LSB BANCSHARES INC /NC/ - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q


(Mark One)
x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended March 31, 2004

		OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from _______________ to _______________

Commission file number 0-11448

LSB BANCSHARES, INC.

(Exact Name of Registrant as Specified in Its Charter)


North Carolina		56-1348147

(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification No.)

LSB BANCSHARES, INC.
ONE LSB PLAZA
LEXINGTON, NORTH CAROLINA 27292

(Address of Principal Executive Offices)
(Zip Code)

(336) 248-6500

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes þ No o

Indicate by check þ whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o

LSB Bancshares, Inc. had 8,593,409 shares of common stock outstanding as of April 30, 2004.

LSB BANCSHARES, INC.

FORM 10-Q

INDEX


Part I		Financial Information

Item 1.		Financial Statements.

		Consolidated Balance Sheets March 31,2004 and 2003, and December 31,2003

		Consolidated Statements of Income Three Months Ended March 31, 2004 and 2003

		Consolidated Statements of Changes in Shareholders’ Equity Three Months Ended March 31,2004 and 2003

		Consolidated Statements of Cash Flows Three Months Ended March 31,2004 and 2003

		Notes to Consolidated Financial Statements Three Months Ended March 31,2004 and 2003

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.		Quantitative and Qualitative Disclosures about Market Risk

Item 4.		Controls and Procedures

Part II		Other Information

Item 1.		Legal Proceedings

Item 2.		Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

Item 3.		Defaults Upon Senior Securities

Item 4.		Submission of Matters to a Vote of Security Holders

Item 5.		Other Information

Item 6.		Exhibits and Reports on Form 8-K

Signatures

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

LSB Bancshares, Inc.
Consolidated Balance Sheets
(In Thousands)


			(Unaudited)						(Unaudited)
			March 31			December 31			March 31
			2004			2003			2003

Assets
Cash and Due From Banks			$	35,585		$	36,418		$	40,221
Interest-Bearing Bank Balances				1,493			2,267			4,819
Federal Funds Sold				17,458			25,886			33,370
Investment Securities:
	Held to Maturity, Market Value $29,633, $30,711 & $42,522			27,891			29,078			40,676
	Available for Sale			96,532			92,013			98,888
Loans				678,980			663,446			658,275
Less, Allowance for Loan Losses				(8,224	)		(7,846	)		(7,394	)

		Net Loans		670,756			655,600			650,881
Premises and Equipment				15,995			14,951			14,004
Other Assets				11,613			11,693			11,217

		Total Assets	$	877,323		$	867,906		$	894,076


Liabilities
Deposits:
	Demand		$	83,857		$	82,588		$	89,023
	Savings, NOW and Money Market Accounts			400,309			411,322			401,728
	Certificates of Deposit of less than $100,000			121,966			126,343			141,957
	Certificates of Deposit of $100,000 or more			94,005			82,249			101,980

		Total Deposits		700,137			702,502			734,688
Securities Sold Under Agreements to Repurchase				1,345			2,032			1,703
Borrowings from the Federal Home Loan Bank				80,000			70,000			63,000
Other Liabilities				6,287			4,812			8,331

		Total Liabilities		787,769			779,346			807,722

Shareholders’ Equity
Preferred Stock, Par Value $.01 Per Share:
	Authorized 10,000,000 shares; none issued			0			0			0
Common Stock, Par Value $5 Per Share:
Authorized 50,000,000 Shares; Issued 8,560,254 Shares in 2004 and 8,548,942 and 8,480,955 shares in 2003				42,801			42,745			42,405
Paid-In Capital				10,294			10,205			9,772
Directors’ Deferred Plan				(1,162	)		(1,101	)		(1,125	)
Retained Earnings				36,487			35,702			33,775
Accumulated Other Comprehensive Income				1,134			1,009			1,527

		Total Shareholders’ Equity		89,554			88,560			86,354

		Total Liabilities and Shareholders’ Equity	$	877,323		$	867,906		$	894,076


Memorandum: Standby Letters of Credit			$	4,605		$	4,098		$	3,708

Notes to consolidated financial statements are an integral part hereof.

LSB Bancshares, Inc.
Consolidated Statements of Income
(In Thousands except Share Data)
(Unaudited)


			Three Months Ended
			March 31

			2004		2003

Interest Income
	Interest and Fees on Loans		$	10,594	$	11,311
	Interest on Investment Securities:
		Taxable		820		1,042
		Tax Exempt		382		405
	Interest-Bearing Bank Balances			49		54
	Federal Funds Sold			46		97

		Total Interest Income		11,891		12,909

Interest Expense
	Deposits			1,645		2,299
	Securities Sold Under Agreements to Repurchase			3		5
	Borrowings from the Federal Home Loan Bank			809		775

		Total Interest Expense		2,457		3,079

Net Interest Income				9,434		9,830
	Provision for Loan Losses			511		587

	Net Interest Income After Provision for Loan Losses			8,923		9,243

Noninterest Income
	Service Charges on Deposit Accounts			1,671		1,607
	Gains on Sales of Mortgages			110		358
	Other Operating Income			1,575		1,384

		Total Noninterest Income		3,356		3,349

Noninterest Expense
	Personnel Expense			5,147		5,016
	Occupancy Expense			460		384
	Equipment Depreciation and Maintenance			539		475
	Other Operating Expense			2,958		2,882

		Total Noninterest Expense		9,104		8,757

	Income Before Income Taxes			3,175		3,835
	Income Taxes			1,022		1,281

Net Income			$	2,153	$	2,554

Earnings Per Share:
	Basic		$	0.25	$	0.30
	Diluted			0.25		0.30

Weighted Average Shares Outstanding:
	Basic			8,553,379		8,475,330
	Diluted			8,631,926		8,540,543

Cash Dividends Declared per Share			$	0.16	$	0.16

Notes to consolidated financial statements are an integral part hereof.

LSB Bancshares, Inc.
Consolidated Statements of
Changes in Shareholders’ Equity
(In Thousands)
(Unaudited)


												Accumulated
						Directors'						Other			Total
		Common		Paid-In		Deferred			Retained			Comprehensive			Shareholders'
		Stock		Capital		Plan			Earnings			Income			Equity

Balances at December 31, 2002		$	42,363	$	9,729	$	(995	)	$	32,578		$	1,832		$	85,507
Net Income										2,554						2,554
Change in unrealized gain on securities available for sale, net of deferred income taxes													(305	)		(305	)

	Comprehensive income															2,249
Cash dividends declared on common stock										(1,357	)					(1,357	)
Common stock issued for stock options exercised			42		43											85
Common stock acquired							(130	)								(130	)

Balances at March 31, 2003		$	42,405	$	9,772	$	(1,125	)	$	33,775		$	1,527		$	86,354


Balances at December 31, 2003		$	42,745	$	10,205	$	(1,101	)	$	35,702		$	1,009		$	88,560
Net Income										2,153						2,153
Change in unrealized gain on securities available for sale, net of deferred income taxes													125			125

	Comprehensive income															2,278
Cash dividends declared on common stock										(1,368	)					(1,368	)
Common stock issued for stock options exercised			56		89											145
Common stock acquired							(61	)								(61	)

Balances at March 31, 2004		$	42,801	$	10,294	$	(1,162	)	$	36,487		$	1,134		$	89,554

Notes to consolidated financial statements are an integral part hereof.

LSB Bancshares, Inc.
Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)


			Three Months Ended March 31

			2004			2003

Cash Flow from Operating Activities
Net Income			$	2,153		$	2,554
Adjustments to reconcile net income to net cash:
	Depreciation and amortization			500			441
	Securities premium amortization and discount accretion, net			25			18
	(Increase) decrease in loans held for sale			4,038			(2,884	)
	Deferred income taxes			(40	)		(13	)
	Increase in income taxes payable			1,062			1,253
	Increase in income earned but not received			(18	)		(277	)
	Increase (decrease) in interest accrued but not paid			52			(49	)
	Net decrease in other assets			60			446
	Net increase in other liabilities			361			1,850
	Provision for loan losses			511			587
	Gain on sale of premises and equipment			(12	)		(25	)

		Net cash provided by operating activities		8,692			3,901

Cash Flow From Investing Activities
Purchases of securities held to maturity				(560	)		0
Proceeds from maturities of securities held to maturity				1,746			3,353
Purchases of securities available for sale				(16,840	)		(20,030	)
Proceeds from maturities of securities available for sale				12,500			5,000
Net increase in loans made to customers				(19,705	)		(10,319	)
Purchases of premises and equipment				(1,548	)		(955	)
Proceeds from sale of premises and equipment				16			25
Net (increase) decrease in federal funds sold				8,428			(19,986	)

	Net cash used by investing activities			(15,963	)		(42,912	)

Cash Flow from Financing Activities
Net increase (decrease) in demand deposits, NOW, money market and savings accounts				(9,743	)		10,158
Net increase in time deposits				7,378			28,050
Net increase (decrease) in securities sold under agreements to repurchase				(687	)		173
Proceeds from long-term debt				20,000			0
Payments on long-term debt				(10,000	)		0
Dividends paid				(1,368	)		(1,357	)
Proceeds from issuance of common stock				145			85
Common stock acquired				(61	)		(130	)

	Net cash provided by financing activities			5,664			36,979


Increase (decrease) in cash and cash equivalents				(1,607	)		(2,032	)
Cash and cash equivalents at the beginning of the period				38,685			47,072

Cash and cash equivalents at the end of the period			$	37,078		$	45,040


Supplemental Disclosures of Cash Flow Information
	Cash paid during the years for:
		Interest	$	2,406		$	3,128
		Income Taxes		0			0
Supplemental Disclosures of Noncash Transactions
	Transfer of loans to other real estate owned		$	213		$	202
	Unrealized gains/(losses) on securities available for sale:
		Change in securities available for sale		203			(497	)
		Change in deferred income taxes		(78	)		192
		Change in shareholders’ equity		125			(305	)

Notes to consolidated financial statements are an integral part hereof.

LSB Bancshares, Inc.
Notes to Consolidated Financial Statements
Three Months Ended March 31,2004 and 2003

Note 1. Basis of Presentation

The accompanying interim unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

LSB Bancshares, Inc. (sometimes referred to herein as “Bancshares” or the “operation”)is a bank holding company headquartered in Lexington, North Carolina. Bancshares principal business is providing banking and other financial services through its banking subsidiary, Lexington State Bank (“LSB”). LSB has two wholly owned subsidiaries, Peoples Finance Company of Lexington, Inc. and LSB Investment Services, Inc. LSB offers a complete array of services in commercial banking including accepting deposits, corporate cash management, discount brokerage, IRA plans, secured and unsecured loans and trust functions through twenty-seven offices in seventeen communities located in Davidson, Forsyth, Stokes, Guilford and Randolph counties. LSB also operates a mortgage production office in Wake County. LSB has two subsidiaries that operate within its market area. Peoples Finance offers secured and unsecured loans to individuals up to a maximum of $10,000 as well as dealer originated loans. LSB Investment Services offers products through UVEST Investment Services, an independent broker-dealer. Investments are neither deposits nor obligations of Lexington State Bank, nor are they guaranteed or insured by any depository institution, the FDIC, or any other government agency.

For further information, refer to the Consolidated Financial Statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003.

Note 2. Investment Securities

The valuations of investment securities as of March 31, 2004 and December 31, 2003 were as follows (in thousands):


		March 31, 2004

								Approximate
		Amortized		Unrealized		Unrealized		Market
		Cost		Gains		Losses		Value

Securities held to maturity:
U.S. Treasury and other U.S. government agency obligations		$	1,000	$	19	$	0	$	1,019
State, county and municipal securities			26,891		1,730		7		28,614

	Total securities held to maturity	$	27,891	$	1,749	$	7	$	29,633


								Approximate
		Amortized		Unrealized		Unrealized		Market
		Cost		Gains		Losses		Value

Securities available for sale:
U.S. Treasury and other U.S. government agency obligations		$	87,129	$	1,838	$	34	$	88,933
State, county and municipal securities			3,558		59		18		3,599
Federal Home Loan Bank stock			4,000		0		0		4,000

	Total securities available for sale	$	94,687	$	1,897	$	52	$	96,532


		December 31, 2003

								Approximate
		Amortized		Unrealized		Unrealized		Market
		Cost		Gains		Losses		Value

Securities held to maturity:
U.S. Treasury and other U.S. government agency obligations		$	1,000	$	31	$	0	$	1,031
State, county and municipal securities			28,078		1,604		2		29,680

	Total securities held to maturity	$	29,078	$	1,635	$	2	$	30,711


								Approximate
		Amortized		Unrealized		Unrealized		Market
		Cost		Gains		Losses		Value

Securities available for sale:
U.S. Treasury and other U.S. government agency obligations		$	85,020	$	1,622	$	45	$	86,597
State, county and municipal securities			1,851		65		0		1,916
Federal Home Loan Bank stock			3,500		0		0		3,500

	Total securities available for sale	$	90,371	$	1,687	$	45	$	92,013

No investment securities were sold during the period ending March 31, 2004.

Investment securities with amortized cost of $83,145,000 and $81,004,555, as of March 31, 2004 and December 31, 2003, respectively, were pledged to secure public deposits and for other purposes. The Bank also has a $20,000,000 irrevocable letter of credit with FHLB that is used in lieu of securities to pledge against public deposits.

Note 3. Loans (Table in thousands)

A summary of consolidated loans follows:


	March 31

	2004		2003

Commercial, financial, & agricultural	$	288,823	$	281,467
Real estate — construction		46,520		39,520
Real estate — mortgage		285,730		275,955
Installment loans to individuals		54,883		53,961
Lease financing		935		512
Other		2,089		6,860

Total loans, net of unearned income	$	678,980	$	658,275

The Corporation generally considers loans to be impaired when future payments of principal and interest are in doubt. Included in impaired loans are loans that are consistently past due, loans 90 days or more past due and nonaccrual loans. Interest income on impaired loans is recognized consistent with the Corporation’s income recognition policy of daily accrual of income until the loan is determined to be uncollectible and placed in a nonaccrual status. For all impaired loans other than nonaccrual loans, interest income totaling $79,664 for the period was recorded on an accrual basis. Interest income on nonaccrual loans is recognized on a cash basis. No interest has been collected during the period on nonaccrual loans since being placed in a nonaccrual status. Interest income on nonaccrual loans that would have been recorded in accordance with the original terms of the notes was $244,712. At March 31, 2004, the total investment in loans that are considered impaired was $6,409,000, including nonaccrual loans of $2,074,000. A related valuation allowance of

$1,224,000 was determined for the total amount of impaired loans. The average recorded investment in impaired loans for the quarter ended March 31, 2004 was approximately $7,408,000.

At March 31, 2004, loans totaling $ 17,046,000 were held for sale stated at the lower of cost or market on an individual loan basis.

Note 4. Reserve for Loan Losses (in thousands)

The following sets forth the analysis of the consolidated reserve for loan losses:


	Three Months Ended
	March 31

	2004			2003

Balances at beginning of periods	$	7,846		$	7,282
Provision for loan losses		511			587
Recoveries of amounts previously charged off		309			58
Loan losses		(442	)		(533	)

Balances at end of periods	$	8,224		$	7,394

Note 5. Other Accounting Changes

In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based Compensation-Transition and Disclosure”. SFAS 148 provides alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock-based employee compensation, and stipulates additional disclosure provisions related to stock-based employee compensation. SFAS 148 is effective for financial statements for fiscal years ending after December 15, 2002. Bancshares adopted the disclosure provisions of SFAS 148 with no resulting material effect on its financial position or operating results.

In December 2003, the FASB revised SFAS 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits”. SFAS 132, as revised, retains the disclosures previously required, and requires additional disclosures related to pension plans and postretirement benefits. SFAS 132 is effective for fiscal years ending after December 15, 2003. Bancshares adopted SFAS 132 with no resulting material effect on its financial position or operating results.

In July 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (The Act). The purpose of the act is to increase the reliability of financial statements issued by public companies. The act does this by increasing the number of independent parties responsible for the issuance of the statements, by increasing the independence of those already involved in the process and by the imposition of sanctions for those in violation of accounting and reporting rules. Bancshares intends to fully comply with the act and is currently determining the costs related to compliance with Sarbanes-Oxley.

In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires the recognition of a liability at fair value upon issuance of certain guarantees, including standby letters of credit. FIN 45 is effective for guarantees issued after December 31, 2002. Bancshares determined, if adopted, FIN 45 would have an immaterial effect on its financial position and operating results.

Note 6. Stock Compensation Plans

Bancshares had three stock-based compensation plans at March 31, 2004, accounted for under Accounting Principles Board Opinion Number 25, under which no compensation cost has been recognized. A new equity compensation plan was approved at the Annual Shareholder’s Meeting on April 21, 2004. This plan will replace all existing equity plans and any future equity compensation grants will be made under this new plan. Had compensation cost for these plans been determined consistent with Statement of Financial Accounting Standards Numbers 123 and 148, Bancshares’ net income and earnings per share would have been reduced to the following pro forma amounts:


		3 Months Ended March 31

		2004		2003

Net income, as reported		$	2,153	$	2,554
(In thousands)
Less, total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects (In thousands)			68		92

Pro Forma Net Income (In thousands)		$	2,085	$	2,462

Earnings Per Share:
	Basic — as reported	$	0.25	$	0.30

	Basic — pro forma	$	0.24	$	0.29

	Diluted — as reported	$	0.25	$	0.30

	Diluted — pro forma	$	0.24	$	0.29

Note 7. Pension and Postretirement Medical Benefit Expenses

The components of net periodic benefit cost for pension and retiree medical plans are as follows:


	Pension Benefits						Retiree Medical
	Three Months Ended						Three Months Ended

	2004			2003			2004		2003

Service cost	$	169		$	152		$	9	$	8
Interest cost		185			166			13		12
Expected Return on plan assets		(158	)		(138	)		0		0
Amortization of prior service cost		17			16			3		3
Amortization of loss		51			48			3		2

Net periodic benefit cost	$	264		$	244		$	28	$	25

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The discussion presented herein is intended to provide an overview of the changes in financial condition and results of operation for LSB Bancshares, Inc. (“Bancshares”) and its wholly owned subsidiary, Lexington State Bank (“LSB” or the “Bank”) for the three months ended March 31, 2004 and 2003. The consolidated financial statements also include the accounts and results of operation of LSB’s wholly owned subsidiaries, Peoples Finance Company of Lexington, Inc. (“Peoples Finance”) and LSB Investment Services, Inc. (“LSB Investment Services”). This discussion and analysis is intended to complement the unaudited financial statements, footnotes and supplemental financial data in this Form 10-Q, and should be read in conjunction therewith.

This report contains certain forward-looking statements related to anticipated future operating and financial performance, and other similar statements of expectations.

These forward-looking statements are often identified by words such as “believes”, “anticipates”, “expects” or other similar words or phrases. These forward-looking statements are based on estimates, beliefs and assumptions made by management and are not guarantees of future performance. Actual results may differ from those expressed or implied as the result of various factors, including: (1) the strength of the United States economy generally and the strength of the local economies in which Bancshares conducts operations may be different than expected resulting in, among other things, a deterioration in credit quality or a reduced demand for credit, including the resultant effect on Bancshares’ loan portfolio and allowance for loan losses; (2) the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; (3) inflation, interest rate, market and monetary fluctuations; (4) adverse conditions in the stock market, the public debt market and other capital markets (including changes in interest rate conditions) and the impact of such conditions on Bancshares’ capital markets and capital management activities, including, without limitation, Bancshares’ private equity investment activities and brokerage activities; (5) the timely development of competitive new products and services by Bancshares and the acceptance of these products and services by new and existing customers; (6) the willingness of customers to accept third party products marketed by Bancshares; (7) the willingness of customers to substitute competitors’ products and services for Bancshares’ products and services and vice versa; (8) the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking and securities); (9) technological changes; (10) changes in consumer spending and saving habits; (11) the effect of corporate restructurings, acquisitions and/or dispositions, and the failure to achieve the expected revenue growth and/or expense savings from such corporate restructurings, acquisitions and/or dispositions; (12) the growth and profitability of Bancshares’ noninterest or fee income being less than expected; (13) unanticipated regulatory or judicial proceedings; (14) the impact of changes in accounting policies by the Securities and Exchange Commission or other regulatory agencies; (15) adverse changes in financial performance and/or condition of Bancshares’ borrowers which could impact repayment of such borrowers’ outstanding loans; and (16) Bancshares’ success at managing the risks involved in the foregoing. Bancshares cautions that the foregoing list of important factors is not exclusive. Bancshares does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of Bancshares.

Introduction

Bancshares is a bank holding company headquartered in Lexington, North Carolina. Its principal assets are all of the outstanding shares of common stock of its commercial bank subsidiary, LSB. Founded in 1949, LSB operates as a North Carolina chartered commercial bank serving customers through twenty-seven offices in seventeen communities located in Davidson, Forsyth, Stokes, Guilford and Randolph counties in North Carolina. In addition, as described below, so far in 2004,Bancshares has expanded its operations through the opening of a loan production office in the Raleigh-Durham area of North Carolina, and a new full-service branch in Jamestown, North Carolina. Through LSB and LSB’s two non-bank subsidiaries, Bancshares provides a wide range of financial services to individuals and corporate customers.

Bancshares’ results of operations are dependent primarily on the results of operations of LSB and thus are dependent to a significant extent on net interest income, which is the difference between the income earned on its loan and investment portfolios and its cost of funds, consisting of interest paid on deposits and borrowings. LSB’s non-interest income has become increasingly important to its performance through fees earned by its non-bank subsidiaries, Peoples Finance and LSB Investment Services. Results of operations are also affected by Bancshares’s provision for loan losses, mortgage loan sales activities, service charges and other fee income, and noninterest expense. Bancshares’ noninterest expense principally consists of compensation and employee benefits, office occupancy and equipment expense, data processing, professional fees, and advertising and business promotion expenses. Bancshares’ results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities.

LSB (and Bancshares as its holding company) faces competition in both the attraction of deposit accounts and in the origination of mortgage, commercial, and consumer loans. Its most direct competition for deposits has historically derived from other commercial banks located in and around the counties in which it maintains banking offices. LSB also competes for deposits with both regional and super-regional banks, and money market instruments and mutual funds. LSB competes for loans principally through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers. Its competition for loans also comes principally from other commercial banks, including offices of regional and super-regional banks, located in and around the counties in which it maintains banking offices. Competition for deposits and loans is likely to continue to increase as a result of legislative,

regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to market entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Recent legislation permits affiliation among banks, securities firms and insurance companies, and further legislation will likely continue to change the competitive environment in which Bancshares does business.

The following discussion and analysis is presented on a consolidated basis and focuses on the major components of Bancshares’ operations and significant changes in its results of operations for the periods presented. For further information, refer to the Consolidated Financial Statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003.

Critical Accounting Policies

The accounting and reporting policies of the bank and its subsidiaries comply with generally accepted accounting principles in the United States and conform to standards within the industry. The allowance for loan and lease losses policy is particularly critical, as it requires the most subjective and complex judgments from senior management. Management considers several factors in determining the allowance for loan and lease losses. These include economic conditions, advice of regulators, historical experience and factors affecting particular borrowers. Changes in the assumptions of these policies could result in a significant impact on the bank’s financial statements. For further information, see the Asset Quality and Provision for Loan Losses section.

Bancshares offers pension and postretirement benefit plans to employees. The calculation of obligations and related expenses under these plans requires the use of actuarial valuation methods and assumptions. Actuarial valuations and the determination of future market values of plan assets are subject to management judgment and may differ significantly if different assumptions are used. For further information, see Note 7. Pension and Postretirement Medical Benefit Expenses.

Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003

Net Interest Income

The primary source of earnings for the Corporation is net interest income, which represents the dollar amount by which interest generated from earning assets exceeds the cost of funds. Earning assets consist primarily of loans and investment securities and cost of funds is the interest paid on interest-bearing deposits and borrowed funds.

Net interest income for the first quarter of 2004 of $9.434 million was down $396,000 or 4.0% compared to $9.830 million for the first quarter of 2003. The lower net interest income was largely attributable to a decline in the net interest margin, reduced mortgage financing activity and a lower level of average earning assets. Total interest income of $11.891 million for the first quarter of 2004 was down $1.018 million or 7.9% compared to $12.909 million for the first quarter of 2003. Total interest expense of $2.457 million for the first quarter of 2004 was down $622,000 or 20.2% compared to $3.079 million for the comparable period in 2003. The net interest margin for the first quarter of 2004 was 4.73% compared to 4.95% for the first quarter of 2003. While this was a decline year-over-year, the net interest margin posted an improvement quarter-over-quarter of two basis points. Loan growth in the first quarter of 2004 was $15.534 million or 2.3% compared to December 31, 2003 and $20.750 million or 3.1% compared to March 31, 2003. New loan demand slowed during the first quarter of 2004 with a marked reduction in mortgage refinancing activity. For the period ended March 31, 2004 total deposits were down $2.365 million or 0.3% compared to December 31, 2003 and $34.551 million compared to March 31, 2003. The comparison of deposits for the periods presented is to some degree affected by a surge in time deposits that took place in early to mid-2003. Deposit growth was mixed, but began to show some modest recovery compared to the fourth quarter of 2003. Demand deposits, which were down $5.166 million from March 31, 2003, were up $1.269 million compared to December 31, 2003. Likewise, certificates of deposit over $100,000 were up $11.756 million from the fourth quarter of 2003 but were off $7.975 million from the first quarter of 2003. Savings, NOW and money market deposits were off $11.013 million from the fourth quarter of 2003, but only down $1.419 million from the first quarter of 2003, indicating some temporary build up of these deposits in the fourth quarter of 2003. Certificates of deposit under $100,000 were down $4.377 million compared to December 31, 2003 and down $19.991 million compared to March 31, 2003.

Noninterest Income and Expense

Noninterest income for the first quarter of 2004 of $3.356 million was essentially unchanged from the $3.349 million for the first quarter of 2003. Deposit account fee income for the first quarter of 2004 was up $64,000 or 4.0% compared to the first quarter of 2003. The lower increase in service fee income is attributable to the slower economy.

Mortgage loan refinancing activity declined sharply at the beginning of 2004 affecting the gain on sale of mortgages. For the first quarter of 2004 income from the gain on sales of mortgages of $110,000 was down $248,000 or 69.3% from $358,000 for the first quarter of 2003. Other operating income increased $191,000 or 13.8% for the first quarter of 2004 compared to the first quarter of 2003. Within the other operating income category, fee income from the bankcard division increased 57,000 or 10.2% the first quarter of 2004 compared to the first quarter of 2003. Income from the trust department increased $22,000 or 16.5% in the first quarter of 2004 compared to the corresponding period of 2003.Commissions generated by LSB Investment Services for the first quarter of 2004 increased 62,000 or 20.2% compared to the first quarter of 2003. LSB Investment Services generates commission income from the sale of noninsured investment funds.

Noninterest expense increased $347,000 or 4.0% for the first quarter of 2004 compared to the first quarter of 2003. Personnel expense for the period ended March 31, 2004, comprised of salaries and fringe benefits increased $131,000 or 2.6% compared to the first quarter of 2003. Normal increases in compensation plus some staffing increases to accommodate branch expansion account for the majority of the increase year over year. Slow mortgage financing activity during the first quarter of 2004 resulted in reduced personnel expense relating to mortgage production incentives. The increase for the first quarter of 2004 in occupancy expense was $76,000 or 19.8% compared to the first quarter of 2003. Equipment depreciation and maintenance expense increased $64,000 or 13.5% during the same period. Increases in these expense items are attributable to some extent to branch expansion activity. Other operating expense increased $76,000 or 2.6% for the first quarter of 2004 compared to the first quarter of 2003. Within the other operating expense category, automated processing expenses increased $118,000 or 25.3% for the first quarter of 2004 compared to the corresponding quarter of 2003. The increase in automated expenses is attributable to increases in processing fees and expansion of automated technology to provide enhanced customer services. Expenses for the bankcard division decreased slightly the first quarter of 2004 compared to the first quarter of 2003. Legal and professional expense increased $75,000 or 20.5% for the first quarter of 2004 compared to the first quarter of 2003. Much of this increase is directly attributable to the expenses related to the Sarbanes-Oxley Act of 2002. Expenses of LSB Investment Services for the first quarter of 2004 increased slightly compared to the corresponding period in 2003. Expenses incurred by LSB Investment Services are in connection with the operations of its business of selling mutual funds, annuities and equities.

Asset Quality and Provision for Loan Losses

At March 31, 2004 loan loss reserves were $8.224 million or 1.21% of loans outstanding compared to $7.846 million or 1.18% of loans outstanding at December 31, 2003 and $7.394 million or 1.12% at March 31, 2003. Non-performing assets (including loans over 90 days past due and still accruing) totaled $6.689 million or 0.74% of total assets at March 31, 2004 compared to $5.815 million or 0.67% of total assets at December 31, 2003 and $5.167 million or 0.58% of total assets at March 31, 2003. Non-performing assets include nonaccrual loans, restructured loans, other real estate acquired through foreclosure and accruing loans ninety days or more past due. The increase in non-performing assets for the first quarter of 2004 came primarily from nonaccrual loans that are in work out status. Nonaccrual loans increased to $2.074 million at March 31, 2004 compared to $1.755 million at December 31, 2003 and $576,000 at March 31, 2003. As of March 31, 2004, LSB had restructured loans totaling $1.134 million, which were essentially unchanged from $1.135 million at December 31, 2003 and up compared to $245,000 at March 31, 2003. Properties held in the other real estate category at March 31, 2004 totaled $1.673 million compared to $1.742 million at December 31, 2003 and $1.669 million at March 31, 2003. Accruing loans past due 90 days or more were $1.809 million at March 31, 2004 compared to $1.183 million at December 31, 2003 and $2.676 million at March 31, 2003. The accrual of interest is generally discontinued on any loan that becomes 90 days past due as to principal or interest unless collection of both principal and interest can be assured by way of collateralization, guarantees or other security and the loan is considered to be in the process of collection. At March 31, 2004, the reserve for loan losses was 1.23 times non-performing assets, compared to 1.35 times at December 31, 2003 and 1.43 at March 31, 2003.

Responsibility for market risk management resides with the Asset/Liability Management Committee (the “ALCO Committee”). The ALCO committee monitors market conditions, interest rate trends and the economic environment in its decision-making process. Based upon its view of existing and expected market conditions, balance sheet strategies are adopted to optimize net interest income while minimizing the risks associated with unanticipated changes in interest rates.

The provision for loan losses that was charged to operations the first quarter of 2004 was $511,000 compared to $587,000 for the first quarter of 2003. Net charge-offs for the three-month period ended March 31, 2004 were $133,000 or .07% of average loans outstanding on an annualized basis compared to $475,000 or .28% for the first three months of 2003. Management continues to monitor the asset quality of the loan portfolio. Loans charged-off are recorded based upon the financial condition of the borrower and the

likelihood of repayment.

Loans classified for regulatory purposes as loss, doubtful, substandard or special mention that have not been disclosed as nonperforming do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.

In the opinion of management, all loans where serious doubts exist as to the ability of borrowers to comply with the present repayment terms have been included in the schedule presented.

ASSET QUALITY ANALYSIS


		Period Ended			Year Ended			Period Ended
		3/31/2004			12/31/2003			3/31/2003

RESERVE FOR LOAN LOSSES
	Beginning Balance	$	7,846		$	7,284		$	7,282
	Provision for loan losses		511			5,215			587
	Net (charge-off) recoveries		(133	)		(4,653	)		(475	)

	Ending balance		8,224			7,846			7,394
RISK ASSETS
	Nonaccrual loans	$	2,074		$	1,754		$	576
	Foreclosed real estate		1,673			1,742			1,669
	Restructured loans		1,133			1,135			245
	Loans 90 days or more past due and still accruing		1,809			1,184			2,677

	Total risk assets		6,689			5,815			5,167
ASSET QUALITY RATIOS
Nonaccrual loans as a percentage of total loans			0.32	%		0.26	%		0.09	%
Nonperforming assets as a percentage of:
	Total assets		0.74			0.67			0.58
	Loans plus foreclosed property		0.98			0.87			0.78
Net charge-offs as a percentage of average loans			0.07	*		0.53			0.28	*
Reserve for loan losses as a percentage of loans			1.21			1.18			1.12
Ratio of reserve for loan losses to:
	Net charge-offs		15.45	*		1.69			3.89	*
	Nonaccrual loans		3.96			4.47			12.84

* Denotes Annualized

Income Taxes

Accrued income taxes applicable to income for the three-month period ended March 31, 2004 were $1.022 million compared to $1.281 million for the three-month period ended March 31, 2003. Pretax income for the first three months of 2004 of $3.175 million was down compared to $3.835 million for the first three months of 2003. The decrease in accrued taxes for the period ended March 31, 2004 is primarily due to the lower taxable income.

Capital Resources and Shareholders’ Equity

Regulatory guidelines require minimum levels of capital based on a risk weighting of each

asset category and off-balance sheet contingencies. Regulatory agencies divide capital into Tier 1 or core capital and total capital. Tier 1 capital, as defined by regulatory agencies, consists primarily of common shareholders’ equity less goodwill and certain other intangible assets. Total capital consists of Tier 1 capital plus the allowable portion of the reserve for loan losses and certain long-term debt. At March 31, 2004 based on these measures, Bancshares’ had a Tier 1 capital ratio of 13.07% compared to the regulatory requirement of 4% and total capital ratio of 14.30% compared to an 8% regulatory requirement.

Additional regulatory capital measures include the Tier 1 leverage ratio. The Tier 1 leverage ratio is defined as Tier 1 capital divided by average total assets less goodwill and certain other intangibles and has a regulatory minimum of 3.0%, with most institutions required to maintain a ratio of at least 4.0% to 5.0%, depending primarily upon risk profiles. At March 31, 2004 Bancshares’ Tier 1 leverage ratio was 10.12%.

The Board has authorized a repurchase program for shares of its common stock in the open market or privately negotiated transactions on a time-to-time and ongoing basis, depending upon market conditions and subject to compliance with all applicable securities laws and regulations. The repurchase plan is intended to help Bancshares achieve its goal of building shareholder value and maintaining appropriate capital levels. A maximum of 600,000 total shares have been authorized for repurchase under the plan. As of March 31, 2004 a total of 423,781 shares have been repurchased through the plan. No shares have been repurchased under this plan during 2004 nor were any repurchased during 2003.

Market Risk Management

Bancshares’ market risk arises primarily from the interest rate risk inherent in its lending and deposit-taking activities. The objectives of market risk management are to ensure long-range profitability performance and minimize risk, adhere to proper liquidity and maintain sound capital. To meet these goals, the ALCO Committee monitors the exposure to interest rate risk, balance sheet trends, pricing policies and liquidity position. The objectives are to achieve relatively stable net interest margins and assure liquidity through coordinating the volumes, maturities or repricing opportunities of earning assets, deposits and borrowed funds. This is accomplished through strategic pricing of asset and liability accounts. As a result of this management, appropriate maturities and/or repricing opportunities are developed to produce consistent earnings during changing interest rate environments.

Based upon its view of existing and expected market conditions, the ALCO Committee adopts balance sheet strategies intended to optimize net interest income to the extent possible while minimizing the risk associated with unanticipated changes in interest rates. Core deposits have historically been the primary funding sources for asset growth. Correspondent relationships have been maintained with several large banks in order to have access to federal funds purchases when needed. The Bank also has available lines of credit maintained with the Federal Home Loan Bank (the “FHLB”) that can be used for funding and/or liquidity needs. The Bank has a $20 million irrevocable letter of credit with FHLB that is used in lieu of securities to pledge against public deposits. The Bank also has a retail CD brokerage agreement, which provides an additional source for liquidity or funding needs.

To minimize risk of interest rate movements, the asset/liability management process seeks to match maturities and repricing opportunities of interest-sensitive assets and interest-sensitive liabilities. The Bank uses an asset/liability simulation model to produce a gap analysis. The simulation model computes projected runoff of deposits that do not have contractual maturity dates. On March 31,2004, the gap between interest-sensitive assets and interest-sensitive liabilities was a positive $196,132,000 or 1.75. Under current economic conditions, management believes that is an acceptable ratio.

Asset/liability management also addresses liquidity positioning. Liquidity management is required in order to fund current and future extensions of credit, meet deposit withdrawals, maintain reserve requirements and otherwise sustain operations. As such, it is related to interest rate sensitivity management, in that each is affected by maturing assets and liabilities. While interest sensitivity management is concerned with repricing intervals of assets and liabilities, liquidity management is concerned with the maturities of those respective balances. The Bank’s liquidity position is primarily accomplished through deposit growth, loan repayments and investment securities management. The Bank also has access to federal fund lines at correspondent banks and borrowings from the Federal Reserve discount window.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods.

Bancshares’ market risk arises primarily from the interest rate risk inherent in its lending and deposit-taking activities. The structure of Bancshares’ loan and deposit portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income. Bancshares’ does not maintain a trading account nor is it subject to currency exchange risk or commodity price risk. Responsibility for monitoring interest rate risk rests with the ALCO Committee, which is appointed by the Board. The ALCO Committee meets on a regular basis to review interest rate risk exposure and liquidity positions. Balance sheet management and funding strategies are reviewed to ensure that any potential impact on earnings and liquidity, resulting from a fluctuation in interest rates is within acceptable standards.

Item 4. Controls and Procedures

As of the end of the period covered by this report, Bancshares has evaluated, under the supervision and with the participation of Bancshares’s management, including Bancshares’s Chief Executive Officer and Chief Financial Officer, the effectiveness of Bancshares’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based upon that evaluation, Bancshares’s Chief Executive Officer and Chief Financial Officer have concluded that Bancshares’s disclosure controls and procedures are effective to ensure that information required to be disclosed by Bancshares in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within time periods specified in the rules and forms of the Securities and Exchange Commission (the “Commission”).

During the quarterly period covered by this report, there has been no change in Bancshares’s internal control over financial reporting (as defined in Rule 13a-15(f) promulgated under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, Bancshares’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings
Not applicable.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
Not applicable.

Item 3. Defaults Upon Senior Securities
Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.

Item 5. Other Information
Not Applicable.

Item 6. Exhibits and Reports on Form 8-K
A. Exhibits

     Exhibit 31.1      Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

     Exhibit 31.2      Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

     Exhibit 32      Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

B. Reports on Form 8-K
The Corporation filed an 8-K on January 7, 2004 to announce the opening of an office in Jamestown, NC.

The Corporation filed an 8-K on January 15, 2004 to report an earnings release for the three months ended December 31, 2003.

The Corporation filed an 8-K on March 24, 2004 to announce the opening of an express drive thru in the uptown Lexington area.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


Date May 6, 2004	LSB BANCSHARES, INC. (Registrant)

	By:	/s/ Monty J. Oliver

	Name:	Monty J. Oliver
	Title:	Secretary and Chief Financial Officer
		(Authorized Officer and Chief Accounting Officer)

Exhibit Index


Exhibit 31.1		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Note 1.		Basis of Presentation

		The accompanying interim unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

		LSB Bancshares, Inc. (sometimes referred to herein as “Bancshares” or the “operation”)is a bank holding company headquartered in Lexington, North Carolina. Bancshares principal business is providing banking and other financial services through its banking subsidiary, Lexington State Bank (“LSB”). LSB has two wholly owned subsidiaries, Peoples Finance Company of Lexington, Inc. and LSB Investment Services, Inc. LSB offers a complete array of services in commercial banking including accepting deposits, corporate cash management, discount brokerage, IRA plans, secured and unsecured loans and trust functions through twenty-seven offices in seventeen communities located in Davidson, Forsyth, Stokes, Guilford and Randolph counties. LSB also operates a mortgage production office in Wake County. LSB has two subsidiaries that operate within its market area. Peoples Finance offers secured and unsecured loans to individuals up to a maximum of $10,000 as well as dealer originated loans. LSB Investment Services offers products through UVEST Investment Services, an independent broker-dealer. Investments are neither deposits nor obligations of Lexington State Bank, nor are they guaranteed or insured by any depository institution, the FDIC, or any other government agency.

		For further information, refer to the Consolidated Financial Statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003.

Note 2.		Investment Securities

		The valuations of investment securities as of March 31, 2004 and December 31, 2003 were as follows (in thousands):

		No investment securities were sold during the period ending March 31, 2004.

		Investment securities with amortized cost of $83,145,000 and $81,004,555, as of March 31, 2004 and December 31, 2003, respectively, were pledged to secure public deposits and for other purposes. The Bank also has a $20,000,000 irrevocable letter of credit with FHLB that is used in lieu of securities to pledge against public deposits.

Note 3.		Loans (Table in thousands)

		A summary of consolidated loans follows:

		$1,224,000 was determined for the total amount of impaired loans. The average recorded investment in impaired loans for the quarter ended March 31, 2004 was approximately $7,408,000.

		At March 31, 2004, loans totaling $ 17,046,000 were held for sale stated at the lower of cost or market on an individual loan basis.

Note 4.		Reserve for Loan Losses (in thousands)

		The following sets forth the analysis of the consolidated reserve for loan losses:

Note 5.		Other Accounting Changes

		In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based Compensation-Transition and Disclosure”. SFAS 148 provides alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock-based employee compensation, and stipulates additional disclosure provisions related to stock-based employee compensation. SFAS 148 is effective for financial statements for fiscal years ending after December 15, 2002. Bancshares adopted the disclosure provisions of SFAS 148 with no resulting material effect on its financial position or operating results.

		In December 2003, the FASB revised SFAS 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits”. SFAS 132, as revised, retains the disclosures previously required, and requires additional disclosures related to pension plans and postretirement benefits. SFAS 132 is effective for fiscal years ending after December 15, 2003. Bancshares adopted SFAS 132 with no resulting material effect on its financial position or operating results.

		In July 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (The Act). The purpose of the act is to increase the reliability of financial statements issued by public companies. The act does this by increasing the number of independent parties responsible for the issuance of the statements, by increasing the independence of those already involved in the process and by the imposition of sanctions for those in violation of accounting and reporting rules. Bancshares intends to fully comply with the act and is currently determining the costs related to compliance with Sarbanes-Oxley.

		In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires the recognition of a liability at fair value upon issuance of certain guarantees, including standby letters of credit. FIN 45 is effective for guarantees issued after December 31, 2002. Bancshares determined, if adopted, FIN 45 would have an immaterial effect on its financial position and operating results.

Note 6.		Stock Compensation Plans

		Bancshares had three stock-based compensation plans at March 31, 2004, accounted for under Accounting Principles Board Opinion Number 25, under which no compensation cost has been recognized. A new equity compensation plan was approved at the Annual Shareholder’s Meeting on April 21, 2004. This plan will replace all existing equity plans and any future equity compensation grants will be made under this new plan. Had compensation cost for these plans been determined consistent with Statement of Financial Accounting Standards Numbers 123 and 148, Bancshares’ net income and earnings per share would have been reduced to the following pro forma amounts:

Note 7.		Pension and Postretirement Medical Benefit Expenses

		The components of net periodic benefit cost for pension and retiree medical plans are as follows:

		The discussion presented herein is intended to provide an overview of the changes in financial condition and results of operation for LSB Bancshares, Inc. (“Bancshares”) and its wholly owned subsidiary, Lexington State Bank (“LSB” or the “Bank”) for the three months ended March 31, 2004 and 2003. The consolidated financial statements also include the accounts and results of operation of LSB’s wholly owned subsidiaries, Peoples Finance Company of Lexington, Inc. (“Peoples Finance”) and LSB Investment Services, Inc. (“LSB Investment Services”). This discussion and analysis is intended to complement the unaudited financial statements, footnotes and supplemental financial data in this Form 10-Q, and should be read in conjunction therewith.

		This report contains certain forward-looking statements related to anticipated future operating and financial performance, and other similar statements of expectations.

		These forward-looking statements are often identified by words such as “believes”, “anticipates”, “expects” or other similar words or phrases. These forward-looking statements are based on estimates, beliefs and assumptions made by management and are not guarantees of future performance. Actual results may differ from those expressed or implied as the result of various factors, including: (1) the strength of the United States economy generally and the strength of the local economies in which Bancshares conducts operations may be different than expected resulting in, among other things, a deterioration in credit quality or a reduced demand for credit, including the resultant effect on Bancshares’ loan portfolio and allowance for loan losses; (2) the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; (3) inflation, interest rate, market and monetary fluctuations; (4) adverse conditions in the stock market, the public debt market and other capital markets (including changes in interest rate conditions) and the impact of such conditions on Bancshares’ capital markets and capital management activities, including, without limitation, Bancshares’ private equity investment activities and brokerage activities; (5) the timely development of competitive new products and services by Bancshares and the acceptance of these products and services by new and existing customers; (6) the willingness of customers to accept third party products marketed by Bancshares; (7) the willingness of customers to substitute competitors’ products and services for Bancshares’ products and services and vice versa; (8) the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking and securities); (9) technological changes; (10) changes in consumer spending and saving habits; (11) the effect of corporate restructurings, acquisitions and/or dispositions, and the failure to achieve the expected revenue growth and/or expense savings from such corporate restructurings, acquisitions and/or dispositions; (12) the growth and profitability of Bancshares’ noninterest or fee income being less than expected; (13) unanticipated regulatory or judicial proceedings; (14) the impact of changes in accounting policies by the Securities and Exchange Commission or other regulatory agencies; (15) adverse changes in financial performance and/or condition of Bancshares’ borrowers which could impact repayment of such borrowers’ outstanding loans; and (16) Bancshares’ success at managing the risks involved in the foregoing. Bancshares cautions that the foregoing list of important factors is not exclusive. Bancshares does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of Bancshares.

		Introduction

		Bancshares is a bank holding company headquartered in Lexington, North Carolina. Its principal assets are all of the outstanding shares of common stock of its commercial bank subsidiary, LSB. Founded in 1949, LSB operates as a North Carolina chartered commercial bank serving customers through twenty-seven offices in seventeen communities located in Davidson, Forsyth, Stokes, Guilford and Randolph counties in North Carolina. In addition, as described below, so far in 2004,Bancshares has expanded its operations through the opening of a loan production office in the Raleigh-Durham area of North Carolina, and a new full-service branch in Jamestown, North Carolina. Through LSB and LSB’s two non-bank subsidiaries, Bancshares provides a wide range of financial services to individuals and corporate customers.

		Bancshares’ results of operations are dependent primarily on the results of operations of LSB and thus are dependent to a significant extent on net interest income, which is the difference between the income earned on its loan and investment portfolios and its cost of funds, consisting of interest paid on deposits and borrowings. LSB’s non-interest income has become increasingly important to its performance through fees earned by its non-bank subsidiaries, Peoples Finance and LSB Investment Services. Results of operations are also affected by Bancshares’s provision for loan losses, mortgage loan sales activities, service charges and other fee income, and noninterest expense. Bancshares’ noninterest expense principally consists of compensation and employee benefits, office occupancy and equipment expense, data processing, professional fees, and advertising and business promotion expenses. Bancshares’ results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities.

		LSB (and Bancshares as its holding company) faces competition in both the attraction of deposit accounts and in the origination of mortgage, commercial, and consumer loans. Its most direct competition for deposits has historically derived from other commercial banks located in and around the counties in which it maintains banking offices. LSB also competes for deposits with both regional and super-regional banks, and money market instruments and mutual funds. LSB competes for loans principally through the interest rates and loan fees it charges and the efficiency and quality of services it provides borrowers. Its competition for loans also comes principally from other commercial banks, including offices of regional and super-regional banks, located in and around the counties in which it maintains banking offices. Competition for deposits and loans is likely to continue to increase as a result of legislative,

		regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to market entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Recent legislation permits affiliation among banks, securities firms and insurance companies, and further legislation will likely continue to change the competitive environment in which Bancshares does business.

		The following discussion and analysis is presented on a consolidated basis and focuses on the major components of Bancshares’ operations and significant changes in its results of operations for the periods presented. For further information, refer to the Consolidated Financial Statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003.

		Critical Accounting Policies

		The accounting and reporting policies of the bank and its subsidiaries comply with generally accepted accounting principles in the United States and conform to standards within the industry. The allowance for loan and lease losses policy is particularly critical, as it requires the most subjective and complex judgments from senior management. Management considers several factors in determining the allowance for loan and lease losses. These include economic conditions, advice of regulators, historical experience and factors affecting particular borrowers. Changes in the assumptions of these policies could result in a significant impact on the bank’s financial statements. For further information, see the Asset Quality and Provision for Loan Losses section.

		Bancshares offers pension and postretirement benefit plans to employees. The calculation of obligations and related expenses under these plans requires the use of actuarial valuation methods and assumptions. Actuarial valuations and the determination of future market values of plan assets are subject to management judgment and may differ significantly if different assumptions are used. For further information, see Note 7. Pension and Postretirement Medical Benefit Expenses.

		The primary source of earnings for the Corporation is net interest income, which represents the dollar amount by which interest generated from earning assets exceeds the cost of funds. Earning assets consist primarily of loans and investment securities and cost of funds is the interest paid on interest-bearing deposits and borrowed funds.

		Net interest income for the first quarter of 2004 of $9.434 million was down $396,000 or 4.0% compared to $9.830 million for the first quarter of 2003. The lower net interest income was largely attributable to a decline in the net interest margin, reduced mortgage financing activity and a lower level of average earning assets. Total interest income of $11.891 million for the first quarter of 2004 was down $1.018 million or 7.9% compared to $12.909 million for the first quarter of 2003. Total interest expense of $2.457 million for the first quarter of 2004 was down $622,000 or 20.2% compared to $3.079 million for the comparable period in 2003. The net interest margin for the first quarter of 2004 was 4.73% compared to 4.95% for the first quarter of 2003. While this was a decline year-over-year, the net interest margin posted an improvement quarter-over-quarter of two basis points. Loan growth in the first quarter of 2004 was $15.534 million or 2.3% compared to December 31, 2003 and $20.750 million or 3.1% compared to March 31, 2003. New loan demand slowed during the first quarter of 2004 with a marked reduction in mortgage refinancing activity. For the period ended March 31, 2004 total deposits were down $2.365 million or 0.3% compared to December 31, 2003 and $34.551 million compared to March 31, 2003. The comparison of deposits for the periods presented is to some degree affected by a surge in time deposits that took place in early to mid-2003. Deposit growth was mixed, but began to show some modest recovery compared to the fourth quarter of 2003. Demand deposits, which were down $5.166 million from March 31, 2003, were up $1.269 million compared to December 31, 2003. Likewise, certificates of deposit over $100,000 were up $11.756 million from the fourth quarter of 2003 but were off $7.975 million from the first quarter of 2003. Savings, NOW and money market deposits were off $11.013 million from the fourth quarter of 2003, but only down $1.419 million from the first quarter of 2003, indicating some temporary build up of these deposits in the fourth quarter of 2003. Certificates of deposit under $100,000 were down $4.377 million compared to December 31, 2003 and down $19.991 million compared to March 31, 2003.

		Mortgage loan refinancing activity declined sharply at the beginning of 2004 affecting the gain on sale of mortgages. For the first quarter of 2004 income from the gain on sales of mortgages of $110,000 was down $248,000 or 69.3% from $358,000 for the first quarter of 2003. Other operating income increased $191,000 or 13.8% for the first quarter of 2004 compared to the first quarter of 2003. Within the other operating income category, fee income from the bankcard division increased 57,000 or 10.2% the first quarter of 2004 compared to the first quarter of 2003. Income from the trust department increased $22,000 or 16.5% in the first quarter of 2004 compared to the corresponding period of 2003.Commissions generated by LSB Investment Services for the first quarter of 2004 increased 62,000 or 20.2% compared to the first quarter of 2003. LSB Investment Services generates commission income from the sale of noninsured investment funds.

		Noninterest expense increased $347,000 or 4.0% for the first quarter of 2004 compared to the first quarter of 2003. Personnel expense for the period ended March 31, 2004, comprised of salaries and fringe benefits increased $131,000 or 2.6% compared to the first quarter of 2003. Normal increases in compensation plus some staffing increases to accommodate branch expansion account for the majority of the increase year over year. Slow mortgage financing activity during the first quarter of 2004 resulted in reduced personnel expense relating to mortgage production incentives. The increase for the first quarter of 2004 in occupancy expense was $76,000 or 19.8% compared to the first quarter of 2003. Equipment depreciation and maintenance expense increased $64,000 or 13.5% during the same period. Increases in these expense items are attributable to some extent to branch expansion activity. Other operating expense increased $76,000 or 2.6% for the first quarter of 2004 compared to the first quarter of 2003. Within the other operating expense category, automated processing expenses increased $118,000 or 25.3% for the first quarter of 2004 compared to the corresponding quarter of 2003. The increase in automated expenses is attributable to increases in processing fees and expansion of automated technology to provide enhanced customer services. Expenses for the bankcard division decreased slightly the first quarter of 2004 compared to the first quarter of 2003. Legal and professional expense increased $75,000 or 20.5% for the first quarter of 2004 compared to the first quarter of 2003. Much of this increase is directly attributable to the expenses related to the Sarbanes-Oxley Act of 2002. Expenses of LSB Investment Services for the first quarter of 2004 increased slightly compared to the corresponding period in 2003. Expenses incurred by LSB Investment Services are in connection with the operations of its business of selling mutual funds, annuities and equities.

		At March 31, 2004 loan loss reserves were $8.224 million or 1.21% of loans outstanding compared to $7.846 million or 1.18% of loans outstanding at December 31, 2003 and $7.394 million or 1.12% at March 31, 2003. Non-performing assets (including loans over 90 days past due and still accruing) totaled $6.689 million or 0.74% of total assets at March 31, 2004 compared to $5.815 million or 0.67% of total assets at December 31, 2003 and $5.167 million or 0.58% of total assets at March 31, 2003. Non-performing assets include nonaccrual loans, restructured loans, other real estate acquired through foreclosure and accruing loans ninety days or more past due. The increase in non-performing assets for the first quarter of 2004 came primarily from nonaccrual loans that are in work out status. Nonaccrual loans increased to $2.074 million at March 31, 2004 compared to $1.755 million at December 31, 2003 and $576,000 at March 31, 2003. As of March 31, 2004, LSB had restructured loans totaling $1.134 million, which were essentially unchanged from $1.135 million at December 31, 2003 and up compared to $245,000 at March 31, 2003. Properties held in the other real estate category at March 31, 2004 totaled $1.673 million compared to $1.742 million at December 31, 2003 and $1.669 million at March 31, 2003. Accruing loans past due 90 days or more were $1.809 million at March 31, 2004 compared to $1.183 million at December 31, 2003 and $2.676 million at March 31, 2003. The accrual of interest is generally discontinued on any loan that becomes 90 days past due as to principal or interest unless collection of both principal and interest can be assured by way of collateralization, guarantees or other security and the loan is considered to be in the process of collection. At March 31, 2004, the reserve for loan losses was 1.23 times non-performing assets, compared to 1.35 times at December 31, 2003 and 1.43 at March 31, 2003.

		Responsibility for market risk management resides with the Asset/Liability Management Committee (the “ALCO Committee”). The ALCO committee monitors market conditions, interest rate trends and the economic environment in its decision-making process. Based upon its view of existing and expected market conditions, balance sheet strategies are adopted to optimize net interest income while minimizing the risks associated with unanticipated changes in interest rates.

		The provision for loan losses that was charged to operations the first quarter of 2004 was $511,000 compared to $587,000 for the first quarter of 2003. Net charge-offs for the three-month period ended March 31, 2004 were $133,000 or .07% of average loans outstanding on an annualized basis compared to $475,000 or .28% for the first three months of 2003. Management continues to monitor the asset quality of the loan portfolio. Loans charged-off are recorded based upon the financial condition of the borrower and the

		likelihood of repayment.

		Loans classified for regulatory purposes as loss, doubtful, substandard or special mention that have not been disclosed as nonperforming do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.

		In the opinion of management, all loans where serious doubts exist as to the ability of borrowers to comply with the present repayment terms have been included in the schedule presented.

		asset category and off-balance sheet contingencies. Regulatory agencies divide capital into Tier 1 or core capital and total capital. Tier 1 capital, as defined by regulatory agencies, consists primarily of common shareholders’ equity less goodwill and certain other intangible assets. Total capital consists of Tier 1 capital plus the allowable portion of the reserve for loan losses and certain long-term debt. At March 31, 2004 based on these measures, Bancshares’ had a Tier 1 capital ratio of 13.07% compared to the regulatory requirement of 4% and total capital ratio of 14.30% compared to an 8% regulatory requirement.

		Additional regulatory capital measures include the Tier 1 leverage ratio. The Tier 1 leverage ratio is defined as Tier 1 capital divided by average total assets less goodwill and certain other intangibles and has a regulatory minimum of 3.0%, with most institutions required to maintain a ratio of at least 4.0% to 5.0%, depending primarily upon risk profiles. At March 31, 2004 Bancshares’ Tier 1 leverage ratio was 10.12%.

		The Board has authorized a repurchase program for shares of its common stock in the open market or privately negotiated transactions on a time-to-time and ongoing basis, depending upon market conditions and subject to compliance with all applicable securities laws and regulations. The repurchase plan is intended to help Bancshares achieve its goal of building shareholder value and maintaining appropriate capital levels. A maximum of 600,000 total shares have been authorized for repurchase under the plan. As of March 31, 2004 a total of 423,781 shares have been repurchased through the plan. No shares have been repurchased under this plan during 2004 nor were any repurchased during 2003.

		Bancshares’ market risk arises primarily from the interest rate risk inherent in its lending and deposit-taking activities. The objectives of market risk management are to ensure long-range profitability performance and minimize risk, adhere to proper liquidity and maintain sound capital. To meet these goals, the ALCO Committee monitors the exposure to interest rate risk, balance sheet trends, pricing policies and liquidity position. The objectives are to achieve relatively stable net interest margins and assure liquidity through coordinating the volumes, maturities or repricing opportunities of earning assets, deposits and borrowed funds. This is accomplished through strategic pricing of asset and liability accounts. As a result of this management, appropriate maturities and/or repricing opportunities are developed to produce consistent earnings during changing interest rate environments.

		Based upon its view of existing and expected market conditions, the ALCO Committee adopts balance sheet strategies intended to optimize net interest income to the extent possible while minimizing the risk associated with unanticipated changes in interest rates. Core deposits have historically been the primary funding sources for asset growth. Correspondent relationships have been maintained with several large banks in order to have access to federal funds purchases when needed. The Bank also has available lines of credit maintained with the Federal Home Loan Bank (the “FHLB”) that can be used for funding and/or liquidity needs. The Bank has a $20 million irrevocable letter of credit with FHLB that is used in lieu of securities to pledge against public deposits. The Bank also has a retail CD brokerage agreement, which provides an additional source for liquidity or funding needs.

		To minimize risk of interest rate movements, the asset/liability management process seeks to match maturities and repricing opportunities of interest-sensitive assets and interest-sensitive liabilities. The Bank uses an asset/liability simulation model to produce a gap analysis. The simulation model computes projected runoff of deposits that do not have contractual maturity dates. On March 31,2004, the gap between interest-sensitive assets and interest-sensitive liabilities was a positive $196,132,000 or 1.75. Under current economic conditions, management believes that is an acceptable ratio.

		Asset/liability management also addresses liquidity positioning. Liquidity management is required in order to fund current and future extensions of credit, meet deposit withdrawals, maintain reserve requirements and otherwise sustain operations. As such, it is related to interest rate sensitivity management, in that each is affected by maturing assets and liabilities. While interest sensitivity management is concerned with repricing intervals of assets and liabilities, liquidity management is concerned with the maturities of those respective balances. The Bank’s liquidity position is primarily accomplished through deposit growth, loan repayments and investment securities management. The Bank also has access to federal fund lines at correspondent banks and borrowings from the Federal Reserve discount window.

		As of the end of the period covered by this report, Bancshares has evaluated, under the supervision and with the participation of Bancshares’s management, including Bancshares’s Chief Executive Officer and Chief Financial Officer, the effectiveness of Bancshares’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based upon that evaluation, Bancshares’s Chief Executive Officer and Chief Financial Officer have concluded that Bancshares’s disclosure controls and procedures are effective to ensure that information required to be disclosed by Bancshares in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within time periods specified in the rules and forms of the Securities and Exchange Commission (the “Commission”).

		During the quarterly period covered by this report, there has been no change in Bancshares’s internal control over financial reporting (as defined in Rule 13a-15(f) promulgated under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, Bancshares’s internal control over financial reporting.

Item 1.		Legal Proceedings Not applicable.

Item 2.		Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities Not applicable.

Item 3.		Defaults Upon Senior Securities Not applicable.

Item 4.		Submission of Matters to a Vote of Security Holders Not applicable.

Item 5.		Other Information Not Applicable.

Item 6.		Exhibits and Reports on Form 8-K A. Exhibits

		Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

		Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

		Exhibit 32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

		B. Reports on Form 8-K The Corporation filed an 8-K on January 7, 2004 to announce the opening of an office in Jamestown, NC.

		The Corporation filed an 8-K on January 15, 2004 to report an earnings release for the three months ended December 31, 2003.

		The Corporation filed an 8-K on March 24, 2004 to announce the opening of an express drive thru in the uptown Lexington area.