FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended June 30, 1997 Commission file number: 33-18888 ORRSTOWN FINANCIAL SERVICES, INC. (Exact name of registrant as specified in its charter) Commonwealth of Pennsylvania 23-2530374 State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 77 East King Street P. O. Box 250, Shippensburg, Pennsylvania 17257 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (717) 532-6114 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 shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at July 31, 1997 (Common stock, no par value) 1,025,101 Page 1 of 14 pages ORRSTOWN FINANCIAL SERVICES, INC. INDEX Page PART I - FINANCIAL INFORMATION Condensed consolidated balance sheets - June 30, 1997 and December 31, 1996 3 Condensed consolidated statements of income - Three months ended June 30, 1997 and 1996 4 Condensed consolidated statements of income - Six months ended June 30, 1997 and 1996 5 Condensed consolidated statements of cash flows - Six months ended June 30, 1997 and 1996 6 Notes to condensed consolidated financial statements 7 and 8 Management's discussion and analysis of financial condition and results of operations 9 - 12 PART II - OTHER INFORMATION 13 Signatures 14 Page 2 of 14 pages PART I - FINANCIAL INFORMATION PART I - FINANCIAL INFORMATION ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY, ORRSTOWN BANK CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) June 30, December 31, 1997 1996 * ASSETS (Unaudited) (000 Omitted) Cash and due from banks $ 6,868 $ 5,236 Interest-bearing deposits with banks 73 1,554 Federal funds sold 2,340 2,936 Securities available for sale 40,221 33,421 Federal Home Loan Bank, Federal Reserve and Atlantic Central Bankers Bank Stock, at cost which approximates market value 983 934 Loans 117,986 108,926 Allowance for loan losses ( 1,684) ( 1,620) Net loans 116,302 107,306 Bank premises and equipment, net 4,369 3,916 Other assets 2,557 2,253 Total assets $ 173,713 $ 157,556 LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Deposits: Noninterest-bearing $ 18,569 $ 16,322 Interest-bearing 130,685 120,937 Total deposits 149,254 137,259 Federal funds purchased and other borrowed money 5,334 2,339 Other liabilities 2,315 2,102 Total liabilities 156,903 141,700 STOCKHOLDERS' EQUITY Common stock, no par value - $ .2083 stated value per share at June 30, 1997 and December 31, 1996 2,000,000 shares authorized with 1,025,101 shares issued at June 30, 1997 and 976,863 issued at December 31, 1996 214 204 Additional paid-in capital 12,351 10,625 Retained earnings 3,926 4,786 Unrealized holding gain (loss), net of tax $ 164 and $ 124 at June 30, 1997 and December 31, 1996, respectively 319 241 Total stockholders' equity 16,810 15,856 Total liabilities and stockholders' equity $ 173,713 $ 157,556 * Condensed from audited financial statements The accompanying notes are an integral part of these condensed financial statements. Page 3 of 14 pages ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY, ORRSTOWN BANK CONDENSED CONSOLIDATED STATEMENTS OF INCOME Three Months Ended June 30, 1997 and 1996 (UNAUDITED) 1997 1996 (Unaudited) (Unaudited) (000 Omitted) Interest Income Interest and fees on loans $ 2,624 $ 2,403 Interest on federal funds sold 74 112 Interest and dividends on investment securities 616 452 Interest income on deposits with banks 2 27 Total interest income 3,316 2,994 Interest Expense Interest on deposits 1,339 1,249 Interest on borrowed money 79 37 Total interest expense 1,418 1,286 Net interest income 1,898 1,708 Provision for loan losses 45 60 Net interest income after provision for loan losses 1,853 1,648 Other Income Service charges on deposits 151 106 Other service charges 86 74 Other 153 121 Total other income 390 301 Other Expenses Salaries and employee benefits 697 675 Net occupancy and equipment expense 175 145 Other operating expense 382 364 Total other expense 1,254 1,184 Income before income taxes 989 765 Income tax expense 270 227 Net income $ 719 $ 538 Weighted average number of shares outstanding 1,025,548 1,025,906 Net income per share $ .70 $ .52 Cash dividends declared per share $ .19 $ .16 The accompanying notes are an integral part of these condensed financial statements. Page 4 of 14 pages ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY, ORRSTOWN BANK CONDENSED CONSOLIDATED STATEMENTS OF INCOME Six Months Ended June 30, 1997 and 1996 (UNAUDITED) 1997 1996 (Unaudited) (Unaudited) (000 Omitted) Interest Income Interest and fees on loans $ 5,115 $ 4,769 Interest on federal funds sold 119 155 Interest and dividends on investment securities 1,181 928 Interest income on deposits with banks 4 48 Total interest income 6,419 5,900 Interest Expense Interest on deposits 2,599 2,472 Interest on borrowed money 119 74 Total interest expense 2,718 2,546 Net interest income 3,701 3,354 Provision for loan losses 90 120 Net interest income after provision for loan losses 3,611 3,234 Other Income Service charges on deposits 294 205 Other service charges 144 109 Other 292 243 Total other income 730 557 Other Expenses Salaries and employee benefits 1,396 1,275 Net occupancy and equipment expense 353 292 Other operating expense 812 718 Total other expense 2,561 2,285 Income before income taxes 1,780 1,506 Income tax expense 502 434 Net income $ 1,278 $ 1,072 Weighted average number of shares outstanding 1,025,548 1,025,706 Net income per share $ 1.25 $ 1.04 Cash dividends declared per share $ .37 $ .32 The accompanying notes are an integral part of these condensed financial statements. Page 5 of 14 pages ORRSTOWN FINANCIAL SERVICES, INC. AND ITS WHOLLY-OWNED SUBSIDIARY, ORRSTOWN BANK CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30, 1997 and 1996 (UNAUDITED) 1997 1996 (Unaudited) (Unaudited) (000 Omitted) Cash flows from operating activities: Net income $ 1,278 $ 1,072 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 144 125 Provision for loan losses 90 120 Other, net ( 131) 20 Net cash provided by operating activities 1,381 1,337 Cash flows from investing activities: Net (increase) decrease in interest bearing deposits with banks 1,481 ( 342) Purchase of investment securities ( 8,740) ( 1,576) Maturities of investment securities 2,046 1,130 Sales of investment securities 12 2,396 Purchases of FHLB stock ( 49) ( 65) Net (increase) in loans ( 9,086) ( 3,944) Purchases of bank premises and equipment - Net ( 597) ( 528) Net cash (used) by investing activities ( 14,933) ( 2,929) Cash flows from financing activities: Net increase in deposits 11,995 8,843 Cash dividends paid ( 381) ( 332) Cash paid in lieu of fractional dividends ( 21) 0 Proceeds from long-term debt 3,000 0 Payments on debt ( 5) ( 5) Net cash provided by financing activities 14,588 8,506 Net increase in cash and cash equivalents 1,036 6,914 Cash and cash equivalents, beginning balance 8,172 6,647 Cash and cash equivalents, ending balance $ 9,208 $ 13,561 Supplemental disclosure of cash flows information: Cash paid during the period for: Interest $ 2,414 $ 2,462 Income taxes 452 413 Supplemental schedule of noncash investing and financing activities: Unrealized gain (loss) on investments available for sale (net of deferred taxes of $ 40 and $ 321 at June 30, 1997 and 1996, respectively) 78 ( 622) 5% stock dividend issued May, 1997 1,736 0 The accompanying notes are an integral part of these condensed financial statements. Page 6 of 14 pages NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1997 (UNAUDITED) Note 1. Basis of Presentation The financial information presented at and for the three months ended and six months ended June 30, 1997 and 1996 is unaudited. Information presented at December 31, 1996 is condensed from audited year-end financial statements. However, unaudited information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim period. Note 2. Principles of Consolidation The consolidated financial statements include the accounts of the corporation and its wholly-owned subsidiary, Orrstown Bank. All significant intercompany transactions and accounts have been eliminated. Note 3. Cash Flows For purposes of the statements of cash flows, the corporation has defined cash and cash equivalents as those amounts included in the balance sheet captions "cash and due from banks" and "federal funds sold". As permitted by Statement of Financial Accounting Standards No. 104, the corporation has elected to present the net increase or decrease in deposits in banks, loans and time deposits in the statement of cash flows. Note 4. Federal Income Taxes For financial reporting purposes the provision for loan losses charged to operating expense is based on management's judgment, whereas for federal income tax purposes, the amount allowable under present tax law is deducted. Additionally, certain expenses are charged to operating expense in the period the liability is incurred for financial reporting purposes, whereas for federal income tax purposes, these expenses are deducted when paid. As a result of these timing differences, deferred income taxes are provided in the financial statements. Federal income taxes were computed after reducing pretax accounting income for nontaxable municipal and loan income. Note 5. Other Commitments In the normal course of business, the bank makes various commitments and incurs certain contingent liabilities which are not reflected in the accompanying financial statements. These commitments include various guarantees and commitments to extend credit and the bank does not anticipate any losses as a result of these transactions. Page 7 of 14 pages Note 6. Changes in Common Stock Earnings per share of common stock for the period ended June 30, 1996 were computed based on an average of 989,389 shares after giving retroactive recognition to the 5% stock dividend, issued in May, 1997. Note 7. Investment Securities Management determines the appropriate classification of securities at the time of purchase. If management has the intent and the corporation has the ability at the time of purchase to hold securities until maturity or on a long-term basis, they are classified as securities held to maturity and carried at amortized historical cost. Securities to be held for indefinite periods of time and not intended to be held to maturity or on a long-term basis are classified as available for sale and carried at fair value. Securities held for indefinite periods of time include securities that management intends to use as part of its asset and liability management strategy and that may be sold in response to changes in interest rates, resultant prepayment risk and other factors related to interest rate and resultant prepayment risk changes. Realized gains and losses on dispositions are based on the net proceeds and the adjusted book value of the securities sold, using the specific identification method. Unrealized gains and losses on investment securities available for sale are based on the difference between book value and fair value of each security. These gains and losses are credited or charged to shareholders' equity, whereas realized gains and losses flow through the corporation's operations. Management has classified all investments securities as "available for sale". At June 30, 1997 fair value exceeded amortized cost by $ 483,000. This resulted in an increase in stockholders' equity of $ 319,000 after recognizing the tax effects of the unrealized gains. At December 31, 1996, fair market value exceeded amortized cost by $ 365,000 resulting in an increase in stockholders' equity of $ 241,000 after recognizing the tax effects of the unrealized gains. Page 8 of 14 pages ORRSTOWN FINANCIAL SERVICES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Net after tax income for the first six months of 1997 was $ 1,278,000 compared to $ 1,072,000 for the same period in 1996 representing an increase of $ 206,000 or 19.2%. Net income on an adjusted per share basis for the first six months was $ 1.29 up $ .21 from the $ 1.08 per share realized during the six months ended June 30, 1996. RESULTS OF OPERATIONS Second Quarter 1997 vs. Second Quarter 1996 Interest income for the second quarter of 1996 was $ 3,316,000 compared to $ 2,994,000 as of June 30, 1996, for an increase of $ 322,000. The increase is due primarily to an increase in loan volumes. Interest expense for the current quarter was $ 1,418,000, an increase of $ 132,000 over the $ 1,286,000 for the same period of the prior year. Deposit volumes continued to increase during the second quarter with the growth being concentrated in interest bearing transaction accounts. Average rates have decreased over those paid in the second quarter of 1996. Net interest income for the second quarter of 1997 totaled $ 1,898,000, up $ 190,000 from the second quarter of 1996. Six Months 1997 vs. Six Months 1996 For the six months ended June 30, 1997, interest income was $ 6,419,000, an increase of $ 519,000 over the $ 5,900,000 of the six months ended June 30, 1996. The increase is largely due to an increase in loan volumes. Gross loans at June 30, 1997 stood at $ 116,302,000 compared to $ 106,767,000 as of June 30, 1996. Interest expense for the first six months of 1997 was $ 2,718,000 compared to $ 2,546,000 for the same period in 1996 representing a 6.7% increase. The corporation realized growth in all deposit categories through June 30, 1997. However, the most significant increases occurred in noninterest bearing demand deposit accounts, and interest bearing transaction accounts. Average rates paid have decreased slightly compared to those paid in the second quarter of 1996 resulting in a smaller increase in interest cost than was experienced as of June 30, 1996. Net interest income for the first half of 1997 totaled $ 3,701,000, up $ 347,000 from the first half of 1996. Management continuously monitors liquidity and interest rate risk through its ALCO reporting and reprices products in order to maintain desired net interest margins. Page 9 of 14 pages OTHER INCOME Second Quarter 1997 vs. Second Quarter 1996 Noninterest income increased from $ 301,000 in 1996 to $ 390,000 in 1997. The increase was primarily due to increases in trust department fees and service charges on deposit accounts. Six Months 1997 vs. Six Months 1996 Noninterest income for the first six months of 1997 was $ 730,000 compared to $ 557,000 in 1996. Increases occurred in trust fees and in service charges on deposits as the volume of transaction accounts continues to grow. OTHER EXPENSES Second Quarter 1997 vs. Second Quarter 1996 Other operating expenses totaled $ 1,254,000 as of June 30, 1997, an increase of $ 70,000 over the $ 1,184,000 recorded for June 30, 1996. Employee related expenses were up 3.2% over the second quarter 1996. Net occupancy increased $ 30,000 primarily due to increases in depreciation expense and equipment maintenance as the result of new branch expansions. Other expenses increased 4.9% over the prior year. Six Months 1997 vs. Six Months 1996 Other operating expenses for the first six months of 1997 reflect a $ 276,000 increase over the same period in 1996. Employee related expenses increased 9.5% as a result of normal salary increases and the addition of staff to accommodate branch expansions. Net occupancy increased $ 61,000 largely due to increases in depreciation expense and equipment maintenance as corporate facilities are expanded. INCOME TAXES The effective income tax rate for the second quarter 1997 was 28.2% compared to 28.8% for the same period for 1996. FINANCIAL CONDITION Total assets at June 30, 1997 were $ 173,713 a 10.2% increase over December 31, 1996. Gross loans at June 30, 1997 totaled $ 117,986,000, an increase of $ 9,060,000 over the $ 108,926,000 level at December 31, 1996. Page 10 of 14 pages PROVISION AND ALLOWANCE FOR LOAN LOSSES The provision for loan losses and the other changes in the allowance for loan losses are shown below (in thousands): Quarter Ended Six Months Ended June 30 June 30 1997 1996 1997 1996 Balance, beginning of period $ 1,657 $ 1,475 $ 1,620 $ 1,433 Recoveries 1 7 1 11 Provision for loan loss charged to income 45 60 90 120 Total 1,703 1,542 1,711 1,564 Losses 19 23 27 45 Balance, end of period $ 1,684 $ 1,519 $ 1,684 $ 1,519 In the opinion of management, the allowance, when taken as a whole, is adequate to absorb reasonably estimated loan losses inherent in the Bank's loan portfolio. Loans 90 days or more past due (still accruing interest) and those on nonaccrual status were as follows at June 30 (in thousands): 90 Days or More Past Due Nonaccrual Status 1997 1996 1997 1996 Real estate mortgages $ 15 $ 39 $ 0 $ 0 Installment loans 94 33 16 32 Demand and time loans 567 0 0 16 Credit card 20 8 0 0 Total $ 696 $ 80 $ 16 $ 48 There were no restructured loans for any of the time periods set forth above. Total deposits increased to $ 149,254,000 at June 30, 1997 compared to $ 137,259,000 at December 31, 1996. Increases occurred primarily in noninterest bearing demand deposits and interest bearing transaction accounts. Total equity at June 30, 1997 was $ 16,810,000 representing 9.7% of total assets. This is a $ 954,000 increase from the company's capital position at December 31, 1996. A comparison of Orrstown Financial Services' capital ratios to regulatory minimum requirements at June 30, 1997 is as follows: Page 11 of 14 pages Orrstown Financial Regulatory Minimum Services Requirements Leverage ratio 9.7% 4% Risk based capital ratios: Tier I (core capital) 12.93% 4% Combined tier I and tier II (core capital plus allowance for loan losses) 14.29% 8% BALANCE SHEET ANALYSIS The following table highlights the changes in the balance sheet. Since period end balances can be distorted by one-day fluctuations, an analysis of changes in average balances is provided to give a better indication of balance sheet trends. AVERAGE BALANCE SHEETS Six Months Ended June 30 (000 Omitted) ASSETS 1997 1996 Securities available for sale: Taxable securities $ 21,699 $ 18,744 Nontaxable securities 14,534 10,263 Total available for sale securities 36,233 29,007 Other investments 1,378 1,106 Loans (net of unearned discounts) 112,580 103,830 Other short-term investments 4,470 5,875 Total interest earning assets 154,661 139,818 Allowance for loan losses ( 1,661) ( 1,479) Cash and due from banks 4,668 6,216 Bank premises and equipment 4,100 3,222 Other assets 2,546 2,194 Total assets $ 164,314 $ 149,971 LIABILITIES AND STOCKHOLDERS' EQUITY Interest bearing demand deposits $ 32,251 $ 26,685 Savings deposits 25,931 26,433 Time deposits 67,026 63,097 Long-term borrowings 3,964 2,341 Total interest bearing liabilities 129,172 118,556 Demand deposits 17,065 14,960 Other liabilities 1,946 1,617 Total liabilities 148,183 135,133 Stockholders' equity 16,131 14,838 Total liabilities and stockholders' equity $ 164,314 $ 149,971 Page 12 of 14 pages PART II - OTHER INFORMATION PART II - OTHER INFORMATION Item 1 - Legal Proceedings None Item 2 - Changes in Securities None Item 3 - Defaults Upon Senior Securities Not applicable 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 - None (b) Reports on Form 8-K - None Page 13 of 14 pages 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. /s/ (Kenneth R. Shoemaker, President) Duly Authorized Officer) Date /s/ (Robert B. Russell, Controller) (Chief Accounting Officer) Page 14 of 14 pages