FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC. 20549 (X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from ___________________to___________ Commission file number 0-17077 PENNS WOODS BANCORP, INC. (exact name of registrant as specified in its charter) Pennsylvania 23-2226454 (State or other jurisdiction (IRS. Employer of incorporation or organization) Identification No.) 115 South Main Street, PO. Box 5098 Jersey Shore, Pennsylvania 17740 (Address of principal executive offices) Registrant's telephone number, including area code (570) 398-2213 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange which registered None None Securities to be registered pursuant to Section 12(g) of the Act: Common Stock, par value $10 per share (Title of Class) 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. Yes X No <PAGE 1> Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] State the aggregate market value of the voting stock held by non-affiliates of the registrant $151,664,915 at February 28, 1999. 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 February 28, 1999 Common Stock, $10 Par Value 2,837,167 Shares PAGE 2
DOCUMENTS INCORPORATED BY REFERENCE The following document is incorporated by reference in response to Part III of this Report: Penns Woods Bancorp, Inc. Proxy Statement (Proxy Statement dated March 25, 1999) PAGE 3
PART I ITEM 1. BUSINESS A. General Development of Business and History On January 7, 1983, Penns Woods Bancorp, Inc. (the "Company") was incorporated under the laws of the Commonwealth of Pennsylvania as a bank holding company. The Jersey Shore State Bank (the "Bank") became a wholly-owned subsidiary of the Company, and each outstanding share of Bank common stock was converted into one share of Company common stock. This transaction was approved by the shareholders of the Bank on April 11, 1983 and was officially effective on July 12, 1983. The Company's business has consisted primarily of managing and supervising the Bank, and its principal source of income has been dividends paid by the Bank. The Company's two other wholly-owned subsidiaries are Woods Real Estate Development Company and Woods Investment Company, Inc. The Bank is engaged in commercial and retail banking and the taking of time and regular savings and demand deposits, the making of commercial and consumer loans and mortgage loans, and safe deposit services. Auxiliary services, such as cash management, are provided to commercial customers. The Bank operates full banking services with nine branch offices and a Mortgage/Loan Center in Northcentral Pennsylvania. Neither the Company nor the Bank anticipates that compliance with environmental laws and regulations will have any material effect on capital expenditures, earnings, or on its competitive position. The Bank is not dependent on a single customer or a few customers, the loss of whom would have a material effect on the business of the Bank. The Bank employed approximately 140 persons as of December 31, 1998. The Company does not have any employees. The principal officers of the Bank also serve as officers of the Company. B. Regulations and Supervision The Company is under the jurisdiction of the Securities and Exchange Commission (the "SEC") and of state securities commissions for matters relating to the offering and sale of its securities. In addition, the Company is subject to the SEC's rules and regulations relating to periodic reporting, reporting to its shareholders, proxy solicitation and insider trading. The Company is also subject to the provisions of the Bank Holding Company Act of 1956, as amended (the "BHCA") and to supervision and examination by the Board of Governors of the Federal Reserve System (the "FRB"). The Bank is subject to the supervision and examination by the Federal Deposit Insurance Corporation (the "FDIC"), as its primary federal regulator and as the insurer of <PAGE 4> the Bank's deposits. The Bank is also regulated and examined by the Pennsylvania Department of Banking (the "Department"). The FRB has issued regulations under the BHCA that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the FRB, pursuant to such regulations, may require the Company to stand ready to use its resources to provide adequate capital funds to the Bank during periods of financial stress or adversity. The BHCA requires the Company to secure the prior approval of the FRB before it can acquire all or substantially all of the assets of any bank, or acquire ownership or control of 5% or more of any voting shares of any bank. Such a transaction would also require approval of the Department. A bank holding company is prohibited under the BHCA from engaging in, or acquiring direct or indirect control of, more than 5% of the voting shares of any company engaged in non-banking activities unless the FRB, by order or regulation, has found such activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Under the BHCA, the FRB has the authority to require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon FRB's determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company. Bank holding companies are required to comply with the FRB'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. Currently, the required minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least half of the total capital is required to be Tier 1 capital, consisting principally of common shareholders' equity, less certain intangible assets. The remainder ("Tier 2 capital") may consist of certain preferred stock, a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, 45% of net unrealized gains on marketable equity securities, and a limited amount of the general loan loss allowance. The risk-based capital guidelines are required to take adequate account of interest rate risk, concentration of credit risk, and risks of nontraditional activities. In addition to the risk-based capital guidelines, the FRB requires each bank holding company to comply with the leverage ratio, under which the bank holding company must maintain a minimum level of Tier 1 capital to average total consolidated assets of 3% for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank <PAGE 5> holding companies are expected to maintain a leverage ratio of at least 4% to 5%. The Bank is subject to similar capital requirements adopted by the FDIC. C. Regulation of the Bank From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions of, the business of the Bank. It cannot be predicted whether any such legislation will be adopted or how such legislation would affect the business of the Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, the Bank's business is particularly susceptible to being affected by federal legislation and regulations that may increase the costs of doing business. Prompt Corrective Action - The FDIC has specified the levels at which an insured institution will be considered "well- capitalized," "adequately capitalized," "undercapitalized," and "critically undercapitalized." In the event an institution's capital deteriorates to the "undercapitalized" category or below, the Federal Deposit Insurance Act (the "FDIA") and FDIC regulations prescribe an increasing amount of regulatory intervention, including: (1) the institution of a capital restoration plan by a bank and a guarantee of the plan by a parent institution; and (2) the placement of a hold on increases in assets, number of branches or lines of business. If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and (in critically undercapitalized situations) appointment of a receiver. For well-capitalized institutions, the FDIA provides authority for regulatory intervention where the institution is deemed to be engaging in unsafe or unsound practices or receives a less than satisfactory examination report rating for asset quality, management, earnings or liquidity. Deposit Insurance - There are two deposit insurance funds administered by the FDIC - the Savings Association Insurance Fund ("SAIF") and the Bank Insurance Fund ("BIF"). The Bank's deposits are insured under the BIF; however, the deposits assumed by the Bank in connection with the merger of Lock Haven Savings Bank are treated and assessed as SAIF-insured deposits. The FDIC has implemented a risk-related premium schedule for all insured depository institutions that results in the assessment of premiums based on capital and supervisory measure. Under the risk-related premium schedule, the FDIC assigns, on a semiannual basis, each institution to one of three capital groups (well-capitalized, adequately capitalized or undercapitalized) and further assigns such institution to one of three subgroups within a capital group. The institution's subgroup assignment is based upon the FDIC's judgment of the institution's strength in light of supervisory evaluations, including examination reports, statistical analyses and other information relevant to gauging the risk posed by the institution. Only institutions with a <PAGE 6> total capital to risk-adjusted assets ratio of 10.0% or greater, a Tier 1 capital to risk-adjusted assets ratio of 6.0% or greater and a Tier 1 leverage ratio of 5.0% or greater, are assigned to the well-capitalized group. As of December 31, 1998, the Bank's ratios were well above required minimum ratios. Both the BIF and SAIF are presently fully funded at more than the minimum amount required by law. Accordingly, the BIF and SAIF assessment rates range from zero for those institutions with the least risk, to $0.27 for every $100 of insured deposits for institutions deemed to have the highest risk. The Bank is in the category of institutions that presently pay nothing for deposit insurance. The FDIC adjusts the rates every six months. While the Bank presently pays no premiums for deposit insurance, it is subject to assessments to pay the interest on Financing Corporation ("FICO") bonds. FICO was created by Congress to issue bonds to finance the resolution of failed thrift institutions. Prior to 1997, only thrift institutions were subject to assessments to raise funds to pay the FICO bonds. Commercial banks are subject to 1/5 of the assessment to which thrifts are subject for FICO bond payments through 1999. Beginning in 2000, commercial banks and thrifts will be subject to the same assessment for FICO bonds. The annual FICO assessment for the Bank (and all commercial banks) is $.0122 for each $100 of BIF deposits. Because the Bank has SAIF deposits as a result of its acquisition of Lock Haven Savings Bank, the Bank is also subject to a FICO assessment of $.0610 for each $100 of SAIF deposits. Environmental Laws Environmentally related hazards have become a source of high risk and potential liability for financial institutions relating to their loans. Environmentally contaminated properties owned by an institution's borrowers may result in a drastic reduction in the value of the collateral securing the institution's loans to such borrowers, high environmental clean up costs to the borrower affecting its ability to repay the loans, the subordination of any lien in favor of the institution to a state or federal lien securing clean up costs, and liability to the institution for clean up costs if it forecloses on the contaminated property or becomes involved in the management of the borrower. The Company is not aware of any borrower who is currently subject to any environmental investigation or clean up proceeding which is likely to have a material adverse effect on the financial condition or results of operations of the Company. Effect of Government Monetary Policies The earnings of the Company are and will be affected by domestic economic conditions and the monetary and fiscal policies of the United States Government and its agencies. <PAGE 7> The monetary policies of the FRB have had, and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The FRB has a major effect upon the levels of bank loans, investments and deposits through its open market operations in the United States Government securities and through its regulation of, among other things, the discount rate on borrowing of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature and impact of future changes in monetary and fiscal policies. DESCRIPTION OF BANK a. History and Business Jersey Shore State Bank (Bank) was incorporated under the laws of the Commonwealth of Pennsylvania as a state bank in 1934 and became a wholly-owned subsidiary of the Company on July 12, 1983. As of December 31, 1998, the Bank had total assets of $297,115,000; total shareholders' equity of $32,703,000 and total deposits of $228,925,000. The Bank's deposits are insured by the Federal Deposit Insurance Corporation for the maximum amount provided under current law. Jersey Shore State Bank engages in business as a commercial bank, doing business at several locations in Lycoming, Clinton and Centre Counties, Pennsylvania. Services offered by the Bank include accepting time, demand and savings deposits including Super NOW accounts, regular savings accounts, money market certificates, investment certificates, fixed rate certificates of deposit and club accounts. Its services also include making secured and unsecured commercial and consumer loans, financing commercial transactions, making construction and mortgage loans and the renting of safe deposit facilities. Additional services include making residential mortgage loans, revolving credit loans with overdraft protection, small business loans, etc. Business loans include seasonal credit collateral loans and term loans, as well as accounts receivable and inventory financing. The Bank's loan portfolio mix can be classified into four principal categories. They are real estate, agricultural, commercial and consumer. Real estate loans can be further segmented into construction and land development, farm land, one-to-four family residential, multi-family and commercial or industrial. Qualified borrowers are defined by policy or by industry underwriting standards. Owner provided equity requirements range from 20% to 30% with a first lien status required. Terms are restricted to between 10 <PAGE 8> and 20 years with the exception of construction and land development, which is limited to one to five years. Appraisals, verifications and visitations comply with industry standards. Financial information that is required on all commercial mortgages includes the most current three years' balance sheets and income statements and projections on income to be developed through the project. In the case of corporations and partnerships, the principals are often asked to indebt themselves personally as well. As regards residential mortgages, repayment ability is determined from information contained in the application and recent income tax returns. Emphasis is on credit, employment, income and residency verification. Broad hazard insurance is always required and flood insurance where applicable. In the case of construction mortgages, builders risk insurance is requested. Adjustable rate mortgages are not offered for residential mortgages. Agricultural loans for the purchase or improvement of real estate must meet the Bank's real estate underwriting criteria. The only permissible exception is when a Farmers Home Loan Administration guaranty is obtained. Agricultural loans made for the purchase of equipment are usually payable in three years, but never more than seven, depending upon the useful life of the purchased asset. Minimum borrower equity required is 20%. Livestock financing criteria depends upon the nature of the operation. A dairy herd could be financed over five years, but a feeder operation would require cleanup in intervals of less than one year. Agricultural loans are also made for crop production purposes. Such loans are structured to repay within the production cycle and not carried over into a subsequent year. General purpose working capital loans are also a possibility with repayment expected within one year. It is also a general policy to collateralize non-real estate loans with not only the asset purchased but also junior liens on all other available assets. Insurance and credit criteria is the same as mentioned previously. In addition, annual visits are made to our agricultural customers to determine the general condition of assets. Personal credit requirements are handled as consumer loans. Commercial loans are made for the acquisition and improvement of real estate, purchase of equipment and for working capital purposes on a seasonal or revolving basis. Criteria was discussed under real estate financing for such loans, but it is important to note that such loans may be made in conjunction with the Pennsylvania Industrial Development Authority. Caution is also exercised in taking industrial property for collateral by requiring, on a selective basis, environmental audits. Equipment loans are generally amortized over three to seven years, with an owner equity contribution required of at least 20% of the purchase price. Unusually expensive pieces may be financed for a longer period depending upon the asset's useful life. The increased cash flow resulting from the additional <PAGE 9> piece, through improved income or greater depreciation expense, serves in establishing the terms. Insurance coverage with the Bank as loss payee is required, especially in the case where the equipment is rolling stock. Seasonal and revolving lines of credit are offered for working capital purposes. Collateral for such a loan includes the pledge of inventory and/or receivables. Drawing availability is usually 50% of inventory and 75% of eligible receivables. Eligible receivables are defined as invoices less than 90 days delinquent. Exclusive reliance is very seldom placed on such collateral, therefore other lienable assets are also taken into the collateral pool. Where reliance is placed on inventory and accounts receivable, the applicant must provide financial information including agings on a monthly basis. In addition, the guaranty of the principals is usually obtained. It is unusual for Jersey Shore State Bank to make unsecured commercial loans. But when such a loan is a necessity, credit information in the file must support that decision. Letter of Credit availability is limited to standbys where the customer is well known to the Bank. Credit criteria is the same as that utilized in making a direct loan and collateral is obtained in most cases, and whenever the expiration date is for more than one year. Consumer loan products include second mortgages, automobile financing, small loan requests, overdraft check lines and PHEAA referral loans. Our policy includes standards used in the industry on debt service ratios and terms are consistent with prudent underwriting standards and the use of proceeds. Verifications are made of employment and residency, along with credit history. Second mortgages are confined to equity borrowing and home improvements. Terms are generally ten years or less and rates are fixed. Loan to collateral value criteria is 80% or less and verifications are made to determine values. Automobile financing is generally restricted to four years and done on a direct basis. The Bank, as a practice, does not floor plan and therefore does not discount dealer paper. Small loan requests are to accommodate personal needs such as the purchase of small appliances or for the payment of taxes. Overdraft check lines are limited to $5,000 or less. The Bank's investment portfolio is analyzed and priced on a monthly basis. Investments are made in U.S. Treasuries, U.S. Agency issues, bank qualified municipal bonds, corporate bonds and corporate stocks which consist of Pennsylvania bank stocks. Bonds with BAA or better ratings are used, unless a local issue is purchased that has a lesser or no rating. Factors taken into consideration when investments are made include liquidity, the company's tax position and the policies of the Asset/Liability Committee. <PAGE 10> The Bank has experienced deposit growth in the range of .38% to 8.63% over the last five years. This growth has primarily come in the form of core deposits. Although the Bank has regular opportunities to bid on pools of funds of $100,000 or more in the hands of municipalities, hospitals and others, it does not rely on these monies to fund loans on intermediate or longer term investments. Minor seasonal growth in deposits is experienced at or near the year end. It is the policy of Jersey Shore State Bank to generally maintain a rate sensitive asset (RSA) to rate sensitive liability (RSL) cumulative gap of 200% of equity for a 6-month time horizon, 175% of equity for a 2-year time horizon and 150% of equity for a 5-year time horizon. The Bank operates 9 full service offices in Lycoming, Clinton and Centre Counties, Pennsylvania, and a Mortgage/Center in Centre County, Pennsylvania. The economic base of the region is developed around service, light manufacturing industries and agriculture. The banking environment in Lycoming, Clinton and Centre Counties, Pennsylvania is highly competitive. The Bank competes for loans and deposits with commercial banks, savings and loan associations and other financial institutions. The Bank has a relatively stable deposit base and no material amount of deposits is obtained from a single depositor or group of depositors (including federal, state and local governments). The Bank has not experienced any significant seasonal fluctuations in the amount of its deposits. b. Supervision and Regulation The earnings of the Bank are affected by the policies of regulatory authorities including the Federal Deposit Insurance Corporation and the Board of Governors of the Federal Reserve System. An important function of the Federal Reserve System is to regulate the money supply and interest rates. Among the instruments used to implement these objectives are open market operations in U.S. Government Securities, changes in reserve requirements against member bank deposits, and limitations on interest rates that member banks may pay on time and savings deposits. These instruments are used in varying combinations to influence overall growth and distribution of bank loans, investments in deposits, and their use may also affect interest rates charged on loans or paid for deposits. The policies and regulations of the Federal Reserve Board have had and will probably continue to have a significant effect on the Bank's deposits, loans and investment growth, as well as the rate of interest earned and paid, and are expected to affect the Bank's operation in the future. The effect of such policies and regulations upon the future business and earnings of the Bank cannot accurately be predicted. <PAGE 11> EXECUTIVE OFFICERS OF THE REGISTRANT: NAME AGE FIVE-YEAR ANALYSIS OF DUTIES Theodore H. Reich 60 President and Chief Executive Officer of the Company; the Bank; Woods Real Estate Development Co., Inc.; and Woods Investment Company, Inc. Ronald A. Walko 52 Vice President of the Company; Senior Vice President and Senior Loan Officer of the Bank from 1986 to current; Vice President of Woods Investment Company, Inc.; Federal bank examiner prior to 1986 for an eighteen-year period. Hubert A. Valencik 57 Vice President of the Company; Senior Vice President and Operations Officer of the Bank; Vice President of Woods Real Estate Development Co., Inc. and Woods Investment Company, Inc.; Vice President with another bank prior to 1985 for a fourteen-year period. Sonya E. Hartranft 39 Secretary of the Company; Controller of the Bank; Secretary of Woods Real Estate Development Co., Inc. and Woods Investment Company, Inc. ITEM 2 PROPERTIES The Company owns and leases its properties. Listed herewith are the locations of properties owned or leased, in which the banking offices and Mortgage/Loan Center are located; are located; all properties are in good condition and adequate for the Bank's purposes: <TABLE> <CAPTION> Office Address <S> <C> <C> Jersey Shore Main 115 South Main Street Owned PO. Box 5098 Jersey Shore, Pennsylvania 17740 Jersey Shore 112 Bridge Street Owned Jersey Shore, Pennsylvania 17740 DuBoistown 2675 Euclid Avenue Under Lease DuBoistown, Pennsylvania 17702 -- see below Williamsport 300 Market Street Owned P.O. Box 967 Williamsport, Pennsylvania 17703-0967 Montgomery RD. 1, Box 493 Under Lease Montgomery, Pennsylvania 17752 -- see below <PAGE 12> Lock Haven 4 West Main Street Owned Lock Haven, Pennsylvania 17745 Mill Hall (Inside Wal-Mart), 167 Hogan Boulevard Under Lease Mill Hall, Pennsylvania 17751 -- see below Spring Mills Route 45, Ross Hill Road, P.O. Box 66 Owned Spring Mills, Pennsylvania 16875 Centre Hall RR 2, Route 45 West Land Under Lease Centre Hall, 16828 -- see below Mortgage/Loan Center State College 300 Allen Street Under Lease State College, Pennsylvania 16801 -- see below </TABLE> The DuBoistown branch office was leased for a twenty-year period that ended in 1995. After the initial twenty-year period, the Bank had the option to extend the lease for each of four successive five-year terms. In 1995 the bank extended the lease for the first of four five-year optional terms. At the end of the last five-year extension, the Bank shall be afforded the opportunity to negotiate a new lease agreement. The Bank is granted, during the term of the lease or any renewal or extension thereof, an option to purchase the leased property at any time at a purchase price to be determined in the following manner: Two competent real estate appraisers to be selected by agreement of the Bank and the lessor, and if no such agreement can be reached, then one selected by the lessor and one selected by the Bank shall individually appraise the property, and the purchase price shall be seventy-five (75%) percent of the average of the two appraisals. The annual rent for the DuBoistown branch office was $9,000 for the year ended December 31, 1998. The Montgomery branch office is leased for a fifteen-year period ending in the year 2002. The Bank has the option to extend the lease for a five-year period after the initial fifteen-year term has expired. The Bank also has the opportunity to negotiate a new lease agreement after the five-year extension has expired. The Bank is granted, at the end of the initial term of the lease or at any time during the extended period, an option to purchase the property at a price to be determined in the following manner: Two competent real estate appraisers selected by agreement of the Bank and the lessor, and if no such agreement can be reached then one selected by the Bank and one selected by the lessor, shall individually appraise the property and the purchase price shall be the average of the two. The annual rent for the Montgomery branch office was $30,000 for the year ended December 31, 1998. The Mill Hall branch office space, inside WAL-MART, is leased for a five-year period ending in October, 2003. After the initial period the Bank has the option to extend the lease for two additional five-year terms. The rent for the Mill Hall branch office from opening date, October 14th, to year end December 31, 1998 was $9,543. <PAGE 13> Penns Woods Bancorp, Inc. completed the acquisition of the First National Bank of Spring Mills on January 11, 1999. The Centre Hall branch office is situated on a lot leased for a five-year period ending March 2003. The Bank has the option to renew this lease for three successive ten-year terms. The monthly rent is adjusted annually in accordance with changes in the Consumer Price Index published by the United States Department of Labor with the measuring month being February of each year. On July 7, 1997, the Bank commenced operating a Mortgage/Loan Center in State College, Pennsylvania. The Mortgage/Loan Center was initially leased for a one-year term ending in May, 1998, with the option to renew the lease for one additional, one-year period. The Bank exercised this option, renewing the lease term, which will end May, 1999. In October of 1998, the Bank again renewed the lease for an additional, one-year term which will end in May, 2000. The annual rent for the State College Mortgage/ Loan Center was $13,900 for the year ended December 31, 1998. ITEM 3 LEGAL PROCEEDINGS In the normal course of business, various lawsuits and claims arise against the Company and its subsidiary. There are no such legal proceedings or claims currently pending or threatened. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 1998. PAGE 14
PART II ITEM 5 MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Registrant's Common Stock is traded locally. The following table sets forth (1) the quarterly high and low prices for a share of the Registrant's Common Stock during the periods indicated as reported by the management of the Registrant, and (2) quarterly dividends on a share of the Common Stock with respect to each quarter since January 1, 1996. The following quotations represent prices between buyers and sellers and do not include retail markup, markdown or commission. They may not necessarily represent actual transactions. Dividends HIGH LOW Declared 1996: First quarter $18 $18 0.110 Second quarter $19 3/4 $18 1/4 0.110 Third quarter $21 $19 1/2 0.125 Fourth quarter $21 1/4 $19 7/8 0.255 1997: First quarter $25 $21 0.125 Second quarter $28 2/3 $26 9/16 0.150 Third quarter $30 1/2 $28 3/4 0.400 Fourth quarter $31 3/4 $30 0.175 1998: First quarter $48 $32 3/8 0.180 Second quarter $53 $47 0.180 Third quarter $55 1/2 $54 0.180 Fourth quarter $57 $53 1/12 0.460 The stock prices and the dividend have been adjusted to reflect the issuance of a stock split effected in the form of a 100% stock dividend paid on January 15, 1998. The Bank has paid cash dividends since December 31, 1941. The Registrant has paid dividends since the effective date of its formation as a bank holding company. It is the present intention of the Registrant's Board of Directors to continue the dividend payment policy; however, further dividends must necessarily depend upon earnings, financial condition, appropriate legal restrictions and other factors relevant at the time the Board of Directors of the Registrant considers dividend policy. Cash available for dividend distributions to shareholders of the Registrant must initially come from dividends paid by the Bank to the Registrant. Therefore, the restrictions on the Bank's dividend payments are directly applicable to the Registrant. Under the Pennsylvania Business Corporation Law of 1988 a corporation may not pay a dividend, if after giving effect <PAGE 15> thereto, the corporation would be unable to pay its debts as they become due in the usual course of business and after giving effect thereto the total assets of the Corporation would be less than the sum of its total liabilities plus the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of the shareholders whose preferential rights are superior to those receiving the dividend. As of February 28, 1999, the Registrant had approximately 1,074 shareholders of record. <PAGE 16> ITEM 6 SELECTED FINANCIAL DATA The following table sets forth certain financial data as of and for each of the years in the five-year period ended December 31, 1998. <TABLE> <CAPTION> As of and for the Years Ended December 31, 1998 1997 1996 1995 1994 (Dollars in thousands, except per share amounts) <S> <C> <C> <C> <C> <C> Consolidated Statement of Income Data: Interest income $ 22,591 $ 20,823 $ 19,997 $ 18,695 $ 16,882 Interest expense 9,447 8,317 8,079 7,793 6,902 Net interest income 13,144 12,506 11,918 10,902 9,980 Provision for loan losses 300 220 105 300 577 Net interest income after provision for loan losses 12,844 12,286 11,813 10,602 9,403 Other income 3,334 5,840 2,461 2,215 2,137 Other expense 7,717 7,384 6,967 7,534 6,997 Income before income taxes 8,461 10,742 7,307 5,283 4,543 Applicable income taxes 2,050 2,991 1,965 1,421 1,174 Net Income $ 6,411 $ 7,751 $ 5,342 $ 3,862 $ 3,369 Consolidated Balance Sheet at End of Period: Total assets $309,763 $283,988 $259,724 $242,629 $235,638 Loans 196,052 187,567 162,267 153,640 151,492 Allowance for loan losses (2,501) (2,414) (2,413) (2,353) (2,127) Deposits 228,537 220,536 203,016 202,258 190,839 Long-term debt -- other 20,000 0 0 0 7,000 Stockholders' equity 45,626 42,974 33,557 29,685 23,839 Per Share Data: Net income Earnings per share - Basic $ 2.50 $ 3.03 $ 2.10 $ 1.52 $ 1.33 Earnings per share - Diluted $ 2.49 $ 3.01 $ 2.09 $ 1.52 $ 1.33 Cash dividends declared 1.00 0.85 0.60 0.50 0.395 Book Value 17.72 16.75 13.14 11.67 9.42 Number of shares outstanding, at end of period 2,578,352 1,282,779 1,277,298 1,271,339 1,265,597 Average number of shares outstanding 2,568,780 2,556,804 2,544,561 2,535,076 2,533,756 Selected financial ratios: Return on average stockholders' equity 14.23% 20.07% 17.25% 14.07% 13.89% Return on average total assets 2.12% 2.88% 2.12% 1.64% 1.45% Net interest income to average interest earning assets 4.77% 5.25% 5.08% 5.04% 4.71% Dividend payout ratio 40.00% 28.05% 28.57% 32.79% 29.70% Average stockholders' equity to average total assets 15.10% 14.46% 12.31% 11.64% 10.42% Loans to deposits, at end of period 84.69% 83.96% 78.74% 74.80% 78.27% </TABLE> Numbers adjusted to reflect a stock split effected in the form of a 50% stock dividend. In addition, per share data and number of shares outstanding have been adjusted in each reporting <PAGE 17> period to give retroactive effect to a stock split effected in the form of a 100% stock dividend issued January 15, 1998. ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's Discussion and Analysis of Consolidated Financial Condition and Results of Operations RESULTS OF OPERATIONS NET INTEREST INCOME Net interest income is determined by calculating the difference between the yields earned on interest earning assets and the rates paid on interest bearing liabilities. 1998 vs 1997 Fully taxable equivalent net interest income increased to $13,896,000 for the year ended December 31, 1998, or an increase of $680,000 or 5.1% over the previous year. The increase in total interest earning average assets from year end 1997 to year end 1998 was $33,656,000. Total average securities increased $10,213,000, total average loans increased $27,932,000, total average federal funds sold decreased $1,136,000 and total average other assets decreased $3,353,000. The increase in tax equivalent net interest income, related to the volume increase in average investment securities, was $229,000, while the decrease due to a decline in average interest rate of return was $174,000. The resulting net increase of $55,000 to tax equivalent net interest income was primarily due to two leverage transactions completed in April and June of 1998; each transaction was $10,000,000. Average net loans contributed $2,611,000 to tax equivalent net interest income due to a volume increase; a decline in the average rate of return on loans offset this increase by $614,000, resulting in a net increase of $1,997,000. Average loans grew primarily due to strong demand for commercial loans. The increase in total interest bearing average liabilities from year end 1997 to year end 1998 was $22,601,000. Total average savings increased $2,148,000 and total average other time deposits increases $5,142,000. Total average securities sold under repurchase agreements and federal funds purchased increased $2,462,000 and total average borrowed money increased $12,849,000. Average total deposits increased by total of $7,290,000. The related increase in interest expense due to <PAGE 18> volume increases was $343,000. The related decrease in interest expense due to interest rate was $64,000 for a net increase in interest expense of $279,000 related to deposits. Average total borrowed money, federal funds purchased and securities sold under agreement to repurchase increased $15,311,000 in total. Increases in interest expense due to volume on the above accounts was $488,000 and $363,000 due to interest rate. The net increase in interest expense related to these items was $851,000. In summary, the total effective interest differential declined 43 basis points mainly due to a decline in interest rates on interest earning assets. The decline in interest rates was due to the economy in general and the result of the effects of a 75 basis point decline in the Federal Reserve discount rate. 1997 vs 1996 Taxable equivalent net interest income increased $204,000 during 1997 or an increase of 1.6%. Increases in aggregate average asset volume contributed $442,000 to this net increase, offset by increases in aggregate average liability volume which contributed a net decrease of $238,000. Total average interest earning assets increased $3,892,000 in 1997, consisting of an increase in average total loans of $8,460,000, a decrease in average total securities of $5,618,000 and an increase in average federal funds sold of $1,050,000. The loan growth experienced was a result of loan demand and competitive rates. Total average interest bearing liabilities increased $3,223,000 in 1997, as a net result of the following: a decrease in average savings deposits of $1,647,000, an increase in average other time deposits of $6,284,000, and a decrease in average securities sold under repurchase agreements and federal funds purchased of $1,414,000. The total effective interest rate differential was unchanged from 1996 at 5.54% to 1997 at 5.54%. The average rate of return on average interest earning assets increased by .04%, however, the average cost of funds on average interest bearing liabilities also increased by .04% for a net effect of no change to the effective interest rate differential of 5.54%. <PAGE 19> AVERAGE BALANCES AND INTEREST RATES (INCOME AND RATES ON A FULLY TAXABLE EQUIVALENT BASIS) (IN THOUSANDS) <TABLE> <CAPTION> 1998 AVERAGE AVERAGE BALANCE INTEREST RATE <S> <C> <C> <C> ASSETS: Interest earning assets: Securities: US. Treasury and federal agency $ 42,667 $ 2,792 6.54% State and political subdivisions 18,747 1,595 8.51% Other 20,375 805 3.95% Total securities 81,789 5,192 6.35% LOANS: Tax-exempt loans 6,742 520 7.71% All other loans, net of discount where applicable 186,851 17,811 9.53% Total loans 193,593 18,331 9.47% Federal funds sold 0 0 0.00% Total earning assets 275,382 $23,523 8.54% Other assets 23,639 TOTAL ASSETS $299,021 LIABILITIES AND SHAREHOLDERS' EQUITY: Interest bearing liabilities: Deposits: Savings $ 85,223 $ 2,336 2.74% Other time 101,420 5,616 5.54% Total deposits 186,643 7,952 4.26% Securities sold under repurchase agreements & federal funds purchased 15,082 772 5.12% Borrowed money 12,849 723 5.63% Total interest bearing liabilities 214,574 $ 9,447 4.40% Demand deposits 33,479 Other liabilities 5,828 Shareholders' equity 45,145 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $299,026 Interest income/earning assets $275,382 $23,523 8.54% Interest expense/earning assets............. $275,382 9,447 3.43% Effective interest differential............. $14,076 5.11% <PAGE 20> <CAPTION> 1997 1996 AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST RATE BALANCE INTEREST RATE <S> <C> <C> <C> <C> <C> <C> ASSETS: Interest earning assets: Securities: US. Treasury and federal agency......... $ 35,607 $ 2,526 7.09% $ 41,273 $ 2,911 7.05% State and political subdivisions........ 20,574 1,795 8.72% 22,452 1,974 8.79% Other................................... 15,395 816 5.30% 13,469 909 6.75% Total securities...................... 71,576 5,137 7.18% 77,194 5,794 7.51% LOANS: Tax-exempt loans............................ 3,268 295 9.03% 1,568 145 9.25% All other loans, net of discount where applicable................................ 162,393 16,039 9.88% 155,633 15,147 9.73% Total loans........................... 165,661 16,334 9.86% 157,201 15,292 9.73% Federal funds sold.......................... 1,136 62 5.46% 86 5 5.81% Total earning assets.................. 238,373 $21,533 9.03% 234,481 $21,091 8.99% Other assets................................ 26,992 17,052 TOTAL ASSETS........................ $265,365 $251,533 LIABILITIES AND SHAREHOLDERS' EQUITY: Interest bearing liabilities: Deposits: Savings................................. $ 83,075 $ 2,286 2.75% $ 84,722 $ 2,376 2.80% Other time.............................. 96,278 5,387 5.60% 89,994 5,054 5.62% Total deposits........................ 179,353 7,673 4.28% 174,716 7,430 4.25% Securities sold under repurchase agreements & federal funds purchased...... 12,620 644 5.10% 14,034 649 4.62% Borrowed money.............................. 0 0 0.00% 0 0 0.00% Total interest bearing liabilities.... 191,973 $ 8,317 4.33% 188,750 $ 8,079 4.28% Demand deposits............................. 29,697 27,306 Other liabilities........................... 5,318 4,507 Shareholders' equity........................ 38,377 30,970 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.............. $265,365 $251,533 Interest income/earning assets.............. $238,373 $21,533 9.03% $234,481 $21,091 8.99% Interest expense/earning assets............. $238,373 8,317 3.49% $234,481 8,079 3.45% Effective interest differential............. $13,216 5.54% $13,012 5.54% </TABLE> 1. Fees on loans are included with interest on loans. 2. Average daily balance sheets are not maintained by the Bank. Information on this table has been calculated using average monthly balances to obtain average balances. 3. Average daily balances cannot be obtained without undue burden or expense by the Bank. 4. Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings. <PAGE 21> 5. Loan fees are included in interest income as follows: 1998, $623,000, 1997, $527,000, 1996, $673,000. 6. Income and rates on a fully taxable equivalent basis include an adjustment for the difference between annual income from tax-exempt obligations and the taxable equivalent of such income at the standard 34% tax rate (derived by dividing tax-exempt interest by .66). <PAGE 22> <TABLE> <CAPTION> SUMMARY OF CHANGES IN INTEREST EARNED AND INTEREST PAID (IN THOUSANDS) INTEREST EARNED ON TOTAL TAXABLE TAX-EXEMPT FEDERAL INTEREST INVESTMENT INVESTMENT FUNDS EARNING SECURITIES SECURITIES LOANS SOLD ASSETS <S> <C> <C> <C> <C> <C> 1998 compared to 1997 Increase (decrease) Due to: Volume $ 385 $(156) $2,611 $(31) $2,809 Rate (130) (44) (614) (31) $ (819) Net increase (decrease) $ 255 $(200) $1,997 $(62) $1,990 1997 compared to 1996 Increase (decrease) Due to: Volume $(283) $(164) $ 832 $ 57 $ 442 Rate (195) (15) 210 0 0 Net increase (decrease) $(478) $(179) $1,042 $ 57 $ 442 </TABLE> The change in net interest income (expense) due to volume and rate mix has been allocated to the change due to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. <TABLE> <CAPTION> SUMMARY OF CHANGES IN INTEREST EARNED AND INTEREST PAID (IN THOUSANDS) INTEREST PAID ON SECURITIES SOLD UNDER REPURCHASE TOTAL OTHER AGREEMENTS INTEREST NET SAVINGS TIME AND FUNDS BORROWED BEARING INTEREST DEPOSITS DEPOSITS PURCHASED MONEY LIABILITIES EARNINGS <S> <C> <C> <C> <C> <C> $ 59 $284 $126 $362 $ 831 $ 1,978 (9) (55) 2 361 $ 299 $(1,118) $ 50 $229 $128 $723 $1,130 $ 860 $(46) $352 $(68) $ 0 $ 238 $ 204 (44) (19) 63 0 0 $ 0 $(90) $333 $ (5) $ 0 $ 238 $ 204 </TABLE> <PAGE 23> PROVISION FOR LOAN LOSSES 1998 vs 1997 The provision for loan losses was increased 36% over the prior year to $300,000. This increase is attributed to an anticipated significant rise in consumer loan losses accompanied by a further decline in recoveries. Management conducts a quarterly, a comprehensive, detailed credit review of the loan portfolio for quality from which the adequacy of the provision is determined. Supplementing the internal review is an external review. In so doing, management remains committed to an aggressive program of problem loan identification and resolution. 1997 vs 1996 $220,000 was provided for loan losses in 1997, an increase of 110% over the prior year. This adjustment is attributed to a projected rise in consumer and small business loan losses and a decline in recoveries. A detailed comprehensive internal quarterly review of loan portfolio quality is used in determining the provision and is supplemented by an annual external review. Management continues to support a program of aggressive problem loan resolution. <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, (IN THOUSANDS) 1998 1997 1996 1995 1994 <S> <C> <C> <C> <C> <C> Balance at beginning of period $2,414 $2,413 $2,353 $2,127 $1,956 Charge-offs: Domestic: Real estate 0 0 4 0 0 Commercial and industrial 91 182 100 44 432 Consumer and all other loans 180 145 138 210 62 Total charge-offs 271 327 242 254 494 Recoveries: Real estate 0 2 0 0 0 Commercial and industrial 29 68 175 9 67 Consumer and all other loans 29 38 22 171 21 Total recoveries 58 108 197 180 88 Net charge-offs 213 219 45 74 406 Additions charged to operations 300 220 105 300 577 Balance at end of period $2,501 $2,414 $2,413 $2,353 $2,127 Ratio of net charge-offs during the period to average loans outstanding during the period 0.11% 0.13% 0.03% 0.05% 0.28% </TABLE> <PAGE 24> OTHER INCOME 1998 vs 1997 Other income for the year ended December 31, 1998 decreased $2,506,000 from 1997. The majority of the decrease was the result of securities gains taken during 1998 versus those taken in 1997. Securities gains realized during 1998 were $2,076,000 versus $4,656,000 that were realized in 1997. The increase in service charges from $858,000 in 1997 to $1,046,000 in 1998 was the result of increases in charges collected on customer's deposit accounts and overall growth in the deposit base. Other operating income decreased in 1998 over that reported in 1997 by $114,000. There were two main factors that contributed to the majority of the decrease. The first was the sale of foreclosed assets during 1997. The income reported on the 1997 sales exceeded the amount of income reported in 1998 for such sales. The second was a decrease in the income received for insurance purchases on installment loans. This decrease was the result of a decrease in the amount of installment loans opened during 1998. 1997 vs 1996 Total other income increased to $5,840,000 in 1997 over 1996's total other income of $2,461,000. This $3,379,000 increase resulted from the net effect of an increase in service charges collected of $18,000, an increase in securities gains realized of $3,311,000, and an increase in other operating income of $50,000. During 1997 securities gains realized amounted to $4,656,000. The gains were realized on sales of bank stocks and various types of bond securities that were being held in the portfolio. OTHER EXPENSES 1998 vs 1997 When comparing the year ended December 31, 1998 with the year ended December 31, 1997, there was a $333,000 or 4% increase in other expenses. Salaries and employee benefits expensed during 1998 increased by $107,000 over the amount expensed during 1997 due to a special bonus that was paid to all employees and wage increases. Occupancy expense increased $91,000 and furniture and equipment expense decreased in 1998 by $49,000 compared to 1997. <PAGE 25> The increase in occupancy expense is primarily due to an increase in depreciation resulting from the purchase of an imaging system. Other operating expenses, the final component of total other expenses, increased by $184,000. ATM and debit card expenses account for the majority of this difference, $81,000, which is the result of the addition of one ATM machine and increased usage by our customers and foreign customers. 1997 vs 1996 There was a $417,000, or 6% increase in other expenses when comparing the year ended December 31, 1997 with the year ended December 31, 1996. The amount of salaries and employee benefits expensed during 1997 increased by $476,000 over the amount expensed during 1996 due a special bonus that was paid to all employees, wage increases and also an increase in the number of full-time equivalent employees from 112 at December 31, 1996 to 118 at December 31, 1997. Occupancy expense increased in 1997 by $16,000 compared to 1996. This increase is associated with the Bank's Mortgage/Loan Center that was opened in State College, Pennsylvania on July 7, 1997. Total expense for furniture and equipment was $135,000 higher in 1997 compared to 1996. The main factor contributing to the increase in expense was the cost of an IBM lease agreement entered into for upgrading the Bank's AS400 main frame. This upgrade decreased processing time considerably and is expected to reduce operating exepenses in the long term. Other factors include increases in repairs and maintenance and depreciation. Other operating expenses declined by $210,000 when comparing 1997 to 1996. Federal Depository Insurance, which is a component of other operating expenses, declined by $255,000. The Bank's assessment rates decreased in 1997 as compared to 1996. The assessment rates are based on the Bank's classification as "well capitalized" by the FDIC risk classifications. Also, the one- time expense imposed by the FDIC to recapitalize the Savings Association Insurance Fund was charged to operating expense in 1996. In direct correlation to the decline in the balance of foreclosed assets held for sale, expenses on these assets declined in 1997 compared to expenses incurred in 1996. All of the savings mentioned above, netted against net increases in other expenses, mainly advertising, check imprinting, Pennsylvania Shares Tax and stationery and supplies, account for the $210,000 decline in other operating expenses. <PAGE 26> INCOME TAXES 1998 vs 1997 The provision for income taxes for the year ended December 31, 1998 resulted in an effective income tax rate of 24.2% compared to 27.8% for 1997. The decrease in the effective income tax rate was primarily due to a tax credit for Jersey Shore State Bank's investment in a low-to-moderate income housing project. 1997 vs 1996 The income tax provision for 1997 totaled $2,991,000 or an effective income tax rate of 27.8% compared to 26.9% in 1996. The increase in the effective income tax rate was primarily due to a decline in tax-exempt interest. FINANCIAL CONDITION INVESTMENTS 1998 The investment security portfolio increased in 1998 by $17,723,000 due to net increases in U.S. government agencies, state and political subdivisions, other bonds, notes and debentures and corporate stock of $19,624,000 and a decrease in U.S. treasury securities of 1,901,000. The increase in investment securities is primarily due to purchases of equity securities, and purchases of government securities and state and political subdivisions funded by long-term advances from Federal Home Loan Bank. The total investment portfolio at year end 1998 was comprised of 43% U.S. government and agency securities, 27% state and municipal subdivisions, 29% equity securities, and 1% other bonds, notes and debentures. Held-to-maturity securities had a carrying value of $3,078,000. The largest portion of the portfolio is classified as available-for-sale and had an amortized cost of $85,965,000 with an estimated market value of $93,279,000. Due to the unrealized gain on available-for-sale securities of $7,314,000, shareholders' equity was effected by $4,826,000, net of deferred taxes. At this time, management has no intention to establish a trading securities classification. Management also plans to continue to hold tax-free bonds, which maintain the overall quality of the portfolio, and increase its after- tax yield. 1997 The investment security portfolio decreased in 1997 by $5,743,000 due to net increases in U.S. treasury securities and corporate stock of $18,073,000 and decreases in U.S. government agencies, state and political subdivisions and other bonds, notes and debentures, of $23,816,000. The total investment portfolio at year end 1997 was comprised of 48% US government and agency <PAGE 27> securities, 20% state and municipal subdivisions, 30.5% equity securities, and 1.5% other bonds,notes and debentures. Held-to-maturity securities had a carrying value of $3,234,000. The largest portion of the portfolio is classified as available- for-sale and had an amortized cost of $66,331,000 with an estimated market value of $75,400,000. Due to the unrealized gain on available-for-sale securities of $9,069,000, shareholders' equity was effected by $5,985,000, net of deferred taxes. The carrying amounts of investment securities at the dates indicated are summarized as follows ( in thousands): DECEMBER 31, 1998 1997 US. Treasury securities: Held-to-Maturity $ 0 $ 0 Available-for-Sale 10,866 12,767 US.government agencies: Held-to-Maturity 339 513 Available-for-Sale 30,448 24,695 State and political subdivisions: Held-to-Maturity 2,464 2,471 Available-for-Sale 23,466 13,165 Other bonds, notes and debentures: Held-to-Maturity 275 250 Available-for-Sale 701 797 Total bonds, notes and debentures 68,559 54,658 Corporate stock -Available-for-Sale 27,798 23,976 Total $96,357 $78,634 The following table shows the maturities and repricing of investment securities at December 31, 1998 and the weighted average yields (for tax-exempt obligations on a fully taxable <PAGE 28> basis assuming a 34% tax rate) of such securities (in thousands): <TABLE> <CAPTION> WITHIN AFTER ONE AFTER FIVE AFTER ONE BUT WITHIN BUT WITHIN TEN YEAR FIVE YEARS TEN YEARS YEARS <S> <C> <C> <C> <C> US. Treasury securities: HTM Amount $ 0 $ 0 $ 0 $ 0 Yield 0.00% 0.00% 0.00% 0.00% AFS Amount 3,004 7,591 0 0 Yield 6.17% 6.32% 0.00% 0.00% US.government agencies: HTM Amount 0 0 0 339 Yield 0.00% 0.00% 0.00% 8.83% AFS Amount 0 0 0 30,358 Yield 0.00% 0.00% 0.00% 7.21% State and political subdivisions: HTM Amount 0 1,142 401 921 Yield 0.00% 6.34% 7.31% 7.34% AFS Amount 0 1,198 687 20,515 Yield 0.00% 9.02% 8.83% 7.71% Other bonds, notes and debentures: HTM Amount 10 165 100 0 Yield 6.63% 7.34% 7.05% 0.00% AFS Amount 0 0 0 702 Yield 0.00% 0.00% 0.00% 7.62% Total Amount $3,014 $10,096 $1,188 $52,835 Total Yield 6.17% 6.67% 8.14% 7.45% </TABLE> All yields represent weighted average yields expressed on a tax equivalent basis. They are calculated on the basis of the cost, adjusted for amortization of premium and accretion of discount and effective yields weighted for the scheduled maturity of each security. The taxable equivalent adjustment represents the difference between annual income from tax-exempt obligations and the taxable equivalent of such income at the standard 34% tax rate (derived by dividing tax-exempt interest by .66). LOAN PORTFOLIO 1998 Gross loans totaled $196,462,000 at year end, an increase of $8,487,000 or 4.5% over the prior year end. While commercial loans grew by $12,070,000 or 11.9% and consumer loans grew by $1,426,000 or 5.0%, residential real estate mortgages declined by $5,009,000 or 8.6%. Growth has leveled off primarily because of aggressive pricing in the market place. 1997 At year end gross loans totaled $187,975,000, an increase of $25,332,000 or 15.58% over the prior year end. While commercial and industrial loans grew by $21,949,000 or 27.75%, residential real estate mortgages grew $1,576,000 or 2.77% and consumer loans <PAGE 29> grew $1,807,000 or 6.78%. Growth was propelled by increased loan demand and competitive rates. The amount of loans outstanding at the indicated dates are shown in the following table according to type of loan (in thousands): December 31, 1998 1997 Domestic: Real estate mortgage $ 53,483 $ 58,492 Commercial and industrial 113,112 101,042 Consumer and all other loans 29,867 28,441 Gross loans $196,462 $187,975 The amounts of domestic loans at December 31, 1998 are presented below by category and maturity (in thousands): <TABLE> <CAPTION> CATEGORY(1)(2) COMMERCIAL REAL AND ESTATE OTHER CONSUMER TOTAL <S> <C> <C> <C> <C> Loans with floating interest rates: 1 year or less $ 6 $ 10,002 $ 761 $ 10,769 1 through 5 years 97 3,884 208 4,189 5 through 10 years 561 5,905 0 6,466 After 10 years 5,041 8,275 1,754 15,070 Sub Total 5,705 28,066 2,723 36,494 Loans with predetermined interest rates: 1 year or less 123 5,100 1,428 6,651 1 through 5 years 2,039 19,622 15,978 37,639 5 through 10 years 8,480 14,540 9,708 32,728 After 10 years 37,136 45,784 30 82,950 Sub Total 47,778 85,046 27,144 159,968 Total $53,483 $113,112 $29,867 $196,462 </TABLE> (1) The loan maturity information is based upon original loan terms and is not adjusted for "rollovers". In the ordinary course of business, loans maturing within one year may be renewed, in whole or in part, as to principal amount at interest rates prevailing at the date of renewal. (2) Scheduled repayments are reported in maturity categories in which the payment is due. The Bank does not make loans that provide for negative amortization nor do any loans contain conversion features. Also, adjustable rate mortgages are not offered on residential properties. The Bank does not have any foreign loans outstanding at December 31, 1998. <PAGE 30> ALLOWANCE FOR LOAN LOSSES 1998 At December 31, 1998, the allowance for loan losses stood at $2,501,000 or 1.3% of gross loans. This was an increase of $87,000 or 3.6%. Adequacy of the loan loss allowance is determined quarterly in unison with management's comprehensive review of the loan portfolio for credit quality. Reviews are further enhanced by analyses of present and past economic conditions, portfolio trends and growth, peer comparisons and other factors impacting overall credit quality. Underwriting continues to emphasize the need for security and adequate collateral margins. In 1998, non accruing loans increased by $94,000 to $646,000, while overall non performing loans were in fact declining. 12% of non accruing loans are meeting contractual obligations and all such loans are real estate secured. 1997 The allowance for loan losses at December 31, 1997 was $2,414,000 or 1.3% of gross loans. This was an increase of $1,000 over the prior year end. Management determined loan loss allowance adequacy quarterly through an analysis of the loan portfolio for credit quality. Included in these analyses are determinations of current and projected economic conditions, growth performance and other factors felt to impact overall loan portfolio credit quality. Portfolio growth occurred principally in loans to municipalities and in accounts secured by adequately margined real estate collateral thus eliminating the need for growth in the allowance. In 1997 nonaccrual loans declined by $196,000 to $552,000. Of these, 28% continue to make regularly scheduled contractual payments and 98% are supported by adequately margined real estate collateral. Given the preceding factors, management does not anticipate a significant impact on the Company's income or capital resulting from nonaccruing loans. TOTAL NONPERFORMING LOANS (IN THOUSANDS) 90 DAYS NONACCRUAL PAST DUE RENEGOTIATED 1998 $ 646 $ 56 $0 1997 $ 552 $409 $0 1996 $ 748 $256 $0 1995 $1,009 $791 $0 1994 $2,275 $677 $0 <PAGE 31> If interest had been recorded at the original rate on nonaccrual loans, such income would have approximated $98,000, $81,000 and $86,000 for the years ended December 31, 1998, 1997 and 1996, respectively. Interest income on such loans, which is recorded when received, amounted to approximately $50,000, $42,000 and $43,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The significant reduction in nonaccruing loans over the past five years is attributed to a strengthening in underwriting standards and the successful culmination of several commercial loan workouts. At December 31, 1998 and 1997, the Company had loans amounting to approximately $56,000 and $51,000, respectively, that were specifically classified as impaired. Of these amounts $44,000 was included in non-accrual loans in 1997. By definition, a loan is impaired when, based on current information and events, it is probable that all amounts due will not be collected according to the contractual terms of the loan agreement. Due to the low level of loans classified as impaired, and the fact that the majority of such impaired loans are adequately collateralized, impaired loans should not have a material effect on the allowance for loan losses or the earnings of the Company. Presently there are no significant amounts of loans where serious doubts exist as to the ability of the borrower to comply with the current loan payment terms which are not included in the nonperforming categories as indicated above. Management's judgment in determining the amount of the additions to the allowance charged to operating expense considers the following factors: 1. Economic conditions and the impact on the loan portfolio. 2. Analysis of past loan charge-offs experience by category and comparison to outstanding loans. 3. Problem loan trends and levels compared to outstandings and peer banks. 4. Reports of examination of the loan portfolio by the Pennsylvania State Banking Department and the Federal Deposit Insurance Corporation. <PAGE 32> ALLOCATION IN THE ALLOWANCE FOR LOAN LOSSES (IN THOUSANDS) PERCENT OF LOANS IN EACH CATEGORY TO AMOUNT TOTAL LOANS DECEMBER 31, 1998: Balance at end of period applicable to: Domestic: Real Estate $ 50 2.0% Commercial and industrial 2,251 90.0% Consumer and all other loans 200 8.0% Total $2,501 100.0% DECEMBER 31, 1997: Balance at end of period applicable to: Domestic: Real Estate $ 72 3.0% Commercial and industrial 2,173 90.0% Consumer and all other loans 169 7.0% Total $2,414 100.0% DECEMBER 31, 1996: Balance at end of period applicable to: Domestic: Real Estate $ 48 2.0% Commercial and industrial 2,172 90.0% Consumer and all other loans 193 8.0% Total $2,413 100.0% DECEMBER 31, 1995: Balance at end of period applicable to: Domestic: Real Estate $ 24 1.0% Commercial and industrial 2,235 95.0% Consumer and all other loans 94 4.0% Total $2,353 100.0% DECEMBER 31, 1994: Balance at end of period applicable to: Domestic: Real Estate $ 21 1.0% Commercial and industrial 2,000 94.0% Consumer and all other loan 106 5.0% Total $2,127 100.0% DEPOSITS 1998 There was an increase in average deposits in 1998 of $11,072,000, or 5.3% over 1997's average deposits. An increase in other time deposits contributed $5,142,000 to the overall increase. Movements in demand deposits and savings deposits resulted in increases of $3,782,000 and $2,148,000, respectively. <PAGE 33> The $11,072,000 increase is the result of the Bank's successful efforts to offer competitive interest rates on their savings and other time deposit accounts, in addition to providing an attractive, low-fee checking account product. There were approximately $20,950,000 in time deposits exceeding $100,000. 1997 An increase in average deposits amounted to $7,028,000, or 3.5% when comparing average balances for 1997 and 1996. The movements in savings deposits occurred in interest-bearing checking and savings accounts, with a slight decline in both categories, totaling $1,647,000. Non-interest bearing demand accounts moved upward by $2,391,000. Average other time deposits for 1997 increased by $6,284,000 over 1996. The most significant movement contributing to the increase occurred in certificate of deposit accounts. Movements in investment savings accounts remained relatively constant and individual retirement accounts declined slightly. This decline suggests the depositors' desire to invest in higher yielding instruments. During 1997, the Bank offered a special CD to make available an opportunity to current and potential depositors to invest in a competitive, high percentage yielding investment as well as to attract additional funds to support increased loan demand. Time deposits of $100,000 or more totaled approximately $20,950,000 on December 31, 1998 and $19,524,000 on December 31, 1997. Interest expense related to such deposits was approximately $1,151,000, $851,000 and $750,000 for the years ended December 31, 1998, 1997 and 1996, respectively. Time deposits of $100,000 or more at December 31, 1998 mature as follows: 1999 - $18,613,000; 2000 - $987,000; 2001 - $344,000; 2002 - $405,000; 2003 - $100,000; thereafter - $501,000. The average amount and the average rate paid on deposits are summarized below (in thousands): <PAGE 34> <TABLE> <CAPTION> 1998 1997 1996 AVERAGE AVERAGE AVERAGE AMOUNT RATE AMOUNT RATE AMOUNT RATE <S> <C> <C> <C> <C> <C> <C> DEPOSITS IN DOMESTIC BANK OFFICES: Demand deposits: Noninterest bearing $ 33,479 0.00% $ 29,697 0.00% $ 27,306 0.00% Interest Bearing 38,403 2.62% 36,561 2.68% 37,146 2.63% Savings deposits 46,820 2.84% 46,514 3.07% 47,576 2.94% Time deposits 101,420 5.54% 96,278 5.60% 89,994 5.62% Total average deposits $220,122 $209,050 $202,022 </TABLE> SHAREHOLDERS' EQUITY 1998 Shareholders' equity is evaluated in relation to total assets and the risk associated with those assets. A company is more likely to meet its cash obligations and absorb unforeseen losses when the capital resources are greater. At December 31, 1998, total shareholders' equity increased by $2,652,000 reaching $45,626,000, which is up from $42,974,000 at December 31, 1997. Net income of $6,411,000 was added to equity at year-end 1998, in addition to $184,000 from stock options that were exercised throughout 1998. The net change in the unrealized appreciation on securities available-for-sale from year end 1997 to 1998 reduced shareholders' equity by $1,159,000. A purchase of treasury stock also reduced shareholders' equity by $214,000. Dividends that were paid from equity in 1998 totaled $2,570,000. 1997 Total shareholders' equity at December 31, 1997 increased by $9,417,000, reaching $42,974,000, up from $33,557,000 at December 31, 1996. Net income of $7,751,000 at year-end 1997 was added to equity, as was $208,000 from stock options that were exercised throughout 1997. The $3,633,000 increase in the unrealized appreciation on securities available-for-sale was also a contributing factor to the increase in shareholders' equity. Dividends paid from equity in 1997 totaled $2,175,000. Stock dividend distributable was a $12,828,000 component of shareholders' equity at December 31, 1997, resulting from a stock split effected in the form of a 100% stock dividend that was declared by the Board of Directors on November 25, 1997, to shareholders of record, December 15, 1997, issued on January 15, 1998. The declaration of the stock split was recorded in 1997 as a reduction in retained earnings, and an increase in stock dividend <PAGE 35> distributable for the par value of the shares to be issued. This transaction had no net effect on shareholders' equity. Bank regulators have issued risk based capital guidelines. Under these guidelines, banks are required to maintain minimum ratios of core capital and total qualifying capital as a percentage of risk weighted assets and certain off-balance sheet items. At December 31, 1998, the Company's required ratios were well above the minimum ratios as follows: 1998 Minimum Company Standards Tier 1 capital ratio 20.23% 4.00% Total capital ratio 22.73% 8.00% For a more comprehensive discussion of these requirements, see "Regulations and Supervision" on Page 41 of Form 10K. Management believes that the Company will continue to exceed regulatory capital requirements. RETURN ON EQUITY AND ASSETS: The ratio of net income to average total assets and average shareholders' equity and certain ratios are presented as follows: 1998 1997 1996 Percentage of net income to: Average total assets 2.12% 2.88% 2.12% Average shareholders' equity 14.23% 20.07% 17.25% Percentage of dividends declared per common share 40.00% 28.05% 28.57% Percentage of average shareholders' equity to average total assets 14.89% 14.46% 12.31% LIQUIDITY, INTEREST RATE SENSITIVITY AND MARKET RISK 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. Liquidity is generated from transactions relating to both the Company's assets and liabilities. Liquidity from assets is achieved primarily through temporary investments in Federal funds sold and time deposits with financial institutions. Cash receipts arising from normal customer loan payments provide <PAGE 36> another important source of asset related liquidity. On the liability side, deposit growth and temporary borrowings from the Federal Home Loan Bank of Pittsburgh's Repo Plus product provide liquidity. The liquidity provided by these sources is more than adequate to meet the Company's needs. 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 recently developed an asset liability management policy which incorporates two new tools in managing interest rate risk. A market value at risk calculation which is used to determine the effects of interest rate movements on shareholders' equity is now being utilized, as well as simulation analysis to monitor the effects of interest rate changes on the Company's balance sheets. INTEREST RATE SENSITIVITY The following table sets forth the Bank's interest rate sensitivity as of December 31, 1998: <PAGE 37> <TABLE> <CAPTION> AFTER ONE AFTER TWO AFTER WITHIN BUT WITHIN BUT WITHIN FIVE ONE YEAR TWO YEARS FIVE YEARS YEARS <S> <C> <C> <C> <C> Earning assets(1)(2) Investment securities(1) $ 12,039 $ 11,944 $ 28,549 $36,535 Loans(2) 74,521 23,175 83,068 15,698 Total earning assets 86,560 35,119 111,617 52,233 Interest-bearing liabilities: Deposits(3) 108,911 20,659 45,761 14,394 Borrowings 11,370 147 20,440 1,048 Total interest-bearing liabilities 120,281 20,806 66,201 15,442 Net non-interest bearing funding(4) 11,317 8,518 20,518 22,446 Total net funding sources 131,598 29,324 86,719 37,888 Excess assets (liabilities) (45,038) 5,795 24,898 14,345 Cumulative excess (45,038) (39,243) (14,345) 0 assets (liabilities) </TABLE> (1) Investment balances reflect estimated prepayments on mortgage-backed securities. (2) Loan balances include annual repayment assumptions based on projected cash flow from the loan portfolio. The cash flow projections are based on the terms of the credit facilities and estimated prepayments on fixed rate mortgage loans. Loans include loans held for resale. (3) Adjustments to the interest sensitivity of Savings, NOW and MMDA account balances reflect managerial assumptions based on historical experience, expected behavior in future rate environments and the Bank's positioning for these products. (4) Net noninterest-bearing funds is the sum of noninterest-bearing liabilities and shareholders' equity minus noninterest-earning assets and reflect managerial assumptions as to the appropriate maturity categories. In this analysis the Company examines the result of a 100 and 200 basis point change in market interest rates and the effect on net interest income. It is assumed that the change is instantaneous and that all rates move in a parallel manner. In addition, it is assumed that rates on core deposit products such as NOWs, savings accounts, and the MMDA accounts will be adjusted by 50% of the assumed rate change. Assumptions are also made concerning prepayment speeds on mortgage loans and mortgage securities. The results of this rate shock are a useful tool to assist the Company in assessing interest rate risk inherent in its balance sheet. Below are the results of the rate shock analysis for the periods indicated: <PAGE 38> Net Interest Income Changes in Rates Change (After tax) December 31 1998 1997 -200 $ 421 $ 306 -100 $ 239 $ 161 +100 $(273) $(172) +200 $(553) $(345) The model utilized to create the report presented above makes various estimates at each level of interest rate change regarding cash flow from principal repayment on loans and mortgage-backed securities and or call activity on investment securities. Actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change. In addition, the limits stated above do not necessarily represent the level of change under which management would undertake specific measure to realign its portfolio in order to reduce the projected level of change. Generally, management believes the Company is well positioned to respond expeditiously when the market interest rate outlook changes. MERGER WITH FIRST NATIONAL BANK OF SPRING MILLS On January 11, 1999, Penns Woods Bancorp, Inc. and First National Bank of Spring Mills,("FNBSM") completed the merger of FNBSM with and into Jersey Shore State Bank, the wholly owned banking subsidiary of Penns Woods Bancorp, Inc. Penns Woods Bancorp, Inc., Jersey Shore State Bank and FNBSM completed the merger in accordance with an agreement and plan of merger, dated as of July 22, 1998 between Penns Woods Bancorp, Inc. and FNBSM. The merger provides Penns Woods Bancorp, Inc. with a natural extension of its existing Pennsylvania community bank franchise by establishing a strong presence in Centre County, Pennsylvania. The combination of the two companies provides the potential benefit of a reduction in total expenses. The primary expense reduction is expected to be in data processing. First National Bank of Spring Mills outsourced their data processing function. Jersey Shore State Bank's in house processing system is now handling all processing for the combined institution. When reviewing the pro-forma financial statements included in the audit report, it is important to note that $390,000 merger related costs were expensed during 1998. Although we can not forecast the future, management does expect the results of the merger to be favorable. <PAGE 39> 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. 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. COMPREHENSIVE INCOME Comprehensive income is a measure of all the changes in equity of a corporation. It excludes transactions with owners in their capacity as owners (i.e. stock options granted or exercised, repurchase of treasury stock transactions, and dividends to shareholders). Other comprehensive income is the difference between Net Income and Comprehensive Income. The Company's Other Comprehensive Income is composed of unrealized gains and losses on available-for-sale securities, net of deferred income tax. Comprehensive income is not a measure of net income. Net Income would be affected by Other Comprehensive Income only in the event that the entire securities portfolio was sold on the statement date. Unrealized gains or losses reflected in the Company's Comprehensive Income may vary widely at statement dates as a result of changing markets and /or interest rate movements. Other Comprehensive Income (Loss) for the years ended December 31, 1998, 1997 and 1996 were ($1,159,000), $3,633,000 and ($106,000) respectively. 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 Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, Penns Woods Bancorp, Inc. and its subsidiaries (the "Company") notes that a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. The risks and uncertainties that may affect the operations, performance, development and results of the company's business include the following: general economic conditions and changes in interest rates including their impact on capital <PAGE 40> expenditures; business conditions in the banking industry; the regulatory environment; rapidly changing technology and evolving banking industry standards; the effect of changes in accounting policies and practices, including increased competition with community, regional and national financial institutions; new service and product offerings by competitors and price pressures; changes in the Company's organization, compensation and benefit plans; the inability of the Company to accurately estimate the cost of systems preparation for Year 2000 compliance; and similar items. YEAR 2000 COMPLIANCE Definitions Company: Penns Woods Bancorp, Inc. Bank: Jersey Shore State Bank Awareness: Recognition of "Year 2000" issues and their potential effect on the Company. Assessment: First, determining which systems are mission critical and which are not. Second, quantifying risk in loans, deposits, investments as well as outside suppliers and services. Remediation: First, the actual replacement or upgrading of noncompliant systems. Second, drafting of procedures and contingency plans for expected and undeterminable effects. Testing: Actual analysis of the way remediated systems work, independently and together, to assure accurate information through and after Year 2000" Implementation: All areas are certified "Year 2000" compliant and are in place in the everyday operations of the Company and the Bank. YEAR 2000 PROGRESS The Company appointed, through the Bank, a "Year 2000 Committee" on September 18, 1997, to conduct the awareness, assessment, remediation , testing and implementation phases of the compliance plan. As of December 31, 1998 the first three of the five phases are complete. All mission critical systems have been tested. Some smaller peripheral systems are in the process of being tested. Critical core providers were quick to respond with Year 2000 certifications of their software. Customer and third party response went well in accordance with the timetable established <PAGE 41> for their completion. At this time, no significant projects have been delayed as a result of the Company's Year 2000 efforts. Contingency plans in the event of unforeseen operational difficulties have been drafted and should be in place by March 31. 1999. Remaining costs, identified historically, associated with Year 2000 deficiencies are the automated teller machine upgrades, estimated at $8,000. The majority of the costs related to the year 2000 issue have been internal and have not been quantified. Capital purchases related to the Y2K issue expected for 1999 are anticipated to either be zero or minimal. Contingency plans remain part of the Year 2000 compliance program because no absolute guarantee, even if available, would prevent unfavorable Year 2000 issues stemming from unforseen difficulties due to future changes in third party readiness. Financial institution regulators have intensively focused upon Year 2000 exposures, issuing guidance concerning the responsibilities of senior management and directors. Year 2000 testing and certification is being addressed as a key safety and soundness issue in conjunction with regulatory exams. In May 1997, the Federal Financial Institutions Examination Council ("FFIEC") issued an interagency statement to the chief executive officers of all federally supervised financial institutions regarding Year 2000 project management awareness. The FFIEC has highly prioritized Year 2000 compliance in order to avoid major disruptions to the operations of financial institutions and the country's financial systems when the new century begins. The FFIEC statement provides guidance to financial institutions, providers of data services, and all examining personnel of the federal banking agencies regarding the Year 2000 Issue. The federal banking agencies have been conducting Year 2000 examinations. The failure to implement an adequate Year 2000 program can be identified as an unsafe and unsound banking practice. The Company and the Bank are regulated by the Federal Reserve and F.D.I.C. respectively. Both are reviewed regularly for Year 2000 issues. The F.D.I.C. established examination procedures which contain three categories of ratings which are satisfactory, needs improvement, and unsatisfactory. Institutions that receive a Year 2000 rating of unsatisfactory may be subject to formal enforcement action, supervisory agreements, cease and desist orders, civil money penalties, or the appointment of a conservator. In addition, the F.D.I.C. will be taking into account Year 2000 compliance programs when reviewing applications and may deny an application because of Year 2000 issues. Failure to adequately prepare for Year 2000 issues could negatively impact the Company's banking operations, including the imposition of restrictions upon its operations by the F.D.I.C. <PAGE 42> Despite the Company's activities in regards to the Year 2000 issue, there can be no assurance that partial or total systems interruptions or the costs necessary to update hardware and software would not have a material adverse effect upon the Company's business, financial condition, results of operations, and business prospects. ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Incorporated by reference to the information included under the caption "Interest Rate Sensitivity" under Item 7 hereof. ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Certified Public Accountants To the Shareholders and Board of Directors Penns Woods Bancorp, Inc. and Subsidiaries Jersey Shore, Pennsylvania: We have audited the accompanying consolidated balance sheet of Penns Woods Bancorp, Inc. and subsidiaries (the "Company") as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Penns Woods Bancorp, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Williamsport, Pennsylvania January 15, 1999 PAGE 43
Consolidated Balance Sheet December 31, 1998 and 1997 (IN THOUSANDS) 1998 1997 ASSETS: Cash and due from banks $ 10,858 $ 12,557 Securities available-for-sale 93,279 75,400 Securities held-to-maturity 3,078 3,234 Loans, net 193,551 185,153 Bank premises and equipment, net 4,076 3,835 Accrued interest receivable 1,752 1,708 Foreclosed assets held for sale 40 35 Other assets 3,129 2,066 TOTAL $309,763 $283,988 ======== ======== LIABILITIES: Interest-bearing deposits $189,726 $184,725 Noninterest-bearing deposits 38,811 35,811 TOTAL DEPOSITS 228,537 220,536 Securities sold under repurchase agreements 11,223 8,580 Other borrowed funds - 6,980 Long-term Borrowings 20,000 - Accrued interest payable 965 907 Other liabilities 3,412 4,011 TOTAL LIABILITIES 264,137 241,014 SHAREHOLDERS' EQUITY: Common stock, par value $10, 10,000,000 shares authorized 25,784 12,828 Stock dividend distributable - 12,828 Additional paid-in capital 4,768 4,712 Retained earnings 10,462 6,621 Accumulated other comprehensive income 4,826 5,985 Less: Treasury stock at cost (214) - TOTAL SHAREHOLDERS' EQUITY 45,626 42,974 TOTAL $309,763 $283,988 ======== ======== See Notes to Consolidated Financial Statements PAGE 44
Consolidated Statement of Income For the Years Ended December 31, 1998, 1997 and 1996 <TABLE> <CAPTION> (IN THOUSANDS EXCEPT SHARE DATA) 1998 1997 1996 <S> <C> <C> <C> INTEREST INCOME: Interest and fees on loans $ 17,936 $ 16,234 $ 15,022 Interest and dividends on investments: Taxable interest 2,922 2,822 3,126 Tax-exempt interest 1,042 1,185 1,295 Dividends 691 520 529 Interest on federal funds sold 0 62 25 TOTAL INTEREST INCOME 22,591 20,823 19,997 INTEREST EXPENSE: Interest on deposits 7,953 7,674 7,430 Interest on securities sold under repurchase agreements 540 432 310 Interest on other borrowings 954 211 339 TOTAL INTEREST EXPENSE 9,447 8,317 8,079 NET INTEREST INCOME 13,144 12,506 11,918 PROVISION FOR LOAN LOSSES 300 220 105 NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 12,844 12,286 11,813 OTHER INCOME: Service charges 1,046 858 840 Securities gains, net 2,076 4,656 1,345 Other operating income 212 326 276 TOTAL OTHER INCOME 3,334 5,840 2,461 OTHER EXPENSES: Salaries and employee benefits 4,225 4,118 3,642 Occupancy expense, net 573 482 466 Furniture and equipment expense 639 688 553 Other operating expenses 2,280 2,096 2,306 TOTAL OTHER EXPENSES 7,717 7,384 6,967 INCOME BEFORE INCOME TAX PROVISION 8,461 10,742 7,307 INCOME TAX PROVISION 2,050 2,991 1,965 NET INCOME $ 6,411 $ 7,751 $ 5,342 ========= ========= ========= EARNINGS PER SHARE - BASIC $ 2.50 $ 3.03 $ 2.10 ========= ========= ========= EARNINGS PER SHARE - DILUTED $ 2.49 $ 3.01 $ 2.09 ========= ========= ========= WEIGHTED AVERAGE SHARES OUTSTANDING 2,568,780 2,556,804 2,544,561 ========= ========= ========= </TABLE> PAGE 45
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (IN THOUSANDS EXCEPT SHARE DATA) <TABLE> <CAPTION> ACCUMULATED COMMON STOCK ADDITIONAL OTHER TOTAL STOCK DIVIDEND PAID-IN RETAINED COMPREHENSIVE TREASURY SHAREHOLDERS' SHARES AMOUNT DISTRIBUTABLE CAPITAL EARNINGS INCOME STOCK EQUITY <S> <C> <C> <C> <C> <C> <C> <C> <C> Balance, December 31, 1995 1,271,339 $12,714 $ - $4,453 $10,060 $ 2,458 $ - $29,685 Comprehensive Income: Net income 5,342 5,342 Unrealized loss on securities, net of reclassification adjustments and tax effects (106) (106) Total comprehensive income 5,236 Dividends Declared, $0.60 (1,529) (1,529) Stock options exercised 5,959 59 106 165 Balance, December 31, 1996 1,277,298 $12,773 - $4,559 $13,873 $2,352 - $33,557 Comprehensive Income: Net income 7,751 7,751 Unrealized loss on securities, - net of reclassification adjustments and tax effects 3,633 3,633 Total comprehensive income 11,384 Dividends Declared, $0.85 (2,175) (2,175) Stock options exercised 5,481 55 153 208 Declaration of stock split in the form of a 100% stock dividend 12,828 (12,828) - Balance, December 31, 1997 1,282,779 $12,828 $12,828 $4,712 $6,621 $ 5,985 - $42,974 Stock split effected in the 1,282,779 12,828 (12,828) of a 100% stock dividend Comprehensive Income: Net income 6,411 6,411 Unrealized loss on securities, net of reclassification adjustments and tax effects (1,159) (1,159) Total comprehensive income 5,252 Dividends Declared, $1.00 (2,570) (2,570) Stock options exercised 12,794 128 56 184 Treasury stock acquired, 3,656 shares _______ (214) (214) <PAGE 46> Balance, December 31, 1998 2,578,352 $25,784 - $4,768 $10,462 $ 4,826 $(214) $45,626 ========= ======= ======= ====== ======= ======== ===== ======= </TABLE> See Notes to Consolidated Financial Statements PAGE 47
Consolidated Statement of Cash Flows For the Years Ended December 31, 1998, 1997 and 1996 <TABLE> <CAPTION> (IN THOUSANDS) 1998 1997 1996 <S> <C> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 6,411 $ 7,751 $ 5,342 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 419 379 365 Provision for loan losses 300 220 105 Amortization of investment security premiums 65 37 20 Accretion of investment security discounts (105) (117) (70) Securities gains, net (2,076) (4,656) (1,345) Gain on sale of foreclosed assets (12) (67) (40) Stock option compensation expense - 7 16 Decrease(increase) in all other assets (1,107) 438 (1,130) (Decrease)increase in all other liabilities 78 (805) 113 Net cash provided by operating activities 3,973 3,187 3,376 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of securities available-for-sale (47,119) (58,348) (47,761) Proceeds from sales and maturities of securities available-for-sale 27,607 74,437 33,038 Proceeds from the sale of foreclosed assets 47 426 1,083 Purchase of securities held-to-maturity (323) (200) (1,296) Proceeds from calls and maturities of securities held to-maturity 2,473 96 1,015 Net increase in loans (8,738) (25,660) (9,025) Acquisition of bank premises and equipment (660) (379) (391) Net cash used in investing activities (26,713) (9,628) (23,337) CASH FLOWS FROM FINANCING ACTIVITIES: Net increase(decrease) in interest-bearing deposits 5,001 10,665 (1,019) Net increase in noninterest-bearing deposits 3,000 6,855 1,777 Net (decrease) increase in securities sold under repurchase agreements 2,643 2,952 (716) (Decrease)increase in other borrowed funds (6,980) (7,511) 14,491 Proceeds from long-term borrowings 20,000 - - Dividends paid (2,570) (2,175) (1,529) Stock options exercised 161 197 118 Purchase of Treasury Stock (214) - - Net cash provided by financing activities 21,041 10,983 13,122 NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1,699) 4,542 (6,839) CASH AND CASH EQUIVALENTS, BEGINNING 12,557 8,015 14,854 CASH AND CASH EQUIVALENTS, ENDING $ 10,858 $ 12,557 $ 8,015 </TABLE> SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: The Company paid approximately $9,389,000, $8,294,000 and $8,114,000 in interest on deposits and other borrowings during 1998, 1997 and 1996, respectively. <PAGE 48> The Company made income tax payments of approximately $2,453,000, $3,096,000 and $1,998,000 during 1998, 1997 and 1996, respectively. Transfers from loans to foreclosed assets held for sale amounted to approximately $40,000, $142,000 and $352,000 in 1998, 1997 and 1996, respectively. See Notes to Consolidated Financial Statements PAGE 49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation: The accompanying consolidated financial statements include the accounts of Penns Woods Bancorp, Inc. and its wholly-owned subsidiaries, Jersey Shore State Bank ("Bank"), Woods Real Estate Development Co., Inc. and Woods Investment Company, Inc. (collectively, the "Company"). All significant intercompany balances and transactions have been eliminated. Nature of Business: The Bank engages in a full service commercial banking business, making available to the community a wide range of financial services, including, but not limited to, installment loans, credit cards, mortgage and home equity loans, lines of credit, construction financing, farm loans, community development loans, loans to non-profit entities and local government loans and various types of time and demand deposits, including, but not limited to, checking accounts, savings accounts, clubs, money market deposit accounts, certificates of deposit and IRAs. Deposits are insured by the Federal Deposit Insurance Corporation (FDIC) to the extent provided by law. The financial services are provided to individuals, partnerships, non-profit organizations and corporations through its seven offices and Mortgage/Loan Center located in Clinton, Lycoming and Centre Counties, Pennsylvania. Woods Real Estate Development Company engages in real estate transactions on behalf of the Penns Woods Bancorp, Inc. and the Bank. Woods Investment Company, Inc. is engaged in investing activities. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired through, or in lieu of, foreclosure on settlement of debt. Investment Securities: Investment securities are classified as held-to-maturity, available-for-sale or trading. <PAGE 50> Securities held-to-maturity include bonds, notes, and debentures for which the Company has the positive intent and ability to hold to maturity and are reported at amortized cost. Trading account securities are recorded at their fair values. Unrealized gains and losses on trading account securities are included in other income. The Company has no trading account securities as of December 31, 1998 or 1997. Available-for-sale securities consist of bonds, notes, debentures, and certain equity securities not classified as trading securities nor as held-to-maturity securities. Unrealized holding gains and losses, net of tax, on available-for-sale securities are reported as a net amount in a separate component of shareholders' equity until realized. Gains and losses on the sale of all securities are determined using the specific-identification method. Declines in the fair value of individual securities held-to- maturity and available-for-sale below their cost that are other than temporary result in write downs of the individual securities to their fair value and are included in earnings as realized losses. Premiums and discounts on all securities are recognized in interest income using the interest method over the period to maturity. The fair value of investments and mortgage-backed securities, except certain state and municipal securities, is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued. Loans: Loans are stated at the principal amount outstanding, net of unearned interest, unamortized loan fees and costs, and the allowance for loan losses. Loans are placed on a nonaccrual basis when there are serious doubts about the collectibility of principal or interest. The Company recognizes nonrefundable loan origination fees and certain direct loan origination costs over the life of the related loans as an adjustment of loan yield using the interest method. Allowance for Loan Losses: The provision for loan losses charged to operations reflects the amount deemed appropriate by management to establish an adequate allowance to meet the present and foreseeable risks of the loan portfolio. Management's judgment is based upon evaluation of individual loans, overall <PAGE 51> risk of the various portfolio segments, past experience with losses, the impact of economic conditions on borrowers and other relevant factors. It is the opinion of management that the allowance for loan losses is adequate to absorb foreseeable loan losses. Loan losses are charged directly against the allowance and recoveries on previously charged-off loans are added to the allowance. Foreclosed Assets Held For Sale: Foreclosed assets held for sale are carried at the lower of fair value minus estimated costs to sell or cost. Prior to foreclosure, the value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for loan losses, if necessary. Any subsequent write-downs are charged against operating expenses. Operating expenses of such properties, net of related income, and gains and losses on their disposition are included in other expenses. Bank Premises and Equipment: Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using straight-line and accelerated methods over the estimated useful lives of the related assets. Costs incurred for routine maintenance and repairs are expensed currently. Income Taxes: Deferred tax assets and liabilities result from temporary differences in financial and income tax methods of accounting, and are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Cash Flows: The Company utilizes the net reporting of cash receipts and cash payments for deposit and lending activities. The Company considers amounts due from banks and federal funds sold as cash equivalents. NOTE B - PER SHARE DATA Earnings per share is based on the weighted-average number of shares of common stock outstanding. Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share", requires presentation of two amounts, basic and diluted earnings per share. The number of shares used in calculating basic and diluted earnings and cash dividends per share reflect the retroactive effect of stock dividends declared. The following data show the amounts used in computing earnings per share: <PAGE 52> Common Income Shares Earnings Numerator Denominator Per Share 1998 Earnings per share - basic $6,411,000 2,568,780 $2.50 Stock options 6,500 Earnings per share - diluted $6,411,000 2,575,280 $2.49 1997 Earnings per share - basic $7,751,000 2,556,804 $3.03 Stock options 22,499 Earnings per share - diluted $7,751,000 2,579,303 $3.01 1996 Earnings per share - basic $5,342,000 2,544,561 $2.10 Stock options 14,941 Earnings per share - diluted $5,342,000 2,559,502 $2.09 NOTE C - COMPREHENSIVE INCOME The Company adopted SFAS No. 130, "Reporting Comprehensive Income," as of January 1, 1998. Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available- for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. The adoption of SFAS No. 130 had no effect on the Company's net income or shareholders' equity for 1998, 1997 or 1996. As required by SFAS No. 130, the consolidated financial statements for 1997 and 1996 have been reclassified to reflect application of this pronouncement. The components of other comprehensive income and related tax effects are as follows (in thousands): Years Ended December 31, 1999 1998 1997 1996 Unrealized holding gains on available-for-sale securities $ 321 $10,161 $1,184 Less: Reclassification adjustment for gains realized in income 2,076 4,656 1,345 Net unrealized gains(losses) (1,755) 5,505 (161) <PAGE 53> Tax effect (596) 1,872 (55) Net-of-tax effect $(1,159) $ 3,633 $ (106) NOTE D - CASH AND DUE FROM BANKS Banks are required to maintain reserves consisting of vault cash and deposit balances with the Federal Reserve Bank in their district. The reserves are based on deposit levels during the year and account activity and other services provided by the Federal Reserve Bank. Average daily currency, coin and cash balances with the Federal Reserve Bank needed to cover reserves against deposits for 1998 ranged from $1,738,000 to $2,752,000. For 1997, these balances ranged from $1,274,000 to $2,110,000. Average daily cash balances with the Federal Reserve Bank required to cover services provided to the Bank amounted to $800,000 throughout 1998 and 1997. Total balances restricted at December 31, 1998 and 1997, respectively, were $3,246,000 and $2,821,000. <PAGE 54> NOTE E - INVESTMENT SECURITIES The amortized cost of investment securities and their approximate fair values at December 31, 1998 and 1997 were as follows (in thousands): <TABLE> <CAPTION> DECEMBER 31, 1998 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value <S> <C> <C> <C> <C> Securities available-for-sale: Equity securities $20,297 $6,417 $579 $26,135 U.S. government and agency securities 40,953 399 38 41,314 State and municipal securities 22,400 1,133 67 23,466 Restricted equity securities 1,613 50 - 1,663 Other debt securities 702 - 1 701 $85,965 $7,999 $685 $93,279 Securities held-to-maturity: U.S. government and agency securities $ 339 $ 15 - 354 State and municipal securities 2,464 49 1 2,512 Other debt securities 275 - - 275 $ 3,078 $ 64 $ 1 $ 3,141 <CAPTION> DECEMBER 31, 1997 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value <S> <C> <C> <C> <C> Securities available-for-sale: Equity securities $14,774 $7,897 $ 1 $22,670 U.S. government and agency securities 37,096 366 - 37,462 State and municipal securities 12,407 759 1 13,165 Restricted equity securities 1,256 50 - 1,306 Other debt securities 798 - 1 797 $66,331 $9,072 $ 3 $75,400 Securities held-to-maturity: U.S. government and agency securities $ 513 $ 23 $ - $ 536 State and municipal securities 2,471 44 - 2,515 Other debt securities 250 1 - 251 $ 3,234 $ 68 $ 0 $ 3,302 </TABLE> The amortized cost and fair value of debt securities at December 31, 1998, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. <PAGE 55> <TABLE> <CAPTION> Securities Securities Held-to-Maturity Available-for-Sale Amortized Fair Amortized Fair Cost Value Cost Value <S> <C> <C> <C> <C> Due in one year or less $ 10 $ 10 $ 3,004 $ 3,022 Due from one year to five years 1,307 1,322 8,789 9,135 Due from five to ten years 501 517 687 752 Due after ten years 1,260 1,292 51,575 52,572 $3,078 $3,141 $64,055 $65,481 </TABLE> Gross realized gains and gross realized losses on sales of available-for-sale securities were (in thousands): 1998 1997 1996 Gross realized gains: U.S. government and agency securities $ 72 $ 68 $ 13 State and municipal securities - 286 466 Equity securities 2,024 4,923 1,362 Other debt securities - - 13 $2,096 $5,277 $1,854 Gross realized losses: U.S. government and agency securities $ 5 $ 579 $ 445 State and municipal securities 5 19 27 Equity securities 10 1 18 Other debt securities - 22 19 $ 20 $ 621 $ 509 During 1996, the Company sold a debt security with a carrying value of $465,000 which had been classified as held to maturity. Subsequent to the purchase of this security, the Company received information indicating that this was not a bank qualified investment. This transaction resulted in a realized gain of approximately $8,000 for the year 1996. There were no sales of securities classified as held to maturity in 1998 or 1997. Investment securities with a carrying value of approximately $22,729,000 and $18,971,000 at December 31, 1998 and 1997, respectively, were pledged to secure certain deposits, security repurchase agreements and for other purposes as required by law. There is no concentration of investments that exceed 10% of shareholders' equity for any individual issuer, excluding those guaranteed by the U.S. government. <PAGE 56> NOTE F - LOANS Major loan classifications are summarized as follows (in thousands): <TABLE> <CAPTION> DECEMBER 31, 1998 PAST DUE PAST DUE 30 TO 90 90 DAYS NON- CURRENT DAYS OR MORE ACCRUAL TOTAL <S> <C> <C> <C> <C> <C> Real estate loans - mortgage $ 46,078 $2,903 $32 $596 $ 49,609 Real estate loans - construction 3,844 30 - - 3,874 Commercial and industrial loans 112,514 532 22 44 113,112 Consumer and all other loans 29,417 442 2 6 29,867 Gross loans $191,853 $3,907 $56 $646 196,462 Less: Unamortized loan fees/costs 410 Allowance for loan losses 2,501 Loans, net $193,551 <CAPTION> DECEMBER 31, 1998 PAST DUE PAST DUE 30 TO 90 90 DAYS NON- CURRENT DAYS OR MORE ACCRUAL TOTAL <S> <C> <C> <C> <C> <C> Real estate loans - mortgage $ 53,492 $1,765 $ 88 $136 $ 55,481 Real estate loans - construction 3,011 - - - 3,011 Commercial and industrial loans 9,362 988 283 409 101,042 Consumer and all other loans 27,871 525 38 7 28,441 Gross loans $183,736 $3,278 $409 $552 $187,975 Less: Unearned income 4 Unamortized loan fees/costs 404 Allowance for loan losses 2,414 Loans, net $185,153 </TABLE> Loans on which the accrual of interest has been discontinued or reduced amounted to approximately $646,000 and $552,000 at December 31, 1998 and 1997, respectively. If interest had been recorded at the original rate on those loans, such income would have approximated $98,000, $81,000, and $86,000 for the years ended December 31, 1998, 1997 and 1996, respectively. Interest income on such loans, which is recorded as received, amounted to approximately $50,000, $42,000 and $43,000 for the years ended December 31, 1998, 1997 and 1996, respectively. <PAGE 57> Transactions in the allowance for loan losses are summarized as follows (in thousands): YEAR ENDED DECEMBER 31, 1998 1997 1996 Balance, beginning of year $2,414 $2,413 $2,353 Provision charged to operations 300 220 105 Loans charged off (271) (327) (242) Recoveries 58 108 197 Balance, end of year $2,501 $2,414 $2,413 At December 31, 1998 and 1997, the Company had loans amounting to approximately $56,000 and $51,000 respectively, that were specifically classified as impaired. Of these amounts, $44,000, was included in nonaccrual loans in 1997. By definition, a loan is impaired when, based on current information and events, it is probable that all amounts due will not be collected according to the contractual terms of the loan agreement. (This classification excludes large groups of smaller balance loans that are collectively evaluated for impairment, such as residential mortgage, credit card and consumer installment loans.) In 1998 and 1997, the average balance of these loans amounted to approximately $56,000 and $52,000, respectively for the year. There was no specific allowance for the loan losses related to impaired loans at December 31, 1998 and 1997. Due to the low level of loans classified as impaired, and the fact that the majority of such impaired loans are adequately collateralized, impaired loans should not have a material effect on the allowance for loan losses or the earnings of the Company. The following is a summary of cash receipts on these loans and how they were applied (in thousands): 1998 1997 1996 Cash receipts applied to reduce principal balance $1 $1 $ 6 Cash receipts recognized as interest income 8 2 5 Total $9 $3 $11 The Company has no commitments to loan additional funds to borrowers with impaired or nonaccrual loans. The Company has no concentration of loans to borrowers engaged in similar businesses or activities which exceed 5% of total assets at December 31, 1998 or 1997. The Company grants commercial, industrial, residential and consumer loans to customers throughout Northcentral Pennsylvania. Although the Company has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent on the economic conditions within this region. <PAGE 58> NOTE G - BANK PREMISES AND EQUIPMENT Bank premises and equipment are summarized as follows (in thousands): DECEMBER 31, 1998 1997 Land $ 511 $ 511 Bank premises 3,871 3,670 Furniture and equipment 3,991 3,583 Leasehold improvements 601 551 Total 8,974 8,315 Less accumulated depreciation 4,898 4,480 Net $4,076 $3,835 NOTE H - DEPOSITS Time deposits of $100,000 or more totaled approximately $20,950,000 on December 31, 1998 and $19,524,000 on December 31, 1997. Interest expense related to such deposits was approximately $1,151,000, $851,000 and $750,000 for the years ended December 31, 1998, 1997 and 1996, respectively. Time deposits of $100,000 or more at December 31, 1998 mature as follows: 1999 - $18,613,000; 2000 - $988,000; 2001 - $344,000; 2002 - $405,000; 2003 - $100,000; thereafter - $501,000. NOTE I - OTHER BORROWED FUNDS At December 31, 1998, the Company did not have any borrowings in the form of advances received from the Federal Home Loan Bank of Pittsburgh under the "Repo Plus" credit program. There were $6,980,000 of such borrowings at December 31, 1997. The weighted average interest rate for the years ended December 31, 1998, 1997 and 1996 was 5.60%, 5.63% and 5.44%, respectively. The maximum amount of other borrowed funds outstanding at any time was $11,760,000, $14,491,000 and $16,737,000, respectively, for those same periods. NOTE J - LONG-TERM BORROWINGS Long Term borrowings are "Convertible Select" advances with the Federal Home Bank of Pittsburgh ("FHLB"). These advances are set at a fixed rate for five years. After the five years, FHLB has the option to convert the advance to a floating rate. The borrowings are as follows (in thousands): 1998 5.54%, maturing April 7, 2008 $10,000 5.56%, maturing June 16, 2008 10,000 Total advances 20,000 Both advances are collateralized by the Company's Federal Home Loan Bank stock, deposits and mortgage loans. <PAGE 59> NOTE K - INCOME TAXES The following temporary differences gave rise to the net deferred tax liability at December 31, 1998 and 1997 (in thousands): 1998 1997 Deferred tax asset: Allowance for loan losses $ 542 $ 506 Deferred compensation 234 198 Contingencies 75 75 Pension 126 107 Loan fees and costs 139 137 Stock option 18 25 Total 1,134 1,048 Deferred tax liability: Bond accretion (25) (39) Depreciation (122) (117) Unrealized gains on available- for-sale securities (2,486) (3,083) Total (2,633) (3,239) Deferred tax liability, net $(1,499) $(2,191) The provision for income taxes is comprised of the following (in thousands): YEAR ENDED DECEMBER 31, 1998 1997 1996 Currently payable $2,149 $3,095 $2,110 Deferred benefit (99) (104) (145) Total provision $2,050 $2,991 $1,965 The effective federal income tax rate for the years ended December 31, 1998, 1997 and 1996 was 24.2%, 27.8% and 26.9%, respectively. A reconciliation between the expected income tax and rate and the effective income tax and rate on income before income tax provision follows (in thousands): <TABLE> <CAPTION> 1998 1997 1996 AMOUNT % AMOUNT % AMOUNT % <S> <C> <C> <C> <C> <C> <C> Provision at expected rate $2,877 34.0% $3,759 35.0% $2,484 34.0% Increase (decrease) in tax resulting from: Tax-exempt income (365) (4.30) (570) (5.4) (578) (7.9) Other, net (462) (5.5) (198) (1.8) 59 0.8 Effective income tax and rates $2,050 24.2% $2,991 27.8% $1,965 26.9% </TABLE> <PAGE 60> NOTE L - EMPLOYEE BENEFIT PLANS DEFINED BENEFIT PENSION PLAN The Company has a noncontributory defined benefit pension plan (the "Plan") for all employees meeting certain age and length of service requirements. Benefits are based primarily on years of service and the average annual compensation during the highest five consecutive years within the final ten years of employment. During 1998, the Company adopted SFAS No. 132 "Employers' Disclosures About Pensions and Other Postretirement Benefits". As required under SFAS No. 132, the following tables show the funded status and components of net periodic benefit cost from this defined benefit plan (in thousands). <PAGE 61> Pension Benefits 1998 1997 CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of year $3,026 $2,664 Service cost 222 191 Interest cost 213 185 Plan participants' contributions - - Amendments - - Actuarial loss 59 19 Benefits paid (61) (33) Benefit obligation at end of year 3,459 3,026 CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year 2,819 2,137 Actual return on plan assets 547 510 Employer contribution 171 205 Plan participants' contributions - - Benefits paid (61) (33) Fair value of plan assets at end of year 3,476 2,819 17 (207) Unrecognized net actuarial gain (619) (357) Unrecognized transition asset (35) (38) Unrecognized prior service cost 268 286 Accrued benefit cost $ (369) $ (316) WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31: Discount rate 7.00% 7.00% Expected return on plan assets 8.00% 8.00% Rate of compensation increase 5.00% 5.00% COMPONENTS OF NET PERIODIC BENEFIT COST: Service costs $ 222 $ 191 Interest cost 213 185 Expected return on plan assets (224) (171) Amortization of transition asset (3) (3) Amortization of prior service cost 18 20 Recognized net actuarial gain (1) - Net periodic benefit cost $ 225 $ 222 401(k) SAVINGS PLAN The Company offers a 401(k) savings plan in which eligible participating employees may elect to contribute up to a maximum percentage allowable not to exceed the limits of Code Sections 401(k), 404 and 415. The Company may make matching contributions equal to a discretionary percentage to be determined by the Company. Participants are at all times fully vested in their contributions and vest over a period of five years in the employer contribution. Contribution expense was approximately $54,000, $52,000 and $45,000 for the years ended December 31, 1998, 1997 and 1996, respectively. <PAGE 62> DEFERRED COMPENSATION PLAN The Company has a deferred compensation plan whereby participating directors elected to forego director's fees for a period of five years. Under this plan the Company will make payments for a ten year period beginning at age 65, in most cases or at death if earlier, at which time payments would be made to their designated beneficiaries. To fund benefits under the deferred compensation plan, the Company has acquired corporate owned life insurance policies on the lives of the participating directors for which insurance benefits are payable to the Company. The total expense charged to other expenses was approximately $114,000, $114,000 and $114,000 for the three years ended December 31, 1998. Benefits paid under the Plan were approximately $45,000 in 1998 and 1997, and $39,000 in 1996. NOTE M - STOCK OPTIONS Prior to 1998, the Company granted a select group of its officers options to purchase shares of its common stock. These options, which are immediately exercisable, expire within three to ten years after having been granted. The Company applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for these options. Accordingly, compensation expense is recognized on the grant date, in amounts equivalent to the intrinsic value of the options (stock price less exercise price, at measurement date). Had compensation costs for these options been determined based on the fair values at the grant dates for awards consistent with the method of SFAS No. 123, the effect on the Company's net income and earnings per share for 1998, 1997 and 1996 would have been insignificant. For purposes of the calculations required by SFAS No. 123, the fair value of each option grant is estimated on the date of the grant using the Black-Scholes option- pricing model with the following weighted average assumptions for grants issued in 1998, 1997 and 1996, respectively: dividend yield of 2.52%, 3.45% and 3.05%, respectively; risk free interest rates of 5.63%, 5.69% and 5.81%, respectively; expected option lives of three years and expected volatility of 14.51%, 17.50% and 17.58%, respectively. Also in 1998, the Company adopted the "1998 Stock Option Plan" for key employees and director's. Both incentive stock options and nonqualified stock options may be granted to eligible employees of the Company. In addition, non-employee directors are eligible to receive grants of nonqualified stock options. Incentive stock options granted under the 1998 Plan may be exercised not later than five years after the date of grant. Nonqualified stock options granted under the 1998 Plan may be exercised not later than 10 years after the date of grant. Each option granted under the 1998 Plan shall be exercisable only after the expiration of six months following the date of grant of such option. <PAGE 63> A summary of the status of the Company's common stock option plans, adjusted to reflect a stock split effective in the form of a 100% stock dividend issued January 15, 1998, is presented below: <TABLE> <CAPTION> 1998 1997 1996 Weighted- Weighted- Weighted- Average Average Average Stock Options Exercise Exercise Exercise Shares Price Shares Price Shares Price <S> <C> <C> <C> <C> <C> <C> Outstanding, beginning of year 29,684 $20.57 24,746 $14.27 26,464 $11.08 Granted 9,000 58.50 15,900 25.58 10,200 17.50 Exercised 12,794 12.59 10,962 17.97 11,918 9.94 Forfeited - - - - - - Outstanding, end of year 25,890 $37.69 29,684 $20.57 24,746 $14.27 Options exercisable at year-end 16,890 29,684 24,746 Fair value of options granted during the year $7.89 $6.86 $4.60 </TABLE> The following table summarizes information about nonqualified and incentive stock options outstanding at December 31, 1998: Exercise Number Remaining Number Prices Outstanding Contractual Life Exercisable 17.500 400 2 400 17.500 2,600 1 2,600 28.575 13,890 5 13,890 58.500 6,500 5 - 58.500 2,500 10 - 25,890 16,890 NOTE N - RELATED PARTY TRANSACTIONS Certain directors and executive officers of the Company and the Bank, including their immediate families and companies in which they are principal owners (more than 10%), are indebted to the Company. Such indebtedness was incurred in the ordinary course of business on the same terms and at those rates prevailing at the time for comparable transactions with others. A summary of loan activity with executive officers, directors, principal stockholders and associates of such persons is listed below (in thousands): BEGINNING RETIRED/ CHARGE- ENDING YEAR BALANCE ADDITIONS PAYMENTS RESIGNED OFFS BALANCE 1998 $2,096 $1,642 $1,074 $212 $- $2,452 1997 $2,014 $ 900 $ 818 $ - $- $2,096 1996 $1,781 $1,009 $ 776 $ - $- $2,014 <PAGE 64> NOTE O- COMMITMENTS AND CONTINGENT LIABILITIES The following is a schedule of future minimum rental payments under operating leases with noncancellable terms in excess of one year as of December 31, 1998 (in thousands): YEAR ENDING DECEMBER 31, 1999 $168 2000 167 2001 157 2002 117 2003 79 Thereafter 309 Total $997 Total rental expense for all operating leases for years ended December 31, 1998, 1997 and 1996 approximated $268,000, $263,000 and $172,000, respectively. The Company is subject to lawsuits and claims arising out of its business. In the opinion of management, after review and consultation with counsel, any proceedings that may be assessed will not have a material adverse effect on the consolidated financial position of the Company. NOTE P- OFF-BALANCE-SHEET RISK The Company is a party to financial instruments with off- balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit, interest rate or liquidity risk in excess of the amount recognized in the consolidated balance sheet. The contract amounts of these instruments express the extent of involvement the Company has in particular classes of financial instruments. The Company's exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The Company may require collateral or other security to support financial instruments with off-balance-sheet credit risk. Financial instruments whose contract amounts represent credit risk are as follows (in thousands) <PAGE 65> CONTRACT AMOUNT DECEMBER 31, 1998 1997 Commitments to extend credit $26,961 $27,942 Standby letters of credit $ 1,157 $ 1,608 Commitments to extend credit are legally binding agreements to lend to customers. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements. The Company evaluates each customer's credit worthiness on a case-by- case basis. The amount of collateral obtained, if deemed necessary by the Company, on extension of credit is based on management's credit assessment of the counterparty. Standby letters of credit are conditional commitments issued by the Company guaranteeing performance by a customer to a third party. Those guarantees are issued primarily to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. NOTE Q - REGULATORY MATTERS The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of December 31, 1998, that the Bank meets all capital adequacy requirements to which it is subject. To be categorized as adequately capitalized a bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table. <PAGE 66> The Bank's actual capital amounts and ratios are also presented in the following table (in thousands): <TABLE> <CAPTION> To Be Well Capitalized Under Prompt For Capital Corrective Adequacy Action Actual Purposes Provisions AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO <S> <C> <C> <C> <C> <C> <C> As of December 31, 1998: Total Capital (to Risk Weighted Assets) $45,839 22.7%> $16,400 >8.0% >$20,500 >10.0% Tier I Capital (to Risk Weighted Assets) $40,800 20.2%> $ 8,200 >4.0% >$12,300 > 6.0% Tier I Capital (to Average Assets) $40,800 13.5%> $12,099 >4.0% >$15,123 > 5.0% As of December 31, 1997: Total Capital (to Risk Weighted Assets) $39,218 22.0%> $14,251 >8.0% >$17,814 >10.0% Tier I Capital (to Risk Weighted Assets) $36,989 20.8%> $ 7,125 >4.0% >$10,688 > 6.0% Tier I Capital (to Average Assets) $36,989 13.8%> $10,762 >4.0% >$13,452 > 5.0% </TABLE> Banking regulations limit the amount of dividends that may be paid by the Bank to Penns Woods Bancorp, Inc. Retained earnings against which dividends may be paid without prior approval of the banking regulators amounted to approximately $24,570,000 at December 31, 1998, subject to minimum capital ratio requirements noted above. The Bank is subject to regulatory restrictions which limit its ability to loan funds to Penns Woods Bancorp, Inc. At December 31, 1998, the regulatory lending limit amounted to approximately $3,035,000. NOTE R - ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires that the Company disclose estimated fair values for its financial instruments. Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Also, it is the Company's general practice and intention to hold most of its financial instruments to maturity and not to engage in trading or sales activities. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of <PAGE 67> significant judgment and therefore cannot be determined with precision. Changes in assumptions can significantly affect the estimates. Estimated fair values have been determined by the Company using historical data and an estimation methodology suitable for each category of financial instruments. The estimated fair value of the Company's investment securities is described in Note A. The Company's fair value estimates, methods and assumptions are set forth below for the Company's other financial instruments. Cash and cash equivalents: The carrying amounts for cash, due from banks and federal funds sold approximate fair value. Loans: Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial real estate, residential mortgage, credit card and other consumer. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories. The fair value of performing loans, except residential mortgage and credit card loans, is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimate of maturity is based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. For performing residential mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discounted rates based on secondary market sources adjusted to reflect differences in servicing and credit costs. For credit card loans, cash flows and maturities are estimated based on contractual interest rates and historical experience and are discounted using secondary market rates adjusted for differences in servicing and credit costs. Fair value for significant nonperforming loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discounted rates are judgmentally determined using available market information and specific borrower information. <PAGE 68> The following table presents information for loans (in thousands): <TABLE> <CAPTION> AVERAGE AVERAGE ESTIMATED BOOK HISTORICAL MATURITY DISCOUNT FAIR VALUE YIELDS (YRS)(1) RATE(2) VALUE <S> <C> <C> <C> <C> <C> DECEMBER 31, 1998 Commercial $113,112 8.61% 4.03 8.25% $113,488 Real Estate 53,483 8.48% 5.17 7.63% 53,908 Other 29,867 9.52% 5.76 8.50% 30,148 DECEMBER 31, 1997 Commercial $101,042 8.93% 3.60 9.38% $100,642 Real Estate 58,492 9.47% 4.77 8.63% 58,947 Other 28,441 9.75% 5.80 9.00% 28,637 </TABLE> (1) Average maturity represents the expected average cash-flow period, which in some instances is different than the stated maturity. (2) Management has made estimates of fair value discount rates that it believes to be reasonable. However, because there is no market for many of these financial instruments, management has no basis to determine whether the fair value presented above would be indicative of the value negotiated in an actual sale. Deposits: The fair value of deposits with no stated maturity, such as noninterest bearing demand deposits, savings and NOW accounts, and money market and checking accounts, is equal to the amount payable on demand as of December 31, 1998 and 1997 The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities (in thousands): BOOK VALUE FAIR VALUE DECEMBER 31, 1998 Interest-bearing deposits $189,726 $190,303 Noninterest-bearing deposits $ 38,811 $ 38,811 DECEMBER 31, 1997 Interest-bearing deposits $184,725 $184,942 Noninterest-bearing deposits $ 35,811 $ 35,811 The fair value estimates above do not include the benefit that results from the low- cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible. Securities sold under repurchase agreements and short-term borrowings: <PAGE 69> The carrying amounts for securities sold under repurchase agreements and short-term borrowings approximate fair value. Commitments to extend credit, standby letters of credit and financial guarantees written: There is no material difference between the notional amount and the estimated fair value of off-balance sheet items which total approximately $28,118,000 and $29,550,000 at December 31, 1998 and 1997, respectively, and are primarily comprised of unfunded loan commitments which are generally priced at market at the time of funding. <PAGE 70> NOTE S - PARENT COMPANY ONLY FINANCIAL STATEMENTS Condensed financial information for Penns Woods Bancorp, Inc. follows: <TABLE> <CAPTION> (IN THOUSANDS) CONDENSED BALANCE SHEET, DECEMBER 31, 1998 1997 <S> <C> <C> ASSETS: Cash $ 51 $ 255 Investment in subsidiaries: Bank 32,703 31,606 Nonbank 13,221 11,581 Deferred tax asset 18 26 Prepaid taxes 149 79 Total assets $46,142 $43,547 LIABILITIES AND SHAREHOLDERS' EQUITY: Other liabilities 516 573 Shareholders' equity 45,626 42,974 Total liabilities and shareholders' $46,142 $43,547 equity <CAPTION> CONDENSED STATEMENT OF INCOME FOR (IN THOUSANDS) THE YEARS ENDED DECEMBER 31, 1998 1997 1996 <S> <C> <C> <C> Operating income: Dividends from subsidiaries $ 3,789 $ 4,956 $ 1,707 Equity in undistributed net income of subsidiaries 2,634 2,777 3,727 Other income - 156 - Operating expenses (12) (138) (92) Net income 6,411 $ 7,751 $ 5,342 CONDENSED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, (IN THOUSANDS) 1998 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 6,411 $ 7,751 $ 5,342 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of subsidiaries (2,634) (2,777) (3,727) Increase (decrease) in income taxes payable 37 6 37 (Decrease) increase in liabilities (105) 9 9 Stock option compensation expense - 7 16 Net cash provided by operating activities 3,709 4,996 1,677 CASH FLOWS FROM INVESTING ACTIVITIES, Additional investment in subsidiaries (1,290) (2,800) (335) CASH FLOWS FROM FINANCING ACTIVITIES: Dividends paid (2,570) (2,175) (1,529) Proceeds from exercise of stock options 161 197 118 Purchase of Treasury Stock (214) - - Net cash used in financing activities (2,623) (1,978) (1,411) NET INCREASE (DECREASE) IN CASH 204 218 (69) CASH, BEGINNING OF YEAR 255 37 106 CASH, END OF YEAR $ 51 $ 255 $ 37 <PAGE 71> CONDENSED STATEMENT OF CASH FLOWS SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITY: NOTE T - CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA FOR THE THREE MONTHS ENDED MAR JUN SEPT DEC 1998 31 31 31 31 Interest income $5,355 $5,602 $5,844 $5,790 Interest expense 2,133 2,319 2,521 2,474 Net interest income 3,222 3,283 3,323 3,316 Provision for loan losses 75 75 75 75 Other income 328 297 301 332 Securities gains 609 234 216 1,017 Other expenses 1,823 1,810 1,809 2,275 Income before income tax provision 2,261 1,929 1,956 2,315 Income tax provision 589 439 545 477 Net income $1,672 $1,490 $1,411 $1,838 Earnings per share $ 0.65 $ 0.58 $ 0.55 $ 0.72 FOR THE THREE MONTHS ENDED MAR JUN SEPT DEC 1997 31 31 31 31 Interest income $5,111 $5,034 $5,129 $5,549 Interest expense 2,082 2,069 2,030 2,136 Net interest income 3,029 2,965 3,099 3,413 Provision for loan losses 60 60 40 60 Other income 276 291 292 325 Securities gains 1,176 1,149 970 1,361 Other expenses 1,776 1,749 1,847 2,012 Income before income tax provision 2,645 2,596 2,474 3,027 Income tax provision 699 703 688 901 Net income $1,946 $1,893 $1,786 $2,126 Earnings per share $ 0.76 $ 0.74 $ 0.70 $ 0.83 NOTE U- SUBSEQUENT EVENT On January 11, 1999, the Company acquired all of the outstanding common stock of the First National Bank of Spring Mills in exchange for 262,500 shares of the Company's common stock, in a business combination accounted for as a pooling of interests. Historical financial information presented in future reports will be restated to include the First National Bank of Spring Mills. <PAGE 72> The following summarized operating data gives effect to the acquisition had it occurred on January 1, 1996(in thousands except share data): 1998 1997 1996 Interest income $25,096 $23,146 $22,074 Interest expense 10,529 9,324 8,985 Net interest income 14,567 13,822 13,089 Provision for loan losses 305 274 137 Other income 3,435 5,921 2,611 Other expense 9,065 8,219 7,726 Income before income tax provision 8,632 11,250 7,837 Income tax provision 2,164 3,113 2,082 Net income $ 6,468 $ 8,137 $ 5,755 Earnings per share - basic $ 2.28 $ 2.89 $ 2.05 Earnings per share - diluted $ 2.28 $ 2.86 $ 2.04 The Registrant does not meet both of the tests under Item 302(a)(5) of Regulation S-K, and therefore, is not required to provide supplementary financial data. PAGE 73
SCHEDULE 1 PENNS WOODS BANCORP, INC. INDEBTEDNESS OF RELATED PARTIES </TABLE> <TABLE> <CAPTION> Column A Column B Column C Column D Column E Deductions Beginning Retired Charge- Ending Year Name of Debtor Balance Additions Payments Resigned offs Balance <S> <C> <C> <C> <C> <C> <C> 1998 7 directors, 18 affiliated $2,096 $1,642 $1,074 $212 $0 $2,452 interests, and 3 officers 1997 8 directors, 15 affiliated $2,014 $ 900 $ 818 $ 0 $0 $2,096 interests, and 3 officers 1996 8 directors, 10 affiliated $1,781 $1,009 $ 776 $ 0 $0 $2,014 interests, and 3 officers </TABLE> ITEM 9 DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PAGE 74
PART III ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information appearing under the caption "Election of Directors" in the Company's Proxy Statement dated March 9, 1999 is incorporated herein by reference. ITEM 11 EXECUTIVE COMPENSATION The information appearing under the caption "Executive Compensation" in the Company's Proxy Statement is incorporated herein by reference. ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information appearing under the caption "Security Ownership of Beneficial Owners and Management" in the Company's Proxy Statement is incorporated herein by reference. ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS CERTAIN TRANSACTIONS There have been no material transactions between the Corporation and the Bank, nor any material transactions proposed, with any Director or executive officer of the Corporation and the Bank, or any associate of the foregoing persons. The Corporation and the Bank have had, and intend to continue to have, banking and financial transactions in the ordinary course of business with Directors and Officers of the Corporation and the Bank and their associates on comparable terms and with similar interest rates as those prevailing from time to time for other customers of the Corporation and the Bank. Total loans outstanding from the Bank at December 31, 1998 to the Corporation's and the Bank's Officers and Directors as a group and members of their immediate families and companies in which they had an ownership interest of 10% or more was $2,452,000 or approximately 7.50% of the total equity capital of the Bank. Loans to such persons were made in the ordinary course of business, were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than the normal risk of collectability or present other unfavorable features. See also the information appearing in Footnote N to the Consolidated Financial Statements included under Item 7 hereof. PAGE 75
PART IV ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Financial Statements 1. The following consolidated financial statements and reports are set forth in Item 8: Report of Independent Certified Public Accountants Consolidated Balance Sheet Consolidated Statement of Income Consolidated Statement of Changes in Shareholders' Equity Consolidated Statement of Cash Flows Notes to the Consolidated Financial Statements 2. The following schedules are submitted herewith: I. Indebtedness of Related Parties (b) Reports on Form 8-K No Current Reports on Form 8-K were filed during the fourth quarter of 1998. The schedules not included are omitted because the required matter or conditions are not present, the data is insignificant or the required information is submitted as part of the consolidated financial statements and notes thereto. (c) Exhibits: 3.1 Articles of Incorporation of the Registrant (incorporated herein by reference to Exhibit 3.1 to Registration Statement on Form S-4 (No. 333- 65821)). 3.2 Bylaws of the Registrant (incorporated herein by reference to Exhibit 3.2 to Registration Statement on Form S-4 (No. 333-65821). 10.1 Penns Woods Bancorp, Inc. 1998 Stock Option Plan, as amended and restated (incorporated herein by reference to Exhibit 10.1 to Registration Statement on Form S-4 (No. 333-65821).* 10.2 Agreement dated as of January 1, 1995 among Penns Woods Bancorp, Inc. Jersey Shore State Bank and Theodore H. Reich (incorporated herein by reference to Exhibit 10.2 to Registration Statement on Form S-4 (No. 333-65821).* <PAGE 76> 10.3 Agreement dated as of August 29, 1991, among Penns Woods Bancorp, Inc., Jersey Shore State Bank and Ronald A. Walko (incorporated herein by reference to Exhibit 10.3 to Registration Statement on Form S-4 (No. 333-65821).* 10.4 Severance Agreement dated May 30, 1996, between Jersey Shoe State Bank and Ronald A. Walko (incorporated herein by reference to Exhibit 10.3 to Registration Statement on Form S-4 (No. 333- 65821).* (22) Subsidiaries of the Registrant. (23) Consent of Independent Certified Public Accountants. (27) Financial Data Schedule. ______________________ * Indicates compensatory plan or arrangement PAGE 77
EXHIBIT INDEX (22) Subsidiaries of the Registrant. (23) Consent of Independent Certified Public Accountants. (27) Financial Data Schedule. PAGE 78
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. March 9, 1999 PENNS WOODS BANCORP, INC. BY: THEODORE H. REICH President Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: Theodore H. Reich, President and Director March 9, 1999 Sonya E. Hartranft, Principal Accounting March 9, 1999 Officer & Principal Financial Officer Phillip H. Bower, Director March 9, 1999 Lynn S. Bowes, Director March 9, 1999 William S. Frazier, Director March 9, 1999 James M. Furey II, Director March 9, 1999 Allan W. Lugg, Director March 9, 1999 Jay H. McCormick, Director March 9, 1999 R. Edward Nestlerode, Jr., Director March 9, 1999 James E. Plummer, Director March 9, 1999 William H. Rockey, Sr. Vice President & March 9, 1999 Director This statement has not been reviewed or confirmed for accuracy or relevance, by the Federal Deposit Insurance Corporation. <PAGE 79>