<PAGE> 1
FORM 10-KSB
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
ANNUAL REPORT UNDER SECTION 13 or 15(d) of the
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year ended December 31, 1997
HERITAGE FINANCIAL SERVICES, INC.
(Exact Name of Registrant as Specified in Its Charter)
Tennessee 62-1484807
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
25 Jefferson Street, Clarksville, Tennessee 37040
(Address of Principal Executive Office) (Zip Code)
(615) 553-0500
(Issuer's telephone number including area code)
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $2.00 par value per share
Check whether the issuer: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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
--- ---
Check if there is no disclosure of delinquent filers pursuant to Item 405
of Regulation S-B contained in this form, and no disclosure will 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-KSB or any
amendment to this Form 10-KSB X
---
State issuer's revenues for its most recent fiscal year:
$17,241,258
As of December 31, 1997, 568,574 shares of the registrant's Common Stock
were outstanding with an aggregate market value of $41,620,894, using the
average sale price over the last 60 days.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive proxy statement, which will be
filed with the Securities and Exchange Commission not later than March 30, 1998,
are incorporated by reference into Part III of this annual report on
Form 10-KSB.
<PAGE> 2
Table of Contents
Item
- ----
Part I
1. Description of Business
2. Description of Property
3. Legal Proceedings
4. Submission of Matters to a Vote of Shareholders
Part II
5. Market for the Registrant's Common Equity and Related Shareholder Matters
6. Management's Discussion and Analysis of Financial Condition and
Results of Operations
7. Financial Statements
8. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
Part III
9. Directors and Executive Officers, Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act
10. Executive Compensation
11. Security Ownership of Certain Beneficial Owners and Management
12. Certain Relationships and Related Transactions
Part IV
13. Exhibits and Reports on Form 8-K
Signatures
Proxy
<PAGE> 3
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Heritage Financial Services, Inc. (the "Company" or "HFSI") is a registered bank
holding company which was incorporated under Tennessee law in 1992. The
Company's activities are primarily conducted through its wholly-owned
subsidiary, Heritage Bank (the "Bank") which began business in 1989 and was
acquired by the Company in 1992. The Bank is a Tennessee state bank, which was
organized in 1989 after three locally-owned banks headquartered in Montgomery
County were acquired. From the time of its opening in June 1989, until December
31, 1997, the Bank has grown to total assets exceeding $166 million.
The Bank's primary trade area is comprised of Montgomery County, Tennessee, and
the surrounding counties in Tennessee and Kentucky. The Bank provides a wide
range of competitive retail and commercial banking services. Deposit services
offered include various personal and business checking accounts, savings
accounts, money market investment accounts, certificates of deposit, automated
teller machines networking into national teller systems, and retirement
accounts. Lending services include consumer loans, commercial real estate loans,
personal lines of credit, home equity loans, credit cards, real estate
construction loans, commercial loans and leases to small and medium size
businesses and professionals, and letters of credit. Accounts receivable billing
services are also provided. Drive through and night depository facilities are
provided, as well as, five automated teller machines (ATMs) at banking offices
and an additional eight ATMs located at convenience stores in Clarksville. Safe
deposit facilities, cashier's checks, money orders, travelers checks, U.S.
savings bonds, bank-by-mail and wire transfer services are also offered.
Additionally, the Bank originates, services and markets residential mortgage
loans through its mortgage banking operation. Heritage Bank also has three
non-bank affiliates which provide services incidental to the Bank's operations,
including brokerage services, property ownership, and reinsurance of credit
life, accidental and health insurance. In addition, the Bank opened a consumer
finance subsidiary in June of 1997 to originate traditional consumer finance
loans. The Bank does not provide trust services.
The Bank conducts its banking business in Clarksville, Tennessee at its five
branch locations of 25 Jefferson Street, 1805 Madison Street, 111 Cunningham
Lane, 2786 Wilma Rudolph Boulevard and 400 Highway 49 (Hilltop Super Market). A
mortgage banking office is located at 529 North Second Street. The Bank's
wholly-owned subsidiary, Heritage Investment Center, Inc., is engaged in earning
fees from investment brokerage services through Robert Thomas Securities, Inc.
The Bank has another wholly-owned subsidiary, Heritage Investment Corporation, a
limited partner in a partnership, engaged in the development and sale of a
speculative industrial building located in the Clarksville/Montgomery County
Industrial Park. Also, in December of 1996, Central Life Insurance Company
(Central) was incorporated as a wholly-owned subsidiary of the Bank. Central has
entered into a reinsurance arrangement and receives underwriting profits by
providing life and disability
<PAGE> 4
insurance to borrowers of the Bank. In June of 1997, a finance subsidiary
(Advance Credit Company, Inc.) was opened to originate traditional consumer
finance loans.
The Bank considers its primary market for loans and deposits to be individuals,
small-to-medium size businesses, and professionals within the Bank's primary
trade area. The Bank is actively soliciting business in this target market and
considers the potential growth opportunities to be favorable. No material
portion of the Bank's deposits has been obtained from any single person or group
of persons.
COMPETITION
There is significant competition among banks and bank holding companies in
Tennessee. The Bank competes for deposits and loans with both national and state
banks, as well as, with savings and loan associations and credit unions. The
deregulation of depository institutions as well as the increased ability of
nonbanking financial institutions, such as finance companies, investment
companies, insurance companies and several governmental agencies, to provide
services previously reserved to commercial banks has further intensified
competition. Accordingly, the Bank now competes with these nonbanking financial
institutions, all of which are engaged in marketing various types of loans,
commercial paper, short-term obligations, investments and other services.
Because nonbanking financial institutions are not subject to the same regulatory
restrictions as banks and bank holding companies, in many instances they may
operate with greater flexibility. The continued deregulation of the financial
services industry may have a detrimental effect on the Bank's long-term growth
and profitability.
LOANS
Various types of secured and unsecured commercial, consumer and real estate
loans are offered by the Bank. The Bank's current policy is to make loans to
borrowers who maintain depository relationships with the Bank or reside or work
in the Bank's market area. Generally, real estate loans are secured by real
property located in the Bank's market area.
The Bank provides each lending officer with written loan guidelines. Lending
authority is delegated by the Board of Directors to loan officers, each of whom
has limited authority to extend secured and unsecured credit. Any credit in
excess of $500,000 must have the approval of the executive committee of the
board of directors, which consists of both management and non-management
directors of the Bank. Any loan in excess of 15% of regulatory capital must be
approved by the full board of directors.
<PAGE> 5
MONETARY POLICIES
The operating results of the Bank and the Company are affected by credit
policies of monetary authorities, particularly the Federal Reserve Board. The
instruments of monetary policy employed by the Federal Reserve Board include
open market operations in U.S. government securities, changes in the discount
rate on bank borrowings, and changes in reserve requirements against bank
deposits.
PERSONNEL
At December 31, 1997, the Company had 88 full-time equivalent employees of which
27 are Bank officers. Although the Bank has only been in existence since 1989,
the Bank believes its staff possesses a high degree of experience and expertise.
Coming primarily from other Clarksville banking institutions, staff members have
banking experience ranging from one to thirty-two years. The Company is not a
party to any collective bargaining agreement and believes its employee relations
generally are good.
Employee benefit programs include group life, disability, dental and health
insurance, a 401(k) pension plan, an employee stock ownership plan (ESOP),
discretionary incentive bonuses, a stock option plan, training programs and paid
vacations.
SUPERVISION AND REGULATION
The banking industry is extensively regulated under federal and state law. As a
bank holding company, the Company is subject to regulation under the Bank
Holding Company Act (the "BHCA") and to supervision by the Board of Governors of
the Federal Reserve System (the "FRB"). Pursuant to the BHCA, the Company may
not directly or indirectly acquire the ownership or control of more than 5% of
any class of voting shares or substantially all of the assets of any company,
including a bank, without the prior approval of the FRB. The BHCA further limits
the activities of both the Company and the Bank to the business of banking and
activities closely related or incidental to banking.
As a Tennessee state bank, the Bank is subject to supervision and regular
examination by the Tennessee Department of Financial Institutions (the "TDFI").
Such examinations, however, are for the protection of the Bank Insurance Fund
("BIF") and, indirectly to a degree, for depositors, and not for the protection
of investors and shareholders. Pursuant to the terms of the Federal Deposit
Insurance Act (the "FDIA"), the deposits of the bank are insured through the BIF
of the Federal Deposit Insurance Corporation (the "FDIC"). Accordingly, the Bank
is subject to regulation by the FDIC and is also subject to the Federal
Reserve's requirements to maintain reserves against deposits, restrictions on
the types and amounts of loans that may be granted and the interest that may be
charged thereon, and limitations on the types of investments that may be made
and the types of services that may be offered.
<PAGE> 6
In 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement
Act ("FDICIA"), which, among other things, substantially revised the depository
institution regulatory and funding provisions of the FDIA. FDICIA also expanded
the regulatory and enforcement powers of bank regulatory agencies. Most
significantly, FDICIA mandates annual examinations of banks by their primary
regulators and requires the federal banking agencies to take prompt "corrective
action" whenever financial institutions do not meet minimum capital
requirements. FDICIA establishes five capital tiers: "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized"
and "critically undercapitalized." A depository institution's capitalization
status will depend on how well its capital levels compare to various relevant
capital measures and certain other factors, as established by regulation. FDICIA
also prohibits a depository institution from making any capital distribution
(including payment of dividend) or paying any management fee to its holding
company if the depository institution would thereafter be "undercapitalized." As
of December 31, 1997, the Bank's capital level qualified it as being "well
capitalized" under such regulations.
The banking industry is affected by the policies of the FRB. An important
function of the FRB is to regulate the national supply of bank credit, to
moderate recessions and to curb inflation. Among the instruments of monetary
policy used by the FRB to implement its objectives are: open-market operations
in U.S. Government securities, changes in the discount rate on bank borrowings
and changes in reserve requirements on bank deposits.
INTERSTATE BANKING AND BRANCHING LEGISLATION
FEDERAL LAW. In 1994, Congress passed the Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 ("Riegle-Neal"), which affected the interstate
banking and branching abilities of bank holding companies and banks.
Riegle-Neal authorizes a national bank domiciled in one state to establish
branches in any other state as long as neither state has opted out of interstate
branching. Riegle-Neal, however, does allow states to preserve certain
restrictions on the entry of out-of-state banks, such as the fashion in which
entry can be made, an age requirement for a bank being merged or acquired, and a
deposit cap. Under Riegle-Neal, once a bank has established a branch in another
state, it may exercise the same rights in that state as national and state banks
enjoy in that state, including the ability to branch intra-state.
Riegle-Neal also permits states to allow banks to enter the state by
establishing a de novo branch in that state. In order to allow de novo entry
into a state, that state must expressly provide for de novo branching. Once a
bank has established a branch in a host state through de novo branching, it may
exercise the same rights in that state as national and state banks enjoy,
including the ability to branch intra-state. If a state opts out of interstate
branching, no bank domiciled in another state may establish branches in that
state.
<PAGE> 7
TENNESSEE LAW. Tennessee law allows banks and bank holding companies in any
state to acquire banks and bank holding companies in Tennessee provided that the
state in which such acquiror is headquartered also permits Tennessee banks and
bank holding companies to acquire banks and bank holding companies in that
state. Acquisitions of banks or bank holding companies in Tennessee require the
approval of the TDFI, and all interstate branching transactions require
appropriate regulatory approval.
CONSEQUENCE OF INCREASED INTERSTATE ACTIVITY. Because of the increasing
liberalization of the laws and regulations affecting the conduct of interstate
banking activities, it is anticipated that competition in the Bank's
geographical market area will increase. Large, regional bank holding companies
acquiring branches in the Bank's market area, may offer a wider range of
services than are currently offered by the Bank. In addition, some of these
competitors may be more highly capitalized than the Bank and the Company.
FURTHER CHANGES IN REGULATORY REQUIREMENTS. The United States Congress and the
Tennessee General Assembly have periodically considered and adopted legislation
that has resulted in deregulation of, among other matters, banks and other
financial institutions, or adversely affected the profitability of the banking
industry. Future legislation could further modify or eliminate geographic
restrictions on banks and bank holding companies and current prohibitions with
other financial institutions, including mutual funds, securities brokerage
firms, insurance companies, banks from other states and investment banking
firms. The effect of any such legislation on the business of the Company or the
Bank cannot be accurately predicted. The Company also cannot predict what
legislation might be enacted or what other implementing regulations might be
adopted, and if enacted or adopted, the effect thereof.
RESTRICTION ON DIVIDENDS.
The Company is a legal entity separate and distinct from the Bank and
substantially all of the Company's revenues result from amounts paid by the
Bank, as dividends, to the Company. The payment of dividends by the Bank is, of
course, dependent upon its earnings and financial condition. The Bank, however,
as a state bank, is also subject to legal limitations on the amount of its
earnings that it may pay as dividends. For additional information regarding the
restrictions on the Bank's payment of dividends, see note 15 to the consolidated
financial statements.
ENVIRONMENTAL
The Company is subject to various federal, state and local statutes and
ordinances regulating the discharge of materials into the environment. The
Company does not believe that it will be required to expend any material amounts
to comply with these laws and regulations.
<PAGE> 8
ITEM 2. DESCRIPTION OF PROPERTY
The Bank's main office is located at 25 Jefferson Street in the central business
district of the city. The Bank purchased approximately three acres of land and
constructed a 4,000 square foot temporary facility, which began operations in
1989. An additional 3,950 square feet of temporary space was later constructed
to provide for additional growth bringing the total facility to 7,950 square
feet. An automated teller machine was also added. As further discussed below,
the Bank's permanent main office is currently under construction and the
temporary facility currently utilized will be moved or raized.
A branch is located at 1805 Madison Street in the Hilldale area of Clarksville.
The facility is leased and contains approximately 2,000 square feet of space.
This location opened in February of 1991, and is a full service branch with
drive through lanes. An ATM is in operation at this location.
The mortgage banking office is located at 529 North Second Street near the main
business district of Clarksville. This facility is leased and contains
approximately 2,900 square feet. The mortgage banking office is not a full
service location.
An additional branch is located at 111 Cunningham Lane in the north Clarksville
area. The 2,600 square foot facility opened in January of 1993, and is a full
service branch including drive through lanes. An ATM is in operation at this
location.
A third branch is located at 2786 Wilma Rudolph Boulevard in the northeast (St.
Bethlehem) area of Clarksville. The 3,500 square foot facility opened in May of
1994, and is a full service branch including drive through lanes. An ATM is in
operation at this location.
A fourth full service branch was opened in November of 1995. This location is
leased space inside Hilltop Market on Highway 149. The 400 square foot facility
is a full service branch, but does not provide drive through facilities. An ATM
is in operation at this facility.
Heritage Investment Center, Inc. (the brokerage service) is located at 720
Memorial Drive in the Hilldale area of Clarksville. The facility is leased and
contains approximately 1,000 square feet of space. The full service brokerage
began operations in July of 1995, under a broker/dealer relationship with Robert
Thomas Securities.
In July of 1996, the Bank leased a 2,500 square foot commercial building at 319
Riverside Drive, which neighbors the main office building. This facility serves
as the new consumer finance subsidiary's (Advance Credit Company, Inc.)
permanent location. In addition, the Bank's accounting and marketing personnel
will occupy the facility until the new main office building is completed.
In 1993, the Bank acquired a 2.1 acre lot and building adjacent to the main
office location. This facility is currently used for storage and meeting
functions, and this property and the temporary main
<PAGE> 9
office property discussed above are the site for the Bank's permanent main
office building currently under construction. The new 40,000 square foot
facility is scheduled for completion in 1998, and the mortgage banking,
accounting and marketing personnel will relocate to this facility. Construction
cost of the permanent main office is estimated at $4.5 million.
ITEM 3. LEGAL PROCEEDINGS
The Bank is not aware of any material pending legal proceedings, other than
ordinary routine litigation incidental to the business, to which the Bank is a
party, or of which, any of their properties are the subject.
There are no material legal proceedings to which any director, any nominee for
election as a director, principal officer of the Bank or Company, or any
associate of the foregoing, or any owner of record or beneficial owner of more
than 5% of any class of voting securities of the Company is a party adverse to
the Company, or the Bank, or has a material adverse impact to the Company or the
Bank
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
No matter was submitted during the fourth quarter of the year ended December 31,
1997, to a vote of security holders, through the solicitation of proxies or
otherwise.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The common stock of Heritage Financial Services, Inc. is not traded through an
organized exchange nor is there a known active trading market. The following
table indicates the quarterly range of high and low sale prices for the stock
during the years of 1997 and 1996. The sales prices represent known transactions
and may not necessarily represent all trading transactions for the periods.
<TABLE>
<CAPTION>
Year Ended December 31, 1997 Year Ended December 31, 1996
---------------------------- ----------------------------
Dividend Dividend
High Low Declared High Low Declared
---- --- -------- ---- --- --------
<S> <C> <C> <C> <C> <C> <C>
First Quarter 32.00 42.00 0.00 25.20 25.00 0.00
Second Quarter 44.00 49.00 0.00 30.00 30.00 0.00
Third Quarter 49.00 49.00 0.00 32.00 30.00 0.00
Fourth Quarter 75.00 62.00 1.20 32.00 25.00 1.00
</TABLE>
As of December 31, 1997, there were 923 shareholders of record of Heritage
Financial Services, Inc.
<PAGE> 10
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
The purpose of this discussion and analysis is to provide readers with
information relevant to understanding and assessing the financial condition and
results of operations of Heritage Financial Services, Inc. (Heritage Financial
or Company). Heritage Financial's business activity is currently limited to
holding the stock of its wholly-owned subsidiary, Heritage Bank (the Bank).
Accordingly, the discussion that follows relates primarily to the financial
condition and results of operation of Heritage Bank and its subsidiaries. This
discussion should be read in conjunction with the consolidated financial
statements and accompanying notes.
Certain of the information included in this discussion and analysis includes
forward-looking statements. Many factors affect the Company's financial position
and profitability, including fluctuations in the economy, the volatility of
interest rates, political events, regulatory actions, competition from other
providers of financial services, and the continued growth of the market in which
the Company operates consistent with recent historical experience. Because these
factors are unpredictable and beyond the Company's control, actual results may
vary materially from those anticipated.
Heritage Bank is a locally owned independent bank with its primary market in
Montgomery County, Tennessee and the surrounding counties of Tennessee and
Kentucky. The Bank provides general commercial bank services through six banking
offices. Heritage Bank also has three non-bank affiliates which provide services
incidental to the Bank's operations, including brokerage services, property
ownership, and reinsurance of credit life, accident and health insurance. In
addition, the Bank opened a consumer finance subsidiary in June 1997 to
originate traditional consumer finance loans. Commercial banking services,
mortgage banking and consumer financing are all activities the Company considers
to be its one business segment.
FINANCIAL CONDITION
OVERVIEW. The Bank experienced solid loan growth in 1997. At December 31, 1997,
the Company reported total assets of $166.1 million compared with $132.8 million
at the end of 1996. Average assets were $148.2 million in 1997 compared with
$119.4 million in 1996
EARNING ASSETS. Average earning assets of the Company for 1997, increased 23%,
or $26.2 million to $138.9 million from $112.7 million for 1996. This compares
to growth of average earning assets of 18% and 17% for 1996 and 1995,
respectively. The Company's average earning assets to average assets ratio was
93.7% for 1997, compared to 94.3% and 93.7% for 1996 and 1995, respectively.
Economic growth in the local market has enabled the Bank to achieve continued
loan growth (the primary earning asset). Average loans for 1997 increased 29%,
or $26.7 million, to $120.3 million, while average loan growth for 1996 and 1995
was 29% and 24%, respectively. The changing mix of earning assets was favorable
during the last three years as average loans were an increasing percentage of
total earning assets. Average loans for 1997 were 87% of total average earning
assets, compared to 83% and 76% during 1996 and 1995, respectively. Strong loan
demand and a slowed
<PAGE> 11
growth of deposits used for investment in securities has led to the improved
earning asset composition.
Commercial real estate loans continued as the single largest loan category,
representing 31% and 25% of total loans at December 31, 1997 and 1996,
respectively. Commercial real estate loans grew $15.1 million (58%) in 1997 and
$5.4 million (26%) in 1996. Real estate construction loans amounted to 12% and
16% of total loans at December 31, 1997 and 1996, respectively. Real estate
construction loans were flat from year-end 1996 to 1997, following an increase
of $7.6 million (83%) in 1996. The growth in commercial and construction loans
reflect the economic growth and vigorous housing market in the Bank's lending
area.
Commercial, financial and agricultural loans represented 17% and 20% of total
loans at December 31, 1997 and 1996, respectively. Commercial, financial and
agricultural loans increased 14% in 1997 and 27% in 1996. Portfolio residential
loans (1-4 family, excluding mortgage loans held for sale) amounted to 23% and
22% of total loans at year-end 1997 and 1996, respectively. Portfolio
residential loans increased 36% in 1997 and 10% in 1996.
The consumer loan portfolio consists of real estate, auto, and other consumer
installment loans that require periodic payments of principal and interest.
Consumer loans represented 17% and 18% of total loans at December 31, 1997 and
1996, respectively. Consumer loans increased $5.1 million (28%) in 1997 and $3.8
million (26%) in 1996. The Bank's new consumer finance subsidiary contributed to
the 1997 increase.
The Bank maintains a securities portfolio of principally debt securities held
for sale as a source of income and liquidity, to balance interest rate risk with
other categories of the balance sheet, and to supply securities to pledge as
required collateral for certain deposits. During the last three years, a portion
of the proceeds from the sale and maturity of securities was used to fund loan
growth. Average securities decreased $0.5 million and $3.4 million in 1997 and
1996, respectively. Average securities for 1997 were 13% of total earning
assets, as compared to 17% and 24% during 1996 and 1995, respectively.
At December 31, 1997, the securities portfolio consisted of: U.S. agency
obligations - 55%, mortgage-backed securities - 20%, tax-exempt securities - 21%
and equity securities (primarily FHLB stock) - 4%. U.S. agency obligations
include $1.5 million of structured notes (as currently defined by regulatory
agencies). Mortgage-backed securities consist of Real Estate Mortgage Investment
Conduit (REMIC) and collateralize mortgage obligation (CMO) instruments. The
REMIC issues are 100% U.S. agency issues and the CMO issues are marketable,
collateralized mortgage obligations backed by agency-pooled collateral. All
tax-exempt securities are rated investment grade by Moody's or Standard &
Poor's.
FUNDING SOURCES. The Bank's primary funding source is its base of local area
deposits which consist of noninterest-bearing demand, interest checking,
savings, money market and retirement accounts, and certificates of deposit. The
Bank had total deposits of $134.4 million as of December 31, 1997, compared to
$115.3 million as of December 31, 1996. Average 1997 deposits increased
<PAGE> 12
19%, or $20.4 million to $126.1 million from $105.8 million in 1996. Average
deposit growth for 1996 and 1995 was $14.3 million (16%) and $12.5 million
(16%), respectively. Certificates of deposit (generally the Bank's highest rate
paying deposit) accounted for most of the deposit growth during the last three
years. To fund loan growth, management increased marketing efforts and offered
attractive rates for certificates of deposit. Average 1997 certificates of
deposits increased 28%, or $15.1 million to $68.7 million from $53.6 million in
1996. Average certificates of deposit growth for 1996 and 1995 was $10.6 million
(25%) and $9.3 million (27%), respectively. Currently, the Bank has no brokered
deposits.
Due to the competitive local market for deposits, the Bank supplements its
deposit base with alternative funding sources (Federal funds purchased and
borrowings from the Federal Home Loan Bank) to fund loan growth. The average
balance of these other borrowings amounted to $8.2 million, $2.4 million and
$1.2 million in 1997, 1996 and 1995, respectively. Management expects an
increasing need to rely on alternative funding sources as local area deposits
become a decreasing portion of the Bank's sources of funds. Additional use of
FHLB borrowings and Federal funds purchased, as well as, brokered and
out-of-the-area certificates of deposit are anticipated to meet the challenge of
obtaining acceptable funding sources without incurring an undesirable amount of
interest rate risk.
NONPERFORMING ASSETS, PAST DUE LOANS, POTENTIAL PROBLEM ASSETS, AND THE
ALLOWANCE FOR LOAN LOSSES. Nonperforming assets consist of (1) nonaccrual loans
where the recognition of interest income was discontinued, (2) loans which have
been restructured to provide for a reduction or deferral of interest or
principal because the borrower's financial condition deteriorated, (3) loans
past due ninety days or more that are still accruing interest, and (4)
foreclosed and repossessed assets. Nonperforming assets were .63% ($853,000) and
1.22% ($1,268,000) of portfolio loans (excludes mortgage loans held for sale)
and foreclosed and repossessed assets at December 31, 1997 and 1996,
respectively.
Potential problem assets, which are not included in nonperforming assets, were
2.09% ($2,814,000) of portfolio loans at December 31, 1997, compared to .43%
($447,000) at December 31, 1996. The 1997 increase in potential problem assets
is principally due to three commercial real estate loans in the Bank's primary
market totaling $2.2 million. Potential problem assets represent those assets
where information about possible credit problems of borrowers has caused
management to have serious doubts about the borrower's ability to comply with
present repayment terms. This definition is believed to be substantially
consistent with the standards established by banking regulatory agencies for
loans classified substandard and doubtful.
Management's policy is to maintain the allowance for loan losses at a level
sufficient to absorb estimated losses inherent in the loan portfolio. The
allowance for loan losses was 1.42% of outstanding portfolio loans at December
31, 1997, as compared to 1.49% at December 31, 1996. At December 31, 1997, the
allowance for loan losses to nonperforming assets ratio was 224%, as compared to
122% at December 31, 1996. Said in another way, the Bank has set aside $2.24 for
every dollar of nonperforming assets.
<PAGE> 13
CAPITAL. Management believes that a strong capital position is vital to
continued profitability and to promote depositor and investor confidence.
Stockholders' equity was $13.3 million or 7.98% of total assets at December 31,
1997, and $11.3 million or 8.48% of total assets at December 31, 1996. Net
income is the primary source of new capital for the Company. In addition,
proceeds from the sale of common stock through director and employee plans
contributed $368,000 and $432,000 of capital in 1997 and 1996, respectively.
Unrealized gain or loss on securities held for sale, net of applicable income
taxes, are recorded directly to stockholders' equity. To record the fair value
of securities held for sale, stockholders' equity was increased by $57,000 and
decreased by $41,000 at December 31, 1997 and 1996, respectively.
Heritage Financial's continuing record of strong earnings performance allowed
the board of directors to raise the annual dividend 20% to $1.20 per share in
1997 from the 1996 level of $1.00 per share. Additionally, the board of
directors develops and reviews the capital goals of Heritage Financial and the
Bank. The Company's dividend policy is designed to retain sufficient amounts for
healthy financial ratios, considering future planned asset growth and other
prudent financial management principles.
Heritage Bank and the banking industry are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Capital adequacy in the banking industry is
evaluated primarily by the use of ratios which measure capital against assets
and certain off-balance-sheet items. Certain ratios weight these assets based on
risk characteristics according to regulatory accounting practices. At December
31, 1997, the Bank's capital exceeded the regulatory minimums and met the
regulatory definition of well-capitalized. The Bank's capital ratios and the
regulatory guidelines are presented in Note 15 to the consolidated financial
statements.
INTEREST RATE SENSITIVITY AND LIQUIDITY MANAGEMENT
Managing net interest income is a critical element in optimizing the earnings of
a banking organization. Movements in interest and the corresponding effects on
net interest income may significantly affect profitability. With the goal of
consistent earnings growth with minimal interest rate risk, the Bank's
asset/liability management committee (ALCO) oversees this process by
establishing guidelines to manage the sensitivity and repricing of the Bank's
assets and liabilities.
The impact of interest rate changes can be mitigated by maintaining a balance
between interest rate-sensitive assets and liabilities within given time frames.
The difference between assets and liabilities within a given repricing period is
expressed as a ratio and as a dollar amount known as the "gap," both of which
are used as a measure of interest rate risk. A ratio of 100% suggest a balanced
position between rate-sensitive assets and liabilities within a given repricing
period. While the measurement process and related assessment of risk are
somewhat imprecise, the Bank believes its asset/liability management program
allows adequate reaction time for trends in the market place as they occur,
thereby minimizing the potential negative effect of its gap position against the
event of interest rate changes.
<PAGE> 14
The Bank also uses net interest income simulation modeling to better quantify
the impact of potential interest rate fluctuations on net interest income. With
this understanding management can best determine possible balance sheet changes,
pricing strategies, and appropriate levels of capital and liquidity which allow
the Bank to generate strong net interest income while controlling and monitoring
interest rate risk.
The following table reflects the Bank's interest rate sensitivity position both
individually within specified time periods and cumulatively over various time
horizons. In the table assets and liabilities are placed in categories based on
their actual or expected repricing date. As indicated in the table, a
significant percentage of the Bank's assets and liabilities reprice within three
months. In the one year cumulative time frame, assets and liabilities are
closely matched at 104%. In a period of generally falling interest rates, this
gap position will normally result in a decrease in net interest income. Whereas,
in a period of generally rising interest rates, this gap position will normally
result in an increase in net interest income.
<PAGE> 15
INTEREST RATE SENSITIVITY
<TABLE>
<CAPTION>
(dollars in thousands) Time to Repricing or Maturity from December 31, 1997
4 months Over 1
3 months through through Over 3
or less 1 year 3 years years Total
-------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans $62,864 $ 32,293 $36,841 $ 2,852 $134,850
Mortgage loans held for sale 631 0 0 0 $ 631
Securities 985 5,654 7,375 5,139 $ 19,153
- ----------------------------------------------------------------------------------------
Total interest-earning assets $64,480 $ 37,947 $44,216 $ 7,991 $154,634
- ----------------------------------------------------------------------------------------
Interest-bearing liabilities:
Transaction and savings $26,684 $ 2,353 $ 6,648 $ 5,896 $ 41,581
Certificates of deposits 14,222 38,836 20,451 468 $ 73,977
Borrowed funds 16,803 34 35 64 $ 16,936
- ----------------------------------------------------------------------------------------
Total interest-bearing
liabilities 57,709 $41,223 $27,134 $ 6,428 $132,494
- ----------------------------------------------------------------------------------------
Interest sensitivity gap $ 6,771 $ (3,276) $17,082 $ 1,563 $ 22,140
Cumulative interest sensitivity $ 6,771 $ 3,495 $20,577 $22,140
Cumulative net interest-earning
assets as a percentage of
interest-bearing liabilities(1) 112% 104% 116% 117%
</TABLE>
(1) If all transaction and savings accounts had been included in the 3 months
or less category above, the cumulative net interest-earning assets as a
percentage of interest-bearing liabilities would have been 89%, 92%, 111%
and 117% respectively, for the 3 months or less, 4 months through 1 year,
over 1 through 3 years and over 3 years categories at December 31, 1997.
The ALCO committee also monitors the Company's liquidity position. The objective
of liquidity management is to ensure the ability to meet cash flow needs of
customers, such as new loan demand and deposit withdrawals, while at the same
time maximizing lending and investment opportunities. Failure to properly manage
liquidity requirements can result in the need to satisfy customer withdrawals
and other obligations with expensive funding sources. Too much liquidity on the
balance sheet can also be undesirable as earnings will suffer due to
underutilized resources. The Bank maintains adequate liquidity with sufficient
levels of liquid assets, deposit growth, and available alternative funding
sources, such as Federal Home Loan Bank advances and Federal funds purchased.
<PAGE> 16
RESULTS OF OPERATIONS
COMPARISON OF YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995. Heritage Financial's
net income rose $197,000 to reach $2,302,000 in 1997, a 9% increase over 1996.
Net income for 1996 increased 25% from the $1,687,000 earned in 1995 while 1995
net income increased 41% . Basic net income per share was $4.15 in 1997,
compared with $3.93 in 1996 and $3.23 in 1995. Diluted net income per share was
$4.11 for 1997, compared with $3.84 in 1996 and $3.12 in 1995. Return on average
equity decreased to 18.65% in 1997 from 20.27% in 1996 and 19.79% in 1995.
Return on average assets declined for the year ended December 31, 1997, to 1.55%
from 1.76% in 1996 and 1.66% in 1995.
NET INTEREST INCOME. For purposes of this discussion, net interest income has
been adjusted to a fully taxable equivalent basis for certain tax-exempt loans
and investments included in earning assets. Net interest income, the Bank's
largest single source of earnings, represents the difference between interest
(including fees) earned on loans, securities and other earning assets, and the
interest paid on deposits and other borrowings obtained to fund them. The net
interest margin is net interest income, on a tax equivalent basis, expressed as
a percentage of average earning assets. The margin is influenced by a number of
factors, such as the volume and mix of earning assets and funding sources, the
interest rate environment, and the level of earning assets funded by
interest-free funding sources (primarily noninterest-bearing demand deposits and
equity capital).
On a fully taxable equivalent (TE) basis, net interest income for 1997 grew 23%,
or $1,472,000 over 1996. Average earning assets increased 23% or $26.2 million
between years, while interest-bearing liabilities rose 27% or $24.9 million. Net
interest margin was 5.59% for both 1997 and 1996. Earning assets yield increased
16 basis points to 9.86% while the cost of interest-bearing liabilities
increased 4 basis points to 5.05%. In 1997, the mix of earning assets changed as
the average balance of higher yielding loans rose $26.7 million or 29% and
comprised 87% of total earning assets, up from 83% in 1996. Overall loan yields
declined 6 basis points to 10.35%, due to competitive pressures in the Bank's
market. Securities declined 2% or $0.5 million while the yield on securities
rose 48 basis points, as higher yielding securities replaced those sold or
maturing. All of the Company's interest-bearing deposit categories rose, as
interest-bearing deposits grew $19.1 million or 21%. While all categories
increased, certificates of deposit led with an increase of $15.1 million or 28%.
Other borrowed funds also played a significant role in the funding of asset
growth as they rose $5.8 million. The cost of all liability categories increased
4 basis points primarily due to the change in mix to higher costing certificates
of deposit and other borrowings.
During 1996, net interest income rose 22%, or $1,124,000 and totaled $6,295,000.
Average earning assets grew 18% in 1996, a $17.4 million increase.
Interest-bearing liabilities rose $13.3 million or 17%. Net interest margin
increased from 5.43% to 5.59%. While the yield on earning assets increased 34
basis points to 9.70%, the cost of interest-bearing liabilities rose 28 basis
points to 5.01%. The mix of earning assets shifted favorably as loans
experienced $21 million of growth or a 29% increase while securities decreased
$3.4 million or 15%. Interest-bearing liabilities grew $13.3 million or 17%
while the cost of interest-bearing liabilities increased 28 basis points to
5.01%. Certificates of deposit led the increase rising 25% or $10.6 million. The
increase in the cost of
<PAGE> 17
interest-bearing liabilities was due to the change in the mix to higher rate
paying certificates of deposit, and to a lesser extent, an increase in rates.
The following table sets forth certain information relating to the Company's
average consolidated balance sheets and consolidated statements of income for
the years ended December 31, 1997, 1996 and 1995.
AVERAGE BALANCE SHEETS AND ANALYSIS OF NET INTEREST INCOME
<TABLE>
<CAPTION>
(dollars in thousands) 1997 1996 1995
------------------------- -------------------------- -------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
ASSETS Balance Interest Cost Balance Interest Cost Balance Interest Cost
- ------ ------- -------- ---- ------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Earning Assets
Net loans (1) $120,343 $12,453 10.35% $ 93,599 $ 9,746 10.41% $ 72,635 $7,497 10.32%
Taxable securities 15,224 995 6.53% 15,524 930 5.99% 18,568 1,130 6.08%
Tax exempt securities 3,308 241 7.29% 3,478 246 7.07% 3,870 277 7.16%
Federal funds sold 0 0 0.00% 51 3 4.98% 150 8 5.64%
- ------------------------------------------------------------------------------------------------------------------------------
Total earning assets 138,876 13,689 9.86% 112,651 10,925 9.70% 95,222 8,912 9.36%
Nonearning assets 9,280 6,787 6,460
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $148,156 $119,438 $101,682
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing Liabilities
Interest checking $ 9,757 $ 202 2.07% $ 8,523 $ 178 2.09% $ 8,450 $ 188 2.22%
Money market accounts 21,911 921 4.21% 19,656 848 4.31% 18,386 763 4.15%
Savings accounts 5,188 128 2.47% 4,976 122 2.46% 4,714 116 2.45%
Retirement accounts 3,479 187 5.38% 3,227 178 5.51% 3,292 194 5.88%
Certificates of deposit 68,728 4,029 5.86% 53,626 3,175 5.92% 43,008 2,410 5.60%
Other borrowings 8,194 454 5.54% 2,359 129 5.45% 1,216 71 5.86%
- ------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities(2) 117,257 5,922 5.05% 92,367 4,629 5.01% 79,066 3,741 4.73%
Noninterest-bearing liabilities 18,558 16,684 14,173
- ------------------------------------------------------------------------------------------------------------------------------
Total liabilities 135,815 109,051 93,239
Stockholders' equity 12,341 10,386 8,443
- ------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $148,156 $119,438 $101,682
Net interest income/net
interest spread(2) $ 7,767 4.81% $ 6,295 4.69% $5,171 4.63%
Net earning assets/net interest
margin(2) $ 21,619 5.59% $ 20,284 5.59% $ 16,156 5.43%
</TABLE>
(1) Net loans include mortgage loans held for sale.
(2) In 1997, the Company capitalized $68,000 of interest expense related to the
carrying cost of construction in progress. If the capitalized interest had
been included in interest expense the average cost of total
interest-bearing liabilities, net interest spread, and net interest margin
would have been 5.11%, 4.75% and 5.64%, respectively.
The following table presents the extent to which changes in interest rates and
changes in the volume of earning assets and interest-bearing liabilities have
affected the Company's interest income and expense during the years indicated.
<PAGE> 18
RATE/VOLUME ANALYSIS
<TABLE>
<CAPTION>
(dollars in thousands)
1997 VS. 1996 1996 VS. 1995 1995 VS. 1994
ASSETS INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
--------------------------- --------------------------- ---------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL VOLUME RATE TOTAL
------- ----- ------- ------- ----- ------- ------- ----- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income on:
Loans $ 2,784 $ (77) $ 2,707 $ 2,164 $ 85 $ 2,249 $ 1,287 $ 828 $ 2,115
Taxable securities (18) 83 65 (185) (14) (199) 47 95 142
Tax exempt securities (12) 7 (5) (28) (3) (31) 5 1 6
Federal funds sold (3) -- (3) (6) (1) (7) (35) 2 (33)
- ----------------------------------------------------------------------------------------------------------------------
Total interest income 2,751 13 2,764 1,945 67 2,012 1,304 926 2,230
- ----------------------------------------------------------------------------------------------------------------------
Interest expense on:
Interest checking 26 (1) 25 2 (12) (10) 11 1 12
Money market accounts 97 (24) 73 53 32 85 (43) 218 175
Savings accounts 5 1 6 6 1 7 14 (1) 13
Retirement accounts 14 (5) 9 (4) (12) (16) 30 31 61
Certificates of deposit 894 (40) 854 595 170 765 417 473 890
Other borrowings 318 7 325 67 (10) 57 35 20 55
- ----------------------------------------------------------------------------------------------------------------------
Total interest expense 1,354 (62) 1,292 719 169 888 464 742 1,206
- ----------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME $ 1,397 $ 75 $ 1,472 $ 1,226 $(102) $ 1,124 $ 840 $ 183 $ 1,024
</TABLE>
Changes attributable to changes in both rate and volume have been allocated to
rate.
PROVISION FOR LOAN LOSSES. The provision for loan losses is the charge to
operating income that management determines to be necessary to maintain the
allowance for loan losses at an adequate level, and reflects management's
estimate of the risk of loss inherent in the loan portfolio. The provision for
loan losses was $676,000, $485,000 and $374,000 in 1997, 1996 and 1995,
respectively. The provision has increased to cover the growth in the loan
portfolio and the increase in net chargeoffs. Net chargeoffs to average
portfolio loans outstanding (excludes mortgage loans held for sale) was .26%
($311,000), .23% ($208,000) and .18% ($129,000) for 1997, 1996 and 1995,
respectively.
NONINTEREST INCOME. Besides the attention to net interest income, the Company
focuses on its ability to generate additional noninterest income from both core
business and newer initiatives, such as brokerage services and insurance.
Excluding securities gains or losses, noninterest income contributed 32%, 35%
and 33% in 1997, 1996 and 1995, respectively, of tax equivalent revenues. Total
noninterest income (excluding securities gains or losses in all periods)
increased 8%, 33% and 14% in 1997, 1996 and 1995, respectively. Noninterest
income (excluding securities gains or losses) as a percentage of average assets
was 2.45%, 2.81% and 2.49% for 1997, 1996 and 1995, respectively.
Service charges on deposit accounts (the largest component of noninterest
income) increased $172,000 (12%), $60,000 (5%) and $186,000 (16%) in 1997, 1996
and 1995, respectively. Income from mortgage banking activities fell $159,000
(19%) in 1997, following an increase of $365,000 (74%) in 1996, and a decline of
$98,000 (17%) in 1995. The brokerage subsidiary's first two years of operations
under the broker/dealer relationship Robert Thomas Securities resulted in
increased brokerage fees of $92,000 (34%) and $191,000 (332%) in 1997 and 1996,
following an increase of $9,000 (13%) in 1995. In prior years, the Bank received
commissions from life and disability
<PAGE> 19
insurance sales to its borrowers. In the second half of 1996, the Bank formed a
reinsurance subsidiary to receive additional underwriting profits from writing
life and disability insurance. Life and disability insurance premiums were
$258,000 in 1997 and $81,000 in 1996. In 1998, additional emphasis will be
placed on the sale of bank-eligible insurance products.
NONINTEREST EXPENSE. Noninterest expense is significant to the Company's
financial performance. Management is continually challenged to control operating
costs and improve efficiencies while still providing higher levels of customer
service. Noninterest expense increased $1,165,000 (20%), $1,255,000 (27%) and
$466,000 (11%) in 1997, 1996 and 1995, respectively. The ratio of noninterest
expense as a percentage of average assets was 4.74%, 4.90% and 4.52% for 1997,
1996 and 1995, respectively.
Salaries and employee benefits, the largest component of noninterest expense,
increased 16% in 1997 compared to 37% and 10% in 1996 and 1995, respectively.
The Bank's rapid growth was largely attributable to the increase in compensation
costs during the last three years. In addition, the 1997 increase was due to the
employment of additional commercial lenders and personnel expense associated
with the new consumer finance subsidiary. The 1996 increase was also due to the
expansion of the brokerage service subsidiary and personnel costs of an
additional branch opened in late 1995. The ratio of personnel expense as a
percentage of average assets was 2.44% in 1997, compared to 2.62% and 2.24%,
respectively, for 1996 and 1995. Salaries and employee benefits include
commissions paid in the brokerage service and mortgage banking operation. As the
revenues increase or decrease in these business lines, the commissions change
accordingly. Also, contributions to the employee incentive bonus and ESOP
pension plans are contingent upon the Company attaining certain asset growth
and/or net income goals which are predetermined annually. The contributions to
these plans increase or decrease in relationship to the level of asset growth
and/or net income achieved.
Furniture and equipment expense increased 72% or $299,000 in 1997, compared to
12% and 11% in 1996 and 1995, respectively. The 1997 increase was related to the
ongoing effort to build the Bank's infrastructure to efficiently accommodate
future growth. Additional operating leases to upgrade the Bank's technology and
communications equipment, as well as, to expand its ATM network increased
equipment lease expense $252,000. Expense related to the reinsurance subsidiary
which began operations in 1996 amounted to $180,000 in 1997 and $75,000 in 1996.
All of the other noninterest expense categories increased in 1997, 1996 and
1995. These increases are the result of the Bank's rapid growth, the opening of
a new branch in late 1995, and costs related to generating noninterest income.
The Bank's occupancy expense and furniture and equipment expense is anticipated
to increase following the completion of the construction of the new main office
building in 1998, with an estimated construction cost of $4.5 million.
The Company monitors its expense ratio and utilizes the efficiency ratio as a
measure of its success in increasing revenues, while controlling expense. The
expense ratio (noninterest expense minus noninterest income, excluding
securities gains and losses divided by average assets) was 2.29%, 2.09% and
2.04%, respectively, for 1997, 1996 and 1995. The efficiency ratio which is
calculated
<PAGE> 20
excluding the same items divides noninterest expense by net interest income (TE)
plus noninterest income. The efficiency ratio was 61.59%, 60.61% and 59.73% for
1997, 1996 and 1995, respectively. Cost containment in 1998 and moving forward
is a management priority.
PROVISION FOR INCOME TAXES. The Company records a provision for income taxes
currently payable and for taxes payable in the future because of differences in
the timing of recognition of certain items for financial statement and income
tax purposes. The major differences between the effective tax rate applied to
the Company's financial statement income and the federal statutory rate is
caused by state income taxes, net of federal tax benefit, and interest on
tax-exempt securities and loans. The Company's effective tax rate was 36%, 37%
and 36% in 1997, 1996 and 1995, respectively. See Note 9 to the consolidated
financial statements for additional details of the Company's income tax
provision.
INVESTMENT PORTFOLIO. All of the Company's investment securities are classified
as available-for-sale. The carrying value of investment securities is summarized
as follows:
<TABLE>
<CAPTION>
(dollars in thousands)
December 31,
Investment Category 1997 1996
- ------------------- ---- ----
<S> <C> <C>
U.S. agencies $10,418 $11,341
Mortgage-backed securities 3,880 4,204
Tax-exempt securities 4,017 3,202
Equity securities 838 398
------- -------
Total $19,153 $19,145
======= =======
</TABLE>
The following table presents the carrying value by maturity distribution of the
investment portfolio along with weighted average yields thereon as of December
31, 1997.
<TABLE>
<CAPTION>
(dollars in thousands)
Within 1-5 5-10 Beyond 10
Investment Category 1 Year Years Years Years Total
- ------------------- ------ ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
U.S. agencies $3,228 $5,179 $2,011 $0 $10,418
Tax-exempt securities 477 1,918 777 845 4,017
------ ------ ------ ----- -------
Total $3,705 $7,097 $2,788 $ 845 $14,435
====== ====== ====== ===== =======
Weighted average yield (tax
equivalent basis) 5.52% 6.36% 7.32% 6.95% 6.36%
====== ====== ====== ===== =======
Mortgage-backed and equity securities $4,718
======
Weighted average yield of mortgage-backed and equity securities 6.59%
======
</TABLE>
<PAGE> 21
LOAN PORTFOLIO. The following table presents as of December 31, 1997 and 1996, a
summary of loans outstanding by category.
<TABLE>
<CAPTION>
(dollars in thousands)
As of December 31,
--------------------------
Type of Loan 1997 1996
- ------------ ------- -------
<S> <C> <C>
Domestic:
Real estate:
1-4 family residential $ 30,396 $ 22,336
Construction 16,759 16,729
Commercial 41,210 26,077
Commercial, financial and
agricultural 23,114 20,291
Consumer 23,579 18,379
-------- --------
135,058 103,812
Less: unearned interest (208) (35)
-------- --------
Total loans $134,850 $103,777
======== ========
</TABLE>
The following is a presentation of portfolio loans (excludes mortgage loans held
for sale) by contractual maturity as of December 31, 1997.
<TABLE>
<CAPTION>
(dollars in thousands) Over 1
1 year through Over 5
Type of Loan or less 5 years years Total
- ------------ ------- ------- ------- -------
<S> <C> <C> <C> <C>
Domestic:
Real estate:
1-4 family residential $ 7,491 $ 2,156 $20,749 $ 30,396
Construction 15,809 587 363 $ 16,759
Commercial 9,568 6,540 25,102 $ 41,210
Commercial, financial
and agricultural 15,044 6,256 1,814 $ 23,114
Consumer 7,395 11,103 5,081 $ 23,579
------- ------- ------- --------
Total $55,307 $26,642 $53,109 $135,058
======= ======= ======= ========
</TABLE>
At December 31, 1997, portfolio loans due after one year with predetermined
interest rates totaled $23,654,000, and portfolio loans due after one year with
floating or adjustable interest rates totaled $56,097,000.
<PAGE> 22
The following table presents information regarding nonperforming assets and
accruing loans which are contractually past due 90 days or more as to principal
or interest payments. Nonperforming assets consist of (a) nonaccrual loans, (b)
restructured loans, and (c) foreclosed and repossessed assets.
<TABLE>
<CAPTION>
(dollars in thousands)
December 31, December 31,
Nonperforming Assets: 1997 1996
- --------------------- ---- ------
<S> <C> <C>
Nonaccrual loans $ 95 $ 173
Restructured loans 82 86
Accruing loans which are contractually
past due 90 days or more as to
principal and interest payments 451 935
Foreclosed and repossessed assets 225 74
---- ------
Total nonperforming asset $853 $1,268
==== ======
</TABLE>
A loan is considered impaired when it is probable that the Company will be
unable to collect the scheduled payments of principal and interest due under the
contractual terms of the loan agreement. Impaired loans are measured at the
present value of expected cash flows discounted at the loan's effective interest
rate, at the loan's observable market price, or at the fair value of the
collateral if the loan is collateral dependent.
The Company considers all loans on nonaccrual to be impaired. Interest accruals
on loans are discontinued when, in the opinion of management, it is not
reasonable to expect that such interest will be collected, or generally, when
collection of principal or interest becomes 90 days or more past due. Management
may make exceptions to this policy when the estimated net realizable value of
the collateral is sufficient to recover the principal and interest balance. When
interest accrual is discontinued, all unpaid accrued interest is reversed.
Interest income is subsequently recognized only to the extent cash payments are
received.
Interest income that would have been earned on nonaccrual loans if the loans had
been current in accordance with their original terms and had been outstanding
throughout the period amounted to $27,000 and $13,000 in 1997 and 1996,
respectively. Interest income recognized on nonaccrual loans amounted to $4,000
and $5,000 in 1997 and 1996, respectively.
Potential problem loans, which are not included in nonperforming assets, were
$2,814,000 of total loans at December 31, 1997, as compared to $447,000 of total
loans at December 31, 1996. The increase from 1996 to 1997 is primarily due to
three commercial real estate loans in the Bank's primary market totaling $2.2
million. Potential problem assets represent those assets where information about
possible credit problems of borrowers has caused management to have serious
doubts about the borrower's ability to comply with present repayment terms. This
definition is
<PAGE> 23
believed to be substantially consistent with the standards established by
banking regulatory agencies for loans classified substandard and doubtful.
There are no other loans which are not disclosed above, but where known
information about possible credit problems of borrowers causes management to
have serious doubts as to the ability of such borrowers to comply with the
present loan repayment terms.
As of December 31, 1997, the Bank had no concentrations of ten percent or more
of total loans in any single industry nor any geographical area outside the
immediate market area of the Bank.
Although the Company's loan portfolio is concentrated in Montgomery County,
Tennessee and the surrounding counties in Tennessee and Kentucky, management
does not believe this geographic concentration presents an abnormally high risk.
<PAGE> 24
SUMMARY OF LOAN LOSS EXPERIENCE. The activity in the Bank's allowance for loan
losses is presented in the following table for the years ended December 31, 1997
and 1996.
<TABLE>
<CAPTION>
(dollars in thousands)
Years Ended December 31,
------------------------
1997 1996
------ ------
$1,544 $1,267
------ ------
<S> <C> <C>
Balance at beginning of period
Charge-offs:
Real estate:
1-4 family residential 0 0
Construction 0 0
Commercial 0 0
Commercial, financial and
agricultural 129 93
Consumer 212 151
------ ------
341 244
------ ------
Recoveries:
Real estate:
1-4 family residential 0 0
Construction 0 0
Commercial 0 0
Commercial, financial and
agricultural 8 29
Consumer 21 7
------ ------
29 36
------ ------
Net charge-offs 312 208
------ ------
Additions charged to operations 676 485
------ ------
Balance at end of period $1,908 $1,544
====== ======
Ratio of net charge-offs to average
portfolio loans outstanding
during the periods (excludes
mortgage loans held for sale) 0.26% 0.23%
====== ======
</TABLE>
<PAGE> 25
At December 31, 1997 and 1996, the allowance for loan losses was allocated as
follows:
<TABLE>
<CAPTION>
(dollars in thousands)
December 31, 1997 December 31, 1996
------------------------------- -----------------------------
% of loans % of loans
in each category in each category
Amount to total loans Amount to total loans
------ ------------- ------ --------------
<S> <C> <C> <C> <C>
Real estate:
1-4 family residential $ 238 22.5% $ 129 21.5%
Construction 170 12.4% 125 16.1%
Commercial 425 30.5% 160 25.1%
Commercial, financial & agricultural 317 17.1% 265 19.6%
Consumer 303 17.5% 231 17.7%
Unallocated 455 N/A 634 N/A
------ ----- ------ -----
Total $1,908 100% $1,544 100%
====== ===== ====== =====
</TABLE>
DEPOSITS. The following tables present, for the periods indicated, the average
amount of and average rate paid on each of the following deposit categories:
<TABLE>
<CAPTION>
(dollars in thousands)
Year Ended Year Ended
December 31, 1997 December 31, 1996
------------------------ ------------------------
Average Average Average Average
Deposit Category Amount Rate Paid Amount Rate Paid
- ---------------- ------ --------- ------ ---------
<S> <C> <C> <C> <C>
Non interest-bearing demand $ 17,071 0 $ 15,747 0
Interest checking 9,757 2.07% 8,523 2.09%
Money market accounts 21,911 4.21% 19,656 4.31%
Savings deposits 5,188 2.47% 4,976 2.46%
Retirement accounts 3,479 5.38% 3,227 5.51%
Certificates of deposit 68,728 5.86% 53,626 5.92%
-------- --------
Total $126,134 $105,755
======== ========
</TABLE>
<PAGE> 26
The following table presents the amount outstanding of time certificates of
deposit of $100,000 or more and respective maturities for the years ended
December 31, 1997 and 1996.
<TABLE>
<CAPTION>
(dollars in thousands)
December 31, December 31,
1997 1996
------- ------
<S> <C> <C>
3 months or less $ 3,178 $1,984
3 to 6 months 2,482 629
6 to 12 months 3,379 2,854
over 12 months 2,632 743
------- ------
Total $11,671 $6,210
======= ======
</TABLE>
RETURN ON EQUITY AND ASSETS. Return on average assets (ROA), return on average
stockholders' equity (ROE), average equity to average assets ratio, and dividend
payout ratio for the periods indicated are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1996
----- -----
<S> <C> <C>
Return on average assets 1.55% 1.76%
Return on average equity 18.65% 20.27%
Average equity to average assets ratio 8.33% 8.69%
Dividend payout ratio 29.54% 26.04%
</TABLE>
SHORT-TERM BORROWINGS. The Company did not have any category of short-term
borrowings for which the average balance outstanding during the reported periods
was 30 percent or more of stockholders' equity at the end of the reported
periods.
ITEM 7. FINANCIAL STATEMENTS.
<PAGE> 27
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Heritage Financial Services, Inc.
We have audited the consolidated balance sheets of Heritage Financial Services,
Inc. and Subsidiary as of December 31, 1997 and 1996, and the related
consolidated statements of operations, changes in stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1997. 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Heritage Financial
Services, Inc. and Subsidiary as of December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for mortgage servicing rights in 1996.
HEATHCOTT & MULLALY, P.C.
January 14, 1998
<PAGE> 28
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
Consolidated Balance Sheets
December 31, 1997 and 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Assets 1997 1996
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and due from banks $ 4,531,237 3,598,438
Securities, available-for-sale, at fair value 19,153,082 19,144,724
Mortgage loans held for sale 631,486 2,333,480
Loans 134,850,045 103,777,428
Allowance for loan losses (1,908,420) (1,544,123)
- --------------------------------------------------------------------------------------------------
Net loans 132,941,625 102,233,305
- --------------------------------------------------------------------------------------------------
Premises and equipment 5,461,051 2,490,820
Accrued interest receivable 1,584,622 1,293,007
Deferred income taxes 590,213 571,797
Foreclosed and repossessed assets 225,132 73,450
Other assets 964,434 1,044,426
- --------------------------------------------------------------------------------------------------
Total assets $ 166,082,882 132,783,447
==================================================================================================
Liabilities and Stockholders' Equity
- --------------------------------------------------------------------------------------------------
Deposits:
Noninterest-bearing $ 18,821,225 17,184,748
Interest-bearing 115,559,087 98,126,860
- --------------------------------------------------------------------------------------------------
Total deposits 134,380,312 115,311,608
- --------------------------------------------------------------------------------------------------
Federal funds purchased and other short-term borrowings 8,150,000 4,850,000
Long-term borrowings 8,785,688 183,159
Accrued interest payable 555,956 442,872
Other liabilities 958,275 732,606
- --------------------------------------------------------------------------------------------------
Total liabilities 152,830,231 121,520,245
- --------------------------------------------------------------------------------------------------
Stockholders' equity:
Common stock, $2.00 par value. Authorized
1,000,000 shares; issued 568,574 shares
in 1997 and 551,367 shares in 1996 1,137,147 1,102,734
Additional paid-in capital 5,078,587 4,842,482
Retained earnings 6,980,416 5,358,522
Unrealized gains (losses) on securities
available-for-sale, net 56,501 (40,536)
- --------------------------------------------------------------------------------------------------
Total stockholders' equity 13,252,651 11,263,202
- --------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 166,082,882 132,783,447
==================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 29
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
Consolidated Statements of Operations
Years Ended December 31, 1997, 1996 and 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income:
Loans, including fees $ 12,453,155 9,741,973 7,479,626
Investment securities:
Taxable 994,678 930,172 1,129,585
Tax-exempt 168,158 171,462 192,492
Federal funds sold -- 2,534 8,452
- -----------------------------------------------------------------------------------------------------
Total interest income 13,615,991 10,846,141 8,810,155
- -----------------------------------------------------------------------------------------------------
Interest expense:
Deposits 5,468,212 4,500,893 3,669,951
Other 453,887 128,590 71,267
- -----------------------------------------------------------------------------------------------------
Total interest expense 5,922,099 4,629,483 3,741,218
- -----------------------------------------------------------------------------------------------------
Net interest income 7,693,892 6,216,658 5,068,937
Provision for loan losses 675,700 485,000 374,000
- -----------------------------------------------------------------------------------------------------
Net interest income after provision
for loan losses 7,018,192 5,731,658 4,694,937
- -----------------------------------------------------------------------------------------------------
Noninterest income:
Service charges on deposit accounts 1,555,017 1,383,177 1,323,463
Mortgage banking activities 696,312 854,934 490,156
Net securities gains (losses) (2,376) 83,126 1,986
Brokerage fees 365,321 273,029 82,180
Life and disability insurance premiums 258,395 80,716 --
Other 752,598 770,186 632,636
- -----------------------------------------------------------------------------------------------------
Total noninterest income 3,625,267 3,445,168 2,530,421
- -----------------------------------------------------------------------------------------------------
Noninterest expenses:
Salaries and employee benefits 3,617,344 3,129,271 2,280,444
Occupancy 548,209 487,334 407,443
Furniture and equipment 716,445 417,587 372,519
Data processing 469,602 412,363 365,478
Advertising and public relations 301,479 280,536 262,834
Life and disability insurance benefits and expenses 179,629 75,250 --
Other 1,185,816 1,050,800 909,915
- -----------------------------------------------------------------------------------------------------
Total noninterest expenses 7,018,524 5,853,141 4,598,633
- -----------------------------------------------------------------------------------------------------
Income before income taxes 3,624,935 3,323,685 2,626,725
- -----------------------------------------------------------------------------------------------------
Income taxes 1,322,991 1,218,685 939,816
- -----------------------------------------------------------------------------------------------------
Net income $ 2,301,944 2,105,000 1,686,909
=====================================================================================================
Net income per share $ 4.15 3.93 3.23
Net income per share - assuming dilution 4.11 3.84 3.12
=====================================================================================================
Average number of common shares 554,204 535,407 522,587
Average number of common shares - assuming
dilution 560,162 547,900 540,001
=====================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 30
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity
Years Ended December 31, 1997, 1996 and 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
UNREALIZED
ADDITIONAL GAINS
COMMON PAID-IN RETAINED (LOSSES) ON TOTAL
STOCK CAPITAL EARNINGS SECURITIES EQUITY
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1994 1,028,254 4,369,908 2,511,126 (453,022) 7,456,266
Dividends declared, $0.75 per share -- -- (397,128) -- (397,128)
Exercise of stock options 30,840 123,360 -- -- 154,200
Purchase and retirement of common stock (80) (920) -- -- (1,000)
Issuance of common stock 230 2,645 -- -- 2,875
Change in unrealized loss on securities
available-for-sale -- -- -- 444,865 444,865
Net income -- -- 1,686,909 -- 1,686,909
- ------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1995 1,059,244 4,494,993 3,800,907 (8,157) 9,346,987
Dividends declared, $1.00 per share -- -- (547,385) -- (547,385)
Issuance of common stock 3,584 50,176 -- -- 53,760
Exercise of stock options 25,694 108,776 -- -- 134,470
Purchase and retirement of common stock (2,990) (37,993) -- -- (40,983)
Shares issued under employee benefit plan 17,202 226,530 -- -- 243,732
Change in unrealized loss on securities
available-for-sale -- -- -- (32,379) (32,379)
Net income -- -- 2,105,000 -- 2,105,000
- ------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1996 $ 1,102,734 4,842,482 5,358,522 (40,536) 11,263,202
Dividends declared, $1.20 per share -- -- (680,050) -- (680,050)
Issuance of common stock 3,744 56,156 -- -- 59,900
Exercise of stock options 29,006 136,024 -- -- 165,030
Purchase and retirement of common stock (3,963) (93,626) -- -- (97,589)
Shares issued under employee benefit plan 5,626 137,551 -- -- 143,177
Change in unrealized gain (loss) on
securities available-for-sale -- -- -- 97,037 97,037
Net income -- -- 2,301,944 -- 2,301,944
- ------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997 $ 1,137,147 5,078,587 6,980,416 56,501 13,252,651
========================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 31
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years Ended December 31, 1997, 1996 and 1995
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Increase (decrease) in cash and due from banks 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,301,944 2,105,000 1,686,909
Adjustments to reconcile net income to net
cash provided by operating activities:
Deferred income tax benefit (73,000) (117,000) (117,000)
Depreciation and amortization 359,288 356,122 366,113
Net securities (gains) losses 2,375 (83,126) (1,986)
Provision for loan losses 675,700 485,000 374,000
Net accretion of securities (95,396) (106,613) (77,646)
Mortgage loans originated for sale (37,526,362) (40,324,099) (25,763,263)
Proceeds from sale of mortgage loans 39,228,356 39,686,899 25,405,147
Increase in accrued interest receivable (291,615) (350,381) (178,026)
Increase in accrued interest payable 113,084 24,202 126,991
Increase in other liabilities 227,783 215,871 55,779
Other, net (143,939) (227,479) (104,349)
- ---------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 4,778,218 1,664,396 1,772,669
- ---------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from sales of securities available-for-sale 927,040 3,428,727 1,417,813
Maturities and redemptions of securities
available-for-sale 2,476,502 2,128,530 1,660,240
Maturities and redemptions of securities
held-to-maturity -- -- 745,743
Purchases of securities available-for-sale (3,115,758) (2,762,675) (1,478,906)
Purchases of securities held-to-maturity -- -- (617,177)
Advances to limited liability company -- (2,662) (485,157)
Net increase in other loans (31,384,020) (23,415,947) (17,571,893)
Purchases of premises and equipment, net (3,310,883) (463,995) (210,282)
- ---------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (34,407,119) (21,088,022) (16,539,619)
- ---------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Increase in deposits 19,068,704 15,253,430 14,972,753
Increase in federal funds purchased and
other short-term borrowings 3,300,000 3,450,000 280,000
Repayment of long-term borrowings (43,221) (37,633) (38,784)
Proceeds from long-term borrowings 8,645,750 -- --
Proceeds from issuance of common stock 224,930 188,230 157,075
Shares issued under employee benefit plan 143,177 243,732 --
Purchase and retirement of common stock (97,590) (40,983) (1,000)
Cash dividends paid (680,050) (547,385) (397,128)
- ---------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 30,561,700 18,509,391 14,972,916
- ---------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and
due from banks 932,799 (914,235) 205,966
Cash and due from banks at beginning of year 3,598,438 4,512,673 4,306,707
- ---------------------------------------------------------------------------------------------------------------
Cash and due from banks at end of year $ 4,531,237 3,598,438 4,512,673
===============================================================================================================
Supplemental disclosures of cash flow information:
Cash paid during year for interest $ 5,809,015 4,629,483 3,614,227
Cash paid during year for income taxes $ 1,436,788 1,416,594 1,059,102
===============================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 32
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
- --------------------------------------------------------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
Heritage Financial Services, Inc., through its subsidiary, Heritage
Bank, provides a variety of banking and investment services to
individuals and businesses from its seven locations in Clarksville and
Montgomery County, Tennessee. Its primary deposit products are demand
and savings deposits and certificates of deposit, and its primary
lending products are commercial, real estate mortgage and installment
loans. The Bank provides investment services through Heritage
Investment Center, Inc., insurance services through Central Life
Insurance Company, and consumer loans through Advance Credit Company
Inc., wholly-owned subsidiaries of the Bank (see Note 16). The
accounting principles followed and the methods of applying those
principles conform with generally accepted accounting principles and to
general practices in the banking industry. The significant policies
are summarized as follows:
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the
accounts of Heritage Financial Services, Inc. (the Company), a
one-bank holding company formed April 15, 1992, and its wholly-owned
subsidiary, Heritage Bank (the Bank). Material intercompany accounts
and transactions have been eliminated in consolidation.
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 could differ
from those estimates.
CASH AND CASH EQUIVALENTS
For the purpose of presentation in the statements of cash flows, cash
and cash equivalents are defined as those amounts included in the
balance sheet caption "cash and due from banks".
INVESTMENT SECURITIES
Securities are classified into three categories: held-to-maturity
(HTM), available-for-sale (AFS), and trading. Securities classified as
held-to-maturity, which are those the Company has the positive intent
and ability to hold to maturity, are reported at amortized cost.
Securities classified as available-for-sale may be sold in response to
changes in interest rates, liquidity needs, and for other purposes.
These securities are reported at fair value and include securities not
classified as held-to-maturity or trading. Trading securities are those
held principally for the purpose of selling in the near future and are
carried at fair value. Unrealized holding gains and losses for
available-for-sale securities are excluded from earnings and reported,
net of any income tax effect, as a separate component of stockholders'
equity. Realized gains and losses are reported in earnings based on
the adjusted cost of the specific security sold. The Company currently
has no held-to-maturity or trading securities.
LOANS
Loans which management has the intent and ability to hold for the
foreseeable future are reported at their outstanding principal
balance. Interest on commercial and real estate loans is computed
daily based on the principal amount outstanding. Interest on
installment loans is recognized using both the interest method and a
method which approximates the interest method. Loan origination fees
in excess of related direct costs are deferred and recognized as an
adjustment of yield using the interest method.
<PAGE> 33
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
LOANS, CONTINUED
A loan is considered impaired when it is probable that the Company
will be unable to collect the scheduled payments of principal and
interest due under the contractual terms of the loan agreement.
Impaired loans are measured at the present value of expected future
cash flows discounted at the loan's effective interest rate, at the
loan's observable market price, or at the fair value of the collateral
if the loan is collateral dependent. If the measure of the impaired
loan is less than the recorded investment in the loan, a creditor
shall recognize an impairment by creating or adjusting a valuation
allowance with a corresponding charge or credit to the provision for
loan losses.
The Company considers all loans on non-accrual status to be impaired.
Interest accruals on loans are discontinued when, in the opinion of
management, it is not reasonable to expect that such interest will be
collected, or generally, when collection of principal or interest
becomes 90 days or more past due. Management may make exceptions to
this policy when the estimated net realizable value of the collateral
is sufficient to recover the principal and interest balance. When
interest accrual is discontinued, all unpaid accrued interest is
reversed. Interest income is subsequently recognized only to the
extent cash payments are received.
MORTGAGE LOANS HELD FOR SALE
Certain mortgage loans held for sale to permanent investors are stated
at lower of cost or market in the aggregate with respect to the entire
portfolio. At December 31, 1997, cost approximates the market value of
such loans.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established by charges to operations
based on management's evaluation of the assets, economic conditions
and other factors considered necessary to maintain the allowance at an
adequate level. In evaluating the adequacy of the allowance, management
makes certain estimates and assumptions which are susceptible to
change in the near term. While management uses available information
to recognize losses on loans, future additions to the allowance may be
necessary based on changes in economic conditions. Uncollectible loans
are charged to the allowance account in the period such determination
is made. Recoveries on loans previously charged off are credited to
the allowance account in the period received. Allowances for impaired
loans are generally determined based on collateral values or the
present value of estimated cash flows.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, less accumulated
depreciation and amortization. The provision for depreciation is
computed principally on the straight-line method over the estimated
useful lives of the assets.
FORECLOSED AND REPOSSESSED ASSETS
Real estate acquired through foreclosure is recorded at the lower of
the outstanding loan amount or fair value, determined by appraisal,
less estimated costs to sell, at the date of foreclosure. Other
repossessed assets are recorded at the lower of the loan amount or fair
value, determined by recognized industry standards at the date the
properties are repossessed. Further declines in value, as well as
losses resulting from disposition are charged to operations.
<PAGE> 34
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
PER SHARE AMOUNTS
Earnings per share (EPS) is calculated in accordance with Statement of
Financial Accounting Standards (SFAS) NO. 128, issued in February,
1997. The statement requires the dual presentation of basic and
diluted EPS on the income statement. Basic EPS excludes dilution, and
is computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period.
Diluted EPS reflects the potential dilution that could occur if
securities or contracts to issue common stock were exercised or
converted into common stock that then shared in the earnings of the
entity. All prior period EPS data has been restated to reflect
implementation of this statement.
MORTGAGE SERVICING RIGHTS
Effective January 1, 1996, the Company adopted SFAS No. 122,
"Accounting for Mortgage Servicing Rights". SFAS No. 122, among other
provisions, requires the recognition of originated mortgage servicing
rights (OMSRs) as assets by allocating the carrying value between the
loan and the servicing rights based on their fair value. To determine
the fair value of the servicing rights created, the Company uses
market prices under comparable servicing sale contracts. The OMSRs are
being amortized as noninterest expense over the period of estimated
net servicing revenues. The Company has no purchased mortgage servicing
rights.
STOCK-BASED COMPENSATION
In October, 1995, the Financial Accounting Standards Board issued SFAS
No. 123, "Accounting for Stock-Based Compensation", which is effective
for awards granted in fiscal years beginning after December 31, 1995.
The standard defines a fair value-based method of measuring employee
stock options or similar equity instruments. Under this method,
compensation cost is measured at the option grant date based on the
value of the award and is recognized over the service period, which is
usually the vesting period. In lieu of recording the value of such
options, the Company has elected to continue to measure compensation
cost using APB Opinion 25 and to provide pro forma disclosures
quantifying the difference between compensation cost included in
reported net income and the related cost measured by such fair
value-based method.
TRANSFER AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF
LIABILITIES
Effective January 1, 1997, the Company Adopted SFAS NO. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities". The statement, which supercedes SFAS
No. 122, provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities based
on application of a financial-components approach that focuses on
control. It distinguishes transfers of financial assets that are sales
from transfers of assets that are secured borrowings. The adoption of
SFAS 125 did not have a material effect on the Company's financial
position or results of operations.
INCOME TAXES
The Company files a consolidated tax return with its subsidiary.
Income taxes are allocated to members of the consolidated group on a
separate return basis. Income taxes have been provided using the
liability method as prescribed by Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes".
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is
practicable to estimate that value. These fair values are provided for
disclosure purposes only and do not impact carrying values of financial
statement amounts.
Cash and Cash Equivalents - The carrying amounts reported in the
balance sheet for cash and cash equivalents approximate those assets'
fair values.
<PAGE> 35
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
FAIR VALUE OF FINANCIAL INSTRUMENTS, CONTINUED
Securities (including mortgage-backed securities) - Fair values for
securities are based on quoted market prices, where available. If
quoted market prices are not available, fair values are based on
quoted market prices of comparable instruments.
Loans Receivable - For variable-rate loans that reprice frequently and
have no significant change in credit risk, fair values are based on
carrying values. The fair values for other loans are estimated using
discounted cash flow analyses, using interest rates currently offered
for loans with similar terms to borrowers of similar credit quality.
Deposit Liabilities - The fair values disclosed for demand deposits
are, by definition, equal to the amount payable on demand at the
reporting date (i.e., their carrying amounts). The carrying amounts
for variable-rate, fixed-term money market accounts and certificates of
deposits approximate their fair values at the reporting date. Fair
values for fixed-rate certificates of deposit are estimated using a
discounted cash flow calculation that applies interest rates currently
offered on certificates to a schedule of expected monthly maturities on
time deposits.
Short-Term Borrowings - The carrying amounts of short-term borrowings
approximate their fair values.
Long-Term Borrowings - The fair values of long-term borrowings are
estimated using discounted cash flow analyses, based on the Company's
current incremental borrowing rates for similar types of borrowing
arrangements.
Accrued Interest - The carrying amounts of accrued interest approximate
their fair values.
Off-Balance Sheet Instruments - Fair values for off-balance sheet
lending commitments are based on fees currently charged to enter into
similar agreements, taking into account the remaining terms of the
agreements and the counterparties' credit standings.
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the FASB issued SFAS No. 129, "Disclosure of
Information about Capital Structure." The statement establishes
standards for disclosing information about an entity's capital
structure and applies to all entities. This statement continues the
previous requirements to disclose certain information about an
entity's capital structure found in Accounting Principles Board
("APB") Opinions No. 10, "Omnibus Opinion - 1966", and No. 15,
"Earnings Per Share", and SFAS No. 47, "Disclosure of Long-Term
Obligations", for entities that were subject to those standards. This
statement is effective for financial statements for periods ending
after December 15, 1997. This statement contains no change in
disclosure requirements for entities that were previously subject to
the requirements of APB Opinions Nos. 10 and 15 and SFAS No. 47. The
adoption of the provisions of this statement is not expected to have a
material impact on the Company.
In July 1997, the FASB issued SFAS No. 130, "Comprehensive Income".
The statement establishes standards for reporting and presentation of
comprehensive income and its components (revenues, expenses, gains,
and losses) in a full set of general-purpose financial statements. It
requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported
in a financial statement that is presented with the same prominence as
other financial statements. This statement requires that companies (i)
classify items of other comprehensive income by their nature in a
financial statements and (ii) display the accumulated balance of other
comprehensive income separately from retained earnings and additional
paid-in capital in the equity section of the statement of financial
condition. This statement is effective for fiscal years beginning after
December 15, 1997. Reclassification of financial statements for
earlier periods provided for comprehensive purposes is required.
<PAGE> 36
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS, CONTINUED
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments
of an Enterprise and Related Information". The statement establishes
standards for disclosure about operating segments in annual financial
statements and selected information in interim financial reports. It
also establishes standards for related disclosures about products and
services, geographic areas, and major customers. This statement
supersedes SFAS No. 14, "Financial Reporting for Segments of a
Business Enterprise". This statement becomes effective for the Bank's
fiscal year ending December 31, 1998, and requires that comparative
information from earlier years be restated to conform to its
requirements. The adoption of the provisions of this statements is not
expected to have a material impact on the Company.
(2) RESTRICTED CASH BALANCES
The Company's subsidiary bank is required to maintain reserves, in the
form of cash and due from banks against its deposit liabilities.
Aggregate reserves of $803,000 were required to be maintained to
satisfy federal regulatory requirements at December 31, 1997.
(3) INVESTMENT SECURITIES
The following table reflects the amortized cost and fair values of
investment securities held at December 31, 1997 and 1996.
<TABLE>
<CAPTION>
1997
-------------------------------------------------------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE-FOR-SALE COST GAINS LOSSES VALUE
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. agencies $10,420,563 62,584 65,110 10,418,037
Mortgage-backed:
U.S. agencies 3,876,781 50,078 46,497 3,880,362
Tax-exempt securities 3,929,241 87,253 11 4,016,483
Equity securities 838,200 - - 838,200
-------------------------------------------------------------------------------------------------------------------------
$19,064,785 199,915 111,618 19,153,082
=========================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
1996
-------------------------------------------------------------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE-FOR-SALE COST GAINS LOSSES VALUE
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. agencies $11,446,346 26,608 132,153 11,340,801
Mortgage-backed:
U.S. agencies 4,230,377 52,500 78,686 4,204,191
Tax-exempt securities 3,133,226 72,552 4,146 3,201,632
Equity securities 398,100 - - 398,100
-------------------------------------------------------------------------------------------------------------------------
$19,208,049 151,660 214,985 19,144,724
=========================================================================================================================
</TABLE>
<PAGE> 37
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(3) INVESTMENT SECURITIES, CONTINUED
The amortized cost and fair value of debt securities at December 31,
1997 by contractual maturity are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the
right to call or prepay obligations.
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
---------------------------------
<S> <C> <C>
Available-for-Sale:
Due in one year or less $3,717,635 3,704,827
Due after one through five years 4,982,952 4,984,609
Due after five through ten years 4,816,239 4,901,082
Due after ten years 832,978 844,002
Mortgage-backed securities 3,876,781 3,880,362
--------------------------------
$18,226,585 18,314,882
================================
</TABLE>
Securities carried at $6,052,000 and $5,396,000 at December 31, 1997
and 1996, respectively, were pledged to secure public deposits and for
other purposes as required or permitted by law.
For the years ended December 31, 1997, 1996 and 1995, the Company had
gross realized gains from sales of securities available-for-sale of
$7,790, $85,988 and $3,142 respectively, and gross realized losses of
$10,165, $2,862, and $827, respectively.
(4) LOANS
A summary of loans outstanding by category follows:
<TABLE>
<CAPTION>
1997 1996
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Real estate:
1 to 4 family residential properties $ 30,396,000 22,336,000
Construction 16,759,000 16,729,000
Commercial 41,210,000 26,077,000
Commercial, financial and agricultural 23,114,000 20,291,000
Consumer 23,579,045 18,379,428
------------------------------------------------------------------------------------------------------------------------
135,058,045 103,812,428
Less unearned interest (208,000) (35,000)
------------------------------------------------------------------------------------------------------------------------
Total loans $134,850,045 103,777,428
========================================================================================================================
</TABLE>
At December 31, 1997 and 1996, the Bank had loans amounting to $95,270
and $173,065, respectively that were specifically classified as
impaired. The allowance for loan losses related to impaired loans
amounted to approximately $30,000 and $26,000 at December 31, 1997 and
1996, respectively. The average balance of these loans amounted to
approximately $186,000, $107,000 and $41,000 for the years ended
December 31, 1997, 1996 and 1995, respectively. The amount of interest
income recognized on these loans was not material to the Bank's
results of operations.
Certain parties (principally directors and officers of the Bank,
including their affiliates, families, and companies in which they hold
ten percent or more ownership) were customers of, and had loans and
other transactions with the Bank in the ordinary course of business.
The outstanding balances of such loans totaled $3,675,182 and
$1,907,677 as of December 31, 1997 and 1996, respectively. During
1997, $3,729,194 of new loans were made and repayments amounted to
$1,961,689. These loan transactions were made on substantially the
same terms as those prevailing at the time for comparable loans to
other persons. They did not involve more than the normal risk of
collectibility or present other unfavorable features.
<PAGE> 38
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(5) COMMITMENTS AND CONTINGENT LIABILITIES
The Bank 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, standby letters of credit and mortgage loans sold with
recourse. Those instruments involve, to varying degrees, elements of
credit risk in excess of the amount recognized in the balance sheet.
The contract or notional amounts of those instruments reflect the
extent of involvement the Bank has in those particular financial
instruments.
The Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend
credit, standby letters of credit, and mortgage loans sold with
recourse is represented by the contractual notional amount of those
instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance
sheet instruments.
<TABLE>
<CAPTION>
CONTRACT OR
NOTIONAL
AMOUNT
-----------
<S> <C>
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit $16,054,000
Standby letters of credit 662,000
</TABLE>
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of
the commitments are expected to expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash
requirements. The Bank evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained if deemed
necessary by the Bank upon extension of credit is based on management's
credit evaluation. Collateral held varies but may include accounts
receivable, inventory, property, plant and equipment, and
income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party.
Those guarantees are primarily issued to support public and private
borrowing arrangements, including commercial paper, bond financing, and
similar transactions. All letters of credit are due within one year or
less of the original commitment date. The credit risk involved in
issuing letters of credit is essentially the same as that involved in
extending loan facilities to customers.
In connection with its mortgage banking activities, the Bank may be
required to repurchase certain loans sold if they become delinquent
within a specified period, generally no longer than 120 days. The
number of loans the Bank has been required to repurchase since
inception of the mortgage banking department has not been material.
The Bank primarily serves customers located in Montgomery County,
Tennessee and surrounding areas. As such, the Bank's loans,
commitments, and stand-by letters of credit have been granted to
customers in that area. The area's largest employer is the United
States Army base at Fort Campbell which employs approximately 23,000
military personnel and 5,000 civilians. Concentration of credit by
type of loan is presented in Note 4.
In the normal course of business, the Bank is involved in various
legal proceedings. Management has concluded, based upon advice of
counsel, that the result of these proceedings will not have a material
effect on the Bank's financial condition or results of operations.
<PAGE> 39
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(6) ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
BALANCE AT BEGINNING OF YEAR $1,544,123 1,267,252 1,022,732
Provision charged to operating expenses 675,700 485,000 374,000
Loan losses:
Loans charged off (341,023) (244,581) (149,605)
Recoveries on loans previously charged off 29,620 36,452 20,125
-----------------------------------------------------------------------------------------------------------------------
BALANCE AT END OF YEAR $1,908,420 1,544,123 1,267,252
=======================================================================================================================
</TABLE>
(7) PREMISES AND EQUIPMENT AND LEASE COMMITMENTS
Annual provisions for depreciation and amortization totaled $340,173,
$339,916, and $353,381 for 1997, 1996 and 1995, respectively. The
following is a summary of bank premises and equipment as of December
31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Land $ 934,809 934,809
Buildings 884,868 884,868
Furniture and equipment 1,676,983 1,531,771
Leasehold improvements 366,547 348,010
Construction in progress 3,410,278 293,299
------------------------------------------------------------------------------------------------------------------------
7,273,485 3,992,757
Less allowance for depreciation and amortization 1,812,434 1,501,937
------------------------------------------------------------------------------------------------------------------------
$5,461,051 2,490,820
========================================================================================================================
</TABLE>
During 1996, construction was begun on a new main office building.
Total expenditures for the building are expected to be approximately
$4,500,000 with completion scheduled for 1998.
Included in construction in progress is $68,083 and $3,097 in 1997 and
1996, respectively of capitalized interest expense related to the
carrying cost of the construction in progress.
Rent expense for 1997, 1996 and 1995 was $523,458, $246,994, and
$148,372, respectively. Future minimum rental payments required under
operating leases that have initial or remaining non-cancelable lease
terms in excess of one year as of December 31, 1997 are as follows:
<TABLE>
<CAPTION>
Year Ending
December 31, Amount
------------ -------
<S> <C>
1998 515,582
1999 412,727
2000 292,341
2001 203,043
2002 38,231
Later years 6,050
</TABLE>
<PAGE> 40
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(8) DEPOSITS
A summary of deposits at December 31, 1997 and 1996 follows:
<TABLE>
<CAPTION>
1997 1996
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Noninterest-bearing demand $ 18,821,225 17,184,748
Interest checking 10,485,366 9,467,575
Money market accounts 22,353,707 20,755,654
Savings 5,195,774 5,471,362
Retirement accounts 3,546,987 3,298,158
Certificates of deposit of $100,000 or more 11,670,621 6,210,047
Other time 62,306,632 52,924,064
------------------------------------------------------------------------------------------------------------------------
$134,380,312 115,311,608
========================================================================================================================
</TABLE>
Interest expense on deposits of $100,000 or more amounted to $540,637,
$382,048 and $263,370 in 1997, 1996 and 1995, respectively.
(9) INCOME TAXES
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
1997 1996 1995
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CURRENT: Federal $1,174,841 1,118,052 877,376
State 221,150 217,633 179,440
-------------------------------------------------------------------------------------------------------------------------
Total current 1,395,991 1,335,685 1,056,816
-------------------------------------------------------------------------------------------------------------------------
DEFERRED: Federal (61,500) (98,500) (98,500)
State (11,500) (18,500) (18,500)
-------------------------------------------------------------------------------------------------------------------------
Total deferred (73,000) (117,000) (117,000)
-------------------------------------------------------------------------------------------------------------------------
Total provision for income taxes $1,322,991 1,218,685 939,816
=========================================================================================================================
</TABLE>
The sources of deferred income taxes (benefits) and the tax effect of
each follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Provision for loan losses $(119,000) (98,500) (84,000)
Depreciation (8,500) (24,500) (40,000)
Mortgage servicing rights 53,000 13,000 -
Other, net 1,500 (7,000) 7,000
--------------------------------------------------------------------------------------------------------------------------
$ (73,000) (117,000) (117,000)
==========================================================================================================================
</TABLE>
The tax effects of each type of temporary difference that gives rise
to net deferred tax assets are as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Allowance for loan losses $624,260 505,260
Property and equipment 70,000 61,500
Mortgage servicing rights (66,000) (13,000)
Other, net (6,260) (4,760)
Unrealized losses on securities (31,787) 22,797
-------------------------------------------------------------------------------------------------------------------------
$590,213 571,797
=========================================================================================================================
</TABLE>
<PAGE> 41
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(9) INCOME TAXES, CONTINUED
A reconciliation of the provision for income taxes with the amount of
income taxes computed at the federal statutory rate (34%) follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Tax expense at statutory rate $1,224,057 1,130,053 893,087
Increase (decrease) in taxes resulting from:
Tax exempt interest (57,153) (60,983) (78,598)
Disallowed interest expense 9,703 8,895 11,768
State income taxes, net of federal tax benefit 138,369 131,428 106,220
Other, net 8,015 9,292 7,339
-------------------------------------------------------------------------------------------------------------------------
Total provision for income taxes $1,322,991 1,218,685 939,816
=========================================================================================================================
</TABLE>
(10) LONG-TERM BORROWINGS
The Bank obtains various short-term and long-term advances from the
Federal Home Loan Bank of Cincinnati (FHLB) under Blanket agreements
for Advances and Security Agreements (Agreements). The Agreements
entitle the Bank to borrow funds from the FHLB to fund mortgage loan
programs and satisfy other funding needs. At December 31, 1997, the
Bank had lines of credit from the FHLB totaling $5.0 million, of which
$4.9 million was undrawn and available. Of the long-term advances at
December 31, 1997, $138,000 were at fixed rates ranging from 4.90% to
6.35%, and $8,648,000 were London Interbank Offered Rate (LIBOR-based)
floating-rate borrowings at a weighted-average rate of 5.80%. FHLB
advances are collateralized by the Bank's FHLB stock amounting to
$818,200 and certain single-family first mortgage loans in the
approximate amount of $20.7 million. The long-term advances provide
for scheduled monthly payments but may be prepaid at the option of the
Bank with the payment of a premium. The floating rate advances may
generally be prepaid at any monthly anniversary date at the current
outstanding principal balance.
Maturities of the FHLB advances are as follows:
<TABLE>
<S> <C>
1998 $ 42,153
1999 18,940
2000 14,850
2001 2,027,177
2002 16,139
Later years 6,666,429
----------
$8,785,688
==========
</TABLE>
(11) MORTGAGE SERVICING RIGHTS
The outstanding balance of loans serviced for others was $13,234,000
and $3,054,000 at December 31, 1997 and 1996, respectively. Mortgage
servicing rights of $155,800, and $33,100 were capitalized in 1997 and
1996, respectively. Amortization of those rights amounted to $14,400
in 1997 and $1,000 in 1996. The Company had no capitalized servicing
rights prior to 1996.
<PAGE> 42
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(12) STOCK COMPENSATION PLANS
The Company has two stock option plans, an Employee Stock Option Plan
and an Incorporator Stock Option Plan, which are described below. As
discussed in Note 1, The Company will continue to apply APB Opinion 25
and related Interpretations in accounting for its plans. Accordingly,
no compensation cost has been recognized for either plan. Had
compensation cost for the Company's plans been determined based on the
fair value at the grant date for awards under those plans consistent
with the method of FASB Statement No. 123, the Company's net income
would have been reduced by $15,000 ($.03 per share) in 1997 and $14,000
($.03 per share) in 1996.
The fair value of the options granted is estimated as of the date
granted using the Black-Scholes option pricing model with the
following weighted-average assumptions used for grants: dividend yield
of 4.0 percent, expected volatility of 34 percent, risk-free interest
rate of 6 percent, and expected lives of 5 years.
Employee Stock Option Plan - Adopted in 1989, this plan provides for
the granting of options to purchase up to 150,000 shares. The
per-share exercise price of the options may not be less than the fair
value of a share of common stock on the date the option is granted.
Options become exercisable over a period not to exceed ten years and
generally expire three months after employment is terminated.
Incorporator Stock Option Plan - Adopted in 1989, this plan provides
for the granting of options to purchase up to 35,000 shares for $10
per share (the fair value of the stock at the grant date). As of
December 31, 1997, all shares granted under this plan have been
exercised.
A summary of the status of the Company's stock option plans for the
three years ended December 31, 1997 and changes during those years is
presented below.
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
TOTAL OPTION EXERCISABLE EXERCISE
SHARES SHARES PRICE
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Options outstanding at December 31, 1994 56,270 45,270 11.07
Options which became exercisable - 1,500 14.00
Exercised (15,420) (15,420) 10.00
-------------------------------------------------------------------------------------------------------------------------
Options outstanding at December 31, 1995 40,850 31,350 11.47
Options which became exercisable - 1,500 14.00
Granted 10,050 - 25.00
Exercised (12,847) (12,847) 10.47
-------------------------------------------------------------------------------------------------------------------------
Options outstanding at December 31, 1996 38,053 20,003 11.47
Options which became exercisable - 2,000 16.75
Granted 11,069 - 36.61
Exercised (14,503) (14,503) 11.38
-------------------------------------------------------------------------------------------------------------------------
Options outstanding at December 31, 1997 34,619 7,500 23.84
=========================================================================================================================
</TABLE>
The weighted-average fair value of options, calculated using the
Black-Scholes option pricing model, granted during 1997 is $9.77.
<PAGE> 43
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(12) STOCK COMPENSATION PLANS, CONTINUED
The following table summarizes information about the stock options
outstanding under the Company's plans at December 31, 1997:
<TABLE>
<CAPTION>
AVERAGE
EXERCISE NUMBER REMAINING NUMBER
PRICE OUTSTANDING LIFE EXERCISABLE
---------- ----------- ---------- -----------
<S> <C> <C> <C>
10 7,000 1.5 years 7,000
12 3,000 2.5 years -
18 3,500 6.3 years -
25 10,050 5.6 years 500
32 8,069 4.0 years -
49 3,000 9.7 years -
</TABLE>
The effect of these options after applying the "treasury stock" method
was to increase average common shares outstanding by 5,958 in 1997,
12,493 in 1996, and 17,414 in 1995.
(13) OTHER NONINTEREST INCOME AND EXPENSES
Included in other noninterest income are fees for account receivable
processing of $317,991 in 1997, $151,709 in 1996, and $264,875 in 1995.
A summary of other noninterest expenses is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------------------------------------------------------------------------
<S> <C> <C> <C>
Communications $ 216,160 206,564 157,882
Supplies 285,693 235,702 157,844
FDIC and general insurance 48,139 38,646 131,361
Other 635,824 569,888 462,828
----------------------------------------------------------------------------
$1,185,816 1,050,800 909,915
============================================================================
</TABLE>
(14) EMPLOYEE BENEFITS
During 1992 the Company established a noncontributory Employee Stock
Ownership Plan ("ESOP"), which covers substantially all employees.
Employer contributions to the ESOP are determined annually by the
board of directors and amounted to $143,750 in 1997, $131,250 in 1996
and $110,000 in 1995.
The Company does not provide postretirement or postemployment benefits
other than those mentioned above.
(15) STOCKHOLDERS' EQUITY
Funds for cash distributions to shareholders and normal operating
expenses of the Company are derived primarily from dividends from the
subsidiary bank. The subsidiary is subject to federal and state
statutes and regulations that impose restrictions on the amount of
dividends that can be declared without prior regulatory approval. At
December 31, 1997, approximately $6,194,000 of retained earnings was
available for dividend declaration without prior regulatory approval.
<PAGE> 44
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(15) STOCKHOLDERS' EQUITY, CONTINUED
Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Company's subsidiary bank is required to
meet specific capital adequacy guidelines that involve quantitative
measures of a bank's assets, liabilities, and certain off-balance sheet
items as calculated under regulatory accounting practices. Failure to
meet minimum capital requirements can initiate certain mandatory and
possible additional discretionary actions by regulators that, if
undertaken, could have a material effect on the Company's financial
condition. The bank's capital amounts and classifications are also
subject to qualitative judgments by the regulators about components,
risk weightings, and other factors. The risk-based guidelines are
based on the assignment of risk weights to assets and off-balance
sheet items depending on the level of credit risk associated with
them.
In addition to minimum capital requirements, under the regulatory
framework for prompt corrective action, regulatory agencies have
specified certain ratios an institution must maintain to be considered
"undercapitalized", "adequately capitalized", and "well capitalized".
As of December 31, 1997 the most recent notification from the bank's
regulatory authority categorized the bank as "well capitalized". There
are no conditions or events since that notification that management
believes have changed the bank's category.
The bank's capital amounts and ratios at December 31, 1997 were as
follows:
<TABLE>
<CAPTION>
REQUIRED
TO BE REQUIRED
ADEQUATELY TO BE WELL BANK'S
CAPITALIZED CAPITALIZED ACTUAL
------------------------------------------------------------------------------------
<S> <C> <C> <C>
Amount
Tier I leverage 6,618,000 8,273,000 12,210,000
Tier I risk-based 5,397,000 6,746,000 12,210,000
Total risk-based 10,794,000 13,492,000 13,899,000
Ratio
Tier I leverage 4.00% 5.00% 7.38%
Tier I risk-based 4.00% 6.00% 9.05%
Total risk-based 8.00% 10.00% 10.30%
</TABLE>
(16) BANK SUBSIDIARIES
Heritage Investment Corporation (the Corporation) was incorporated
March 1, 1995, as a wholly-owned subsidiary of Heritage Bank. The only
asset of the Corporation is 40.5 percent of Bi-Banc Industrial
Development, L.L.C. (the LLC). The purpose of the LLC is to build for
speculative sale an industrial building in Clarksville, Tennessee. The
Bank has advanced approximately $490,000 to the LLC as its share of
construction costs. That amount is carried in the balance sheet in
other assets. In January, 1998, the LLC entered into a contract to sell
the industrial building. The net proceeds to Heritage Investment
Corporation is expected to amount to approximately $600,000. The
revenues from this transaction are not included in the 1997 results of
operations.
<PAGE> 45
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(16) BANK SUBSIDIARIES, CONTINUED
Heritage Investment Center (the Center) was incorporated June 28,
1995, as a wholly-owned subsidiary of Heritage Bank. On July 24, 1995,
the Center purchased the assets of an investment brokerage business.
Goodwill in the amount of $78,735 related to the purchase is being
amortized over five years. The Center is engaged in investment
brokerage activities under the broker/dealer relationship of Robert
Thomas Securities.
Central Life Insurance Company (Central) was incorporated December,
1996 as a wholly-owned subsidiary of Heritage Bank. Central has
entered into a reinsurance arrangement and receives underwriting
profits by providing life and disability insurance to borrowers of
Heritage Bank. Management services are provided to Central through a
third party.
Advance Credit Company, Inc. (Advance Credit) began operations in June,
1997 as a wholly-owned subsidiary of the Bank. Advance Credit is
located in Clarksville, Tennessee and originates traditional consumer
finance loans.
(17) FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
-------------------------------------------------------------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 4,531,237 4,531,237 3,598,438 3,598,438
Securities 19,153,082 19,153,082 19,144,724 19,144,724
Loans receivable 134,850,045 135,216,000 103,777,428 104,730,000
Financial liabilities:
Deposits $134,380,312 134,264,000 115,311,608 115,546,000
Short-term borrowings 8,150,000 8,150,000 4,850,000 4,850,000
Long-term borrowings 8,785,688 8,785,000 183,159 180,000
Off-balance sheet instruments:
NOTIONAL FAIR NOTIONAL FAIR
AMOUNT VALUE AMOUNT VALUE
------------------------------------------------------------------------------
Loan commitments $ 16,054,000 - 18,611,000 -
Letters of credit 662,000 - 740,000 -
</TABLE>
<PAGE> 46
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(18) PARENT COMPANY FINANCIAL INFORMATION
Following are condensed balance sheets of Heritage Financial Services,
Inc. (parent company only) as of December 31, 1997 and 1996, and the
related condensed statements of operations and cash flows for the
three years ended December 31, 1997.
<TABLE>
<CAPTION>
CONDENSED BALANCE SHEETS
DECEMBER 31, 1997 1996
-------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Cash $ 415,626 345,159
Securities available-for-sale 20,000 --
Investment in subsidiary bank, at equity 12,812,124 10,909,369
Other assets 5,901 9,674
-------------------------------------------------------------------------------------------
TOTAL ASSETS $13,253,651 11,264,202
===========================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Other liabilities $ 1,000 1,000
Stockholders' equity:
Common stock, $2.00 par value 1,137,147 1,102,734
Additional paid-in capital 5,078,587 4,842,482
Retained earnings 6,980,416 5,358,522
Unrealized gains (losses) on AFS securities, net 56,501 (40,536)
-------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 13,252,651 11,263,202
-------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $13,253,651 11,264,202
===========================================================================================
</TABLE>
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997 1996 1995
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INCOME:
Dividends from subsidiary $ 500,000 400,000 400,000
Other income -- 12,381 12,505
-----------------------------------------------------------------------------------------------
TOTAL INCOME 500,000 412,381 412,505
-----------------------------------------------------------------------------------------------
EXPENSES:
Other expenses 5,771 9,253 9,253
-----------------------------------------------------------------------------------------------
NET INCOME BEFORE INCOME TAXES AND EQUITY
IN UNDISTRIBUTED INCOME OF SUBSIDIARY 494,229 408,419 403,252
INCOME TAX EXPENSE (BENEFIT) (2,000) 4,000 656
-----------------------------------------------------------------------------------------------
NET INCOME BEFORE EQUITY IN
UNDISTRIBUTED EARNINGS OF SUBSIDIARY 496,229 404,419 402,596
EQUITY IN UNDISTRIBUTED EARNINGS
OF SUBSIDIARY 1,805,715 1,700,581 1,284,313
-----------------------------------------------------------------------------------------------
NET INCOME $2,301,944 2,105,000 1,686,909
===============================================================================================
</TABLE>
<PAGE> 47
- --------------------------------------------------------------------------------
HERITAGE FINANCIAL SERVICES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
- --------------------------------------------------------------------------------
(18) PARENT COMPANY FINANCIAL INFORMATION, CONTINUED
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997 1996 1995
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,301,944 2,105,000 1,686,909
Adjustments to reconcile net income to
net cash provided by operating activities:
Equity in undistributed earnings
of subsidiary (1,805,715) (1,700,581) (1,284,313)
Other, net 3,771 41,986 8,884
----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 500,000 446,405 411,480
----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of securities available-for-sale (20,000) -- --
----------------------------------------------------------------------------------------------------------
NET CASH USED BY INVESTING ACTIVITIES (20,000) -- --
----------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 224,930 188,230 157,075
Shares issued under employee benefit plan 143,177 243,732 --
Purchase and retirement of common stock (97,590) (40,983) (1,000)
Capital contributed to subsidiary -- -- (150,000)
Cash dividends paid (680,050) (547,385) (397,128)
----------------------------------------------------------------------------------------------------------
NET CASH USED BY FINANCING ACTIVITIES (409,533) (156,406) (391,053)
----------------------------------------------------------------------------------------------------------
NET INCREASE IN CASH 70,467 289,999 20,427
CASH AT BEGINNING OF YEAR 345,159 55,160 34,733
----------------------------------------------------------------------------------------------------------
CASH AT END OF YEAR $ 415,626 345,159 55,160
==========================================================================================================
</TABLE>
<PAGE> 48
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There have been no disagreements with the Company's independent auditors on any
matters of accounting principles or practices or financial statement disclosure.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
Information with respect to the directors and executive officers is incorporated
herein by reference to the proxy statement relating to the annual meeting of
shareholders to be held April 21, 1998.
Biographies of Executive Officers
Earl O. Bradley, III (age 42) has served as President, Chief Executive Officer
and Director of the Bank since its formation in 1989. Mr. Bradley is a 1977
graduate of Austin Peay State University with a bachelor's degree in accounting.
He is a certified public accountant and is a graduate of the University of
Wisconsin School for Bank Administration and Tennessee Commercial Lending School
held at Vanderbilt University.
John T. Halliburton (age 50) has served as Executive Vice President and
Secretary of the Board since its formation in 1989. Mr. Halliburton is a
graduate of Austin Peay State University with a bachelor's degree in business
administration. He is a graduate of the Tennessee Commercial Lending School held
at Vanderbilt University.
Biographies of Other Key Officers
Frank G. Wallace (age 47) has served as Vice President and Cashier of the Bank
since 1989. In charge of information systems, Mr. Wallace previously served as
Vice President of Dominion Bank of Middle Tennessee. Mr. Wallace is a graduate
of the School for Bank Administration at the University of Wisconsin and the
Vanderbilt School of Banking.
J. Randal Clouser (age 44) has served as Vice President\Commercial Lending since
1990. A banker of 15 years, Mr. Clouser previously served as a commercial loan
officer with Dominion Bank of Middle Tennessee. Mr. Clouser is a 1978 graduate
of Austin Peay State University.
Paul E. Schaaf (age 57) has served as Vice President\Commercial Lending since
1991. A veteran banker of 32 years, Mr. Schaaf previously served as Senior Vice
President of Dominion Bank of Middle Tennessee. Mr. Schaaf is a graduate of the
School for Bank Administration at the Banking School of the South at Louisiana
State University.
<PAGE> 49
David L. Watson (age 55) has served as Vice President\Marketing since joining
the Bank in 1994. Mr. Watson previously served as Vice President of Nationsbank
of Tennessee, and is a graduate of Austin Peay State University. Mr. Watson has
18 years of banking experience with specific emphasis in marketing, employee
training and consumer loan management.
Jack L. Graham (age 47) joined the Bank as Chief Financial Officer in 1995. Mr.
Graham previously served as President, Chief Executive Officer and Director of
Guaranty Federal Savings Bank in Clarksville, Tennessee. Mr. Graham is a
certified public accountant and is a graduate of Western Kentucky University
with bachelors' degrees in accounting and economics.
ITEM 10. EXECUTIVE COMPENSATION.
Information with respect to executive compensation is incorporated herein by
reference to the proxy statement relating to the annual meeting of shareholders
to be held April 21, 1998.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information with respect to the security ownership of certain beneficial owners
and management is incorporated herein by reference to the proxy statement
relating to the annual meeting of shareholders to be held April 21, 1998.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information with respect to certain relationships and related transactions is
incorporated herein by reference to the proxy statement relating to the annual
meeting of shareholders to be held April 21, 1998.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
(3) Articles of Incorporation and Bylaws*
(13) Annual Report to Shareholders
(20) Proxy Statement to the Annual Meeting of Shareholders
* Incorporated herein by reference to the Preeffective Amendment No. 2
to the Form S-4 Registration Statement of Heritage Financial Service,
Inc. filed with the Securities and Exchange Commission on January 23,
1992.
** Incorporated herein by reference to Item 7 -- Financial Statements.
(b) No Reports on Form 8-K were filed during the 1997 calendar year.
<PAGE> 50
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Heritage Financial Services, Inc.
(Registrant)
By Earl O. Bradley, III
--------------------------------
Earl O. Bradley, III
President and Chief Executive Officer
Date March 20, 1998
--------------
By Jack L. Graham
--------------------------------
Jack L. Graham
Chief Financial Officer
Date March 20, 1998
--------------
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By John T. Halliburton By W. Lawson Mabry
-------------------------------- --------------------------------
Date March 20, 1998 Date March 20, 1998
-------------- --------------
By James W. Russell By Jeffrey V. Bibb
-------------------------------- --------------------------------
Date March 20, 1998 Date March 20, 1998
-------------- --------------
<PAGE> 1
Exhibit 20
HERITAGE FINANCIAL SERVICES, INC.
25 Jefferson Street
Clarksville, Tennessee 37040
March 31, 1998
Dear Fellow Shareholder:
On behalf of the Board of Directors, we cordially invite you to attend the
1998 Annual Meeting of shareholders of Heritage Financial Services, Inc. The
Annual Meeting will be held beginning at 1:00 p.m., local time, on Tuesday,
April 21, 1998, at the Volunteer Room, Ramada Inn, 50 College Street,
Clarksville, Tennessee 37040. The formal notice of the Annual Meeting appears on
the next page.
Enclosed is our Proxy Statement for the 1998 Annual Meeting that discusses
the proposals for which we seek your support.
The enclosed Notice and Proxy Statement contain detailed information about
the business to come before the meeting. We urge you to review the Proxy
Statement and each of the proposals contained therein carefully. Regardless of
the number of shares you own, it is important that your shares be represented
and voted at the meeting. Please take a moment now to sign, date and mail the
enclosed proxy in the postage prepaid envelope. Your Board of Directors
recommends a vote FOR each proposal.
We are gratified by our shareholders' continued interest in Heritage
Financial and pleased that in the past so many of you have voted your shares. We
hope that you will continue to do so and again urge you to return your proxy as
soon as possible.
Sincerely,
James G. Holleman Earl O. Bradley, III
Chairman of the Board President and Chief Executive Officer
<PAGE> 2
HERITAGE FINANCIAL SERVICES, INC.
25 Jefferson Street
Clarksville, Tennessee 37040
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD ON TUESDAY, APRIL 21, 1998
Notice is hereby given that the annual meeting of shareholders of Heritage
Financial Services, Inc. (the "Company"), will be held beginning at 1:00 p.m.
local time, on Tuesday, April 21, 1998, at the Volunteer Room, Ramada Inn, 50
College Street, Clarksville, Tennessee:
I. To elect four directors whose terms expire in 1998, to serve three
year terms until the 2001 annual meeting of shareholders and until
their successors are elected and qualified.
II. To consider and act upon a proposal to amend the Company's Charter to
increase the Company's authorized Common Stock and to authorize the
Company to issue no par value Preferred Stock.
III. To consider and act upon a proposal to adopt the 1998 Stock Option
Plan.
IV. To consider and act upon a proposal to adopt the Outside Directors'
Stock Option Plan.
V. To ratify the appointment of Heathcott & Mullaly, P.C., Brentwood,
Tennessee, as Independent Public Accountants of the Company and its
affiliates for the fiscal year ending December 31, 1998.
VI. To transact such other business as may properly come before the Annual
Meeting or any adjournment thereof.
Shareholders of record at the close of business on February 27, 1998, are
entitled to notice of and to vote at the Annual Meeting.
All shareholders are cordially invited to attend the meeting in person.
Regardless of whether you plan to attend the meeting, however, please sign and
date the enclosed proxy and return it in the envelope provided as promptly as
possible. A proxy may be revoked at any time before it is voted at the meeting.
By Order of the Board of Directors
John T. Halliburton, Secretary
Clarksville, Tennessee
March 31, 1998
<PAGE> 3
HERITAGE FINANCIAL SERVICES, INC.
PROXY STATEMENT
ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD APRIL 21, 1998
This proxy statement (the "Proxy Statement") is furnished to the
shareholders of Heritage Financial Services, Inc. (the "Company") in connection
with the solicitation of proxies on behalf of the Board of Directors of the
Company (the "Board of Directors" or the "Board"), for use at the annual meeting
of shareholders (the "Annual Meeting") to be held at 1:00 p.m., local time, on
Tuesday, April 21, 1998, at the Volunteer Room, Ramada Inn, 50 College Street,
Clarksville, Tennessee, and any adjournments or postponements thereof.
The mailing address of the Company's principal executive offices are
located at, 25 Jefferson Street, Clarksville, Tennessee and its telephone number
is (931)553-0500.
This Proxy Statement, the attached proxy and the Notice of Annual Meeting
were mailed to all shareholders entitled to vote at the Annual Meeting on or
about March 31, 1998. The Company's annual report to shareholders for the fiscal
year ended December 31, 1997 accompanies this Proxy Statement.
The purposes of the Annual Meeting are to act upon the following six
Proposals:
I. To elect four directors whose terms expire in 1998, to serve three
year terms until the 2001 annual meeting and until their successors
are elected and qualified.
II. To consider and act upon a proposal to amend the Company's Charter to
increase the Company's authorized Common Stock and to authorize the
Company to issue no par value Preferred Stock.
III. To consider and act upon a proposal to adopt the 1998 Stock Option
Plan.
IV. To consider and act upon a proposal to adopt the Outside Directors'
Stock Option Plan.
V. To ratify the appointment of Heathcott & Mullaly, P.C., Brentwood,
Tennessee, as Independent Public Accountants of the Company and its
affiliates for the fiscal year ending December 31, 1998.
VI. To transact such other business as may properly come before the Annual
Meeting or any adjournment thereof.
<PAGE> 4
The Board of Directors has fixed the close of business on Friday, February
27, 1998 as the record date (the "Record Date") for the Annual Meeting. Only
shareholders of record at the close of business on that date will be entitled to
notice of, and to vote at, the Annual Meeting. The total number of shares of
Common Stock outstanding and entitled to vote on the Record Date was 569,928
shares. The Company has no other outstanding class of securities.
PROXY PROCEDURE
The Board of Directors solicits proxies so that each shareholder has the
opportunity to vote on the Proposals. When a proxy is returned properly signed
and dated by a shareholder, the shares represented thereby will be voted in
accordance with the instructions on the proxy. A shareholder may revoke his or
her proxy at any time before it is voted by attending the Annual Meeting and
voting in person, or by delivering to the Company's Corporate Secretary at the
Company's principal executive offices referred to above a written notice of
revocation or a duly executed proxy bearing a date later than that of the
previously submitted proxy.
If a shareholder returns a properly signed and dated proxy but does not
mark the boxes located on the proxy, the shares represented by that proxy will
be voted FOR each of the Proposals. Otherwise, the signed proxy will be voted as
indicated on the proxy. The proxy also gives the individuals named as proxies
discretionary authority to vote the shares represented on any other matter that
is properly presented for action at the Annual Meeting. If a shareholder neither
returns a signed proxy nor attends the Annual Meeting and votes in person, his
or her shares will not be voted.
VOTING PROCEDURES
A majority of the votes entitled to be cast at the Annual Meeting
constitutes a quorum. A share, once represented for any purpose at the Annual
Meeting, is deemed present for purposes of determining a quorum for the
remainder of the Annual Meeting and for any adjournment of the Annual Meeting,
unless a new record date is set for the adjourned meeting. This is true even if
the holder of the share abstains from voting with respect to any matter brought
before the Annual Meeting. Shareholders will be entitled to one vote for each
share held, which may be given in person or by proxy authorized in writing.
"Abstentions" are counted only for purposes of determining whether a quorum is
present at the meeting.
With respect to Proposal VI and to any other matter to properly come before
the Annual Meeting, such Proposal or other matters will be approved if the votes
cast favoring the Proposal or other matter exceed the votes cast opposing the
Proposal or other matter, unless the Company's Charter or Tennessee law require
a greater number of affirmative votes.
COST OF SOLICITATION
The cost of solicitation of proxies will be borne by the Company, including
expenses incurred in connection with preparing and mailing the Proxy Statement.
The initial solicitation will be by mail.
2
<PAGE> 5
PROPOSAL I
ELECTION OF DIRECTORS
The Company's Charter and ByLaws provide that the Board of Directors shall
consist of a minimum of three (3) and a maximum of twelve (12) directors. The
Board currently consists of twelve directors, which also serve as directors of
Heritage Bank. The directors are elected by the shareholders for staggered three
year terms. Directors whose term of office expires at the 1998 Annual Meeting
are William G. Beach, Jeffrey V. Bibb, James G. Holleman and James E. Thomas,
Jr. Each of these directors has been nominated for terms expiring at the 2001
annual meeting, or until their successor is duly elected and qualified.
Unless otherwise instructed on the proxy, the proxy holders will vote the
proxies received by them FOR the election of the four nominees named above. If,
for any reason, one or more of the nominees named above should not be available
as a candidate for director, an event that the Board of Directors does not
anticipate, the proxy holders will vote for such other candidate or candidates
as may be nominated by the Board of Directors and discretionary authority to do
so is included in the proxy.
The Board of Directors recommends a vote FOR the election of all the
nominees.
The following table provides certain information about the nominees and the
other present directors of the Company. The information in the table has been
furnished to the Company by the individuals listed therein.
<TABLE>
<CAPTION>
Positions Held With Director
Name Age (1) the Company/Bank Since (2)
---- ------- ------------------- ---------
<S> <C> <C> <C>
NOMINEES FOR TERMS TO EXPIRE AT 2001 ANNUAL MEETING
William G. Beach 41 Director 1996
Jeffrey V. Bibb 43 Director 1989
James G. Holleman 66 Director, Chairman of 1989
Company and Bank
James E. Thomas, Jr. 64 Director 1989
CONTINUING DIRECTORS UNTIL 1999 ANNUAL MEETING
Earl O. Bradley, III 42 Director, President and 1989
Chief Executive Officer
of Company and Bank
W. Lawson Mabry 42 Director 1989
James W. Russell 73 Director 1989
Dr. Ted R. McCurdy 52 Director 1996
</TABLE>
3
<PAGE> 6
<TABLE>
<CAPTION>
Positions Held With Director
Name Age (1) the Company/Bank Since (2)
---- ------- ------------------- ---------
<S> <C> <C> <C>
CONTINUING DIRECTORS UNTIL 2000 ANNUAL MEETING
David R. Farris 60 Director 1994
George R. Fleming, Sr. 75 Director 1989
John T. Halliburton 50 Director, Executive Vice 1989
President and Secretary
of Company and Bank
Ruth C. Hutton 74 Director 1989
</TABLE>
(1) As of February 1, 1998
(2) Director of the Company or, prior to formation of the Company, the Bank.
WILLIAM G. BEACH is the President of Beach Oil Company, an Amoco Oil
distributor and owner/operator of convenience markets. He is a 1978 graduate of
Austin Peay State University.
JEFFREY V. BIBB is a partner in the firm of Bibb, Lott and Fryer
Marketing/Advertising. Mr. Bibb is a 1976 graduate of Austin Peay State
University with a bachelor's degree in urban affairs and regional development.
EARL O. BRADLEY, III has served as President and Chief Executive Officer of
the Company and the Bank since their formation. Mr. Bradley is a 1977 graduate
of Austin Peay State University with a bachelor's degree in accounting. He is a
certified public accountant, and is a graduate of the University of Wisconsin
School for Bank Administration and Tennessee Commercial Lending School held at
Vanderbilt University.
DAVID R. FARRIS is a marketing consultant. Mr. Farris served as Executive
Vice President and Corporate Officer of American Standard, Inc. for 28 years. He
is a graduate of the University of Wisconsin with a bachelor's degree in
engineering, and did post graduate work at the University of Missouri.
GEORGE R. FLEMING, SR. practices law in the Clarksville community. He
received his J. D. degree from the University of Tennessee College of Law.
JOHN T. HALLIBURTON has served as Executive Vice President and Secretary of
the Company and the Bank since their formation. He is also the senior credit
officer of the Bank. He is a graduate of Austin Peay State University with a
bachelor's degree in business administration, and is a graduate of the Tennessee
Commercial Lending School held at Vanderbilt University.
JAMES G. HOLLEMAN has served as Chairman of the Board of the Company and
the Bank since their formation. He is engaged in the real estate business, and
is President of Conroy, Marable & Holleman Real Estate, Inc. and Chairman of the
Board of CM&H Commercial Properties, Inc. He is a graduate of Vanderbilt
University with a bachelor's degree in business administration.
4
<PAGE> 7
RUTH C. HUTTON served as the manager of the Clarksville Credit Bureau prior
to her retirement. She is a graduate of the Garrett School of Business and the
University of North Carolina Management Institute.
W. LAWSON MABRY is a real estate broker with Conroy, Marable and Holleman
Real Estate, Inc., and is actively involved in the ownership and development of
real estate. He is a graduate of Austin Peay State University.
DR. TED R. MCCURDY is an oral and maxillofacial surgeon in private practice
at the Clarksville Oral Surgery Center. He is a graduate of Mercer University in
Macon, Georgia, attended the University of Tennessee Medical School in Memphis,
and completed his intern/residency at the University of Tennessee Memorial
Research Hospital in Knoxville.
JAMES W. RUSSELL, SR. serves as Chairman of Russell, Russell and Waddle,
Inc., a firm engaged in real estate development and contracting.
JAMES E. THOMAS, JR. is the owner and manager of real estate investment
properties. He is a graduate of Vanderbilt University with a bachelor's degree
in business administration.
STOCK OWNERSHIP OF DIRECTORS, OFFICERS AND PRINCIPAL SHAREHOLDERS
The following table sets forth information as of the Record Date as to the
shares of Common Stock beneficially owned by directors and executive officers
individually and by all executive officers and directors as a group.
<TABLE>
<CAPTION>
SHARES OF
COMMON STOCK
BENEFICIALLY PERCENT OF
NAME TITLE OWNED (1) CLASS
---- ----- --------- -----
<S> <C> <C> <C>
William G. Beach (2) Director 1,382 0.24%
Jeffrey V. Bibb (4) Director 10,222 1.79%
Earl O. Bradley, III (3) (5) President and Chief 48,232 8.46%
Executive Officer of
Company and Bank
David R. Farris (2) (6) Director 3,365 0.59%
George R. Fleming, Sr. (2) (7) Director 19,759 3.47%
John T. Halliburton (3) (8) Executive Vice President 41,972 7.33%
and Secretary of Company
and Bank
James G. Holleman (2) (9) Chairman of the Board 14,928 2.62%
of Company and Bank
Ruth C. Hutton (2) Director 1,134 0.20%
</TABLE>
5
<PAGE> 8
<TABLE>
<CAPTION>
SHARES OF
COMMON STOCK
BENEFICIALLY PERCENT OF
NAME TITLE OWNED (1) CLASS
---- ----- --------- -----
<S> <C> <C> <C>
W. Lawson Mabry (2) (10) Director 15,047 2.64%
Dr. Ted R. McCurdy (2) Director 1,279 0.22%
James W. Russell (2) (11) Director 20,765 3.64%
James E. Thomas (2) (12) Director 18,571 3.26%
Directors and Officers as a group (17 persons) (13) 228,418 39.53%
</TABLE>
(1) Includes shares as to which such person, directly or indirectly, through any
contract, arrangement, understanding, relationship, or otherwise has or shares
voting power and/or investment power as these terms are defined in Rule 13d-3(a)
of the Securities Exchange Act of 1934.
(2) Includes 282, 377, 428, 534, 420, 278, 412, 400 and 89 shares beneficially
owned by Messrs. Beach, Farris, Fleming, Holleman, Mabry, McCurdy, Russell,
Thomas and Ms. Hutton, respectively, under the Directors' Unfunded Deferred
Compensation Plan.
(3) Includes 2,275 and 1,889 shares beneficially owned by Messrs. Bradley and
Halliburton, respectively, under the Heritage Bank Employee Stock Ownership Plan
& Trust (ESOP), and 500 and 3,000 shares subject to options granted to Messrs.
Bradley and Halliburton, respectively, under the 1989 Employees Stock Option
Plan, which are currently exercisable. The Company's 1997 ESOP contribution has
not been allocated.
(4) Includes 209 shares held in custodian accounts for minor children over which
Mr. Bibb has joint voting and investment power, 9,700 shares held in Mr. Bibb's
individual retirement account, and 313 shares jointly owned with his wife.
(5) Includes 871 shares held in custodian accounts for minor children over which
Mr. Bradley has sole voting and investment power, and 1,022 shares held in Mr.
Bradley's individual retirement account.
(6) Includes 1,494 shares held in Mr. Farris' individual retirement account, and
1,494 shares held in his wife's individual retirement account to which Mr.
Farris disclaims beneficial ownership.
(7) Includes 6,269 shares held by Fleming and Fleming Rental, a partnership of
which Mr. Fleming is a partner.
(8) Includes 4,406 shares held in Mr. Halliburton's individual retirement
account, and 32,677 shares jointly owned with his wife.
6
<PAGE> 9
(9) Includes 1,054 shares owned by Mr. Holleman's wife.
(10) Includes 10,371 shares held in Mr. Mabry's individual retirement account.
(11) Includes 486 shares held in Mr. Russell's individual retirement account,
486 shares held in his wife's individual retirement account as to which Mr.
Russell disclaims beneficial ownership, and 19,381 shares held in the James W.
and Vista Russell Revocable Living Trust.
(12) Includes 5,642 shares owned by Mr. Thomas's wife as to which Mr. Thomas
disclaims beneficial ownership, and 12,528 shares held in the James Eldon Thomas
Family Family Partnership, L.P.
(13) Includes 8,000 exercisable stock options, and 8,150 vested shares in the
Company's ESOP. The Company's 1997 ESOP contribution has not been allocated as
of the Record Date.
MEETINGS AND COMMITTEES OF THE BOARD OF DIRECTORS
The Board of the Company met five times during 1997. The Board of the Bank
meets monthly and on a called basis. During the fiscal year ended December 31,
1997, the Board met thirteen times. Each director attended at least 75% of all
meetings held by the Board and the committees on which he or she served.
The Bank has the following committees:
The Executive Committee generally meets weekly and acts upon Bank matters
between Board meetings. The Executive Committee consists of three permanent
members - the Chairman of the Board, the President and Chief Executive Officer,
and the Executive Vice President. The remaining directors serve on the Executive
Committee on a rotational basis. This Committee met 41 times in 1997.
The Audit Committee consists of Messrs. Fleming, McCurdy, Mabry and Ms.
Hutton. None of the members of the Audit Committee are employees of either the
Company or Bank. This Committee generally reviews internal and external audit
activities, compliance activities, and the adequacy of the systems of internal
control over operations and financial reporting, and advises the Board and
management of broad issues related to these areas. This Committee met twice
during 1997.
The Human Resources Committee consists of Messrs. Farris, Thomas, Beach,
Bibb and ex-officio Holleman. None of these members of the Human Resources
Committee are employees of the Company or Bank. Messrs. Bradley and Halliburton
also serve as ex-officio members of the Committee on matters not involving their
personal compensation. This Committee establishes the compensation of the
President and Chief Executive Officer and Executive Vice President, and approves
the compensation of senior officers (including grants of stock options), and
various compensation and benefits to be paid to employees of the Bank. This
Committee met twice during 1997.
The Facilities Committee consists of Messrs. Bibb, Farris, Mabry, Russell,
and Thomas. Also, Messrs. Holleman, Bradley and Halliburton serve as ex-officio
members. This Committee is responsible for planning future needs related to
facilities including site selection and building
7
<PAGE> 10
and space requirements. Due to the construction of the new main office building,
this Committee met in conjunction with the monthly Board of Directors meetings.
COMPENSATION OF DIRECTORS
During 1997, the Chairman of the Board and Committee Chairmans received
annual retainers of $3,000 and $2,000, respectively. All other non-employee
directors receive an annual retainer of $1,800. Non-employee directors also
receive $200 for attendance at each Board Meeting and $100 for attendance at
each Committee Meeting. In addition, non-employee directors receive an incentive
fee of $1,800 should the Company achieve certain net income and asset growth
goals.
DIRECTORS' UNFUNDED DEFERRED COMPENSATION PLAN
In 1996, the Company adopted the Directors' Unfunded Deferred Compensation
Plan to provide incentive to the directors who have contributed to the success
of the Company, and which are expected to continue to contribute to such success
in the future. The plan is administrated by the Board, and acts through a
majority of its members. Non-employee directors are eligible to participate in
the plan and may elect to defer all or part of their director's compensation to
the plan. The plan purchases the Company's Common Stock for the benefit of those
directors electing to participate in the plan. Directors elected to defer
$74,128 and $59,900 in 1997 and 1996, respectively, of compensation into the
plan. Common Stock purchased for the benefit of the participating directors was
1,348 shares and 1,872 shares in January 1998 and 1997, respectively.
PROPOSAL II
AMENDMENT TO CHARTER TO INCREASE AUTHORIZED COMMON STOCK
AND AUTHORIZE PREFERRED STOCK
The Board of Directors has adopted resolutions approving and recommending
to the shareholders for their approval an amendment to the Company's Charter
which would increase the number of authorized shares of Common Stock, $2.00 par
value per share, from 1,000,000 shares to 3,000,000 shares and authorize the
Company to issue up to 1,000,000 shares of no par value preferred stock (the
"Preferred Stock"). The following summary of the proposed amendment should be
read in conjunction with, and is qualified in its entirety by reference to, the
complete text of the proposed amendment which is attached hereto as Appendix A.
EXPLANATION OF AND REASONS FOR THE AMENDMENT.
A. INCREASE IN AUTHORIZED COMMON STOCK.
The Board of Directors believes that it is advisable to increase the
authorized number of shares of Common Stock in order to have such additional
shares available for the Company for, among other things, possible issuances in
connection with such activities as stock splits and stock dividends,
implementation of employee benefit plans, public offerings of shares for cash,
and acquisitions of other companies. As of January 31, 1998, the Company had a
total of 569,928 shares of Common Stock outstanding, and in addition 33,881
shares of Common Stock were reserved for issuance under the Company's stock
option plan. Except for the shares issuable under the Company's option plans
described above, the Company has no agreements or understandings regarding the
issuance of any shares of Common Stock.
8
<PAGE> 11
Under the provisions of the Tennessee Business Corporation Act, the Board
of Directors generally may issue authorized but unissued shares of Common Stock
without shareholder approval. Having a substantial number of authorized but
unissued shares of Common Stock that is not reserved for specific purposes would
allow the Company to take prompt action with respect to corporate opportunities
that develop, without the delay and expense of convening a special meeting of
shareholders for the purpose of approving an increase in the Company's
capitalization The issuance of additional shares of Common Stock may, depending
upon the circumstances under which such shares are issued, reduce shareholders'
equity per share and may reduce the percentage ownership of Common Stock by
existing shareholders. It is not the present intention of the Board of Directors
to seek shareholder approval prior to any issuance of shares of Common Stock
that would become authorized by the amendment unless otherwise required by law
or regulation. Frequently, opportunities arise that require prompt action, and
it is the belief of the Board of Directors that the delay necessitated for
shareholder approval of a specific issuance could be to the detriment of the
Company and its shareholders.
When issued, the additional shares of Common Stock authorized by the
amendment will have the same rights and privileges as the shares of Common Stock
currently authorized and outstanding. Holders of Common Stock have no preemptive
rights and, accordingly, shareholders would not have any preferential rights to
purchase any of the additional shares of Common Stock when such shares are
issued.
B. AUTHORIZATION OF PREFERRED STOCK.
The Board of Directors recommends the authorization of Preferred Stock to
increase the Company's financial flexibility. The Board of Directors believes
that the complexity of modern business financing and acquisition transactions
requires greater flexibility in the Company's capital structure than now exists.
The Preferred Stock would be available for issuance from time to time as
determined by the Board of Directors for any proper corporate purpose. Such
purposes might include, without limitation, issuance in public or private sales
for cash as a means of obtaining additional capital for use in the Company's
business and operations, and issuance as part or all of the consideration
required to be paid by the Company for acquisitions of other businesses or
properties. The Company does not, at present, have any agreements,
understandings or arrangements which would result in the issuance of any shares
of Preferred Stock.
If the proposed amendment is approved, the Board of Directors would be
empowered, without the necessity of further action or authorization by the
Company's shareholders, unless required in a specific case by applicable laws or
regulations, to authorize the issuance of the Preferred Stock from time to time
in one or more series, and to fix by resolution or resolutions, designations,
preferences, limitations and relative rights of each such series. Each series of
Preferred Stock could, as determined by the Board of Directors at the time of
issuance, rank, with respect to dividends and redemption and liquidation rights,
senior to the Company's Common Stock. No preferred stock is presently authorized
by the Company's Charter.
The amendment would authorize the Board of Directors to determine, among
other things, with respect to each series of Preferred Stock which may be
issued: (a) the distinctive designation and number of shares constituting such
series; (b) the dividend rates, if any, on the shares of that series and whether
dividends would be payable in cash, property, rights or securities; (c) whether
dividends would be non-cumulative, cumulative to the extent earned,
9
<PAGE> 12
partially cumulative or cumulative and, if cumulative, the date from which
dividends on the series would accumulate; (d) whether, and upon what terms and
conditions, the shares of that series would be convertible into or exchangeable
for other securities or cash or other property or rights; (e) whether, and upon
what terms and conditions, the shares of that series would be redeemable; (f)
the rights and preferences, if any, to which the shares of that series would be
entitled in the event of voluntary or involuntary dissolution or liquidation of
the Company; (g) whether a sinking fund would be provided for the redemption of
the series and, if so, the terms of and amounts payable into such sinking fund;
(h) whether the holders of such securities would have voting rights and the
extent of those voting rights; (i) whether the issuance of any additional shares
of such series, or of any other series, shall be subject to restrictions as to
issuance or as to the powers, preferences or rights of any such other series;
and (j) any other preferences, privileges and relative rights of such series as
the Board of Directors may deem advisable. Holders of the Company's Common Stock
have no preemptive right to purchase or otherwise acquire any Preferred Stock
that may be issued in the future.
It is not possible to state the precise effect of the authorization of the
Preferred Stock upon the rights of holders of the Company's Common Stock until
the Board of Directors determines the respective preferences, limitations and
relative rights of the holders of one or more series of the Preferred Stock.
However, such effect might include: (a) reduction of the amount otherwise
available for payment of dividends on Common Stock, to the extent dividends are
payable on any issued shares of Preferred Stock, and restrictions on dividends
on Common Stock if dividends on the Preferred Stock are in arrears; (b) dilution
of the voting power of the Common Stock to the extent the Preferred Stock has
voting rights; and (c) the holders of Common Stock not being entitled to share
in the Company's assets upon liquidation until satisfaction of any liquidation
preference granted to the Preferred Stock.
The adoption of the amendment may be viewed as having the effect of
discouraging an unsolicited attempt by another person or entity to acquire
control of the Company. The Board of Directors would have the ability to issue a
significant number of shares of Common and Preferred Stock as a defense to an
attempted takeover of the Company. Issuances of authorized preferred shares can
be implemented, and have been implemented by some companies in recent years,
with voting or conversion privileges intended to make acquisition of the company
more difficult or more costly. Such an issuance could discourage or limit the
shareholders' participation in certain types of transactions that might be
proposed (such as a tender offer), whether or not such transactions were favored
by the majority of the shareholders, and could enhance the ability of officers
and directors to retain their positions.
VOTE REQUIRED. Under Tennessee law, the affirmative vote of the holders of
a majority of the votes cast by the holders of the Company's Common Stock
represented and entitled to vote at the Annual Meeting is required to adopt
Proposal II.
The Board of Directors recommends a vote FOR the proposed amendment to the
Charter.
PROPOSAL III
ADOPTION OF 1998 STOCK OPTION PLAN
The Company currently has two stock-based incentive compensation plans -
the 1989 Employees Stock Option Plan and the Incorporators Stock Option Plan.
10
<PAGE> 13
The 1989 Employees Stock Option Plan (which expires this year) allows the
Company to grant incentive stock options to officers and key employees of the
Company. Options to purchase 33,881 shares are currently available for grant.
The Incorporators Stock Option Plan authorized the Board to grant non-qualified
stock options to the incorporators of the Bank. There are no remaining shares
available for grant under the Incorporators Stock Option Plan.
The Human Resources Committee studied the Company's stock-based incentive
compensation plans. The Human Resources Committee concluded that the plans did
not provide the Company's management with sufficient share authorization or
award flexibility with respect to stock-based compensation. The Board believes
that a key element of officer and key employee compensation is stock-based
incentive compensation. Such compensation advances the interests of the Company
by encouraging and providing for, the acquisition of equity interests in the
Company by officers and key employees, thereby providing substantial motivation
for superior performance. In order to provide the Board with greater
flexibility, to adapt to changing economic and competitive conditions, and to
implement stock-based compensation strategies which will attract and retain
those employees who are important to the long term success of the Company, the
Board, in March of 1998, adopted, subject to shareholder approval, the 1998
Stock Option Plan (the "Employee Plan"). If approved by the shareholders, the
Employee Plan will become effective as of April 1998 and will terminate 10 years
after that date. A summary of the Employee Plan follows, but this summary is
qualified in its entirety by reference to the full text of the Employee Plan,
which is attached as Appendix B to this proxy statement.
The persons to whom options may be granted under the Employee Plan will be
determined from time to time by the Company's Board of Directors unless and
until such time as the Board delegates administration of the Employee Plan to a
committee of the Board of Directors (the "Committee"). Officers and key
employees of the Company and its subsidiary, as determined by the Board or the
Committee, are eligible for grants of options.
The Employee Plan provides for the granting of incentive stock options and
non-statutory stock options. Incentive stock options offer employees the
possibility of deferring taxes until the underlying shares of stock acquired
upon exercise of the option are sold. For some of the Company's employees, the
benefits of incentive stock options are outweighed by the disadvantages of
certain restrictions imposed by the Internal Revenue Code. In addition, with
non-statutory stock options, the Company receives a tax deduction at the time
the employee recognizes ordinary income in an amount of such income to the
employee. With incentive stock options, the Company does not receive a tax
deduction at any time (assuming that the employee meets the holding period
requirements for capital gain treatment).
The Employee Plan will be administered by the Committee. No person while a
member of the Committee is eligible to be granted an option under the Employee
Plan. Members of the Committee are appointed, and vacancies thereon filled, by
the Board of Directors of the Company, and the Board has the power to remove
members of the Committee.
An aggregate of 150,000 shares of the Company's Common Stock, $2.00 par
value, may be issued pursuant to the exercise of stock options by such officers
and key employees of the Company and its subsidiary as the Committee may
determine. There are no limitations on the number of shares of Common Stock
which may be optioned to any person, except that the aggregate fair market value
(determined as of the time the option is granted) of Company Common Stock with
respect to which incentive stock options are exercisable for the first time
11
<PAGE> 14
by an employee during any calendar year under the Employee Plan (and any other
incentive stock option plan of the Company or any subsidiary) may not exceed
$100,000.
The Board of Directors believes that it is in the best interest of the
Company and its shareholders to adopt the Employee Plan to help to attract and
retain key persons of outstanding competence and to further the identity of
their interests with those of the Company's shareholders generally. A majority
of the votes cast is necessary for approval of this proposal. The Board of
Directors recommends a vote FOR approval of the 1998 Stock Option Plan.
PROPOSAL IV
ADOPTION OF OUTSIDE DIRECTORS' STOCK OPTION PLAN
The Board of Directors has adopted resolutions approving and recommending
to the shareholders for their approval the Company's Outside Directors' Stock
Option Plan which would provide that options under the plan would be granted
pursuant to a formula. The text of the proposed Directors' Plan is attached as
Appendix C to this proxy statement.
The Directors' Plan provides that on the first business day following the
Annual Meeting of Shareholders of the Company of each of the years 1998 through
and including 2002, each person who is a non-employee director of the Company on
such date shall be granted automatically an option to purchase 500 shares of
the Company's Common Stock, $2.00 par value per share. Pursuant to the
Directors' Plan, no non-employee director may receive options to purchase more
than an aggregate of 2,500 shares of the Company's Common Stock over the term
of the Directors' Plan. The options granted will vest at a rate of 20% per year
on the anniversary date of the annual meeting of shareholders with respect to
which such options were granted. The exercise price of all options shall equal
the fair market value of the Company's Common Stock on the date of grant.
An aggregate of 40,000 shares will be reserved for grants of options
pursuant to the Directors' Plan. Shares subject to options which terminate or
expire unexercised will be available for future option grants. The total number
of shares subject to the Directors' Plan and the number covered under each
individual option is subject to automatic adjustment in the event of stock
dividends, recapitalizations, mergers, consolidations, split-ups, combinations
or exchanges of shares and the like, as determined by the Board of Directors.
If any non-employee director ceases to be a director as a result of death
or total disability while holding an option that has not expired and has not
been fully exercised, such person or such person's executors, administrators,
heirs, personal representative, conservator, or distributees may, at any time
within one year after the date of such death or total disability, exercise the
option in its entirety with respect to all remaining shares covered by that
option.
The options under the Directors' Plan are nonstatutory options intended not
to qualify as incentive stock options under Section 422 of the Internal Revenue
Code. The grant of options will not result in taxable income to the non-employee
director or a tax deduction to the Company. The exercise of an option by a
non-employee director will result in taxable ordinary income to the non-employee
director and a corresponding deduction for the Company, in each case equal to
the difference between the option price and the fair market value of the shares
on the date the option is exercised.
The Directors' Plan will be administered by the Board of Directors who will
be authorized to interpret the Plan but will have no authority with respect to
the selection of directors to receive options or the option price for shares
subject to the Directors' Plan. The Board shall have no authority to materially
increase the benefits under the plan. The Board may amend the Directors' Plan as
it shall deem advisable but may not, without further shareholder
12
<PAGE> 15
approval, increase the maximum number of shares under the plan or options
granted thereunder, reduce the minimum option price, extend the period during
which options may be granted or exercised, or change the class of persons
eligible to receive options.
The Board of Directors believes that it is in the best interest of the
Company and its shareholders to adopt the Directors' Plan to help attract and
retain directors of outstanding competence and to further the identity of their
interest with those of the Company's shareholders generally. A majority of the
votes cast is necessary for approval of this proposal. The Board of Directors
recommends a vote FOR approval of the Outside Directors' Stock Option Plan.
PROPOSAL V
RATIFICATION OF THE APPOINTMENT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors proposes for the ratification of the shareholders at
the Annual Meeting the appointment of Heathcott and Mullaly, P.C., Brentwood,
Tennessee, certified public accountants, as Independent Public Accountants for
the Company and its affiliates for the fiscal year ending December 31, 1998.
Heathcott and Mullaly, P.C. has served as Independent Public Accountants for the
Company or Bank since 1990. In the event Heathcott and Mullaly, P.C. is not
ratified by the Shareholders, the Board of Directors will consider appointment
of other independent public accountants for the fiscal year ending December 31,
1998.
The Board of Directors of the Company recommends a vote FOR the
raitification of Heathcott and Mullaly, P.C. as Independent Public Accountants
for the Company.
PROPOSAL VI
OTHER MATTERS
Management of the Company is not aware of any other matters to be brought
before the Annual Meeting. However, if any other matters are properly brought
before the Annual Meeting, the persons named in the enclosed form of proxy will
have discretionary authority to vote all proxies with respect to such matters in
accordance with their judgment.
EXECUTIVE COMPENSATION
The executive officers of the Company receive cash compensation from the
Bank in connection with their positions as executive officers and directors of
the Bank and the Company. The Company generally does not separately compensate
its executive officers.
No executive officer ceased to serve as such at any time during the fiscal
year ended December 31, 1997. The following table sets forth the compensation
for services in all capacities to the Company for the fiscal years ending
December 31, 1997, 1996 and 1995, of Earl O. Bradley, III, the Company's
President and Chief Executive Officer, and John T. Halliburton, the only other
executive officer whose total annual salary and bonus equaled or exceeded
$100,000 in 1997.
13
<PAGE> 16
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
NAME AND PRINCIPAL OFFICE YEAR SALARY BONUS OTHER
- ------------------------- ---- -------- ------- -------
<S> <C> <C> <C> <C>
Earl O. Bradley, III 1997 $144,000 $28,770 $21,666
President and Chief 1996 125,000 14,036 21,265
Executive Officer 1995 100,000 46,722 (1) 18,315
John T. Halliburton 1997 122,000 31,958 21,137
Executive Vice President 1996 106,250 261 21,904
and Secretary 1995 85,000 30,036 (1) 20,280
</TABLE>
(1) Includes bonuses for both fiscal 1994 and 1995.
Total 1997 compensation of the seven Executive Officers as a group,
including those named above, amounted to $808,154.
1989 EMPLOYEES STOCK OPTION PLAN
The Company maintains an employee stock option plan to advance the
interests of the Bank and its shareholders by attracting and retaining in the
employment of the Company key professional and management employees, by
providing such employees with the incentive for outstanding performance inherent
in stock options, and by increasing their proprietary interest in the Company
through stock ownership.
The plan is administered, interpreted and applied by the Human Resources
Committee of the Board, none of which are eligible to receive options. The
Committee is authorized to select key employees (including executive officers
and directors who are salaried employees) of the Company to whom options are to
be granted under the plan; to determine the number of shares subject to each
option; to fix the period or periods during which the option may be exercised
(not to exceed ten years); and to fix the prices at which shares subject to
options may be purchased. The plan provides for a total of 150,000 options,
which may be granted through May 24, 1999, (termination date of the plan). As of
December 31, 1997, 116,119 shares have been granted, 81,500 shares have been
exercised, and 8,000 shares are currently exercisable.
The right to exercise an option generally expires three months after
employment is terminated. In the event of any change in the outstanding shares
of stock by reason of stock dividend, split or combination, recapitalization or
reclassification, or a reorganization, merger, etc., the number and class of
shares then subject to options shall be appropriately adjusted by the Committee
to reflect such change.
14
<PAGE> 17
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL
YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
Value of
Unexercised
Unexercised in-the-Money
Options Options
at Fiscal at Fiscal
Acquired Year End Year End(2)
on Value Exercisable/ Exercisable/
Name Exercise Realized(1) Unexercisable Unexercisable
- ---- -------- ----------- ------------- -------------
<S> <C> <C> <C> <C>
Earl O. Bradley, III 2,200 $ 85,800 500/3,887 $ 32,500/177,921
John T. Halliburton 2,000 78,000 3,000/3,295 195,000/150,875
Seven Executive Officers
as a group, including
those named above 12,700 475,300 8,000/26,619 505,000/1,265,967
</TABLE>
(1) Represents the difference between the last trade price for the Common Stock
on the date of exercise and the option price paid upon exercise.
(2) Last trade price of underlying securities at December 31, 1997 ($75.00)
less the exercise price.
In 1997, the Company granted 2,347, 1,995 and 11,069 stock options to
Messrs. Bradley and Halliburton and all executive officers as a group (including
Messrs. Bradley and Halliburton), respectively. In 1996, the Company granted
1,540, 1,300 and 10,050 stock options to Messrs. Bradley and Halliburton and all
executive officers as a group (including Messrs. Bradley and Halliburton) ,
respectively. No options were granted in 1995.
EMPLOYEE STOCK OWNERSHIP PLAN
The Heritage Bank Employee Stock Ownership Plan & Trust (ESOP) is an
employee stock ownership plan which is designed to invest primarily in the
Company's Common Stock. In general, all employees of the Company and the Bank
are covered under this plan and employees are fully vested in their benefits
after five years of participation in the plan. Company contributions are
determined by the Board of Directors each year and are allocated among
participants on the basis of their total annual compensation. Operating expense
included contributions of $143,750 (1997), $131,250 (1996) and $110,000 (1995)
to the ESOP. The amount contributed in 1997 for the 1996 plan year was $10,282,
$8,000 and $44,439 for Messrs. Bradley and Halliburton, and all executive
officers as a group (including Messrs. Bradley and Halliburton), respectively.
The ESOP trustees are empowered to borrow money to purchase the Company's Common
Stock. In 1997, the ESOP purchased 2,813 shares of the Company's Common Stock at
an average cost of $50.90 per share. The ESOP owned 22,518 shares (3.95% of
outstanding shares) of the Company's Common Stock as of the Record Date. The
average cost of the shares of the Common Stock held by the ESOP at year-end 1997
was approximately $25.70 per share.
15
<PAGE> 18
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Certain of the Bank's officers and directors are at present, as in the
past, customers of the Bank, and are directors or officers of corporations, or
members of partnerships, which are customers of the Bank. As such customers,
they had transactions in the ordinary course of business with the Bank,
including borrowings, all of which are 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 normal
risk of collectability or present any other unfavorable features.
James W. Russell, Sr. is President of Russell, Russell and Waddle, Inc.
(RR&W). During 1997, RR&W received $12,095 for remodeling certain offices of the
Bank.
Jeffrey V. Bibb is a partner in the firm of Bibb, Lott and Fryer
Marketing/Advertising. During 1997, the Bank paid $85,400 to the firm for
services rendered.
James G. Holleman is President of Conroy, Marable & Holleman Real Estate,
Inc. (CM&H). During 1997, the Bank leased office space from CM&H in the amount
of $15,000.
William G. Beach is the President of Beach Oil Company. During 1997, the
Bank paid Beach Oil Company $10,000 to lease automated teller machine space at
various convenience markets, and $3,380 for fuel costs related to the
construction of the new main office building.
Messrs. Bradley, Mabry, Halliburton, Russell, Holleman, Farris, Thomas and
Fleming are partners in Riverside Partners. During 1997, the Bank leased office
space from Riverside Partners in the amount of $27,200.
INDEBTEDNESS OF RELATED PARTIES
Certain directors and officers of the Company, businesses with which they
are associated, and members of their immediate families are customers of the
Bank and had transactions with the Bank in the ordinary course of its business
during the Bank's fiscal years ended December 31, 1997 and 1996. As of December
31, 1997, the aggregate principal amount of indebtedness (including unfunded
commitments) owed to the Bank by Company management and these related parties
was $5,239,000. In the opinion of the Board of Directors, such transactions 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 do not involve more than the
normal risk of collectibility or present other unfavorable features.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's directors,
executive officers, and any person beneficially owning more than ten percent of
the Company's Common Stock to file reports of securities ownership and changes
in that ownership with the Commission. Officers, directors and greater than ten
percent shareholders also are required by rules
16
<PAGE> 19
promulgated by the Commission to furnish the Company with copies of all Section
16(a) forms they file.
Based upon a review of the copies of such forms furnished to the Company
for fiscal 1997, the Company believes that during the fiscal year ended December
31, 1997, its officers, directors and greater than ten percent beneficial owners
complied with all applicable Section 16(a) filing requirements.
AVAILABILITY OF ANNUAL REPORT ON FORM 10 KSB
The annual report to shareholders containing financial statements for the
Company's 1997 fiscal year accompanies this Proxy Statement. However, the annual
report does not form any part of the material for the solicitation of proxies.
Upon the written request of any record holder or beneficial owner of the
shares entitled to vote at the Annual Meeting, the Company, without charge, will
provide a copy of its annual report on Form 10-KSB for the year ended December
31, 1997 which will be filed with the Securities and Exchange Commission on
Tuesday, March 31, 1998. Requests should be mailed to Earl O. Bradley, III,
President and Chief Executive Officer, Heritage Financial Services, Inc., 25
Jefferson Street, Clarksville, Tennessee 37040.
17
<PAGE> 20
APPENDIX A
ARTICLES OF AMENDMENT TO THE CHARTER OF HERITAGE FINANCIAL SERVICES, INC.
CORPORATE CONTROL NUMBER: 0248379
Pursuant to the provisions of Section 48-20-106 of the Tennessee Business
Corporation Act, as Amended, the undersigned, Heritage Financial Services, Inc.,
a Tennessee corporation (the "Corporation"), adopts the following Articles of
Amendment to its Charter:
1. The current name of the Corporation is Heritage Financial Services, Inc.
2. The Charter is hereby amended by deleting Section 2 in its entirety and
by substituting in lieu thereof the following new Section 2:
"2. The number of shares of stock the Corporation is authorized to
issue is:
(A) Three Million (3,000,000) shares of Common Stock, $2.00 par
value per share.
(B) One Million (1,000,000) shares of Preferred Stock, no par
value. Shares of the Preferred Stock may be issued from time
to time in one or more series, each such series to be so
designated as to distinguish the shares thereof from the
shares of all other series and classes. The Board of
Directors is hereby vested with the authority to divide any
or all classes of Preferred Stock into series and to fix and
determine the relative rights and preferences of the shares
of any series so established."
3. This Amendment is to be effective when filed by the Secretary of State.
4. The Amendment was duly adopted on April 21, 1998 by the Shareholders of
the Corporation.
Dated: April 21, 1998 HERITAGE FINANCIAL SERVICES, INC.
By:
-------------------------------
Earl O. Bradley, III, President
A-1
<PAGE> 21
APPENDIX B
HERITAGE FINANCIAL SERVICES, INC.
1998 STOCK OPTION PLAN
1. Purpose. The purpose of the Heritage Financial Services, Inc. 1998 Stock
Option Plan (the "Plan") is to advance the growth and prosperity of Heritage
Financial Services, Inc. (the "Company") and its subsidiaries by providing key
employees with an additional incentive to contribute to the best interests of
the Company. Without prejudice to other compensation programs approved from time
to time by the Board of Directors (the "Board") and/or shareholders of the
Company, such additional incentive is to be given key employees by means of
stock options provided for under the Plan. In the discretion of the Committee
hereinafter provided for and the Board, such options may be "Incentive Stock
Options" within the meaning of Section 422 of the Internal Revenue Code of 1986,
as amended (the "Code"), or "non-statutory" stock options.
2. Administration of the Plan.
(a) The Plan shall be administered by the Board unless and until such time
as the Board delegates administration to a committee pursuant to subparagraph
2(c) (the "Committee"). The Board shall administer the Plan only if a majority
of the entire Board, and a majority of the directors acting with respect to each
matter pertaining to the administration of the Plan, is comprised of
disinterested persons. For the purposes of this paragraph 2, disinterested
person shall mean a person who has not at any time within one year prior to the
date in question been eligible for participation in the Plan or any other plan
of the Company or any of its subsidiaries entitling the participants therein to
acquire stock or stock options of the Company or any of its subsidiaries.
(b) The Board shall have the power, subject to, and within, the limits of
the express provisions of the Plan:
(i) To determine from time to time which of the eligible persons shall
be granted options under the Plan, the term of each granted option, the time or
times during the term of each option within which all or portions of each option
may be exercised, whether the options granted shall be Incentive Stock Options
or non-statutory options, and the number of shares for which each option shall
be granted.
(ii) To construe and interpret the Plan and options granted under it,
and to establish, amend and revoke rules and regulations for its administration.
The Board, in the exercise of this power, shall generally determine all
questions of policy and expediency that may arise and may correct any defect,
omission or inconsistency in the Plan or in any option agreement in a manner and
to the extent it shall deem necessary or expedient to make the Plan fully
effective.
B-1
<PAGE> 22
(iii) To prescribe the terms and provisions of each option granted
(which need not be identical).
(iv) To amend the Plan as provided herein.
(v) Generally, to exercise such powers and to perform such acts as are
deemed necessary or expedient to promote the best interests of the Company.
(c) The Board, by resolution, may delegate administration of the Plan
(including, without limitation, the Board's powers under subparagraph 2(b)) to a
Committee composed of not less than three (3) members, all of whom shall be
disinterested persons. If administration is delegated to a Committee, the
Committee shall have, in connection with the administration of the Plan, the
powers theretofore possessed by the Board, subject, however, to such
constraints, not inconsistent with the provisions of the Plan, as may be adopted
from time to time by the Board. The Board at any time may remove members from or
add members to the Committee or may abolish the Committee and re-vest in the
Board the administration of the Plan. Vacancies on the Committee, however
caused, shall be filled by the Board.
(d) The interpretation and construction by the Board of any provisions of
the Plan or of any option granted under it shall be final, and the
interpretation of construction by any Committee appointed pursuant to
subparagraph 2(c) or any such provisions or option shall also, unless otherwise
determined by the Board, be final. No member of such Committee or the Board
shall be liable for any action or determination made in good faith with respect
to the Plan or any option granted under it.
3. Eligible Employees. The Board or the Committee shall determine from time
to time those officers and key employees of the Company and its subsidiaries to
whom options shall be granted and, pursuant to the provisions of the Plan, the
amount thereof and the terms and conditions, including requirements as to
continued employment by participant, upon which such options are granted and are
exercisable. Directors of the Company who are not also employees of the Company
or its subsidiaries shall not be eligible to participate in the Plan.
4. The Stock. The stock subject to the options shall be shares of the
Company's authorized and unissued Common Stock, $2.00 par value, or reacquired
Common Stock held in the treasury. The total number of shares of the Company's
Common Stock that may be transferred pursuant to the exercise of stock options
under the Plan shall not exceed in the aggregate 150,000 shares. Shares subject
to options which terminate or expire prior to exercise shall be available for
further option hereunder.
Each option granted under this Plan shall be subject to the requirement
that if at any time the Board or the Committee shall determine that the listing,
registration or qualification of the shares subject thereto upon any securities
exchange or under any state or Federal law, or the consent or approval of any
governmental regulatory body are necessary or desirable in connection with the
issue or transfer of shares subject thereto, no such option may be exercised in
whole or in part unless such listing, registration, qualification, consent or
approval shall have been effected or obtained free of any conditions not
acceptable to the Board or Committee. If required at any time by the Board or
the Committee, an option may not be exercised until the optionee has delivered
an investment letter to the Company containing the representations that all
shares being purchased are being acquired for investment and not with a view to,
or for resale in connection with, any distribution of such shares.
B-2
<PAGE> 23
5. Terms and Conditions of Options. All stock options granted pursuant to
the Plan shall be in such form as the Board or the Committee shall from time to
time determine, shall clearly indicate whether such option is an Incentive Stock
Option or a non-statutory stock option, and shall be subject to the following
terms and conditions:
(a) Option Price. The price per share for Common Stock under each option
granted under the Plan shall be determined and fixed by the Board or the
Committee but, in the case of Incentive Stock Options, shall in no event be less
than 100% of the fair market value of the Common Stock on the date of grant of
such option, and, in the case of non-statutory stock options, shall in no event
be less than 85% of the fair market value of the Common Stock on the date of
grant of such option. In the case of the grant of an Incentive Stock Option to
an individual who, at the time of the grant, owns more than 10% of the total
combined voting power of all classes of stock of the Company, such price per
share shall not be less than 110% of the fair market value of the Common Stock
on the date of grant of the option.
(b) Option Period. The period during which an option may be exercised
shall be determined by the Board or the Committee, provided, however, that in no
event shall an Incentive Stock Option be exercisable after the expiration of 10
years from the date such option was granted; and provided further that in the
case of the grant of an Incentive Stock Option to an individual who, at the time
of the grant, owns more than 10% of the total combined voting power of all
classes of stock of the Company, in no event shall such option be exercisable
more than five years from the date of the grant. Options may be made exercisable
in installments, and such options or installments thereof may be exercised in
part from time to time after they become exercisable. The maturity of any
installment or installments may be accelerated at the discretion of the Board or
the Committee.
In the event that a participant shall cease to be employed by the Company
or one of its subsidiaries for any reason other than his death, all options held
by him pursuant to the Plan and not previously exercised at the date of such
termination shall terminate immediately and become void and of no effect;
provided, however, that the Board or the Committee shall have the right to
extend the exercise period not in excess of three months following the date of
termination of the participant's employment, subject to the further condition,
however, that no Incentive Stock Option shall be exercisable after the
expiration of 10 years from the date it is granted. Notwithstanding the
foregoing, if the termination is due to disability, or to retirement with the
consent of the Company, such disabled or retiring participant shall have the
right to exercise his options which have not previously been exercised at the
date of such termination of employment at any time within three months after
such termination, subject to the condition that no Incentive Stock Option shall
be exercisable after the expiration of 10 years from the date it is granted.
Whether termination of employment is due to disability or is to be considered
retirement with the consent of the Company shall be determined by the Board or
the Committee, which determination shall be final and conclusive.
If the participant should die while in the employ of the Company or a
subsidiary of the Company or within a period of three months after the
termination of his employment by retirement and shall not have full exercised
options granted under the Plan, such options may be exercised in whole or in
part at any time within 12 months after the participant's death by the executors
or administrators of the participant's estate or by any person or persons who
shall have acquired the options directly from the participant by bequest or
inheritance, subject to the
B-3
<PAGE> 24
condition that no Incentive Stock Option shall be exercisable after the
expiration of 10 years from the date it is granted.
The exercise of an option granted under the Plan shall not affect the
optionee's right or ability to exercise any other option granted under the Plan
or any other stock option plan of the Company or its subsidiaries.
(c) Limitations on Grants. If any Incentive Stock Option be granted to any
participant under the Plan, the aggregate fair market value (as of the date the
option is granted) of the Common Stock with respect to which Incentive Stock
Options are exercisable for the first time by the optionee during any calendar
year under this Plan and any other incentive stock option plan of the Company or
any subsidiary shall not exceed $100,000. The foregoing limitation shall be
modified from time to time to reflect any changes in Section 422(b)(7) of the
Code setting forth such limitations.
(d) Limitations on Disposition. To obtain any tax benefits which may become
associated with Incentive Stock Options, the optionee must make no disposition
of shares acquired pursuant to the exercise of an Incentive Stock Option within
two years from the granting of such Incentive Stock Option or within one year
from the date of the exercise of such Incentive Stock Option.
6. Payment for Stock. Payment for shares subject to options granted under
the Plan may be made by the optionee in the form of cash or by means of
unrestricted shares of the Company's Common Stock or any combination thereof
upon the exercise of the option. Payment in currency or by check, bank draft,
cashier's check or postal money order shall be considered payment in cash. In
the event of payment in the Company's Common Stock, the shares used in payment
of the purchase price shall be taken at the fair market value thereof on the
date of the exercise of the option.
7. Non-Assignability. No option shall be transferable otherwise than by
will or the laws of descent and distribution and an option is exercisable during
the lifetime of the optionee only by him.
8. Adjustment Upon Changes in Stock.
The number of shares of Common Stock available for the granting of options
under the Plan and the number of shares and price per share of Common Stock
subject to outstanding options and stock appreciation rights granted pursuant to
the Plan shall be adjusted by the Board or the Committee in an equitable manner
to reflect changes in the capitalization of the Company, including, but not
limited to, such changes as result from exchange, consolidation, reorganization,
recapitalization, stock dividend, dividend in property other than cash, stock
split, liquidating dividend, combination of shares, exchange of shares and
change in corporate structure. If any adjustment under this paragraph 8 would
create a fractional share of Common Stock or a right to acquire a fractional
share of Common Stock, such fractional share shall be disregarded and the number
of shares available under the Plan and the number covered under any options
granted pursuant to the Plan shall be the next lower number of shares, rounding
all fractions downward. Any adjustment made by the Board or the Committee under
this paragraph 8 shall be conclusive and binding on all affected persons. No
Incentive Stock Option granted pursuant to the Plan shall be adjusted in a
manner that causes such Incentive Stock Option to fail
B-4
<PAGE> 25
to continue to qualify as an Incentive Stock Option within the meaning of
Section 422 of the Code.
9. Amendment. The Board from time to time may amend this Plan, but except
as provided above with respect to dilutions or other adjustments or exchanges or
consolidations, or with the approval of the Company's shareholders, may not (a)
increase the aggregate number of shares available for option hereunder, (b)
change the price at which options may be granted, (c) extend the maximum period
during which an option may be exercised, or (d) change the eligibility
requirements for options hereunder. Rights and obligations under any option
granted before amendment of the Plan shall not be altered or impaired by
amendment of the Plan, except with the consent of the person to whom the option
was granted.
10. Fair Market Value of Stock. Whenever pursuant to the terms of the Plan
the fair market value of the Company's Common Stock is required to be determined
as of a particular date, such fair market value shall equal the mean between the
closing bid and asked price of the Common Stock on the National Association of
Securities Dealers Automated Quotation System ("NASDAQ"), or if no bid quotation
is available on NASDAQ, the fair market value of such Common Stock as determined
by the Board, in each case, on the business day immediately preceding the date
on which the determination is made. Fair market value shall be determined in all
cases without regard to any restriction other than a restriction which, by its
terms, will never lapse.
11. No Rights as Shareholder. A participant in the Plan shall have no
rights as a shareholder with respect to any shares covered by his option until
the date of the issuance of a stock certificate to him. No adjustment shall be
made for dividends (ordinary or extraordinary, whether in cash, securities or
other property) or distributions or other rights for which the record date is
prior to the date such stock certificate is issued.
12. Indemnification of Committee. In addition to such other rights of
indemnification as they may have as directors or as members of the Committee,
the members of the Committee shall be indemnified by the Company against the
reasonable expenses, including attorney's fees actually and necessarily incurred
in connection with the defense of any action, suit or proceeding, or in
connection with any appeal therein, to which they or any of them may be a party
by reason of any action taken or failure to act under or in connection with the
plan or any option granted thereunder, and against all amounts paid by them in
settlement thereof (provided such settlement is approved by independent legal
counsel selected by the Company) or paid by them in satisfaction of a judgment
in any such action, suit or proceeding, except in relation to matters as to
which it shall be adjudged in such action, suit or proceeding that such
Committee member is liable for negligence or misconduct in the performance of
his duties; provided that within 60 days after institution of any such action,
suit or proceeding, the Committee member shall in writing offer the Company the
opportunity, at its own expense, to handle and defend the same.
13. Termination. This Plan shall terminate on February 28, 2008, unless
sooner terminated by action of the Board. No option may be granted hereunder
after termination of the Plan, but such termination shall not affect the
validity of any option then outstanding.
14. Shareholder Approval. The Plan shall be subject to approval by the
holders of a majority of the outstanding shares of Common Stock of the Company
present and voting at a meeting of shareholders, which approval must occur
within the period beginning 12 months
B-5
<PAGE> 26
before and ending 12 months after the date the Plan is adopted by the Board,
provided, however, that options may be granted thereunder when all the
conditions (other than shareholder approval) precedent to the granting of
options under the Plan have been completed by the Company.
15. Change in Control Provisions.
(a) Impact of Event. Any Stock Option awarded under the Plan not previously
exercisable and vested shall become fully exercisable and vested in the event
of:
(1) a "Change in Control" as defined in Section 15(b) or
(2) a "Potential Change in Control" as defined in Section 15(c), but
only if and to the extent so determined by the Committee or the Board at or
after grant (subject to any right of approval expressly reserved by the
Committee or the Board at the time of such determination).
(b) Definition of "Change in Control". For purposes of Section 15(a), a
"Change in Control means the happening of any of the following:
(i) any person or entity, including a "group" as defined in Section
13(d)(3) of the Securities Exchange Act of 1934, other than the Company or
a wholly-owned subsidiary thereof or any employee benefit plan of the
Company or any of its Subsidiaries, becomes the beneficial owner of the
Company's securities having 20% or more of the combined voting power of the
then outstanding securities of the Company that may be cast for the
election of directors of the Company (other than as a result of an issuance
of securities initiated by the Company in the ordinary course of business);
or
(ii) as a result of, or in connection with, any cash tender or
exchange offer, merger or other business combination, sale of assets or
contested election, or any combination of the foregoing transaction less
than a majority of the combined voting power of the then outstanding
securities of the Company or any successor corporation or entity entitled
to vote generally in the election of the directors of the Company or such
other corporation or entity after such transaction are held in the
aggregate by the holders of the Company's securities entitled to vote
generally in the election of directors of the Company immediately prior to
such transaction; or
(iii) during any period of two consecutive years, individuals who at
the beginning of any such period constitute the Board cease for any reason
to constitute at least a majority thereof, unless the election, or the
nomination for election by the Company's stockholders, of each director of
the Company first elected during such period was approved by a vote of at
least two-thirds of the directors of the Company then still in office who
were directors of the Company at the beginning of any such period.
(c) Definition of Potential Change in Control. For purposes of Section
15(a), a "Potential Change in Control" means the happening of any one of the
following:
(i) The approval by stockholders of an agreement by the Company, the
consummation of which would result in a Change in Control of the Company as
defined in Section 15(b); and
B-6
<PAGE> 27
(ii) The acquisition of beneficial ownership, directly or indirectly,
by an entity, person or group (other than the Company or a Subsidiary or
any Company employee benefit plan (including any trustee of such plan
acting as such trustee)) of securities of the Company representing 5% or
more of the combined voting power of the Company's outstanding securities
and the adoption by the Board of a resolution to the effect that a
Potential Change in Control of the Company has occurred for purposes of
this Plan.
B-7
<PAGE> 28
APPENDIX C
HERITAGE FINANCIAL SERVICES, INC.
1998 OUTSIDE DIRECTORS'
STOCK OPTION PLAN
SECTION 1. PURPOSE; DEFINITIONS
The purpose of the Heritage Financial Services, Inc. 1998 Outside
Directors' Stock Option Plan (the "Plan") is to advance the long-term success of
Heritage Financial Services, Inc. and its shareholders by attracting and
retaining highly qualified non-employee directors. The Plan will provide
non-employee directors with the ability to increase their proprietary interest
in the Company's long term prospects and more closely align themselves with the
interests of the Company's shareholders by the grant to such directors of
Non-Qualified Stock Options of the Company.
For purposes of the Plan, the following terms shall be defined as set forth
below:
A. "Board" means the Board of Directors of the Company.
B. "Code" means the Internal Revenue Code of 1986, as amended from time to
time, and any successor thereto.
C. "Committee" means the Stock Option Committee of the Board, as from time
to time constituted, or any successor committee of the Board with similar
functions, which shall consist of two or more members, each of whom shall be a
Disinterested Person.
D. "Common Stock" shall mean the common stock of the Company ($2.00 par
value), subject to adjustments pursuant to Section 3(b) below.
E. "Company" means Heritage Financial Services, Inc., a corporation
organized under the laws of the State of Tennessee, or any successor
corporation.
F. "Disability" means permanent and total disability of an Eligible
Director within the meaning of Section 22(e)(3) of the Code.
G. "Disinterested Person" shall have the meanings set forth in Rule
16b-3(c)(2)(i) as promulgated by the Securities and Exchange Commission under
the Securities Exchange Act of 1934, or any successor definition adopted by the
Commission.
H. "Eligible Directors" means duly elected directors of the Company who are
not employees of the Company or any Subsidiary thereof.
I. "Exchange Act" means the Securities Exchange Act of 1934, as amended.
J. "Fair Market Value" shall mean, as of any date, (i) if the Common Stock
is listed or admitted to unlisted trading privileges on any national securities
exchange or is not so listed or admitted but transactions in the Common Stock
are reported by the NASDAQ National
C-1
<PAGE> 29
Market System, the closing sale price of the Common Stock on such exchange or by
the NASDAQ National Market System as of such date (or, if no such shares were
traded on such date, as of the next preceding day on which there was such a
trade); (ii) if the Common Stock is not so listed or admitted to unlisted
trading privileges or reported on the NASDAQ National Market System, and bid and
ask prices therefore in the over-the-counter market are reported by the NASDAQ
system or the National Quotation Bureau, Inc. (or any comparable reporting
service), the mean of the closing bid and ask prices of the Common Stock as of
such date, as so reported; or (iii) if no quotations are available by any
reporting services, the fair market value of such Common Stock as determined by
the Board, in each case, on the business day immediately preceding the date on
which the determination is made.
K. "Non-Qualified Stock Option" means any Stock Option that does not comply
with the provisions of Section 422 of the Code.
L. "Plan" means this Heritage Financial Services, Inc. 1998 Outside
Directors' Stock Option Plan, as hereinafter amended from time to time.
M. "Retirement" means the termination of service of an Eligible Director as
a director of the Company pursuant to and in accordance with the Board's tenure
policy or other regular retirement policy or, if approved by the Board for
purposes of this Plan, early retirement or other practice or policy then
covering an Eligible Director.
N. "Stock" means the Common Stock of the Company.
O. "Stock Option" or "Option" means any Non-Qualified Stock Option to
purchase shares of Common Stock granted pursuant to Section 5 below.
P. "Subsidiary" means Heritage Bank (the "Bank") and any corporation (other
than the Company) in an unbroken chain of corporations beginning with the
Company if each of the corporations (other than the last corporation in the
unbroken chain) owns stock possessing 50% or more of the total combined voting
power of all classes of stock in one of the other corporations in the chain.
In addition, the terms "Change in Control" and "Potential Change in
Control" shall have meanings set forth, respectively, in Section 6(b), (c) and
(d) below and the term "Cause" shall have the meaning set forth in Section 5(j)
below.
SECTION 2. ADMINISTRATION
The Plan shall be administered by the Committee. The functions of the
Committee specified in the Plan may be exercised by the Committee, and may be
exercised by the Board, if and to the extent that no Committee exists which
otherwise has the authority to so administer the Plan. The Committee shall have
full authority to grant Stock Options, pursuant to the terms of the Plan, to
Eligible Directors under Section 5.
The Committee shall have the authority to adopt, alter and repeal such
rules, guidelines and practices governing the Plan as it shall, from time to
time, deem advisable; to interpret the terms and provisions of the Plan and any
Stock Options issued under the Plan (and any agreements relating thereto); and
to otherwise supervise the administration of the Plan.
C-2
<PAGE> 30
All decisions made by the Committee pursuant to the provisions of the Plan
shall be made in the Committee's sole discretion and shall be final and binding
on all persons, including the Company and Plan participants.
SECTION 3. STOCK SUBJECT TO PLAN
(a) The maximum number of shares of Common Stock reserved and available for
issuance under the Plan shall be 40,000 shares of the Company's Common Stock,
subject to adjustment upon changes in capitalization of the Company as provided
in Section 3(b) below. Such shares may consist in whole or in part, of
authorized and unissued shares of the Company.
If any shares of Stock that have been optioned cease to be subject to a
Stock Option prior to the payment of any dividend, if applicable, with respect
to such Stock, then such shares shall again be available for distribution in
connection with future awards under the Plan.
(b) In the event of any merger, reorganization, consolidation,
recapitalization, stock dividend, stock split, combination of shares, exchange
of shares, split-up, split-off, spin-off, liquidation or other change in
corporate structure affecting the Common Stock subject to the Plan, then
appropriate substitutions or adjustments shall be made in maximum aggregate
number of shares subject to and reserved for issuance under the Plan, in the
number and option price of shares subject to outstanding Options granted under
the Plan, provided that the number of shares subject to any award shall always
be a whole number.
SECTION 4. ELIGIBILITY
All Eligible Directors shall be eligible to participate in the Plan and to
receive Non-Qualified Stock Options (as described in Section 5) under the Plan.
SECTION 5. STOCK OPTIONS
On the first business day following the 1998 Annual Meeting of Shareholders
of the Company (or if no such meeting is held, on April 16th) of each of the
years 1998 through and including 2002, each person who is a duly elected
Eligible Director of the Company immediately following such annual meeting shall
be granted automatically Non-Qualified Stock Options to purchase 500 shares of
Common Stock of the Company.
Stock Options granted under the Plan shall be subject to the following
terms and conditions:
(a) Option Price. The option price per share of Common Stock purchasable
under a Stock Option shall be 100% of the Fair Market Value of the Common Stock
on the day of the annual meeting of shareholders (or, if no such meeting is
held, on April 15th or the first trading day following such date).
(b) Option Term. No Stock Option shall be exercisable more than ten years
after the date the Option is granted.
(c) Vesting. Stock Options granted under the Plan shall vest with an
Eligible Director at a rate of 20% per year on the anniversary date of the
Annual meeting of shareholders (or, if no such meeting is held, on April 15th)
with respect to which the Stock Options were
C-3
<PAGE> 31
granted, if an Eligible Director has continued to serve on the Board until that
meeting or date as follows:
<TABLE>
<CAPTION>
Percentage of Stock
Anniversary of Grant Options Vested
-------------------- -------------------
<S> <C>
1st . . . . . . . . . . . 20%
2nd . . . . . . . . . . . 40%
3rd . . . . . . . . . . . 60%
4th . . . . . . . . . . . 80%
5th . . . . . . . . . . . 100%
</TABLE>
Notwithstanding the foregoing, Stock Options shall become fully vested as
provided in Sections 5(g), 5(h), 5(i) and 6.
(d) Exercisability. No Stock Option shall be exercisable prior to six
months and one day after the date of the granting of the Option, except as
provided in Sections 5(g), (h) and (i) and Section 6.
(e) Method of Exercise. Stock Options, to the extent they are vested, may
be exercised in whole or in part at any time during the option period, by giving
written notice of exercise to the Company specifying the number of shares to be
purchased.
Such notice shall be accompanied by payment in full of the purchase price,
either by check, note or such other instrument as the Committee may accept. As
determined by the Committee, in its sole discretion, at or after grant, payment
in full or in part may also be made in the form of Common Stock already owned by
the Eligible Director based on the Fair Market Value of the Common Stock on the
date the Option is exercised.
No shares of Common Stock shall be issued until full payment therefor has
been made. An Eligible Director shall have the rights to dividends or other
rights of a stockholder with respect to shares subject to the Option when the
Eligible Director has given written notice of exercise, has paid in full for
such shares, and, if requested, has given the representation described in
Section 8(a).
(f) Non-Transferability of Options. No Stock Option shall be transferable
by an Eligible Director otherwise than by will or by the laws of descent and
distribution, and all Stock Options shall be exercisable, during the Eligible
Director's lifetime, only by the Eligible Director.
(g) Termination by Death. If an Eligible Director's service on the Board
terminates by reason of death, any Stock Option held by such Eligible Director
may thereafter be exercised, to the extent such option was vested and
exercisable at the time of death or on such accelerated basis as the Committee
may determine at or after grant (or as may be determined in accordance with
procedures established by the Committee), by the legal representative of the
estate or by the legatee of the Eligible Director under the will of the Eligible
Director, for a period of one year from the date of such death or until the
expiration of the stated term of such Stock Option, whichever period is the
shorter.
C-4
<PAGE> 32
(h) Termination by Reason of Disability. If an Eligible Director's service
on the Board terminates by reason of Disability, any Stock Option held by such
Eligible Director may thereafter be exercised by the Eligible Director, to the
extent it was vested and exercisable at the time of termination or on such
accelerated basis as the Committee may determine at or after grant (or as may be
determined in accordance with procedures established by the Committee), for a
period of one year from the date of such termination of service on the Board or
until the expiration of the stated term of such Stock Option, whichever period
is the shorter; provided, however, that, if the Eligible Director dies within
such one year period, any unexercised Stock Option held by such Eligible
Director shall thereafter be exercisable to the extent to which it was
exercisable at the time of death for a period of twelve months from the date of
such death or until the expiration of the stated term of such Stock Option,
whichever period is the shorter.
(i) Termination by Reason of Retirement. If an Eligible Director's service
on the Board terminates by reason of Retirement, any Stock Option held by such
Eligible Director may thereafter be exercised by the Eligible Director, to the
extent it was vested and exercisable at the time of such Retirement or on such
accelerated basis as the Committee may determine at or after grant (or as may be
determined in accordance with procedures established by the Committee), for a
period of three years from the date of such termination of service on the Board
or the expiration of the stated term of such Stock Option, whichever period is
the shorter; provided, however, that, if the Eligible Director dies within such
three year period, any unexercised Stock Option held by such Eligible Director
shall thereafter be exercisable, to the extent to which it was vested and
exercisable at the time of death, for a period of one year from the date of such
death or until the expiration of the stated term of such Stock Option, whichever
period is the shorter.
(j) Other Termination. If an Eligible Director's service on the Board
terminates for any reason other than death, Disability or Retirement, the Stock
Option shall thereupon terminate, except that such Stock Option may be
exercised, to the extent otherwise then vested and exercisable, for the lesser
of three months or the balance of such Stock Option's term if the Eligible
Director's service on the Board is involuntarily terminated by the Company or
the shareholders of the Company without Cause. For purposes of this Plan,
"Cause" means (a) a felony conviction of an Eligible Director or the failure of
an Eligible Director to contest prosecution for a felony, or an Eligible
Director's willful misconduct or dishonesty, any of which is directly or
materially harmful to the business or reputation of the Company or any
Subsidiary, or (b) the commission of a material violation of any laws and/or
regulations applicable to the Company or any Subsidiary.
SECTION 6. CHANGE IN CONTROL PROVISIONS
(a) Impact of Event. Any stock Option awarded under the Plan not previously
exercisable and vested shall become fully exercisable and vested in the event
of:
(1) a "Change in Control" as defined in Section 6(b) or
(2) a "Potential Change in Control" as defined in Section 6(c), but
only if and to the extent so determined by the Committee or the Board at or
after grant (subject to any right of approval expressly reserved by the
Committee or the Board at the time of such determination).
C-5
<PAGE> 33
(b) Definition of "Change in Control". For purposes of Section 6(a), a
"Change in Control means the happening of any of the following:
(i) any person or entity, including a "group" as defined in
Section 13(d)(3) of the Securities Exchange Act of 1934, other than
the Company or a wholly-owned subsidiary thereof or any employee
benefit plan of the Company or any of its Subsidiaries, becomes the
beneficial owner of the Company's securities having 20% or more of the
combined voting power of the then outstanding securities of the
Company that may be cast for the election of directors of the Company
(other than as a result of an issuance of securities initiated by the
Company in the ordinary course of business); or
(ii) as a result of, or in connection with, any cash tender or
exchange offer, merger or other business combination, sale of assets
or contested election, or any combination of the foregoing transaction
less than a majority of the combined voting power of the then
outstanding securities of the Company or any successor corporation or
entity entitled to vote generally in the election of the directors of
the Company or such other corporation or entity after such transaction
are held in the aggregate by the holders of the Company's securities
entitled to vote generally in the election of directors of the Company
immediately prior to such transaction; or
(iii) during any period of two consecutive years, individuals who
at the beginning of any such period constitute the Board cease for any
reason to constitute at least a majority thereof, unless the election,
or the nomination for election by the Company's stockholders, of each
director of the Company first elected during such period was approved
by a vote of at least two-thirds of the directors of the Company then
still in office who were directors of the Company at the beginning of
any such period.
(c) Definition of Potential Change in Control. For purposes of Section
6(a), a "Potential Change in Control" means the happening of any one of the
following:
(i) The approval by stockholders of an agreement by the Company,
the consummation of which would result in a Change in Control of the
Company as defined in Section 6(b); and
(ii) The acquisition of beneficial ownership, directly or
indirectly, by an entity, person or group (other than the Company or a
Subsidiary or any Company employee benefit plan (including any trustee
of such plan acting as such trustee)) of securities of the Company
representing 5% or more of the combined voting power of the Company's
outstanding securities and the adoption by the Board of a resolution
to the effect that a Potential Change in Control of the Company has
occurred for purposes of this Plan.
SECTION 7. AMENDMENTS AND TERMINATION
The Board may amend, alter, or discontinue the Plan, but no amendment,
alteration, or discontinuation shall be made which would impair the rights of an
Eligible Director under any Stock Option theretofore granted, without the
Eligible Director's consent or which, without the approval of the Company's
stockholders, would:
(a) except as expressly provided in this Plan, increase the total
number of shares reserved for the purpose of the Plan;
C-6
<PAGE> 34
(b) change the pricing terms of Section 5(a);
(c) change the class of Eligible Directors eligible to participate in
the Plan; or
(d) extend the maximum option period under Section 5(b) of the Plan.
The Committee may amend the terms of any Stock Option theretofore granted,
prospectively or retroactively, but, subject to Section 3 above, no such
amendment shall impair the rights of any holder without the holder's consent.
The Committee may also substitute new Stock Options for previously granted Stock
Options (on a one for one or other basis), including previously granted Stock
Options having higher option exercise prices.
Subject to the above provisions, the Board shall have broad authority to
amend the Plan to take into account changes in applicable securities and tax
laws and accounting rules, as well as other developments. Notwithstanding the
foregoing, no amendment to the Plan may be made more than once every six months,
other than to comport with changes in the Code, the Employee Retirement Income
Security Act, or the rules or regulations promulgated thereunder.
SECTION 8. GENERAL PROVISIONS
(a) The Committee may require each Eligible Director purchasing shares
pursuant to a Stock Option under the Plan to represent to and agree with the
Company in writing that the Eligible Director is acquiring the shares without a
view to distribution thereof.
All certificates or shares of Stock delivered under the Plan shall be
subject to such stock-transfer orders and other restrictions as the Committee
may deem advisable under the rules, regulations, and other requirements of the
Securities and Exchange Commission, any stock exchange upon which the Stock is
then listed, and any applicable Federal or state securities law, and the
Committee may cause a legend or legends to be put on any such certificates to
make appropriate reference to such restrictions.
(b) Nothing contained in this Plan shall prevent the Board from adopting
other or additional compensation arrangements, subject to stockholder approval
if such approval is required; and such arrangements may be either generally
applicable or applicable only in specific cases.
(c) The adoption of the Plan shall not confer upon any Eligible Director
serving on the Board of the Company any right to continued service as a director
with the Company nor shall it interfere in any way with the right of the Company
or the shareholders of the Company to remove or otherwise terminate his or her
service as a director of the Company.
(d) No later than the date as of which an amount first becomes includable
in the gross income of an Eligible Director for Federal income tax purposes with
respect to any award under the Plan, an Eligible Director shall pay to the
Company, or make arrangement satisfactory to the Committee regarding the payment
of any Federal, state, or local taxes of any kind required by law to be withheld
with respect to such amount. Unless otherwise determined by the Committee,
withholding obligations may be settled with Stock, including Stock that is part
of the award that gives rise to the withholding requirement. The satisfaction of
withholding obligations with Stock at the election of a grantee who is subject
to Section 16 of the Exchange
C-7
<PAGE> 35
Act shall be made either (i) during the 10 business day window period described
in Rule 16b-3(e)(3) (or any successor provision) thereunder, if the exercise is
also made during such a period, or (ii) at least six months prior to the date as
of which the income attributable to the exercise of the related award is
recognized under the Code, and shall be irrevocable to the extent required under
such Rule 16b-3(e)(3) (or any successor provision). The obligations of the
Company under the Plan shall be conditional on such payment or arrangements and
the Company shall, to the extent permitted by law, have the right to deduct any
such taxes from any payment of any kind otherwise due to an Eligible Director.
(e) The Plan and all awards made and actions taken thereunder shall be
governed by and construed in accordance with the laws of the State of Tennessee.
(f) It is intended that the Plan shall comply in all respects with Rule
16b-3 (as amended from time to time and including any successor rule or
regulation) of the Securities and Exchange Commission, and in the event that any
provision of the Plan is determined by the Committee, upon advice of counsel, to
not comply with Rule 16b-3, the Committee shall be authorized to nullify and
void any such provision.
SECTION 9. EFFECTIVE DATE OF PLAN
The Plan shall be effective as of March 1, 1998, upon the approval of the
Plan by the holders of the Bank's Common Stock at the 1998 Annual meeting of
shareholders.
SECTION 10. TERM OF PLAN
No Stock Option shall be granted pursuant to the Plan on or after the tenth
anniversary of the date of stockholder approval, but awards granted prior to
such tenth anniversary may extend beyond that date.
C-8
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF HERITAGE FINANCIAL SERVICES INC FOR THE YEAR ENDED
DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1997
<CASH> 4,531
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 19,153
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 135,482
<ALLOWANCE> 1,908
<TOTAL-ASSETS> 166,083
<DEPOSITS> 134,380
<SHORT-TERM> 8,150
<LIABILITIES-OTHER> 1,514
<LONG-TERM> 8,786
0
0
<COMMON> 6,216
<OTHER-SE> 7,037
<TOTAL-LIABILITIES-AND-EQUITY> 166,083
<INTEREST-LOAN> 12,453
<INTEREST-INVEST> 1,163
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 13,616
<INTEREST-DEPOSIT> 5,468
<INTEREST-EXPENSE> 454
<INTEREST-INCOME-NET> 7,694
<LOAN-LOSSES> 676
<SECURITIES-GAINS> (2)
<EXPENSE-OTHER> 7,019
<INCOME-PRETAX> 3,625
<INCOME-PRE-EXTRAORDINARY> 2,302
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,302
<EPS-PRIMARY> 4.11
<EPS-DILUTED> 4.11
<YIELD-ACTUAL> 9.80
<LOANS-NON> 95
<LOANS-PAST> 451
<LOANS-TROUBLED> 82
<LOANS-PROBLEM> 2,814
<ALLOWANCE-OPEN> 1,544
<CHARGE-OFFS> 341
<RECOVERIES> 30
<ALLOWANCE-CLOSE> 1,908
<ALLOWANCE-DOMESTIC> 1,453
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 455
</TABLE>
