million. In addition to this credit arrangement the Company has additional lines of credit with correspondent banks of $10.5 million. The Company's management believes that it has sufficient liquidity to satisfy estimated short-term and long-term funding needs. Federal Home Loan Bank advances totaled $71.8 million as of March 31, 2003. 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. There has been no substantial changes in the Company's GAP analyses or simulation analyses compared to the information provided in the Company's SEC 10-K for the period ended December 31, 2002. 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. 23 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. In reference to the attached financial statements, all adjustments are of a normal recurring nature pursuant to Rule 10-01 (b) (8) of Regulation S-X. Item 3. Quantitative and Qualitative Disclosure About Market Risk Market risk for the Company is comprised primarily from interest rate risk exposure and liquidity risk. Interest rate risk and liquidity risk management is performed at the Bank level as well as the Company level. The Company's interest rate sensitivity is monitored by management through selected interest rate risk measures produced internally. There has been no substantial changes in the Company's GAP analyses or simulation analyses compared to the information provided in the Company's SEC 10-K for the period ended December 31, 2002. Additional information and details are provided in the Interest Sensitivity section of Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Generally, management believes the Company is well positioned to respond expeditiously when the market interest rate outlook changes. Item 4. Controls and Procedures Within the 90 days prior to the date of this Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's President and Chief Executive Officer along with the Company's Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Company's President and Chief Executive Officer along with the Company's Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings. There have been no significant changes in the Company's internal controls or in other factors which could significantly affect internal controls subsequent to the date the Company carried out its evaluation. Part II. OTHER INFORMATION Item 1. Legal Proceedings. 24 None Item 2. Changes in Securities and Use of Proceeds. None Item 3. Defaults Upon Senior Securities. None Item 4. Submission of Matters to a Vote of Security Holders. None Item 5. Other Information None Item 6. Exhibits and reports on Form 8-K. (a) Exhibits (3)(i) Articles of Incorporation of the Registrant, as presently in effect (incorporated by reference to Exhibit 3.1 of the Registrant's Registration Statement on Form S-4, No. 333- 65821). (3)(ii) Bylaws of the Registrant as presently in effect (incorporated by reference to Exhibit 3.2 of the Registrant's Registration Statement on Form S-4, No. 333-65821). (99)(i) Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (99)(ii) Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. A. Reports on Form 8-K April 8, 2003 - First Quarter Earnings Press Release (Item 12) April 28, 2003 - First Quarter Shareholders' Report (Item 12) 25 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 thereunto duly authorized. PENNS WOODS BANCORP, INC. (Registrant) Date: May 13, 2003 /s/Ronald A. Walko ------------------------------ Ronald A. Walko, President and Chief Executive Officer Date: May 13, 2003 /s/Sonya E. Scott ------------------------------ Sonya E. Scott, Secretary 26 SECTION 302 CERTIFICATION I, Ronald A. Walko, Chief Executive Officer of Penns Woods Bancorp, Inc. (the "Company"), certify that: 1. I have reviewed this quarterly report on Form 10-Q of Penns Woods Bancorp, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The Company's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d- 14) for the Company and have: (a) designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the Company's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Company's other certifying officer and I have disclosed, based on our most recent evaluation, to the Company's auditors and the audit committee of Company's board of directors: 27 (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Company's ability to record, process, summarize and report financial data and have identified for the Company's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal controls; and 6. The Company's other certifying officer and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 13, 2003 /s/Ronald A. Walko ----------------------------- Ronald A. Walko, Chief Executive Officer 28 SECTION 302 CERTIFICATION I, Sonya E. Scott, Chief Financial Officer of Penns Woods Bancorp, Inc. (the "Company"), certify that: 1. I have reviewed this quarterly report on Form 10-Q of Penns Woods Bancorp, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The Company's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d- 14) for the Company and have: (a) designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the Company's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and (c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Company's other certifying officer and I have disclosed, based on our most recent evaluation, to the Company's auditors and the audit committee of Company's board of directors: 29 (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Company's ability to record, process, summarize and report financial data and have identified for the Company's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal controls; and 6. The Company's other certifying officer and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 13, 2003 /s/Sonya E. Scott ----------------------------- Sonya E. Scott, Chief Financial Officer 30