FIDELITY D & D BANCORP INC — Interim / Quarterly Report 2001

Aug 2, 2001

SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934 FOR QUARTER ENDED JUNE 30, 2001 COMMISSION FILE NUMBER: 333-90273 FIDELITY D & D BANCORP, INC. STATE OF INCORPORATION: IRS EMPLOYER IDENTIFICATION NO: PENNSYLVANIA 23-3017653 PRINCIPAL OFFICE: BLAKELY & DRINKER ST. DUNMORE, PENNSYLVANIA 18512 TELEPHONE: 570-342-8281 The Company (1) has filed all reports required to be filed by Section 13 of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. X YES ___ NO The number of outstanding shares of Common Stock of Fidelity D & D Bancorp, Inc. at July 25, 2001, the latest practicable date was 1,811,876. FIDELITY D & D BANCORP, INC and SUBSIDIARY. DUNMORE, PA 18512 FORM 10-Q JUNE 30, 2001 INDEX PART I. FINANCIAL INFORMATION Page ITEM 1. FINANCIAL STATEMENTS: Consolidated Balance Sheets as of June 30, 2001 and December 31, 2000 3 Consolidated Statement of Income for the six months ended June 30, 2001 and 2000 4 Consolidated Statement of Changes in Shareholders' Equity for the six months ended June 30, 2001 and 2000 5 Consolidated Statement of Cash Flows for the six months ended June 30, 2001 and 2000 6 Notes to Consolidated Financial Statements 7-8 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9-17 ITEM 3. Quantitative and Qualitative Disclosure about Market Risk, included in Item 2 16-17 PART II.OTHER INFORMATION ITEM 1. Legal Proceedings 18 ITEM 2. Change in Securities and Use of Proceeds 18 ITEM 3. Defaults upon Senior Securities 18 ITEM 4. Submission of Matters to a Vote of Security Holder 18-19 ITEM 5. Other Information 19 ITEM 6. Exhibits and Reports on Form 8-K 19-20 Signature Page 21 Exhibit Index 22 2 FIDELITY D & D BANCORP, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEET As of June 30, 2001 and December 31, 2000

FIDELITY D & D BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF INCOME Three and Six Month Periods Ended June 30, 2001 and 2000 (unadited)

4 FIDELITY D & D BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY For the Six Months Ended June 30, 2001 and 2000 (unaudited)

Comprehensive income (loss) for the three months ended June 30, 2001 and June 30, 2000 was $928,855 and ($1,405,203), respectively. 5 FIDELITY D & D BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOWS For the Six Months Ended June 30, 20001 and 2000 (unaudited)

6 FIDELITY D & D BANCORP, INC. and SUBSIDIARY DUNMORE, PA 18512 FORM 10-Q JUNE 30, 2001 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The accompanying unaudited consolidated financial statements of Fidelity D&D Bancorp, Inc., and subsidiary, The Fidelity Deposit & Discount Bank, (Bank), (collectively the "Company") have been prepared in accordance with accounting principles, generally accepted in the United States of America (GAAP), for interim financial information and with the instructions to Form 10-Q and Article 10-01 of Regulation S-X. In the opinion of management, all normal recurring adjustments necessary for a fair presentation of the financial position and results of operations for the periods have been included. All significant inter-company balances and transactions have been eliminated in the consolidation. Prior period amounts are reclassified when necessary to conform with the current year's presentation. The preparation of financial statements in conformity with GAAP 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 reported periods. Actual results could differ from those estimates. For additional information and disclosures required under GAAP, reference is made to the Bank's Annual Report on Form 10-K for the year ended December 31, 2000. The Bank is a commercial bank chartered by the Commonwealth of Pennsylvania. Having commenced operations in 1903, the Bank provides a full range of traditional banking services and alternative financial products from its main office located in Dunmore and other branches throughout Lackawanna and Luzerne counties. Management is responsible for the fairness, integrity and objectivity of the unaudited financial statements included in this report. Management prepared the unaudited financial statements in accordance with GAAP. In meeting its responsibility for the financial statements, management depends on the Company's accounting systems and related internal controls. These systems and controls are designed to provide reasonable, but not absolute, assurance that the financial records accurately reflect the transactions of the Company, that Company assets are safeguarded and that financial statements present fairly the financial position and results of operations of the Company. In the opinion of management, the consolidated balance sheets as of June 30, 2001 and December 31, 2000 present fairly the consolidated financial position of the Company as of those dates and the related statements of income, changes in shareholders' equity and cash flows for the six months ended June 30, 2001 and 2000 present fairly the consolidated results of its operations and its cash flows for the periods then ended. All material adjustments required for fair presentation have been made. There have been no material changes in accounting principles, 7 practices or in the method of application, and there have been no retroactive adjustments during this period. These adjustments are of a normal reoccurring nature. This quarterly report on Form 10-Q should be read in conjunction with the Company's audited financial statements for the year ended December 31, 2000 and the notes included therein, in the Company's Annual Report on Form 10-K. The results of operations for interim periods are not necessarily indicative of the results of operations to be expected for the entire year. Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period, 1,808,255 shares in 2001 and 1,803,017 shares in 2000. Diluted earnings per share is similar to the computation of basic earnings per common share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. The following data shows the amounts used in computing earnings per share and the effects on income and the weighted average number of shares of dilutive potential common stock for the periods ended June 30, 2001 and 2000:

The Company became a bank holding company on June 30, 2000, when it acquired all of the outstanding shares of the Bank. On that date, each then outstanding share of common stock of the Bank came to represent two shares of the Company's common stock, in accordance with the terms of the plan of reorganization. 8 FIDELITY D & D BANCORP, INC. and SUBSIDIARY DUNMORE, PA 18512 FORM 10-Q JUNE 30, 2001 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations In addition to historical information, this Form 10-Q may contain forward-looking statements. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Important factors that might cause such a difference include, but are not limited to, those discussed in the section entitled, "Management's Discussion and Analysis of Financial Condition and Results of Operations". Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Company undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date hereof. 1. Changes in Financial Condition Total deposits increased $43,504,000 or 12.81% from $339,625,000 at December 31, 2000 to $383,129,000 at June 30, 2001. The success at attracting new customers and additional funds from existing depositors can be linked to the new and renovated branches and competitive product pricing. Non interest-bearing deposits increased $698,000 or 1.47% during 2001. Growth was centered in personal demand deposit accounts (DDA's) which increased $455,000. Interest-bearing deposits increased $42,806,000 or 14.65%. Public fund certificates of deposit (CD's), personal CD's and non-personal CD's increased $39,402,000, $3,978,000 and $7,115,000 respectively. Savings and club accounts increased $1,489,000. Decreases in NOW and money market deposit accounts reduced the increase in CD's, savings and club accounts. Some of the funds in Now and money market deposit accounts transferred into CD's to take advantage of higher yields. Short-term borrowings, which are comprised of repurchase agreements (Repos), treasury tax and loan retained funds and federal funds purchased, decreased $12,249,000 or 4.79%. Of the total decrease, federal funds purchased were reduced $10,950,000. The reduction in federal funds purchased was due to the increase in deposits and Repos. The rise in deposits less the decrease in short-term borrowings, an increase in common stock through the Dividend Reinvestment Plan, and the retention of earnings, caused Total Liabilities and Shareholders' Equity to increase $36,327,000 or 7.39% since December 31, 2000. 9 During 2001, net loans, including available-for-sale loans, grew $8,331,000 or 2.42%. Commercial loans increased $11,134,000 or 7.59%. Consumer loans grew $2,023,000 or 3.04%. Residential mortgages, SBA guaranteed loans and student loans totaling $10,617,000 were sold during 2001 to provide liquidity and improve yield. The Company has classified certain residential mortgages, student loans and SBA guaranteed loans of $12,491,000 as available-for-sale (AFS) at June 30, 2001. The market value of AFS loans at June 30, 2001 and December 31, 2000 was $12,719,00 and $10,507,000, respectively. The following table reflects the composition of the loan portfolio:

Paydowns and early calls of US agency and municipal bonds totaled $11,537,000. US agency bonds of $4,000,000, classified as available-for-sale, were sold to provide liquidity and to improve the yield on earning assets. US Government agency bonds with a par value of $19,000,000 were purchased during 2001. Due to the reduction of borrowings from the Federal Home Loan Bank of Pittsburgh (FHLB), $1,793,000 in FHLB equity stock, owned by the Company to support the borrowings, was redeemed by the FHLB. These activities, plus a $1,461,000 improvement in the market value of available-for-sale securities, were the major changes in the investment portfolio. Fluctuations in capital markets cause frequent changes in the market value of investments. The amount of net depreciation in the investment portfolio does not indicate a material weakness in the Company. Market conditions are monitored daily and the Company is prepared to take remedial actions if deemed appropriate. 10 Securities held-to-maturity and available-for-sale at June 30, 2001 consist of the following:

11 At June 30, 2001, the contractual maturities of securities held-to-maturity and available-for-sale are listed below. Mortgage backed securities, which are subject to monthly principal reductions, are listed in total. Equity securities have no stated maturity dates and are listed in total.

1. Changes in Results of Operations: Net Income for the six months ending June 30, 2001 and 2000 was $2,213,002 and $1,708,193 respectively. The significant differences are as follows:

A) The tax equivalent ("TE") yield on Average Earning Assets increased 6 basis points (bp) from 7.73% at June 30, 2000 to 7.79% at June 30, 2001. This improvement was affected despite six reductions in the discount rate since December 31, 2000. The reductions totaled 275 bp. 12 The discount rate is the rate at which the Federal Reserve Bank lends overnight funds to banks. Changes in the discount rate have a direct effect on loans and investments subject to in accordance with GAAP immediate repricing. Deliberate measures undertaken by the Bank to improve earnings are accountable for the improvement in the TE yield on earning assets. The decline in market rates allowed the Bank to reduce rates paid on interest-bearing liabilities. The cost of funds decreased 11bp from 5.18% at June 30, 2000 to 5.07% at June 30, 2001. The changes in pricing and volume increases in loans improved the TE net yield on earning assets by 14 bp and that increased Net Interest Income by $808,000. B) In the internal review of loans for both delinquency and collateral sufficiency, there was an increase in loans that lacked the ability to repay in accordance with contractual terms. Accordingly, it was necessary to increase the allowance for loan losses. The allowance for loan losses was increased through the provision for loan losses. C) Service charges on loans and deposits rose $26,000 and $159,000 respectively. Included in the increase in service charges on deposits is a $31,000 increase in ATM charges. Fees generated from loan servicing increased $11,000 due to volume increase in sold loans serviced by the Bank. Trust income increased $21,000. Gross fees from the sale of mutual funds and annuities increased $11,000. D) Merit pay increases and higher benefit costs increased personnel expense $223,000. E) A full six months of depreciation on the Peckville branch and fixed assets purchased during 2000 caused an $170,000 rise in depreciation expense. Occupancy expense at the Kingston branch was $27,000 before depreciation of $3,000. F) Advertising costs were lowered $27,000 in 2001, despite the opening of the Kingston branch. Merchant credit card expense was reduced $69,000. Holding company organization costs of $149,000 were incurred in 2000. There were no organization expenses in 2001. Stationary and supply expense declined $74,000 in 2001. G) Income before provision for income taxes in 2001 increased $806,000 over 2000. Non-taxable income as a percentage of net income before taxes declined from 39.92% in 2000 to 26.53% in 2001. 13 THE FIDELITY DEPOSIT & DISCOUNT BANK MANAGEMENT'S DISCUSSION AND ANALYSIS (in thousands of dollars)

14 FIDELITY D & D BANCORP, INC. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS PROVISION FOR LOAN LOSSES

In addition to the allowance for loan losses, there are guarantees and other reserves not recorded on the Company's records that are available to mitigate potential loan loss. The guaranteed portion of SBA and Student Loans that are either 90 days or more delinquent or classified as non-accrual was $764,000 at June 30, 2001. The reserve set aside by the Commonwealth of Pennsylvania for loans registered in the PENNCAP program was $358,000 at June 30, 2001. Loans secured by deposits were $7,065,000 at June 30, 2001. The allowance for loan loses is established through a provision for loan losses. The allowance represents an amount, which, in management's judgement, will be adequate to absorb possible losses on existing loans and leases. Management's judgement in determining the adequacy of the allowance is based on evaluations of the collectibility of the loans. These evaluations take into consideration such factors as: oChanges in the nature and volume of the loan portfolio; oCurrent economic conditions that may effect the borrowers ability to repay; oOverall portfolio quality; and 15 oReview of specific impaired loans. Loans considered uncollectible are charged to the allowance. Recoveries on charged-off loans are added to the allowance. A loan is considered impaired when, based on current information, it is probable that the Company will be unable to collect the scheduled payments. Factors considered in determining impairment include payment status and collateral value. The significance of payment shortfalls is determined on a case by case basis. Such factors include the length of the delinquency, the underlying reasons and the borrower's prior payment record. Impairment is measured on a case by case basis. The Company does not group homogeneous loans collectively for the purpose of determining impairment. The Company carefully monitors potential problem loans. Potential problem loans are those where there is known information that leads the company to believe repayment is in jeopardy. The loans are either non-accrual or past due 90 days or more. Non-accrual loans and loans that were past due 90 days or more at June 30, 2001 were $3,697,000 and $4,635,000 respectively. At June 30, 2001 the allowance for loan loss represents 89.26% of non-accrual loans and 71.20% of loans 90 days or more past due. Interest rate risk management is an integral part of the Asset Liability Management Process. Interest rate risk is defined as the degree to which interest rate movements may affect net interest income and the balance sheet. Fluctuations in rates can affect income through the balance of repricing assets and source funds. If more assets reprice than liabilities, the balance sheet is positively gapped. This position contributes favorably to net interest income in a rising interest rate environment. Conversely, if the balance sheet has more liabilities repricing than assets, the balance sheet is liability sensitive and negatively gapped. In a declining rate environment, net interest income would improve. The Company uses a simulation model to better understand the risks to the company that may be brought about by changes in market interest rates. At June 30, 2001 the Company simulated the effects on net interest income given an immediate parallel shift in the yield curve of 200 basis points in either direction. The results of the simulation were within the Company's established policy limits for changes in net interest income. Liquidity for a bank is the ability to fund customers' needs for borrowings and withdrawals. Sources of liquidity are: oAsset maturities, paydowns and sales oGrowth of core deposits oGrowth of Repos oIncrease of other borrowed funds 16 Management monitors asset and liability maturities to match anticipated cash flow requirements. These cash flow requirements are reviewed with the use of internally generated reports. The Company has instituted certain procedures and policy guidelines to manage the rate sensitive position. Those internal rules enable the Company to react to changes in market rates and protect net interest income from significant fluctuations. Liquidity (in thousands of dollars)

Management believes that the present level of liquidity is adequate for current operations. Investments were scheduled by maturity dates. Liabilities include deposits not having stated maturity dates (DDA's, NOWs, Savings & MMDA's) in the amounts reported. In addition, sweep accounts were classified as having immediate maturity dates. This presentation does not take into consideration lines of credit that are available to the Company, or assets available-for-sale, both of which could be used to meet liquidity needs. The Company's capital amounts and ratios at June 30, 2001 are as follows:

The ratios for the Company are not materially different from those of the Bank. 17 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings. In the opinion of Management, there are no proceedings pending to which the Company is a party or to which its property is subject, which if determined adversely to the Company, would be material in relation to the Company's undivided profits or financial condition. In addition, there are no material proceedings pending, threatened or contemplated against the Company by government authorities. ITEM 2. Changes in Securities and Use of Proceeds. None ITEM 3. Default Upon Senior Securities. None ITEM 4. Submission of matters to a Vote by Security Holders. At the annual meeting of Shareholders held on May 1, 2001, 1,428,097 shares of common stock representing 79% of the total number of shares outstanding, were represented in person or by proxy. The following votes were cast: A Election of Class A Directors to serve for a two-year term: Withhold For Authority Paul A. Barrett 1,425,582 2,515 --------- ----- John T. Cognetti 1,425,358 2,739 --------- ----- John F. Glinsky, Jr. 1,425,358 2,739 --------- ----- Michael J. McDonald 1,425,582 2,515 --------- ----- B Election of Class B Directors to serve for a one-year term: Withhold For Authority Samuel C. Cali 1,425,582 2,515 --------- ----- Mary E. McDonald 1,419,582 8,515 --------- ----- David L. Tressler, Sr. 1,402,687 25,410 --------- ------ 18 C Election of Class C Directors to serve for a three-year term: Withhold For Authority Brian J. Cali 1,419,283 8,814 --------- ----- Patrick J. Dempsey 1,425,582 2,515 --------- ----- Michael F. Marranca 1,422,399 5,698 --------- ----- D Proposal to approve and adopt the Fidelity D & D Bancorp, Inc. Independent Directors Stock Option Plan: 1,355,657 For 20,635 Against 51,805 Abstain --------- ------ ------ E Proposal to approve and adopt the Fidelity D & D Bancorp, Inc. 2000 Stock Incentive Plan: 1,398,132 For 15,330 Against 14,635 Abstain --------- ------ ------ F Proposal to ratify the selection of Parente Randolph, P.C. as the independent auditors for the Company for the year ending December 31, 2001: 1,422,629 For 3,794 Against 1,674 Abstain --------- ------ ------ ITEM 5. Other Information. On April 10, 2001, the Board of Directors named Joseph T. Earyes Executive Vice President and CEO of the Company and Bank. Michael F. Marranca remains President of the Company and Bank and in addition was elected Vice Chairman of the Company's and the Bank's Board of Directors on May 1, 2001. ITEM 6. Exhibits and Reports on Form 8-K. a) Exhibits 3(i) Amended and Restated Articles of Incorporation of Registrant. Incorporated by reference to Exhibit 3(i) to Registrant's Registration Statement No. 333-90273 on Form S-4, filed with the SEC on November 3, 1999 and as amended on April 6, 2000. 3(ii) Bylaws of Registrant. Incorporated by reference to Exhibit 3 (ii) to Registrant's Registration Statement No. 333-90273 on Form S-4, filed with the SEC on November 3, 1999 and as amended on April 6, 2000. 19 10.1 Registrant's 2000 Independent Directors Stock Option Plan. Incorporated by reference to Exhibit 4.3 to Registrant's Registration Statement No. 333-64356 on Form S-8, filed with the SEC on July 2, 2001. 10.2 Registrant's 2000 Stock Incentive Plan. Incorporated by reference to Exhibit 4.4 to Registrant's Registration Statement No. 333-64356 on Form S-8, filed with the SEC on July 2, 2001. 10.3 Form of Deferred Compensation Plan of the Fidelity Deposit and Discount Bank. Incorporated by reference to Exhibit 10.3 to Registrant's Registration Statement No. 333-45668 on Form S-1, filed with the SEC on September 12, 2000, as amended by Pre-effective Amendment No. 1 on October 11, 2000 and by Post-effective Amendment No. 1 on Form S-3 on May 30, 2001. 10.4 Registrant's 2000 Dividend Reinvestment Plan. Incorporated by reference to Exhibit 4.3 to Registrant's Registration Statement No. 333-45668 on Form S-1, filed with the SEC on September 12, 2000, as amended by Pre-effective Amendment No. 1 on October 11, 2000 and by Post-effective Amendment No. 1 on Form S-3 on May 30, 2001. 11 Statement regarding computation of earnings per share. Included herein on page 8. b) No Current Report on Form 8-K was filed by the Company during the quarter ended June 30, 2001. 20 FIDELITY D&D BANCORP, INC. and SUBSIDIARY DUNMORE, PA 18512 FORM 10-Q JUNE 30, 2001 Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DATE: July 27, 2001 MICHAEL F. MARRANCA, PRESIDENT DATE: July 27, 2001 ROBERT P. FARRELL, TREASURER 21 FIDELITY D&D BANCORP, INC. and SUBSIDIARY DUNMORE, PA 18512 FORM 10-Q JUNE 30, 2001 Exhibit Index 3(i)Amended and Restated Articles of Incorporation of Registrant. Incorporated by reference to Exhibit 3(i) to Registrant's Registration Statement No. 333-90273 on Form S-4, filed with the SEC on November 3, 1999 and as amended on April 6, 2000. 3(ii)Bylaws of Registrant. Incorporated by reference to Exhibit 3 (ii) to Registrant's Registration Statement No. 333-90273 on Form S-4, filed with the SEC on November 3, 1999 and as amended on April 6, 2000. 10.1 Registrant's 2000 Independent Directors Stock Option Plan. Incorporated by reference to Exhibit 4.3 to Registrant's Registration Statement No. 333-64356 on Form S-8, filed with the SEC on July 2, 2001. 10.2 Registrant's 2000 Stock Incentive Plan. Incorporated by reference to Exhibit 4.4 to Registrant's Registration Statement No. 333-64356 on Form S-8, filed with the SEC on July 2, 2001. 10.3 Form of Deferred Compensation Plan of the Fidelity Deposit and Discount Bank. Incorporated by reference to Exhibit 10.3 to Registrant's Registration Statement No. 333-45668 on Form S-1, filed with the SEC on September 12, 2000, as amended by Pre-effective Amendment No. 1 on October 11, 2000 and by Post-effective Amendment No. 1 on Form S-3 on May 30, 2001. 10.4 Registrant's 2000 Dividend Reinvestment Plan. Incorporated by reference to Exhibit 4.3 to Registrant's Registration Statement No. 333-45668 on Form S-1, filed with the SEC on September 12, 2000, as amended by Pre-effective Amendment No. 1 on October 11, 2000 and by Post-effective Amendment No. 1 on Form S-3 on May 30, 2001. . 11 Computation of earnings per share. Included herein on page 8. 22