10-K405/A 1 ka1068.txt TIMBERLAND BANCORP, INC. FORM 10-K/A SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended September 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 0-23333 TIMBERLAND BANCORP, INC. ------------------------------------------------------------------------------ (Exact name of registrant as specified in its charter) Washington 91-1863696 ---------------------------------------------- ----------------- (State or other jurisdiction of incorporation (I.R.S. Employer or organization) I.D. Number) 624 Simpson Avenue, Hoquiam, Washington 98550 ---------------------------------------------- ----------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (360) 533-4747 Securities registered pursuant to Section 12(b) of the Act: None ----------------- Securities registered pursuant to Section 12(g) Common Stock, par value of the Act: $.01 per share ----------------------- (Title of Class) Check whether the Registrant (1) 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-K contained herein, and no disclosure will be contained, to the best of the Registrant's knowledge, in any definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. X ----- As of December 5, 2001, there were outstanding 4,006,103 shares of the registrant's Common Stock, which are listed on the Nasdaq National Market System under the symbol "TSBK." Based on the average of the bid and asked prices for the Common Stock on December 5, 2001, the aggregate value of the Common Stock outstanding held by nonaffiliates of the registrant was $58,889,714 (4,006,103 shares at $14.70 per share). For purposes of this calculation, Common Stock held by officers and directors of the registrant and Timberland Bank, Employee Stock Ownership Plan and Trust are considered nonaffiliates. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of Definitive Proxy Statement for the 2002 Annual Meeting of Stockholders (Part III). The Registrant hereby amends Part II, Item 8 of its Annual Report for the fiscal year ended September 30, 2001 for the purpose of including its former accountant's, Knight, Vale & Gregory PLLC, independent report. No other revisions were made to the Registrant's Consolidated Financial Statements for the year ended September 30, 2001. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ---------------------------------------------------- TIMBERLAND BANCORP, INC. AND SUBSIDIARY Index to Consolidated Financial Statements Page ---- Independent Auditor's Report McGladrey & Pullen, LLP 46 Knight Vale & Gregory PLLC 47 Consolidated Balance Sheets as of September 30, 2001 and 2000 48 Consolidated Statements of Income For the Years Ended September 30, 2001, 2000, and 1999 49 Consolidated Statements of Shareholders' Equity For the Years Ended September 30, 2001, 2000 and 1999 50 Consolidated Statements of Cash Flows For the Years Ended September 30, 2001, 2000 and 1999 51 Consolidated Statements of Comprehensive Income For the Years Ended September 30, 2001, 2000 and 1999 53 Notes to Consolidated Financial Statements 54 45 INDEPENDENT AUDITOR'S REPORT The Board of Directors Timberland Bancorp, Inc. Hoquiam, Washington We have audited the accompanying consolidated balance sheet of Timberland Bancorp, Inc. and Subsidiaries as of September 30, 2001, and the related consolidated statements of income, shareholders' equity, cash flows and comprehensive income for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. The consolidated financial statements of Timberland Bancorp, Inc. and Subsidiaries as of September 30, 2000 and for the years ended September 30, 2000 and 1999 were audited by Knight Vale & Gregory PLLC, independent accountants, whose members became partners of McGladrey & Pullen, LLP on September 1, 2001. Knight Vale & Gregory PLLC's report, dated November 2, 2000, expressed an unqualified opinion on those statements. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 audit provides a reasonable basis for our opinion. In our opinion, the 2001 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Timberland Bancorp, Inc. and Subsidiaries as of September 30, 2001, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. McGladrey & Pullen,LLP /s/McGladrey & Pullen,LLP October 31, 2001 Tacoma, Washington 46 INDEPENDENT AUDITOR'S REPORT The Board of Directors Timberland Bancorp, Inc. Hoquiam, Washington We have audited the accompanying consolidated balance sheet of Timberland Bancorp, Inc. and Subsidiaries as of September 30, 2000, and the related consolidated statements of income, shareholders' equity, cash flows and comprehensive income for the years ended September 30, 2000 and 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Timberland Bancorp, Inc. and Subsidiaries as of September 30, 2000, and the results of their operations and their cash flows for the years ended September 30, 2000 and 1999, in conformity with accounting principles generally accepted in the United States of America. /s/Knight Vale & Gregory PLLC Tacoma, Washington November 2, 2000 47 CONSOLIDATED BALANCE SHEETS ------------------------------------------------------------------------------ (Dollars in Thousands) Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 2001 2000 ASSETS Cash and due from financial institutions $ 10,017 $ 8,893 Interest bearing deposits in banks 3,422 3,109 Investments and mortgage-backed securities (available for sale) 29,369 24,925 Federal Home Loan Bank stock (at cost) 4,830 4,150 Loans receivable, net 305,746 284,663 Loans held for sale 18,022 28,343 323,768 313,006 Accrued interest receivable 1,880 1,756 Premises and equipment 10,660 8,614 Real estate owned 1,006 1,966 Accrued interest receivable 1,880 1,756 Other assets 1,353 1,661 TOTAL ASSETS $386,305 $368,080 LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Deposits $242,372 $212,611 Federal Home Loan Bank advances 68,978 81,137 Other liabilities and accrued expenses 3,146 2,020 TOTAL LIABILITIES 314,496 295,768 SHAREHOLDERS' EQUITY Preferred stock, $0.01 par value; 1,000,000 shares authorized; none issued -- -- Common stock, $0.01 par value; 50,000,000 shares authorized; 2001 - 4,570,995 shares issued, 4,010,303 shares outstanding 2000 - 4,793,295 shares issued, 4,361,279 shares outstanding 46 48 Additional paid-in capital 39,574 42,250 Unearned shares issued to employee stock ownership trust (5,948) (6,477) Unearned shares issued to management recognition and & development plan (2,471) -- Retained earnings 40,332 36,795 Accumulated other comprehensive income (loss) 276 (304) TOTAL SHAREHOLDERS' EQUITY 71,809 72,312 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $386,305 $368,080 See notes to consolidated financial statements. 48 CONSOLIDATED STATEMENTS OF INCOME ------------------------------------------------------------------------------ (Dollars in Thousands, Except Per Share Amounts) Timberland Bancorp, Inc. and Subsidiaries Years Ended September 30, 2001, 2000 and 1999 2001 2000 1999 INTEREST AND DIVIDEND INCOME Loans receivable $29,777 $26,325 $20,721 Investments and mortgage-backed securities 962 1,183 1,382 Dividends from investments 791 713 766 Interest bearing deposits in banks 162 141 240 TOTAL INTEREST AND DIVIDEND INCOME 31,692 28,362 23,109 INTEREST EXPENSE Deposits 9,491 8,393 7,276 Federal Home Loan Bank advances 4,433 4,034 1,087 TOTAL INTEREST EXPENSE 13,924 12,427 8,363 NET INTEREST INCOME 17,768 15,935 14,746 PROVISION FOR LOAN LOSSES 1,400 885 363 NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 16,368 15,050 14,383 NON-INTEREST INCOME Service charges on deposits 1,040 507 440 Gain on sale of loans, net 367 103 74 Market value adjustment on loans held for sale 175 408 (583) Gain (loss) on sale of securities available for sale, net 205 (22) -- Escrow fees 205 198 240 Servicing income (expenses) on loans sold 152 (2) (17) ATM transaction fees 379 250 156 Other 404 296 282 TOTAL NON-INTEREST INCOME 2,927 1,738 592 NON-INTEREST EXPENSE Salaries and employee benefits 6,042 4,535 4,246 Premises and equipment 1,208 960 856 Advertising 950 389 299 Loss from real estate operations and write-downs 481 134 45 Other 2,411 1,948 1,714 TOTAL NON-INTEREST EXPENSE 11,092 7,966 7,160 INCOME BEFORE FEDERAL INCOME TAXES 8,203 8,822 7,815 FEDERAL INCOME TAXES 2,741 2,925 2,597 NET INCOME $ 5,462 $ 5,897 $ 5,218 EARNINGS PER COMMON SHARE Basic $1.30 $1.31 $1.03 Diluted 1.28 1.31 1.03 See notes to consolidated financial statements. 49 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY ----------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Timberland Bancorp, Inc. and Subsidiaries Years Ended September 30, 2001, 2000 and 1999 UNEARNED UNEARNED SHARES SHARES ACCUMULATED ISSUED TO ISSUED TO OTHER EMPLOYEE MANAGEMENT COMPRE- COMMON STOCK ADDITIONAL STOCK RECOG- HENSIVE PAID-IN OWNERSHIP NITION RETAINED INCOME SHARES AMOUNT CAPITAL TRUST PLAN EARNINGS (LOSS) TOTAL Balance, September 30, 1998 5,779,325 $63 $60,183 ($7,534) $ -- $28,948 $120 $81,780 Net income -- -- -- -- -- 5,218 -- 5,218 Repurchase of common stock (1,064,453) (11) (13,139) -- -- -- -- (13,150) Cash dividends ($.27 per share) -- -- -- -- -- (1,520) -- (1,520) Earned ESOP shares 35,267 -- (101) 529 -- -- -- 428 Change in fair value of unrealized loss on securities available for sale, net of tax -- -- -- -- -- -- (511) (511) BALANCE, SEPTEMBER 30, 1999 4,750,139 52 46,943 (7,005) -- 32,646 (391) 72,245 Net income -- -- -- -- -- 5,897 -- 5,897 Repurchase of common stock (424,127) (4) (4,599) -- -- -- -- (4,603) Cash dividends ($.35 per share) -- -- -- -- -- (1,748) -- (1,748) Earned ESOP shares 35,267 -- (94) 528 -- -- -- 434 Change in fair value of unrealized loss on securities available for sale, net of tax -- -- -- -- -- -- 87 87 BALANCE, SEPTEMBER 30, 2000 4,361,279 48 42,250 (6,477) -- 36,795 (304) 72,312 Net income -- -- -- -- -- 5,462 -- 5,462 Issuance of MRDP shares -- 2 3,222 -- (3,224) -- -- -- Repurchase of common stock (428,827) (4) (5,914) -- -- -- -- (5,918) Exercise of stock options 1,600 -- 19 -- -- -- -- 19 Cash dividends ($.41 per share) -- -- -- -- -- (1,925) -- (1,925) Earned ESOP shares 35,266 -- (26) 529 -- -- -- 503 Earned MRDP shares 40,985 -- 23 -- 753 -- -- 776 Change in fair value of unrealized loss on securities available for sale, net of tax -- -- -- -- -- -- 580 580 BALANCE, SEPTEMBER 30, 2001 4,010,303 $46 $39,574 ($5,948) ($2,471) $40,332 $276 $71,809
See notes to consolidated financial statements. 50 CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------------------------------------------------ (Dollars in Thousands) Timberland Bancorp, Inc. and Subsidiaries Years Ended September 30, 2001, 2000 and 1999 2001 2000 1999 CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 5,462 $ 5,897 $ 5,218 Noncash revenues, expenses, gains and losses included in net income: Depreciation 527 424 364 Deferred federal income taxes (207) (231) (449) Earned ESOP shares 503 434 428 Earned MRDP Shares 776 -- -- Federal Home Loan Bank stock dividends (310) (224) (134) Market value adjustment on loans held for sale (175) (408) 583 Loss on sale of real estate owned, net 21 25 -- (Gain) loss on sale of securities available for sale (205) 22 -- Gain on sale of loans (367) (103) (74) Provision for loan and real estate owned losses 1,756 936 391 Net increase (decrease) in loans originated for sale (1,063) (5,169) (14,783) Net change in accrued interest receivable and other assets, and other liabilities and accrued expenses 1,167 (89) 1,339 NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 7,885 1,514 (7,117) CASH FLOWS FROM INVESTING ACTIVITIES Net (increase) decrease in interest- bearing deposits in banks (313) (1,793) 13,429 Activity in securities available for sale: Sales 12,334 2,482 -- Maturities, prepayments and calls 10,549 2,421 29,889 Purchases (14,720) (1,989) (26,826) Increase in loans receivable, net (23,653) (54,139) (44,568) Additions to premises and equipment (2,573) (1,416) (2,664) Additions to real estate owned (198) (271) -- Proceeds from sale of real estate owned 2,035 1,109 1,498 Proceeds from sale of premises and equipment -- -- 20 NET CASH USED IN INVESTING ACTIVITIES (16,539) (53,596) (29,222) CASH FLOWS FROM FINANCING ACTIVITIES Increase in deposits 29,761 24,463 17,314 Increase (decrease) in Federal Home Loan Bank advances (12,159) 36,053 33,466 Proceeds from exercise of stock options 19 -- -- Repurchase of common stock (5,918) (4,603) (13,150) Payment of dividends (1,925) (1,748) (1,520) Common stock purchased for ESOP -- -- -- NET CASH PROVIDED BY FINANCING ACTIVITIES 9,778 54,165 36,110 NET INCREASE (DECREASE) IN CASH 1,124 2,083 (229) CASH AND DUE FROM FINANCIAL INSTITUTIONS Beginning of year 8,893 6,810 7,039 END OF YEAR $10,017 $ 8,893 $ 6,810 (continued) See notes to consolidated financial statements. 51 CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------------------------------------------------ (concluded) (Dollars in Thousands) Timberland Bancorp, Inc. and Subsidiaries Years Ended September 30, 2001, 2000 and 1999 2001 2000 1999 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Income taxes paid $ 2,260 $ 3,195 $2,975 Interest paid 14,024 12,151 8,171 SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES Market value adjustment of securities held for sale, net of tax $ 580 $ 87 ($511) Loans transferred to real estate owned 1,254 2,013 581 Shares issued to management recognition and development plan 3,224 -- -- Investment securities acquired in loan securitization 11,926 -- -- See notes to consolidated financial statements. 52 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME ------------------------------------------------------------------------------ (Dollars in Thousands) Timberland Bancorp, Inc. and Subsidiaries Years Ended September 30, 2001, 2000 and 1999 2001 2000 1999 COMPREHENSIVE INCOME Net income $5,462 $5,897 $5,218 Change in fair value of unrealized gains (losses) securities available for sale, net of tax 580 87 (511) TOTAL COMPREHENSIVE INCOME $6,042 $5,984 $4,707 See notes to consolidated financial statements. 53 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Timberland Bancorp, Inc. (the Company); its wholly owned subsidiary, Timberland Bank (the Bank); and the Bank's wholly owned subsidiary, Timberland Service Corp. All significant intercompany transactions and balances have been eliminated. NATURE OF OPERATIONS The Company is a holding company which operates primarily through its subsidiary, the Bank. The Bank was established in 1915 and, through its thirteen branches located in Grays Harbor, Pierce, Thurston, Kitsap and King Counties in Washington State, attracts deposits from the general public, and uses those funds, along with other borrowings, to provide primarily real estate loans to borrowers in western Washington, and to invest in investment securities and mortgage-backed securities. CONSOLIDATED FINANCIAL STATEMENT PRESENTATION The consolidated financial statements have been prepared in accordance with generally accepted accounting principles and practices within the banking industry. The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities, as of the date of the balance sheet, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of real estate owned and deferred tax assets. Certain prior year amounts have been reclassified to conform to the 2001 presentation. INVESTMENTS AND MORTGAGE-BACKED SECURITIES Debt and equity securities that will be held for indefinite periods of time, including securities that may be sold in response to changes in market interest rates, prepayment rates, need for liquidity, and changes in the availability of and the yield of alternative investments, are considered securities available for sale, and are reported at fair value. Fair value is determined using published quotes as of the close of business on reporting dates. Unrealized gains and losses are excluded from earnings, and are reported as a separate component of shareholders' equity, net of the related deferred tax effect, entitled "Accumulated other comprehensive income (loss)." Realized gains and losses on securities available for sale, determined using the specific identification method, are included in earnings. Amortization of premiums and accretion of discounts are recognized in interest income over the period to maturity. (continued) 54 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) LOANS HELD FOR SALE Mortgage loans originated and intended for sale in the secondary market are stated in the aggregate at the lower of cost or estimated market value. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Gains or losses on sales of loans are recognized at the time of sale. The gain or loss is determined by the difference between the net sales proceeds and the recorded value of the loans, including any remaining unamortized deferred loan fees. LOANS RECEIVABLE Loans are stated at the amount of unpaid principal, reduced by the undisbursed portion of loans in process, unearned income and an allowance for loan losses. ALLOWANCES FOR LOSSES Allowances for losses on specific problem loans and real estate owned are charged to earnings when it is determined that the value of these loans and properties, in the judgment of management, is impaired. In addition to specific reserves, the Bank also maintains general provisions for loan losses based on evaluating known and inherent risks in the loan portfolio, including management's continuing analysis of the factors and trends underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, actual loan loss experience, current and anticipated economic conditions, detailed analysis of individual loans for which full collectibility may not be assured, and determination of the existence and realizable value of the collateral and guarantees securing the loans. The ultimate recovery of loans is susceptible to future market factors beyond the Bank's control, which may result in losses or recoveries differing significantly from those provided in the consolidated financial statements. The Bank accounts for impaired loans in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118. These statements address the disclosure requirements and allocation of the allowance for loan losses for certain impaired loans. A loan within the scope of these statements is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. The Bank excludes smaller balance homogenous loans, including single-family residential and consumer loans, from the scope of these statements. When a loan has been identified as being impaired, the amount of the impairment is measured by using discounted cash flows, except when it is determined that the sole source of repayment for the loan is the operation or liquidation of the underlying collateral. In such case, impairment is measured at current fair value of the collateral, reduced by estimated selling costs. When the measurement of the impaired loan is less than the recorded investment in the loan, including accrued interest and net unamortized deferred loan fees or costs, loan impairment is recognized by establishing or adjusting an allocation of the allowance for loan losses. SFAS No. 114, as amended, does not change the timing of charge-offs of loans to reflect the amount ultimately expected to be collected. (continued) 55 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) INTEREST ON LOANS AND LOAN FEES Interest on loans is recorded as income when borrowers' monthly payments become due. Allowances are established for uncollected interest on loans for which the interest is determined to be uncollectible. Generally, all loans past due 90 days or morethree or more payments are placed on nonaccrual status and internally classified as substandard. Any interest income recorded in the current reporting period is fully reserved. Subsequent collections are applied proportionately to past due principal and interest. Loans are removed from nonaccrual status only when the loan is deemed current, and the collectibility of principal and interest is no longer doubtful. The Bank charges fees for originating loans. These fees, net of certain loan origination costs are deferred and amortized to income, on the level-yield basis, over the loan term. If the loan is repaid prior to maturity, the remaining unamortized deferred loan fee is recognized in income at the time of repayment. LOAN SERVICING RIGHTS Loan servicing rights are capitalized when acquired through the origination of loans that are subsequently sold or securitized with the servicing rights retained. The value of loan servicing rights at the date of the sale of loans is determined based on the discounted present value of expected future cash flows using key assumptions for servicing income and costs and prepayment rates on the underlying loans. The estimated fair value is periodically evaluated for impairment by comparing actual cash flows and estimated future cash flows from the servicing assets to those estimated at the time servicing assets were originated. Loan servicing rights are amortized as an offset to service fees in proportion to and over the period of estimated net servicing income. In September 2000, the FASB issued SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of SFAS No. 125. This statement revised the standards for accounting for securitizations and other transfers of financial assets and collateral, and requires certain disclosures; however, it carries over most of SFAS No. 125's provisions without reconsideration. The standards addressed in this statement are based on consistent application of a financial components approach that focuses on control. Under this approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes The Bank records its mortgage servicing rights at fair value in accordance with SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, which requires the Bank to allocate the total cost of all mortgage loans, whether originated or purchased, to the loans (without the mortgage servicing rights), and to mortgage servicing rights based on their relative fair values. The Bank is amortizing the mortgage servicing assets, which totaled $508,000 and $356,000 at September 30, 2001 and 2000, respectively, over the period of the estimated servicing income. liabilities when extinguished. This statement is effective for transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001. The adoption of this statement affects the disclosures in these financial statements; however, the adoption of this statement did not have a material impact on the Company's financial position of results of operations for the year ended September 30, 2001. (continued) 56 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) PREMISES AND EQUIPMENT Premises and equipment are recorded at cost. Depreciation is computed on the straight-line method over the following estimated useful lives: buildings and improvements up to forty years - thirty to forty years; furniture and equipment - three to seven years; automobile - five years. The cost of maintenance and repairs is charged to expense as incurred. Gains and losses on dispositions are reflected in earnings. REAL ESTATE OWNED Real estate owned (REO) consists of properties acquired through or in lieu of foreclosure, recorded initially at the lower of cost or fair value of the properties less estimated costs of disposal. Costs relating to development and improvement of the properties are capitalized; costs relating to holding the properties are expensed. Valuations are periodically performed by management, and an allowance for losses is established by a charge to earnings if the recorded value of a property exceeds its estimated net realizable value. INCOME TAXES The Company files a consolidated federal income tax return with its subsidiaryies. Prior to fiscal year 1997, the Bank qualified under provisions of the Internal Revenue Code which permitted, as a deduction from taxable income, an allowance for bad debts based on a percentage of taxable income. In 1996, the percentage-of-income bad debt deduction for federal tax purposes was eliminated. In addition, federal tax bad debt reserves which had been accumulated since October 1, 1988, that exceeded the reserves which would have been accumulated based on actual experience, are subject to recapture over a six-year recapture period. As of September 30, 2001, the Bank's federal tax bad debt reserves subject to recapture approximated $900,000. Deferred federal income taxes result from temporary differences between the tax basis of assets and liabilities, and their reported amounts in the consolidated financial statements. These will result in differences between income for tax purposes and income for financial reporting purposes in future years. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. (continued) 57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded) EMPLOYEE STOCK OWNERSHIP PLAN The Bank sponsors a leveraged Employee Stock Ownership Plan (ESOP). The ESOP is accounted for in accordance with the American Institute of Certified Public Accountants Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership Plan. Accordingly, the debt of the ESOP is recorded as other borrowed funds of the Bank, and the shares pledged as collateral are reported as unearned shares issued to the employee stock ownership trust on the consolidated balance sheets. The debt of the ESOP is with the Company and is thereby eliminated in the consolidated financial statements. As shares are released from collateral, compensation expense is recorded equal to the average market price of the shares for the period, and the shares become outstanding for earnings per share calculations. Cash dividends on unallocated shares which are collateral for debt are used to reduce scheduled principal and interest payments, and are recorded as a reduction of compensation expense. CASH EQUIVALENTS The Company considers all amounts included in the balance sheet caption "Cash and due from financial institutions" to be cash equivalents. STOCK-BASED COMPENSATION The Company accounts for stock-optionsbased awards to employees using the intrinsic value method, in accordance with APB No. 25, Accounting for Stock Issued to Employees. Accordingly, no compensation expense has been recognized in the financial statements for employee stock optionsarrangements. However, the required pro forma disclosures of the effects of all options granted have been provided in accordance with SFAS No. 123, Accounting for Stock-Based Compensation. EARNINGS PER SHARE Basic earnings per share exclude dilution and are computed by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share reflect the potential dilution that could occur if common shares were issued pursuant to the exercise of options under the Company's stock option and management recognition and development plans. In 2000 and 1999, the effect of the Company's stock options on earnings per share was antidilutive and, thus, basic and diluted earnings per share are the same. NOTE 2 - RESTRICTED ASSETS Federal Reserve Board regulations require that the Bank maintain certain minimum reserve balances on hard or on deposit with the Federal Reserve Bank. The amount of such balances for year ended September 30, 2001 was approximately $926,000. 58 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 3 - INVESTMENTS AND MORTGAGE-BACKED SECURITIES Investments and mortgage-backed securities have been classified according to management's intent (dollars in thousands): GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE AVAILABLE FOR SALE SEPTEMBER 30, 2001 U.S. agency securities $ -- $ -- $ -- $ -- Mortgage-backed securities 18,755 420 (16) 19,159 Municipal bonds 55 2 -- 57 Mutual funds 10,020 40 -- 10,060 FHLB stock 4,830 -- -- 4,830 Equity securities 121 -- (28) 93 TOTAL $28,951 $462 ($44) $29,369 SEPTEMBER 30, 2000 U.S. agency securities $ 6,502 $ -- ($ 86) $ 6,416 Mortgage-backed securities 11,846 2 (279) 11,569 Municipal bonds 73 (2) 71 Mutual funds 6,641 -- (169) 6,472 FHLB stock 4,150 -- -- 4,150 Equity securities 323 116 (42) 397 TOTAL $25,385 $118 ($578) $24,925 Mortgage-backed securities pledged as collateral for public fund deposits and federal treasury tax and loan deposits totaled $2,437,000 and $2,459,000 at September 30, 2001 and 2000, respectively. The contractual maturities of debt securities available for sale at September 30, 2001 are as follows (dollars in thousands). Expected maturities may differ from scheduled maturities due to the prepayment of principal or call provisions. AMORTIZED FAIR COST VALUE Due within one year $ -- $ -- Due from one year to five years 55 57 Due from five to ten years 6,138 6,318 Due after ten years 12,617 12,841 TOTAL $18,810 $19,216 59 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 4 - LOANS RECEIVABLE AND LOANS HELD FOR SALE Loans receivable and loans held for sale consisted of the following at September 30 (dollars in thousands): 2001 2000 Mortgage loans: One- to four-family $112,060 $108,307 Multi-family 29,412 33,604 Commercial 65,731 58,632 Construction and land development 106,244 89,903 Land 13,632 12,561 TOTAL MORTGAGE LOANS 327,079 303,007 Consumer loans: Home equity and second mortgage 11,039 9,816 Other 6,825 6,081 TOTAL CONSUMER LOANS 17,864 15,897 Commercial business loans 7,150 4,808 TOTAL LOANS RECEIVABLE 352,093 323,712 Less: Undisbursed portion of loans in process 39,803 32,831 Deferred loan origination fees and other 3,494 3,578 Allowance for loan losses 3,050 2,640 46,347 39,049 LOANS RECEIVABLE, NET 305,746 284,663 Loans held for sale (one- to four-family) 18,022 28,518 Market value adjustment -- (175) LOANS HELD FOR SALE, NET 18,022 28,343 TOTAL LOANS RECEIVABLE AND LOANS HELD FOR SALE $323,768 $313,006 (continued) 60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 4 - LOANS RECEIVABLE AND LOANS HELD FOR SALE (continued) The weighted average interest rate on all loans at September 30, 2001 and 2000 was 8.46% and 8.64%, respectively. Loans serviced for the Federal Home Loan Mortgage Corporation and others at September 30, 2001 and 2000 were $90,303,000 and $68,849,000, respectively. Certain related parties of the Bank, principally Bank directors and officers, were loan customers of the Bank in the ordinary course of business during 2001 and 2000. Activity in related party loans during the years ended September 30 is as follows (dollars in thousands): 2001 2000 Balance, beginning of year $807 $774 New loans 374 63 Repayments (388) (30) BALANCE, END OF YEAR $793 $807 At September 30, 2001 and 2000, the Bank had non-accruing loans totaling approximately $4,091,000 and $3,612,000, respectively. At September 30, 2001 and September 30, 2000 no loans were 90 days or more past due and still accruing interest. No interest income was recorded on non-accrual loans for the years ended September 30, 2001, 2000 and 1999. The average investment in non-accrual loans for the years ended September 30, 2001, 2000 and 1999 was $3,778,000, $3,460,000 and $3,565,000, respectively. An analysis of the allowance for loan losses for the years ended September 30 follows (dollars in thousands): 2001 2000 1999 Balance, beginning of year $2,640 $2,056 $1,728 Provision for loan losses 1,400 885 363 Loans charged off (1,012) (563) (35) Recoveries 22 262 - - NET CHARGE-OFFS (990) (301) (35) BALANCE, END OF YEAR $3,050 $2,640 $2,056 (continued) 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 4 - LOANS RECEIVABLE AND LOANS HELD FOR SALE (concluded) Following is a summary of information relating to impaired loans as of September 30 (dollars in thousands): 2001 2000 Impaired loans without a valuation allowance $2,300 $3,612 Impaired loans with a valuation allowance 1,791 -- $4,091 $3,612 Valuation allowance related to impaired loans $270 $-- NOTE 5 - LOAN SERVICING Loans serviced for the Federal Home Loan Mortgage Corporation and others are not included in the consolidated balance sheets. The principal amounts of those loans at September 30, 2001 and 2000 were $90,303,000 and $68,849,000, respectively. Following is an analysis of the changes in mortgage servicing rights at September 30 (dollars in thousands): 2001 2000 1999 Balance, at beginning of year $356 $358 $375 Additions 300 87 100 Amortization (148) (89) (117) BALANCE, END OF YEAR $508 $356 $358 In June 2001, the Bank securitized and sold approximately $11.9 million in first mortgage loans. In the securitization, the Bank retained servicing responsibilities, but has no other retained interest in the loans sold. (see Note 25) 62 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 6 - PREMISES AND EQUIPMENT Premises and equipment consisted of the following at September 30 (dollars in thousands): 2001 2000 Land $ 2,654 $ 2,303 Buildings and improvements 7,675 6,271 Leasehold improvements 416 -- Furniture and equipment 3,223 2,294 Automobiles 19 19 Property held for future expansion 834 596 Construction and purchases in progress 158 536 14,563 12,019 Less accumulated depreciation 3,903 3,405 TOTAL PREMISES AND EQUIPMENT $10,660 $ 8,614 NOTE 7 - REAL ESTATE OWNED Real estate owned consisted of the following at September 30 (dollars in thousands): 2001 2000 Real estate acquired through foreclosure $1,1434 $1,992 Allowance for possible losses (137) (26) TOTAL REAL ESTATE OWNED $1,006 $1,966 An analysis of the allowance for possible losses follows (dollars in thousands): 2001 2000 1999 Balance, beginning of year $ 26 $38 $32 Provision for additional losses 356 51 28 Write-downs (245) (63) (22) BALANCE, END OF YEAR $137 $26 $38 63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 8 - ACCRUED INTEREST RECEIVABLE Accrued interest receivable consisted of the following at September 30 (dollars in thousands): 2001 2000 Loans receivable $2,064 $1,976 Less reserve for uncollected interest 319 396 1,745 1,580 Investment securities and interest bearing deposits 135 176 TOTAL ACCRUED INTEREST RECEIVABLE $1,880 $1,756 NOTE 9 - DEPOSITS Deposits consisted of the following at September 30 (dollars in thousands): 2001 2000 Non-interest bearing $ 16,976 $ 15,497 N.O.W. checking 30,626 24,467 Passbook savings 34,228 28,647 Money market accounts 27,251 20,863 Certificates of deposit 133,291 123,137 TOTAL DEPOSITS $242,372 $212,611 The weighted average interest rate on all deposits at September 30, 2001 and 2000 was 3.72% and 4.45%, respectively. Time deposits of $100,000 or greater totaled $44,186,000 and $42,420,000 at September 30, 2001 and 2000, respectively. Scheduled maturities of certificates of deposit at September 30, 2001 are as follows (dollars in thousands): Within one year $113,735 Over one to two years 15,577 Over two to five years 3,128 After five years 851 TOTAL $133,291 (continued) 64 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 9 - DEPOSITS (concluded) Interest expense by account type is as follows for the years ended September 30 (dollars in thousands): 2001 2000 1999 Certificates of deposit $7,396 $6,573 $5,590 Money market accounts 921 741 628 Passbook savings 728 694 695 N.O.W. checking 446 385 363 TOTAL $9,491 $8,393 $7,276 NOTE 10 - FEDERAL HOME LOAN BANK ADVANCES The Bank currently has an Advance, Security and Deposit Agreement with Federal Home Loan Bank that is maintained at 35% of the Bank's total assets ($134,068,000 at September 30, 2001). The Bank had advances at September 30, 2001 as follows (dollars in thousands): WEIGHTED AVERAGE INTEREST RATE AMOUNT Maturities in years ending September 30: 2002 Fixed rate set maturity 3.92% $12,500 2002 Fixed rate monthly amortization 6.11 196 2002 Variable rate set maturity 3.51 3,300 2004 Fixed rate set maturity 5.58 5,000 2005 Fixed rate set maturity 5.49 2,000 2006 Fixed rate set maturity putable 5.98 10,000 2006 Fixed rate set maturity 6.55 982 2008 Fixed rate set maturity putable 6.18 15,000 2011 Fixed rate set maturity putable 4.77 20,000 $68,978 Under the Advances, Security and Deposit Agreement, virtually all of the Bank's assets, not otherwise encumbered, are pledged as collateral for advances. 65 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 11 - OTHER LIABILITIES AND ACCRUED EXPENSES Other liabilities and accrued expenses comprise the following at September 30 (dollars in thousands): 2001 2000 Federal income taxes $ 425 $ -- Accrued pension and profit sharing payable 807 768 Accrued interest payable on deposits and FHLB advances 491 557 Accounts payable and accrued expenses - other 1,423 695 TOTAL OTHER LIABILITIES AND ACCRUED EXPENSES $3,146 $2,020 NOTE 12 - FEDERAL INCOME TAXES The Bank previously qualified under provisions of the Internal Revenue Code that permitted federal income taxes to be computed after a deduction for additions to bad debt reserves. Accordingly, retained earnings include approximately $2,200,000 for which no provision for federal income taxes has been made. If in the future this portion of retained earnings is used for any purpose other than to absorb bad debt losses, federal income taxes at the current applicable rates would be imposed. The components of the provision for income taxes at September 30 are as follows (dollars in thousands): 2000 1999 1999 Current $2,948 $3,156 $3,046 Deferred benefit (207) (231) (449) TOTAL FEDERAL INCOME TAXES $2,741 $2,925 $2,597 The components of the Company's deferred tax assets and liabilities at September 30 are as follows (dollars in thousands): 2001 2000 DEFERRED TAX ASSETS Accrued interest on loans $ 64 $ 110 Accrued vacation 59 50 Deferred compensation 106 105 Unearned ESOP shares 270 239 Allowance for loan losses 888 573 Loans held for sale market value adjustment -- 63 Unrealized securities losses -- 1567 Unearned MRRDP shares 37 -- Other -- 2 TOTAL DEFERRED TAX ASSETS 1,424 1,296 (continued) 66 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 12 - FEDERAL INCOME TAXES (concluded) 2001 2000 DEFERRED TAX LIABILITIES FHLB stock dividends $ 576 $ 501 Real estate sale, installment basis 30 33 Unrealized securities gains 142 - - Other 379 325 TOTAL DEFERRED TAX LIABILITIES 785 566 NET DEFERRED TAX ASSETS $ 639 $ 730 The provision for federal income taxes differs from that computed at the statutory corporate tax rate as follows (dollars in thousands): 2001 2000 1999 AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT Taxes at statutory rate $2,789 34.0% $2,999 34.0% $2,657 34.0% Other - net (487) (.6) (74) (.8) (60) (.8) FEDERAL INCOME TAXES $2,741 33.4% $2,925 33.2% $2,597 33.2% NOTE 13 - PROFIT SHARING PLANS The Bank maintains a tax-qualified profit sharing plan for the benefit of all eligible employees who are at least 21 years of age and work a minimum of 501 hours. The Bank contributed $362,000, $300,000 and $249,000 to the plan for the years ended September 30, 2001, 2000 and 1999, respectively. Contributions are made on a discretionary basis. In addition, the Bank has an employee bonus plan based on net income. Bonuses accrued for the years ended September 30, 2001, 2000 and 1999 totaled $208,000, $229,000 and $195,000, respectively. NOTE 14 - EMPLOYEE STOCK OWNERSHIP PLAN In 1998, the Bank established an Employee Stock Ownership Plan (ESOP) that benefits all employees with at least one year of service who are 21 years of age or older. The ESOP is funded by Bank contributions in cash or stock. Employee vesting occurs over six years. The amount of the annual contribution is discretionary, except that it must be sufficient to enable the ESOP to service its debt. All dividends received by the ESOP are used to pay debt service. (continued) 67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 14 - EMPLOYEE STOCK OWNERSHIP PLAN (concluded) In January 1998, the ESOP borrowed $7,930,000 from the Company to purchase 529,000 shares of common stock of the Company. The loan will be repaid primarily from the Company's contributions to the ESOP over 15 years. The interest rate on the loan is 8.5%. As of September 30, 2001, 2,522 shares had been distributed out of the ESOP to participants. The balance of the loan at September 30, 2001 was $6,743,000. Shares held by the ESOP as of September 30 were classified as follows: 2001 2000 1999 Unallocated shares 396,750 432,016 467,283 Shares released for allocation 129,722 96,143 61,717 TOTAL ESOP SHARES 526,472 528,159 529,000 The approximate fair market value of the Bank's unallocated shares at September 30, 2001, and 2000 and 1999, respectively, is $5,872,000, and $5,184,000 and $5,344,000. Compensation expense recognized under the ESOP was $273,000, $199,000 and $285,000 for the years ended September 30, 2001, 2000 and 1999, respectively. NOTE 15 - STOCK OPTIONS During the year ended September 30, 1999, the Company adopted a stock-based option plan, which is described below. The Company applies APB Opinion No. 25 and related interpretations in accounting for this plan. Accordingly, no compensation cost has been recognized for the plan. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant dates for awards granted under this plan, consistent with the method of SFAS No. 123, the Company's net income and earnings per share for the years ended September 30 would have been reduced to these pro forma amounts (dollars in thousands): 2001 2000 1999 Net income: As reported $5,462 $5,897 $5,218 Pro forma 5,264 5,589 4,901 Earnings per basic share: As reported $1.30 $1.31 $1.03 Pro forma 1.26 1.23 .96 Earnings per diluted share: As reported $1.28 $1.31 $1.03 Pro forma 1.25 1.23 .96 (continued) 68 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 15 - STOCK OPTIONS (continued) Under the Company's stock option plan, the Company may grant options for up to 661,250 shares of its common stock to certain key employees and directors. The exercise price of each option equals the fair market value of the Company's stock on the date of grant. An option's maximum term is ten years. Options are exercisable on a cumulative basis in annual installments of 10% on each of the ten anniversaries from the date of grant. Vesting will be accelerated to 20% per year if certain criteria relating to Company performance are met. At September 30, 2001, options for 50,417 shares are available for future grant under this plan. The fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions. RISK FREE EXPECTED EXPECTED INTEREST RATE LIFE (YEARS) DIVIDENDS Fiscal 2001 5.3% 8.0 2.80% Fiscal 1999 6.0 10.0 2.25 Stock option activity is summarized in the following table: WEIGHTED AVERAGE NUMBER OF EXERCISE SHARES PRICE Outstanding October 1, 1998 -- $ -- Grants 582,494 12.02 OUTSTANDING SEPTEMBER 30, 1999 582,494 12.02 Forfeited (10,000) 12.38 OUTSTANDING SEPTEMBER 30, 2000 572,494 12.01 Grants 38,339 14.35 Options exercised (1,600) 12.00 OUTSTANDING SEPTEMBER 30, 2001 609,233 $12.16 (continued) 69 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 15 - STOCK OPTIONS (concluded) Additional information regarding options outstanding as of September 30, 2001 is as follows: OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------- --------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE EXERCISE CONTRACTUAL NUMBER EXERCISE NUMBER EXERCISE PRICE LIFE (YEARS) OUTSTANDING PRICE EXERCISABLE PRICE $12.00 6.5 553,394 $12.00 237,401 $12.00 12.06 to 12.38 7.7 22,500 12.31 7,000 12.38 13.59 to 14.50 9.6 33,339 14.70 -- -- 7.0 609,233 $12.16 244,401 $12.01 NOTE 16 - DEFERRED COMPENSATION/NON-COMPETITION AGREEMENT AND SEVERANCE COMPENSATION AGREEMENT The Bank has a deferred compensation/noncompetition arrangement with its chief executive officer which will provide monthly payments of $2,000 per month upon retirement. Once payments have commenced, they will continue until his death, at which time, payments will continue to his surviving spouse until her death or for 60 months. The present value of the payments, based on the life expectancy of the chief executive officer, has been accrued based on a retirement age of 65 and is included in other liabilities in the consolidated financial statements. As of September 30, 2001 and 2000, $239,000, has been accrued under the agreement. In connection with the January 1998 conversion, the Bank adopted an Employee Severance Compensation Plan, which expires in ten years, to provide benefits to eligible employees in the event of a change in control of the Company or the Bank (as defined in the plan). In general, all employees with two or more years of service will be eligible to participate in the plan. Under the plan, in the event of a change in control of the Company or the Bank, eligible employees who are terminated or who terminate employment (but only upon the occurrence of events specified in the plan) within 12 months of the effective date of a change in control would be entitled to a payment based on years of service with the Bank. The maximum payment for any eligible employee would be equal to 24 months of their current compensation. 70 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 17 - MANAGEMENT RECOGNITION AND DEVELOPMENT PLAN On November 10, 1998, the Board of Directors adopted a Management Recognition and Development Plan (MRDP). On January 25, 1999, shareholders approved the adoption of the MRDP for the benefit of officers, employees and non-employee directors of the Company. The objective of the MRDP is to retain personnel of experience and ability in key positions by providing them with a proprietary interest in the Company. The Plan allows for the issuance to participants of up to 264,500 shares of the Company's common stock. purchase, in the open market or through the issuance of Shares issued may be purchased in the open market or may be issued from authorized and unissued shares. On July 26, 2001, the Company awarded 204,927 shares under the Plan to employees and directors. Awards under the MRDP were made in the form of restricted shares of common stock that are subject to restrictions on the transfer of ownership. Compensation expense in the amount of the fair value of the common stock at the date of the grant to the plan participants will be recognized over a five year vesting period, with 20% vesting immediately upon grant. Compensation expense of $770,000 for the year ended September 30, 2001 was recognized. NOTE 18 - COMMITMENTS AND CONTINGENCIES The Bank is 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. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets. 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 is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments as it does for on-balance-sheet instruments. A summary of the Bank's commitments at September 30 is as follows (dollars in thousands): 2001 2000 Commitments to extend credit $17,807 $17,322 Standby letters of credit 350 100 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. 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 of the party. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate, and income-producing commercial properties. Because of the nature of its activities, the Company is subject to various pending and threatened legal actions which arise in the ordinary course of business. In the opinion of management, liabilities arising from these claims, if any, will not have a material effect on the financial position of the Company. 71 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 19 - REGULATORY MATTERS The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Under capital adequacy guidelines of the regulatory framework for prompt corrective action, the Bank must meet specific capital adequacy guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital classification is also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios as defined in the regulations (set forth in the table below) of Tier 1 capital to average assets, and minimum ratios of Tier 1 and total capital to risk-weighted assets. As of September 30, 2001, the most recent notification from the Bank's regulator categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category. The Company's and the Bank's actual capital amounts (dollars in thousands) and ratios are also presented in the table. TO BE WELL CAPITALIZED UNDER PROMPT CAPITAL ADEQUACY CORRECTIVE ACTION ACTUAL PURPOSES PROVISIONS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO SEPTEMBER 30, 2001 Tier 1 capital (to average assets): Consolidated $71,482 18.8% $15,218 4.0% N/A N/A Timberland Bank 61,930 16.5 15,038 4.0 $18,798 5.0% Tier 1 capital (to risk-weighted assets): Consolidated 71,482 26.2 10,915 4.0 N/A N/A Timberland Bank 61,930 22.7 10,907 4.0 16,361 6.0 Total capital (to risk-weighted assets): Consolidated 74,532 27.3 21,830 8.0 N/A N/A Timberland Bank 64,980 23.8 21,814 8.0 27,678 10.0 (continued) 72 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 19 - REGULATORY MATTERS (concluded) TO BE WELL CAPITALIZED UNDER PROMPT CAPITAL ADEQUACY CORRECTIVE ACTION ACTUAL PURPOSES PROVISIONS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO SEPTEMBER 30, 2000 Tier 1 capital (to average assets): Consolidated $72,516 20.0% $14,334 4.0% N/A N/A Timberland Bank 58,470 16.6 14,068 4.0 $17,585 5.0% Tier 1 capital (to risk-weighted assets): Consolidated 72,516 26.7 10,857 4.0 N/A N/A Timberland Bank 58,470 21.7 10,765 4.0 16,148 6.0 Total capital (to risk-weighted assets): Consolidated 75,156 27.7 21,714 8.0 N/A N/A Timberland Bank 61,110 22.7 21,530 8.0 26,913 10.0 RESTRICTIONS ON RETAINED EARNINGS The Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. At the time of conversion of the Bank from a Washington-charted mutual savings bank to a Washington-chartered stock savings bank, the Bank established a liquidation account in an amount equal to its retained earnings of $23,866,000 as of June 30, 1997, the date of the latest statement of financial condition used in the final conversion prospectus. The liquidation account will be maintained for the benefit of eligible withdrawable account holders who have maintained their deposit accounts in the Bank after conversion. The liquidation account will be reduced annually to the extent that eligible account holders have reduced their qualifying deposits as of each anniversary date. Subsequent increases will not restore an eligible account holder's interest in the liquidation account. In the event of a complete liquidation of the Bank (and only in such an event), eligible depositors who have continued to maintain accounts will be entitled to receive a distribution from the liquidation account before any liquidation may be made with respect to common stock. The Bank may not declare or pay cash dividends if the effect thereof would reduce its regulatory capital below the amount required for the liquidation account. 73 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 20 - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY CONDENSED BALANCE SHEETS - SEPTEMBER 30 (Dollars in Thousands) 2001 2000 ASSETS Cash and due from financial institutions $ 24 $ 14 Interest bearing deposits 227 1,140 Investments and mortgage-backed securities available for sale 3,837 5,712 Loan receivable from Bank 6,743 7,089 Investment in Bank 62,270 58,337 OTHER ASSETS 26 53 TOTAL ASSETS $ 73,127 $ 72,345 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities and accrued expenses $ 1,318 $ 33 Shareholders' equity 71,809 72,312 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 73,127 $ 72,345 CONDENSED STATEMENTS OF INCOME - YEARS ENDED SEPTEMBER 30 (Dollars in Thousands) 2001 2000 1999 OPERATING INCOME Interest on investments and mortgage- backed securities $ 107 $ 199 $ 287 Interest on loan receivable from Bank 592 621 645 Dividends on investments 180 235 352 Gain (loss) on sale of investment securities available for sale 227 (22) (1) Dividends from Timberland Bank 1,949 1,863 1,612 Other 1 2 -- TOTAL OPERATING INCOME 3,056 2,898 2,895 OPERATING EXPENSES 191 204 245 INCOME BEFORE INCOME TAXES AND EQUITY IN UNDISTRIBUTED INCOME OF BANK 2,865 2,694 2,650 INCOME TAXES 238 220 304 INCOME BEFORE EQUITY IN UNDISTRIBUTED INCOME OF BANK 2,627 2,474 2,346 EQUITY IN UNDISTRIBUTED INCOME OF BANK 2,835 3,423 2,872 NET INCOME $5,462 $5,897 $5,218 (continued) 74 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 20 - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY (CONCLUDED) CONDENSED STATEMENTS OF CASH FLOWS - YEARS ENDED SEPTEMBER 30 (Dollars in Thousands) 2001 2000 1999 CASH FLOWS FROM OPERATING ACTIVITIES Net income $5,462 $5,897 $ 5,218 Adjustments to reconcile net income to net cash provided: Equity in undistributed income of Bank (2,835) (3,423) (2,872) ESOP shares earned 503 434 428 MRDP shares earned 776 -- -- (Gain) loss on sale of securities available for sale (227) 22 (1) Other, net 1,331 (37) 117 NET CASH PROVIDED BY OPERATING ACTIVITIES 5,010 2,893 2,890 CASH FLOWS FROM INVESTING ACTIVITIES Net (increase) decrease in interest-bearing deposits in banks 913 (921) 6,685 Investment in Bank (485) 1,859 (429) Purchases of securities available for sale (2,500) (269) (12,575) Proceeds from maturities of securities available for sale 4,122 -- 17,809 Proceeds from sale of securities available for sale 430 2,482 -- Principal repayments on loan receivable from Bank 346 316 292 NET CASH PROVIDED BY INVESTING ACTIVITIES 2,826 3,467 11,782 CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from exercise of stock options the issuance of common stock, net of related costs 19 -- -- Repurchase of common stock (5,920) (4,603) (13,150) Payment of dividends (1,925) (1,748) (1,520) NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (7,826) (6,351) (14,670) NET INCREASE IN CASH 10 9 2 CASH AND DUE FROM FINANCIAL INSTITUTIONS Beginning of year 14 5 3 END OF YEAR $ 24 $ 14 $ 5 (continued) 75 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 21 - EARNINGS PER SHARE DISCLOSURES Basic earnings per share are computed by dividing net income applicable to common stock by the weighted average number of common shares outstanding during the period, without considering any dilutive items. Diluted earnings per share are computed by dividing net income applicable to common stock by the weighted average number of common shares and common stock equivalents for items that are dilutive, net of shares assumed to be repurchased using the treasury stock method at the average share price for the Company's common stock during the period. Common stock equivalents arise from assumed conversion of outstanding stock options and from assumed vesting of shares awarded but not released under the Company's Management Recognition and Development Plan. In accordance with Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership Plans, issued by the American Institute of Certified Public Accountants, shares owned by the Bank's Employee Stock Ownership Plan that have not been allocated are not considered to be outstanding for the purpose of computing earnings per share. Information regarding the calculation of basic and diluted earnings per share for the years ended September 30, 2001 and 2000, respectively, is as follows (dollars in thousands, except per share amounts). 2001 2000 1999 BASIC EPS COMPUTATION Numerator - net income $ 5,462 $ 5,897 $ 5,218 Denominator - weighted average common shares outstanding 4,193,314 4,508,427 5,089,414 Basic EPS $1.30 $1.31 $1.03 DILUTED EPS COMPUTATION Numerator - net income $ 5,462 $ 5,897 $ 5,218 Denominator - weighted average common shares outstanding 4,193,314 4,508,427 5,089,414 Effect of dilutive stock options 79,299 -- -- Weighted average common shares outstanding-assuming dilution 4,727,613 4,508,427 5,089,414 Diluted EPS $1.28 $1.31 $1.03 76 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 22 - COMPREHENSIVE INCOME Net unrealized gains and losses included in comprehensive income were computed as follows for the years ended September 30 (dollars in thousands): TAX BEFORE-TAX (BENEFIT) NET-OF-TAX AMOUNT EXPENSE AMOUNT 2001 Unrealized holding gains arising during the year $1,084 $369 $715 Reclassification adjustment for gains included in net income (205) (70) (135) NET UNREALIZED GAINS $ 879 $299 $580 2000 Unrealized holding gains arising during the year $ 111 $ 39 $ 72 Reclassification adjustment for losses included in net income 22 7 15 NET UNREALIZED GAINS $ 133 $ 46 $ 87 1999 Unrealized holding losses arising during the year ($774) ($263) ($511) Reclassification adjustment for gains included in net income -- -- -- NET UNREALIZED LOSSES ($774) ($263) ($511) 77 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 23 - FAIR VALUES OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments, requires disclosure of estimated fair values for financial instruments. Such estimates are subjective in nature, and significant judgment is required regarding the risk characteristics of various financial instruments at a discrete point in time. Therefore, such estimates could vary significantly if assumptions regarding uncertain factors were to change. Major assumptions, methods and fair value estimates for the Company's significant financial instruments are set forth below: CASH AND DUE FROM FINANCIAL INSTITUTIONS AND INTEREST BEARING DEPOSITS IN BANKS The recorded amount is a reasonable estimate of fair value. INVESTMENTS, MORTGAGE-BACKED SECURITIES AND LOANS HELD FOR SALE The fair value of investments, mortgage-backed securities and loans held for sale has been based on quoted market prices or dealer quotes. FEDERAL HOME LOAN BANK STOCK The carrying values of stock holdings approximate fair value. LOANS RECEIVABLE Fair values for loans are estimated for portfolios of loans with similar financial characteristics. Fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers for the same remaining maturities. Prepayments are based on the historical experience of the Bank. DEPOSITS The fair value of deposits with no stated maturity date is included at the amount payable on demand. The fair value of fixed maturity certificates of deposit is estimated by discounting future cash flows using the rates currently offered by the Bank for deposits of similar remaining maturities. FEDERAL HOME LOAN BANK ADVANCES The fair value of borrowed funds is estimated by discounting the future cash flows of the borrowings at a rate which approximates the current offering rate of the borrowings with a comparable remaining life. ACCRUED INTEREST The carrying amounts of accrued interest approximate fair value. (continued) 78 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 23 - FAIR VALUES OF FINANCIAL INSTRUMENTS (concluded) The estimated fair values of financial instruments at September 30, 2001 and 2000 were as follows (dollars in thousands): 2001 2000 RECORDED FAIR RECORDED FAIR AMOUNT VALUE AMOUNT VALUE FINANCIAL ASSETS Cash and due from financial institutions and interest bearing deposits in banks $ 13,439 $ 13,439 $ 12,002 $ 12,002 Investments and mortgage-backed securities 29,369 29,369 24,925 24,925 Federal Home Loan Bank stock 4,830 4,830 4,150 4,150 Loans receivable 323,768 327,153 -- 13,006 313,604 Accrued interest receivable 1,880 1,880 1,756 1,756 FINANCIAL LIABILITIES Deposits $242,372 $243,368 $212,611 $213,234 Federal Home Loan Bank advances 68,978 78,405 81,137 80,712 Accrued interest payable 491 491 557 557 NOTE 24 - STOCK REPURCHASE PLAN In September 2001, the Company initiated a stock repurchase plan for the purchase of 200,872 shares of stock which had not been completed as of September 30, 2001. As of September 30, 2001, 44,000 shares had been repurchased. The remainder is anticipated to be purchased during the year ending September 30, 2002. NOTE 25 - SECURITIZATION OF MORTGAGE LOANS In June 2001, the Bank securitized and sold approximately $11.9 million in first mortgage loans. Upon closing the transaction, the Bank sold the securities received, recognizing a loss of $22,000, and invested the majority of the proceeds in other investment securities. The Bank retained servicing responsibilities, but has no other interest in the loans sold. The Bank receives servicing fees of .25% of the outstanding principal balance of the loans sold. A servicing asset of $92,000 was recognized in this transaction, based on the following factors: estimated life of loans of 84 months and cash flow discount rate of 6.87%. Investors have no recourse to the Bank's other assets in the event debtors fail to pay the balance owned. 79 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Timberland Bancorp, Inc. and Subsidiaries September 30, 2001 and 2000 NOTE 26 - SUBSEQUENT EVENT Subsequent to September 30On October 25, 2001, the Board of DirectorsCompany approved a dividend in the amount of $.11 per share to be paid on November 16, 2001 tofor shareholders of record as of November 2, 2001. NOTE 27 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) The following selected financial data are presented for the quarters ended (dollars in thousands, except per share amounts): SEPTEM- DECEM- BER 30, JUNE 30, MARCH 31, BER 31, 2001 2001 2001 2000 Interest and dividend income $7,915 $7,977 $7,845 $7,955 Interest expense (3,237) (3,352) (3,519) (3,816) NET INTEREST INCOME 4,678 4,625 4,326 4,139 Provision for loan losses (250) (800) (200) (150) Noninterest income 664 857 798 608 Noninterest expense (3,543) (2,554) (2,703) (2,292) INCOME BEFORE INCOME TAXES 1,549 2,128 2,221 2,305 Federal income taxes 522 721 734 764 NET INCOME $1,027 $1,407 $1,487 $1,541 Basic earnings per share $0.25 $0.34 $0.35 $0.35 Diluted earnings per share $0.24 $0.34 $0.35 $0.35 Interest and dividend income $7,551 $7,460 $6,796 $6,555 Interest expense (3,636) (3,213) (2,888) (2,690) NET INTEREST INCOME 3,915 4,247 3,908 3,865 Provision for loan losses (120) (410) (280) (75) Noninterest income 869 647 167 55 Noninterest expense (2,107) (1,965) (1,839) (2,055) INCOME BEFORE INCOME TAXES 2,557 2,519 1,956 1,790 Federal income taxes 848 838 647 592 NET INCOME $1,709 $1,681 $1,309 $1,198 Basic and diluted earnings per share $.39 $.38 $.29 $.26 80 SIGNATURES Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TIMBERLAND BANCORP, INC. Date: February 14, 2002 By: /s/Dean J. Brydon ------------------------------------ Dean J. Brydon Chief Financial Officer (Duly Authorized Representative) 81