UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 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 September 30, 2004.
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
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Commission File Number: 0-22219
FIRST SOUTH BANCORP, INC.
-------------------------
(Exact name of registrant as specified in its charter)
VIRGINIA 56-1999749
- ------------------------------ -------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1311 CAROLINA AVENUE, WASHINGTON, NORTH CAROLINA 27889
------------------------------------------------------
(Address of principal executive offices)
(Zip Code)
(252) 946-4178 (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 |X| No |_|
Indicate by check mark whether registrant is an accelerated filer (as defined by
Rule 12b-2 of the Exchange Act).
Yes |X| No |_|
Number of shares of common stock outstanding as of October 30, 2004: 6,248,678
CONTENTS
PART I. FINANCIAL INFORMATION PAGE
--------------------- ----
Item 1. Financial Statements
Consolidated Statements of Financial Condition as of September 30, 2004
(unaudited) and December 31, 2003 1
Consolidated Statements of Operations for the Three and Nine Months Ended
September 30, 2004 and 2003 (unaudited) 2
Consolidated Statement of Stockholders' Equity for the Nine Months Ended
September 30, 2004 (unaudited) 3
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2004 and 2003 (unaudited) 4
Notes to Consolidated Financial Statements (unaudited) 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk 13
Item 4. Controls and Procedures 13
PART II. OTHER INFORMATION
----------------
Item 1. Legal Proceedings 14
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 14
Item 3. Defaults Upon Senior Securities 15
Item 4. Submission of Matters to a Vote of Security Holders 15
Item 5. Other Information 15
Item 6. Exhibits 15
Signatures 15
Exhibits 16
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30 DECEMBER 31
2004 2003
------------- -------------
Assets (UNAUDITED)
Cash and due from banks $ 19,361,553 $ 34,299,553
Interest-bearing deposits in financial institutions 521,636 625,051
Investment securities - available for sale 37,531,690 50,071,520
Mortgage-backed securities - available for sale 7,295,187 11,715,052
Mortgage-backed securities - held for investment 2,728,829 --
Loans and leases receivable, net:
Held for sale 5,793,398 10,924,148
Held for investment 614,504,432 542,275,778
Premises and equipment, net 8,539,848 7,922,588
Real estate owned 186,778 130,798
Federal Home Loan Bank of Atlanta stock, at cost
which approximates market 2,000,000 2,127,200
Accrued interest receivable 3,352,624 3,073,093
Goodwill 4,218,576 4,218,576
Mortgage servicing rights 1,742,265 1,886,522
Identifiable intangible assets 298,680 -
Prepaid expenses and other assets 5,402,125 5,313,528
Note receivable 1,181,045 1,252,703
------------- -------------
Total assets $ 714,658,666 $ 675,836,110
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand $ 235,895,859 $ 227,863,599
Savings 22,708,653 20,292,472
Large denomination certificates of deposit 112,318,729 107,354,231
Other time 245,033,186 227,662,871
------------- -------------
Total deposits 615,956,427 583,173,173
Borrowed money 22,300,436 19,338,059
Junior subordinated debentures 10,000,000 10,000,000
Deferred income taxes 544,231 1,114,567
Other liabilities 8,217,485 7,046,758
------------- -------------
Total liabilities 657,018,579 620,672,557
Common stock, $.01 par value, 25,000,000 and 8,000,000
shares authorized, respectively; 6,248,678 and 4,190,335
shares issued and outstanding, respectively 62,487 41,903
Additional paid-in capital 37,765,652 49,020,632
Retained earnings, substantially restricted 48,626,410 43,171,318
Treasury stock at cost (29,845,608) (39,326,931)
Accumulated other comprehensive income, net 1,031,146 2,256,631
------------- -------------
Total stockholders' equity 57,640,087 55,163,553
------------- -------------
Total liabilities and stockholders' equity $ 714,658,666 $ 675,836,110
============= =============
See Notes to Consolidated Financial Statements.
1
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------- -------------------------
2004 2003 2004 2003
------------------------- -------------------------
Interest income:
Interest and fees on loans $ 9,346,970 $ 8,145,992 $26,648,410 $24,104,360
Interest and dividends on investments and deposits 830,513 1,070,908 2,700,112 3,503,417
----------- ----------- ----------- -----------
Total interest income 10,177,483 9,216,900 29,348,522 27,607,777
Interest expense:
Interest on deposits 2,252,362 2,396,706 6,454,498 7,749,619
Interest on borrowings 112,779 24,918 255,312 97,764
Interest on junior subordinated notes 115,926 5,680 323,826 5,680
----------- ----------- ----------- -----------
Total interest expense 2,481,067 2,427,304 7,033,636 7,853,063
Net interest income before provision for loan losses 7,696,416 6,789,596 22,314,886 19,754,714
Provision for loan losses 268,000 395,000 668,000 850,919
----------- ----------- ----------- -----------
Net interest income 7,428,416 6,394,596 21,646,886 18,903,795
----------- ----------- ----------- -----------
Non-interest income:
Loan fees and service charges 1,658,555 1,549,982 4,905,404 4,426,508
Loan servicing fees 182,220 198,024 540,552 493,111
Gain on sale of real estate, net 1,147 75,082 17,633 117,322
Gain on sale of mortgage loans 148,274 800,816 393,493 2,600,907
Gain on sale of mortgage-backed securities -- 122,800 88,844 291,738
Other income 244,855 208,099 733,364 631,431
----------- ----------- ----------- -----------
Total non-interest income 2,235,051 2,954,803 6,679,290 8,561,017
----------- ----------- ----------- -----------
Non-interest expense:
Compensation and fringe benefits 3,000,235 2,663,719 8,832,490 7,941,199
Federal insurance premiums 21,759 63,447 65,351 106,577
Premises and equipment 399,347 392,216 1,207,228 1,132,527
Advertising 63,907 69,718 146,708 164,710
Payroll and other taxes 239,377 238,508 772,334 720,746
Data processing 513,811 480,678 1,547,869 1,429,410
Amortization of intangible assets 77,990 64,768 220,829 174,177
Other 563,953 624,100 1,743,992 1,852,877
----------- ----------- ----------- -----------
Total non-interest expense 4,880,379 4,597,154 14,536,801 13,522,223
----------- ----------- ----------- -----------
Income before income taxes 4,783,088 4,752,245 13,789,375 13,942,589
Income taxes 1,792,266 1,786,081 5,118,658 5,246,243
----------- ----------- ----------- -----------
NET INCOME $ 2,990,822 $ 2,966,164 $ 8,670,717 $ 8,696,346
=========== =========== =========== ===========
Per share data: (*)
Basic earnings per share $ 0.48 $ 0.48 $ 1.39 $ 1.40
Diluted earnings per share $ 0.46 $ 0.45 $ 1.32 $ 1.32
Dividends per share $ 0.17 $ 0.13 $ 0.51 $ 0.39
Weighted average shares Basic 6,228,697 6,208,111 6,250,742 6,217,168
Weighted average shares Diluted 6,554,013 6,589,464 6,545,261 6,594,288
(*) Adjusted for April 23, 2004 three-for-two stock split.
See Notes to Consolidated Financial Statements.
2
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2004
(UNAUDITED)
Accumulated
Retained Other
Additional Earnings, Comprehensive
Common Paid-in Substantially Treasury Income,
Stock Capital Restricted Stock Net Total
------------ ------------ ------------- ------------ -------------- ------------
Balance, December 31, 2003 $ 41,903 $ 49,020,632 $ 43,171,318 $(39,326,931) $ 2,256,631 $ 55,163,553
Net income 8,670,717 8,670,717
Three-for-two stock split,
including fractional shares * 20,828 (10,832,989) (20,828) 10,832,989 0
Other comprehensive loss, net
of taxes (1,225,485) (1,225,485)
Exercise of stock options 578 (543,656) 981,867 438,789
Acquisition of treasury shares (773) (2,211,917) (2,212,690)
Shares traded to exercise options (49) 121,665 (121,616) 0
Dividends ($ .51 per share) (3,194,797) (3,194,797)
------------ ------------ ------------ ------------ ------------- ------------
Balance, September 30, 2004 $ 62,487 $ 37,765,652 $ 48,626,410 $(29,845,608) $ 1,031,146 $ 57,640,087
------------ ------------ ------------ ------------ ------------- ------------
* April 23, 2004 three-for-two stock split.
See Notes to Consolidated Financial Statements.
3
FIRST SOUTH BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
September 30
------------------------------
2004 2003
------------------------------
Operating activities
Net Income $ 8,670,717 $ 8,696,346
Adjustments to reconcile net income to net cash provided
in operating activities:
Provision for loan losses 668,000 850,919
Depreciation 548,980 527,287
Impairment of servicing asset 133,425 611,842
Impairment of real estate owned -- 90,000
Amortization of premiums and discounts on securities, net (84,026) (126,024)
Gain on sale of real estate, net (17,633) (117,322)
Gain on sales of loans held for sale and mortgage-backed securities (482,337) (2,892,645)
Originations of loans held for sale, net (26,987,556) (108,730,666)
Proceeds from sale of loans held for sale 29,670,315 128,900,000
Other operating activities 536,434 (3,020,243)
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Net cash provided in operating activities 12,656,319 24,789,494
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Investing activities:
Proceeds from maturities of investment securities available for sale 11,000,000 4,000,000
Proceeds from principal repayments and sales of
mortgage-backed securities available for sale 4,336,744 19,439,024
Proceeds from principal repayments and sales of
mortgage-backed securities held for investment 112,655 --
Originations of loans held for investment, net of principal repayments (70,786,818) (60,383,622)
Proceeds from disposal of premises and equipment and real estate owned 70,899 723,598
Redemption of FHLB stock 127,200 275,300
Purchases of premises and equipment (1,109,280) (581,909)
Repayment of note receivable 71,658 60,194
Acquisition of branch offices, net of cash received 15,817,778 --
------------- -------------
Net cash used in investing activities (40,359,164) (36,467,415)
------------- -------------
Financing activities:
Net increase in deposits 14,436,981 49,255,676
Proceeds from FHLB borrowings 214,300,000 168,900,000
Repayments of FHLB borrowings (212,300,000) (202,900,000)
Issuance of trust preferred securities -- 10,000,000
Purchase of treasury shares (2,334,363) (7,280,660)
Proceeds from exercise of stock options 560,462 608,919
Cash paid for dividends and fractional shares (2,964,027) (2,484,771)
Net change in repurchase agreements 962,377 1,579,847
------------- -------------
Net cash provided by financing activities 12,661,430 17,679,011
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Increase (decrease) in cash and cash equivalents (15,041,415) 6,001,090
Cash and cash equivalents, beginning of period 34,924,604 34,472,159
------------- -------------
Cash and cash equivalents, end of period $ 19,883,189 $ 40,473,249
============= =============
Supplemental disclosures:
Real estate acquired in settlement of loans $ 91,206 $ 309,909
Exchange of loans for mortgage-backed securities-held for investment $ 2,841,484 $ 8,952,095
Dividends declared, not paid $ 1,062,275 $ 830,006
See Notes to Consolidated Financial Statements.
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. NATURE OF BUSINESS. First South Bancorp, Inc. (the "Company") was formed
for the purpose of issuing common stock and owning 100% of the stock of First
South Bank (the "Bank") and operating through the Bank a commercial banking
business. The Bank has one significant operating segment, the providing of
general commercial banking services to its markets located in the state of North
Carolina. The Company's common stock is traded on The Nasdaq National Market
under the symbol "FSBK".
NOTE 2. BASIS OF PRESENTATION. The accompanying unaudited consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America and with the instructions to Form 10-Q
of Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America for complete financial statements and should be read in
conjunction with the consolidated financial statements and notes thereto in the
Company's Annual Report on Form 10-K for the year ended December 31, 2003. In
the opinion of management, all adjustments necessary for a fair presentation of
the financial position and results of operations for the periods presented have
been included, none of which were other than normal recurring accruals. The
financial statements of the Company are presented on a consolidated basis with
those of the Bank. The results of operations for the three and nine month
periods ended September 30, 2004 are not necessarily indicative of the results
of operations that may be expected for the year ended December 31, 2004.
NOTE 3. STOCK SPLIT. On March 18, 2004 the Company declared a three-for-two
stock split, in the form of a 50% stock dividend, payable April 23, 2004 to
stockholders of record as of April 2, 2004. Stockholders received one additional
share of stock for every two shares held on the record date. Certain current and
prior period share and per share data has been adjusted to reflect the stock
split.
NOTE 4. GOODWILL. The Company applies the provisions of Statement of Financial
Accounting Standards No. 142 (SFAS No. 142), "Goodwill and Other Intangible
Assets", and Statement of Financial Accounting Standards No. 147 (SFAS No. 147),
"Acquisition of Certain Financial Institutions", effective as of January 1,
2002. As a result of applying the provisions of SFAS No.'s 142 and 147, goodwill
is not amortized, but reviewed for potential impairment on an annual basis. The
Company has performed its annual impairment test and determined no impairment of
goodwill.
NOTE 5. EARNINGS PER SHARE. Basic and diluted earnings per share for the three
and nine month periods ended September 30, 2004 and 2003 are based on weighted
average shares of common stock outstanding, excluding treasury shares. Diluted
earnings per share include the potentially dilutive effects of the Company's
stock option plan.
NOTE 6. STOCK OPTIONS. The Company's 1997 Stock Option Plan (the "Plan")
provides for the issuance of options to purchase shares of the Company's common
stock to selected key employees and Directors of the Company and the Bank. The
options have an original term of ten years with an exercise price equal to the
market price of the common stock on the date of grant, as defined by the Plan.
Vesting is determined on the date of grant. During the quarter ended September
30, 2004, 3,000 options were granted under the Plan. The weighted average
remaining contractual life of currently outstanding options under the Plan is 50
months. At September 30, 2004, 797,100 options were outstanding and 700,268
options were reserved for future issuance, adjusted for the stock split. In
addition, 274,165 options had been exercised under the Plan, adjusted for the
stock split.
5
The Company accounts for the Plan under the provision of SFAS No. 123,
"Accounting for Stock Based Compensation". As permitted by SFAS No. 123, the
Company has chosen to apply APB Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations in accounting for its plans. Accordingly,
no compensation cost had been recognized for options granted under the plans.
Had compensation cost for the Company's plans been determined based on the fair
value at the grant dates for awards under the plans consistent with the method
of SFAS No. 123, the Company's net income and net income per share - basic would
have been adjusted to the pro forma amounts indicated below.
Three Months Ended September 30, 2004 As Reported Pro Forma
- ---------------------------------------------- ------------- -------------
Net income attributable to common shareholders $ 2,990,822 $ 2,970,451
Stock based compensation, before tax effect $ 0 $ 30,865
Net income per share - basic $ .48 $ .48
Net income per share - diluted $ .46 $ .45
Nine Months Ended September 30, 2004 As Reported Pro Forma
- ---------------------------------------------- ------------- -------------
Net income attributable to common shareholders $ 8,670,717 $ 8,610,696
Stock based compensation, before tax effect $ 0 $ 90,941
Net income per share - basic $ 1.39 $ 1.38
Net income per share - diluted $ 1.32 $ 1.32
Three Months Ended September 30, 2003 As Reported Pro Forma
- ---------------------------------------------- ------------- -------------
Net income attributable to common shareholders $ 2,966,164 $ 2,935,393
Stock based compensation, before tax effect $ 0 $ 46,623
Net income per share - basic $ .48 $ .47
Net income per share - diluted $ .45 $ .45
Nine Months Ended September 30, 2003 As Reported Pro Forma
- ---------------------------------------------- ------------- -------------
Net income attributable to common shareholders $ 8,696,346 $ 8,604,032
Stock based compensation, before tax effect $ 0 $ 139,869
Net income per share - basic $ 1.40 $ 1.38
Net income per share - diluted $ 1.32 $ 1.30
NOTE 7. COMPREHENSIVE INCOME. The Company applies the provisions of Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income".
Comprehensive income includes net income and all other changes to the Company's
equity, with the exception of transactions with shareholders ("other
comprehensive income"). The Company's only component of other comprehensive
income relates to unrealized gains and losses on available for sale securities.
Unrealized gains and losses on available for sale securities is primarily
impacted by purchases and sales of available for sale securities and changes in
interest rates between the respective reporting periods. Information concerning
the Company's other comprehensive income for the three and nine month periods
ended September 30, 2004 and 2003 is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Net income $ 2,990,822 $ 2,966,164 $ 8,670,717 $ 8,696,346
Reclassify gain on sale of securities 0 (122,800) (88,844) (291,738)
Losses unrealized, net of taxes (180,500) (538,336) (1,136,641) (804,462)
----------- ----------- ----------- -----------
Other comprehensive loss (180,500) (661,136) (1,225,485) (1,096,200)
----------- ----------- ----------- -----------
Comprehensive income $ 2,810,322 $ 2,305,028 $ 7,445,232 $ 7,600,146
=========== =========== =========== ===========
6
NOTE 8. RECLASSIFICATIONS. Certain amounts reported in the Consolidated
Statements of Financial Condition as of December 31, 2003 have been reclassified
to conform to the presentation for the period ended September 30, 2004. The
reclassifications had no effect on net income or stockholders' equity for the
periods presented, nor did they materially impact trends in financial
information.
NOTE 9. ACQUISITIONS. On February 20, 2004, the Bank completed its acquisition
of two of Central Carolina Bank's ("CCB") branch offices located in Greenville
and New Bern, North Carolina. Pursuant to a Purchase and Assumption Agreement
("Agreement") executed on October 29, 2003, the Bank assumed the deposits of
these offices for a premium of approximately 1.5% of the assumed deposits, and
purchased loans, fixed assets and certain other assets associated with the
branch offices. Summary financial information related to the branch purchase
transaction as of February 20, 2004 is as follows (unaudited) (in thousands):
Loans receivable $ 2,212
Premises and equipment 75
Identifiable intangible assets 314
Other assets 46
Deposits (18,373)
--------
Net cash received $ 15,818
========
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS. The Company has engaged in no activity other than holding the
stock of the Bank and operating through the Bank a commercial banking business.
Therefore, the discussion below focuses primarily on the Bank's results of
operations.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
Total assets increased to $714.7 million at September 30, 2004 from $675.8
million at December 31, 2003, reflecting a 7.7% annualized internal growth rate.
Earning assets increased to $670.4 million at September 30, 2004 from $617.7
million at December 31, 2003, reflecting growth of the commercial and consumer
loan portfolio, as further discussed below. Earning assets were 93.8% of total
assets at September 30, 2004 compared to 91.4% at December 31, 2003.
Interest-bearing overnight deposits in financial institutions were $522,000 at
September 30, 2004, compared to $625,000 at December 31, 2003. Overnight funds
are available to fund loan originations, liquidity management activities and
daily operations of the Bank.
Investment and mortgage-backed securities available for sale were $44.8 million
at September 30, 2004 and $61.8 million at December 31, 2003. The Bank's
strategy is to sell certain securities during favorable interest rate windows,
and securitize certain mortgage loans held for sale into mortgage-backed
securities in order to maintain its liquidity levels. The Bank sold no
securities during the three months and $2.5 million during the nine months ended
September 30, 2004, compared to $7.1 million and $10.1 million of securities
sold during the three and nine months ended September 30, 2003. The Bank
securitized no mortgage loans into mortgage-backed securities during both the
three months ended September 30, 2004 and 2003, compared to $2.8 million and
$9.0 million of mortgage loans securitized into mortgage-backed securities
during the nine months ended September 30, 2004 and 2003, respectively. The
total mortgage-backed securities portfolio was $10.0 million at September 30,
2004, compared to $11.7 million at December 31, 2003.
7
Loans held for sale declined to $5.8 million at September 30, 2004 from $10.9
million at December 31, 2003. The sale of loans held for sale declined to $9.5
million and $29.7 million during the three and nine months ended September 30,
2004, compared to $49.9 million and $128.9 million sold during the three and
nine months ended September 30, 2003, reflecting a slow down in origination and
refinancing volumes due to a nominal rise in interest rates.
Net loans and leases held for investment increased to $614.5 million at
September 30, 2004 from $542.3 million at December 31, 2003, reflecting a 17.8%
annualized net growth rate during the period. This growth reflects the Bank's
continued emphasis on structuring its loan portfolio as a commercial banking
entity.
Deposits increased to $616.0 million at September 30, 2004 from $583.2 million
at December 31, 2003, primarily reflecting the acquisition of two branch
offices. Checking accounts increased to $235.9 million at September 30, 2004
from $227.9 million at December 31, 2003, resulting from the Bank's efforts to
attract more lower costing core checking accounts. Time deposits increased to
$357.4 million at September 30, 2004 from $335.0 million at December 31, 2003.
FHLB advances and junior subordinated debentures used primarily to fund loan
originations and general banking operations were $28.0 million at September 30,
2004, compared to $26.0 million at December 31, 2003. Borrowings in the form of
repurchase agreements were $4.3 million at September 30, 2004 compared to $3.3
million at December 31, 2003. These borrowings represent funds held in cash
management accounts for commercial banking customers.
Stockholders' equity was $57.6 million at September 30, 2004, compared to $55.2
million at December 31, 2003. See "Consolidated Statements of Stockholders'
Equity" for additional information. At September 30, 2004, the Company's equity
to assets ratio was 8.1%, compared to 8.2% at December 31, 2003, primarily
reflecting the correlation of earnings growth generated by the growth in earning
assets as previously discussed.
Accumulated other comprehensive income declined to $1.0 million at September 30,
2004 from $2.3 million at December 31, 2003, reflecting the impact of the
securities sales and a nominal rise in interest rates, as previously discussed.
See "Note 8. Comprehensive Income" of "Notes to Consolidated Financial
Statements (Unaudited)" above for additional information.
As a North Carolina chartered commercial bank, the Bank must meet various
capital standards required by federal and state banking regulatory agencies. The
Bank's stand-alone capital was $66.2 million at September 30, 2004,
substantially in excess of all regulatory capital requirements. See "Liquidity
and Capital Resources" below for additional information.
On March 18, 2004 the Company declared a three-for-two stock split, in the form
of a 50% stock dividend, payable April 23, 2004 to stockholders of record as of
April 2, 2004. Stockholders received one additional share of common stock for
every two shares held on the record date. Certain current year and prior period
share and per share data has been adjusted to reflect the stock split.
On September 21, 2004, the Company declared a cash dividend of $0.17 per share,
payable October 22, 2004 to stockholders of record as of October 4, 2004,
adjusted for the stock split. This dividend payment represents a payout ratio of
35.4% of the basic earnings per share for the quarter ended September 30, 2004,
and is the Company's thirtieth consecutive quarterly cash dividend.
8
During the three and nine months ended September 30, 2004, the Company acquired
79 and 77,258 shares of its common stock, respectively, through open market and
private purchases pursuant to a stock repurchase plan adopted by the board of
directors. Shares acquired via the stock repurchase plan are held as treasury
stock, at cost. At September 30, 2004, treasury shares held were 1,751,322
totaling $29.8 million, compared to 2,355,513 shares totaling $39.3 million at
December 31, 2003. On April 23, 2004, the Company used 628,610 shares of
treasury shares to issue common stock for the stock split previously discussed.
During the three months ended September 30, 2004, 4,941 shares of common stock
were traded to exercise stock options, compared to none traded in 2003.
The Company believes the repurchase of its outstanding common stock will
decrease the potential dilutive effect caused by the exercise of stock options.
During the three and nine months ended September 30, 2004, 31,482 and 59,357
shares were issued as a result of the exercise of stock options, compared to
24,900 and 70,650 shares issued during the three and nine months ended September
30, 2003, adjusted to reflect the stock split.
COMPARISON OF OPERATING RESULTS - THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004
AND 2003
GENERAL. Net income for each of the three and nine month periods ended September
30, 2004 and 2003 was $3.0 million and $8.7 million, respectively. Basic
earnings per share was $0.48 and $1.39 per share for the three and nine months
ended September 30, 2004, compared to $0.48 and $1.40 per share for the three
and nine months ended September 30, 2003, adjusted for the stock split. Diluted
earnings per share were $0.46 and $1.32 for three and nine month periods ended
September 30, 2004 compared to $0.45 and $1.32 for three and nine month periods
ended September 30, 2003, adjusted for the stock split.
Core earnings during the three and nine months ended September 30, 2004 were
supported by sustained growth in net interest income, reflecting growth in both
the commercial and consumer loan and leases receivable portfolio, and in lower
costing core checking accounts. During the three and nine months ended September
30, 2004 the Company experienced much less dependence on gains from mortgage
loan sales, as compared to the three and nine months ended September 30, 2003,
which was an advantageous period for selling loans due to increased origination
and refinance volumes caused primarily by declining interest rates.
INTEREST INCOME. Interest income was $10.2 million and $29.3 million for the
three and nine months ended September 30, 2004, compared to $9.2 million and
$27.6 million for the three and nine months ended September 30, 2003. This
increase is due to the increase in the volume of average interest-earning assets
between the respective periods. Average interest-earning assets were $663.3
million and $648.3 million for the three and nine months ended September 30,
2004, compared to $601.9 million and $590.2 million for the three and nine
months ended September 30, 2003, reflecting the growth in loans and leases held
for investment as previously discussed. The yield on average interest-earning
assets was 6.1% and 6.0% for the three and nine months ended September 30, 2004,
compared to 6.1% and 6.2% for the three and nine months ended September 30,
2003, primarily impacted by an overall decrease in interest rates between the
respective periods.
INTEREST EXPENSE. Interest expense on deposits and borrowings was $2.5 million
and $7.0 million for the three and nine months ended September 30, 2004,
compared to $2.4 million and $7.9 million for the three and nine months ended
September 30, 2003, reflecting the impact of changing interest rates and the
change in the core deposit mix as previously discussed. Average deposits and
borrowings were $649.2 million and $635.5 million for the three and nine months
ended September 30, 2004, compared to $593.7 million and $580.7 million for the
three and nine months ended September 30, 2003. The effective cost of average
deposits and borrowings was 1.5% for both the three and nine months ended
September 30, 2004, compared to 1.6% and 1.8% for the three and nine months
ended September 30, 2003.
9
NET INTEREST INCOME. Net interest income was $7.4 million and $21.6 million for
the three and nine months ended September 30, 2004, compared to $6.4 million and
$18.9 million for the three and nine months ended September 30, 2003. The
interest rate spread (the difference between the effective yield on average
earning assets and the effective cost of average deposits and borrowings) was
4.6% for both the three and nine months ended September 30, 2004, compared to
4.5% and 4.4% for the three and nine months ended September 30, 2003. The net
yield on interest-earning assets (net interest income divided by average
interest-earning assets) was 4.6% for both the three and nine months ended
September 30, 2004, compared to 4.5% for both the three and nine months ended
September 30, 2003.
PROVISION FOR LOAN LOSSES. The Bank recorded $268,000 and $668,000 of provisions
for loan losses for the three and nine months ended September 30, 2004, compared
to $395,000 and $851,000 recorded in the three and nine months ended September
30, 2003. Provisions were necessary to support inherent losses and risk
associated with the growth in the Bank's loan portfolio. Provisions are charged
to current operations and the Bank believes the resulting reserve for loan
losses is adequate to absorb probable losses on loans that may become
uncollectible. Additions to the reserve for loan losses are based on a review
and classification of the loan portfolio and other factors, such as past
collection experience, changes in the nature and volume of the loan portfolio,
risk characteristics of individual loans or groups of similar loans and
underlying collateral, overall portfolio quality and current and prospective
economic conditions.
To support the risk associated with its loan portfolio, the Bank maintained
reserves for loan losses of $8.1 million at September 30, 2004, compared to $7.6
million at December 31, 2003. The ratio of reserves for loan losses to loans
outstanding, net of loans in process and deferred loan fees, was 1.3% at
September 30, 2004 compared to 1.4% at December 31, 2003. Non-performing assets
increased to $3.4 million at September 30, 2004 from $2.8 million at December
31, 2003, as total loans and leases increased significantly between the
respective periods as previously discussed. Based on the credit quality of the
loan and lease portfolio, the Bank believes the current level of its reserves
for loan losses is adequate. However, future additions to the reserve for loan
losses may be necessary based on changes in economic conditions and other
economic factors.
NONINTEREST INCOME. Noninterest income declined to $2.2 million and $6.7 million
for the three and nine months ended September 30, 2004, from $3.0 million and
$8.6 million for the three and nine months ended September 30, 2003. Noninterest
income consists of fees and service charges earned on loans, service charges on
deposit accounts, gains from sales of loans and mortgage-backed securities and
other miscellaneous income. Fees and service charges increased to $1.8 million
and $5.4 million for the three and nine months ended September 30, 2004, from
$1.7 million and $4.9 million for the three and nine months ended September 30,
2003. The increase in fees and service charges during the current periods is
attributable to a greater volume of loans and checking deposits as previously
discussed. The Bank recorded $148,000 and $393,000 of gains from sales of loans
during the three and nine months ended September 30, 2004, compared to $801,000
and $2.6 million during the three and nine months ended September 30, 2003,
reflecting the slow down in origination and refinancing volumes.
10
NONINTEREST EXPENSE. Noninterest expenses were $4.9 million and $14.5 million
for the three and nine months ended September 30, 2004, compared to $4.6 million
and $13.5 million for the three and nine months ended September 30, 2003. The
largest component of these expenses, compensation and fringe benefits, was $3.0
million and $8.8 million for the three and nine months ended September 30, 2004,
compared to $2.7 million and $7.9 million for the three and nine months ended
September 30, 2003. Fulltime equivalent employees were 246 at September 30, 2004
compared to 236 at December 31, 2003. This growth is due to additional personnel
resulting from opening two new de novo full-service branch offices, the
acquisition of two branch offices, and administrative staff required to support
the greater volume of loans and checking deposits as previously discussed. In
addition, during the nine months ended September 30, 2004 the Bank recorded an
expense of approximately $229,000 to eliminate a frozen defined benefit pension
plan unfunded liability.
Premises and equipment and data processing expenses have grown proportionately
with the growth in the number of customer accounts and transaction activity,
primarily attributable to both internal growth and the new offices opened. Other
noninterest expenses including premises and equipment, repairs, printing,
advertising, and office supplies have also grown proportionately with the growth
in earning assets, deposits and branch office locations.
INCOME TAXES. Income tax expense was $1.8 million and $5.1 million for the three
and nine months ended September 30, 2004, compared to $1.8 million and $5.2
million for the three and nine months ended September 30, 2003. The changes in
the amounts of income tax provisions reflect the changes in pretax income at the
estimated effective income tax rates in effect during the respective periods.
FORWARD LOOKING STATEMENTS. The Private Securities Litigation Reform Act of 1995
states that the disclosure of forward looking information is desirable for
investors and encourages such disclosure by providing a safe harbor for forward
looking statements by corporate management. This Form 10-Q, including
Management's Discussion and Analysis of Financial Condition and Results of
Operations, contains forward looking statements that involve risk and
uncertainty. In order to comply with the terms of the safe harbor, the Company
notes that a variety of risks and uncertainties could cause its actual results
and experience to differ materially from the anticipated results or other
expectations expressed in the Company's forward looking statements. There are
risks and uncertainties that may affect the operations, performance,
development, growth projections and results of the Company's business. They
include, but are not limited to, economic growth, interest rate movements,
timely development of technology enhancements for products, services and
operating systems, the impact of competitive products, services and pricing,
customer requirements, regulatory changes and similar matters. Readers of this
report are cautioned not to place undue reliance on forward looking statements
that are subject to influence by these risk factors and unanticipated events, as
actual results may differ materially from management's expectations.
LIQUIDITY AND CAPITAL RESOURCES. Liquidity generally refers to the Bank's
ability to generate adequate amounts of funds to meet its cash needs. Adequate
liquidity guarantees that sufficient funds are available to meet deposit
withdrawals, fund future loan commitments, maintain adequate reserve
requirements, pay operating expenses, provide funds for debt service, pay
dividends to stockholders, and meet other general commitments. The Bank must
maintain certain regulatory liquidity requirements of liquid assets to deposits
and short-term borrowings. At September 30, 2004, the Bank had cash, deposits in
banks, investment securities, mortgage-backed securities, FHLB stock and loans
held for sale totaling $75.2 million, compared to $109.8 million at December 31,
2003, representing 11.8% and 18.2% of deposits and short-term borrowings for the
respective periods.
11
The Bank believes it can meet future liquidity needs with existing funding
sources. The Bank's primary source of funds are deposits, payments on loans and
mortgage-backed securities, maturities of investment securities, earnings and
funds provided from operations, the ability to borrow from the FHLB of Atlanta
and the availability of loans held for sale. While scheduled repayments of loans
and mortgage-backed securities are relatively predictable sources of funds,
deposit flows and general market interest rates, economic conditions and
competition substantially influence loan prepayments. In addition, the Bank
manages its deposit pricing in order to maintain a desired deposit mix.
The FDIC requires the Bank to meet a minimum leverage capital requirement of
Tier I capital (consisting of retained earnings and common stockholder's equity,
less any intangible assets) to assets ratio of 4%. The FDIC also requires the
Bank to meet a ratio of total capital to risk-weighted assets of 8%, of which at
least 4% must be in the form of Tier I capital. The North Carolina Office of the
Commissioner of Banks requires the Bank at all times to maintain a capital
surplus of not less than 50% of common capital stock. The Bank was in compliance
with all regulatory capital requirements at September 30, 2004 and December 31,
2003.
CRITICAL ACCOUNTING POLICIES. The Company has identified the policies below as
critical to its business operations and the understanding of its results of
operations. The impact and any associated risks related to these policies on the
Company's business operations is discussed throughout Management's Discussion
and Analysis of Financial Condition and Results of Operations where such
policies affect reported and expected financial results.
USE OF ESTIMATES. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions. Estimates affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates.
LOAN IMPAIRMENT AND ALLOWANCE FOR LOAN LOSSES. A loan is considered
impaired, based on current information and events, if it is probable that the
Bank will be unable to collect the scheduled payments of principal or interest
when due according to the contractual terms of the loan agreement.
Uncollateralized loans are measured for impairment based on the present value of
expected future cash flows discounted at the historical effective interest rate,
while all collateral-dependent loans are measured for impairment based on the
fair value of the collateral.
The Bank uses several factors in determining if a loan is impaired. The internal
asset classification procedures include a thorough review of significant loans
and lending relationships and include the accumulation of related data. This
data includes loan payment status, borrowers' financial data and borrowers'
operating factors such as cash flows, operating income or loss, etc.
The allowance for loan losses is increased by charges to income and decreased by
charge-offs (net of recoveries). Management's periodic evaluation of the
adequacy of the allowance is based on the Bank's past loan loss experience,
known and inherent risks in the portfolio, adverse situations that may affect
the borrower's ability to repay, the estimated value of any underlying
collateral, and current economic conditions. While management believes that it
has established the allowance in accordance with accounting principles generally
accepted in the United States of America and has taken into account the views of
its regulators and the current economic environment, there can be no assurance
that in the future the Bank's regulators or risks in its portfolio will not
require adjustments to the allowance.
12
INCOME TAXES. Deferred tax asset and liability balances are determined by
application to temporary differences of the tax rate expected to be in effect
when taxes will become payable or receivable. Temporary differences are
differences between the tax basis of assets and liabilities and their reported
amounts in the financial statements that will result in taxable or deductible
amounts in future years. The effect on deferred taxes of a change in tax rates
is recognized in income in the period that includes the enactment date.
OFF-BALANCE SHEET ARRANGEMENTS. The Company is a party to financial
instruments with off-balance sheet risk in the normal course of business to meet
the financing needs of its customers and to reduce its own exposure to
fluctuations in interest rates. These financial instruments include commitments
to extend credit and involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheet.
The Company's exposure to credit loss in the event of non-performance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual amount of those instruments. The Company uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance sheet instruments.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the possible chance of loss from unfavorable changes in market
prices and rates. These changes may result in a reduction of current and future
period net interest income, which is the favorable spread earned from the excess
of interest income on interest-earning assets over interest expense on
interest-bearing liabilities.
The Company considers interest rate risk to be its most significant market risk,
which could potentially have the greatest impact on operating earnings. The
structure of the Company's loan and deposit portfolios is such that a
significant decline in interest rates may have a negative impact on net market
values and net interest income. The Company monitors whether material changes in
market risk have occurred since December 31, 2003. The Company does not believe
that any material adverse changes in market risk exposures occurred since
December 31, 2003.
The current period earnings growth reflects the Company's success in increasing
its net interest income during an environment of declining interest rates. The
Company has made significant progress in restructuring its loan portfolio, in
attracting lower costing core checking accounts and repricing higher costing
certificates of deposit at lower rates, collectively allowing the Company to
maintain more consistent net interest income.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management of the Company
carried out an evaluation, under the supervision and with the participation of
the Company's principal executive officer and principal financial officer, of
the effectiveness of the Company's disclosure controls and procedures. Based on
this evaluation, the Company's principal executive officer and principal
financial officer concluded that the Company's disclosure controls and
procedures are effective in ensuring that information required to be disclosed
by the Company in reports that it files or submits under the Securities Exchange
Act of 1934, as amended, is recorded, processed, summarized and reported, within
the time periods specified in the Securities and Exchange Commission's rules and
forms. It should be noted that the design of the Company's disclosure controls
and procedures is based in part upon certain reasonable assumptions about the
likelihood of future events, and there can be no reasonable assurance that any
design of disclosure controls and procedures will succeed in achieving its
stated goals under all potential future conditions, regardless of how remote,
but the Company's principal executive and financial officers have concluded that
the Company's disclosure controls and procedures are, in fact, effective at a
reasonable assurance level.
13
In addition, there have been no changes in the Company's internal control over
financial reporting (to the extent that elements of internal control over
financial reporting are subsumed within disclosure controls and procedures)
identified in connection with the evaluation described in the above paragraph
that occurred during the Company's last fiscal quarter, that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II. OTHER INFORMATION
ITEM L. LEGAL PROCEEDINGS
The Company is currently not engaged in any material legal proceedings. From
time to time, the Bank is a party to legal proceedings within the ordinary
course of business wherein it enforces its security interest in loans, and other
matters of similar nature.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table sets forth information regarding the Company's repurchases
of its Common Stock during the quarter ended September 30, 2004.
TOTAL NUMBER
OF SHARES
PURCHASED MAXIMUM
AS PART OF NUMBER OF SHARES
TOTAL PUBLICLY THAT MAY YET BE
NUMBER OF AVERAGE ANNOUNCED PURCHASED UNDER
SHARES PRICE PAID PLANS OR THE PLANS OR
PERIOD PURCHASED PER SHARE PROGRAMS (1) PROGRAMS (1)
------ --------- --------- ------------ ----------------
July 2004
Beginning date: July 1 0 0 0 72,821
Ending date: July 31
August 2004
Beginning date: August 1 79 $24.23 79 72,742
Ending date: May 31
September 2004
Beginning date: September 1 0 ~~ 0 72,742
Ending date: September 30
- ----------
(1) Shares were purchased pursuant to a stock repurchase program
announced on January 8, 2004. This repurchase program will expire on
January 8, 2005. Subsequent to announcing the stock repurchase
program, on April 23, 2004 the Company paid a three-for-two stock
split. The maximum number of shares that may yet be purchased under
the plans or programs has been adjusted for the effect of the
three-for-two stock split.
14
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
a) Exhibits
The following exhibits are filed herewith:
Exhibit
Number Title
------- -----
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32 Section 1350 Certification
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.
FIRST SOUTH BANCORP, INC.
/s/ William L. Wall /s/ Kristie W. Hawkins
--------------------------------- ----------------------
William L. Wall Kristie W. Hawkins
Executive Vice President Controller
Chief Financial Officer Treasurer
(Principal Financial Officer) (Principal Accounting Officer)
Date: November 5, 2004 Date: November 5, 2004
15