UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
[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
[_] 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: 000-21383
APPALACHIAN BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Georgia 58-2242407
---------------------- ------------------------------
(State of Incorporation) (IRS Employer Identification No.)
829 Industrial Boulevard
Ellijay, Georgia 30540
(Address of principal executive office)
(706) 276-8000
(Issuer's telephone number, including area code)
No Change (Former name, former address and former fiscal
year, if changed since last report)
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 past 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act - Rule 12b-2).
Yes No X
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $0.01 par value Outstanding at March 31, 2004; 3,697,359 Shares
Form 10-Q
APPALACHIAN BANCSHARES, INC.
March 31, 2004
TABLE OF CONTENTS
Page No.
Part I. Financial Information --------
Item 1.Financial Statements (Unaudited)
Consolidated Statements of Financial Condition at March 31, 2004
and December 31, 2003..................................................................... 1
Consolidated Statements of Income For the Three Months Ended March 31,
2004 and 2003............................................................................. 2
Consolidated Statements of Comprehensive Income For the Three Months
Ended March 31, 2004 and 2003............................................................. 3
Consolidated Statements of Cash Flows For the Three Months Ended
March 31, 2004 and 2003................................................................... 4
Notes to Consolidated Financial Statements.................................................. 5
Item 2.Management's Discussion and Analysis of Financial Condition and
Results of Operation...................................................................... 10
Item 3.Quantitative and Qualitative Disclosures about Market Risk.................................. 17
Item 4.Controls and Procedures..................................................................... 20
Part II. Other Information
Item 2.Changes in Securities, Use of Proceeds and Purchases of Equity Securities................... 21
Item 6.Exhibits and Reports on Form 8-K............................................................ 21
Signatures........................................................................................... 22
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, 2004 (Unaudited) and December 31, 2003
March 31,
2004 December 31,
(Unaudited) 2003
--------------- ----------------
Assets
Cash and due from banks...................................................... $ 13,702,767 $ 6,530,984
Interest bearing deposits with other banks................................... 100,925 273,841
Federal funds sold........................................................... 152,000 586,000
--------------- ----------------
Cash and Cash Equivalents............................................. 13,955,692 7,390,825
Securities available for sale................................................ 56,688,343 55,363,327
Loans........................................................................ 343,906,541 332,306,446
Allowance for loan losses.................................................... (3,915,628) (3,609,794)
--------------- ----------------
Net Loans............................................................. 339,990,913 328,696,652
Premises and equipment, net.................................................. 10,199,703 9,161,652
Accrued interest............................................................. 2,425,761 2,289,994
Cash surrender value on life insurance....................................... 2,619,709 2,592,416
Intangibles, net............................................................. 2,142,058 2,157,433
Other assets................................................................. 1,756,632 1,965,179
--------------- ----------------
Total Assets.......................................................... $ 429,778,811 $ 409,617,478
=============== ================
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Noninterest-bearing..................................................... $ 28,680,831 $ 23,795,787
Interest-bearing........................................................ 326,798,474 309,123,161
--------------- ----------------
Total Deposits........................................................ 355,479,305 332,918,948
Short-term borrowings..................................................... 3,682,099 7,085,992
Accrued interest.......................................................... 577,771 670,614
Long-term debt............................................................ 30,042,858 30,692,858
Subordinated long-term capital notes...................................... 6,186,000 6,186,000
Other liabilities......................................................... 1,053,347 980,713
--------------- ----------------
Total Liabilities..................................................... 397,021,380 378,535,125
--------------- ----------------
Shareholders' Equity
Preferred stock, 20,000,000 shares authorized, none issued................ -- --
Common stock, par value $0.01 per share, 20,000,000 shares
authorized, 3,773,332 shares issued at March 31, 2004,
and 3,734,686 shares issued at December 31, 2003........................ 37,733 37,347
Paid-in capital........................................................... 22,999,212 22,727,208
Retained earnings......................................................... 9,484,613 8,588,160
Accumulated other comprehensive income: net unrealized
holding gains on securities available-for-sale, net of
deferred income tax..................................................... 935,669 429,434
Treasury stock, at cost (75,973 shares at March 31,
2004 and at December 31, 2003).......................................... (699,796) (699,796)
--------------- ----------------
Total Shareholders' Equity............................................ 32,757,431 31,082,353
--------------- ----------------
Total Liabilities and Shareholders' Equity............................ $ 429,778,811 $ 409,617,478
=============== ================
See notes to consolidated financial statements
1
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended March 31, 2004 and 2003
(Unaudited)
Three Months Ended
March 31,
---------------------------------
2004 2003
--------------- ----------------
Interest Income
Interest and fees on loans................................................ $ 5,505,051 $ 5,200,349
Interest on investment securities:
Taxable securities...................................................... 354,435 307,406
Nontaxable securities................................................... 162,390 179,417
Interest on deposit in other banks........................................ 395 24,163
Interest on federal funds sold............................................ 3,390 16,144
--------------- ----------------
Total Interest Income................................................. 6,025,661 5,727,479
Interest Expense
Interest on deposits...................................................... 1,452,603 2,034,884
Interest on federal funds purchased and securities sold under
agreements to repurchase................................................ 16,768 24,903
Interest expense on long-term debt........................................ 206,123 355,955
Interest on subordinated debentures....................................... 63,900 --
--------------- ----------------
Total Interest Expense................................................ 1,739,394 2,415,742
Net Interest Income.......................................................... 4,286,267 3,311,737
Provision for loan losses.................................................... 360,000 360,000
--------------- ----------------
Net Interest Income After Provision for Loan Losses.......................... 3,926,267 2,951,737
Noninterest Income
Customer service fees..................................................... 283,218 188,107
Insurance commissions..................................................... 8,965 40,993
Mortgage origination fees................................................. 220,369 290,299
Other operating income.................................................... 162,837 119,124
Investment securities (losses)............................................ -- (16,978)
--------------- -----------------
Total Noninterest Income.............................................. 675,389 621,545
Noninterest Expenses
Salaries and employee benefits............................................ 1,567,020 1,293,693
Occupancy expense......................................................... 177,643 156,275
Furniture and equipment expense........................................... 265,875 250,596
Other operating expenses.................................................. 1,267,965 990,083
--------------- ----------------
Total Noninterest Expenses............................................ 3,278,503 2,690,647
Income before income taxes................................................... 1,323,153 882,635
Income tax expense........................................................... 426,700 256,000
--------------- ----------------
Net Income................................................................... $ 896,453 $ 626,635
=============== ================
Earnings Per Common Share
Basic..................................................................... $ 0.24 $ 0.18
Diluted................................................................... 0.23 0.17
Cash Dividends Declared
Per Common Share.......................................................... $ 0.00 $ 0.00
Weighted Average Shares Outstanding
Basic..................................................................... 3,689,545 3,484,964
Diluted................................................................... 3,862,309 3,659,692
See notes to consolidated financial statements
2
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Months Ended March 31, 2004 and 2003
(Unaudited)
Three Months Ended
March 31,
---------------------------------
2004 2003
--------------- ----------------
Net Income................................................................... $ 896,453 $ 626,635
Other comprehensive income, net of tax: Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period............. 767,022 (218,970)
Reclassification adjustments for (gains) losses included in net income.. -- 16,978
--------------- ----------------
Net unrealized gains (losses)........................................... 767,022 (201,992)
Income tax expense related to items of other comprehensive income......... (260,787) 68,678
---------------- ----------------
Other comprehensive income (loss)............................................ 506,235 (133,314)
--------------- ----------------
Comprehensive Income......................................................... $ 1,402,688 $ 493,321
=============== ================
See notes to consolidated financial statements
3
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2004 and 2003
(Unaudited)
Three Months Ended
March 31,
---------------------------------
2004 2003
--------------- ----------------
Operating Activities
Net income................................................................ $ 896,453 $ 626,635
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan losses............................................... 360,000 360,000
Net depreciation and amortization....................................... 245,938 215,473
Realized investment security losses..................................... -- 16,978
Loss on disposition of other real estate................................ 56,479 --
(Increase) decrease in accrued interest receivable...................... (135,767) 116,282
Increase in cash surrender value of life insurance...................... (27,293) (30,289)
Decrease in accrued interest payable.................................... (92,843) (157,205)
Other, net.............................................................. (831,058) (7,716)
--------------- ----------------
Net Cash Provided by Operating Activities............................. 471,909 1,140,158
--------------- ----------------
Investing Activities
Purchase of securities available for sale, net............................ (598,203) (3,084,974)
Net increase in loans to customers........................................ (11,342,915) (6,456,957)
Capital expenditures, net................................................. (1,230,018) (205,671)
Proceeds from the disposition of foreclosed real estate................... 485,240 275,000
--------------- ----------------
Net Cash Used in Investing Activities................................. (12,685,896) (9,472,602)
--------------- ----------------
Financing Activities
Net increase in demand deposits, NOW accounts,
and savings accounts.................................................... 17,717,557 4,074,469
Net increase (decrease) in certificates of deposit........................ 4,842,800 (4,072,910)
Net increase (decrease) in short-term borrowings.......................... (3,403,893) 2,282,645
Proceeds from long-term debt.............................................. -- 6,000,000
Repayment of long-term debt............................................... (650,000) (2,649,999)
Proceeds from issuance of common stock.................................... 265,017 140,800
Proceeds from sale of treasury stock...................................... -- 1,251,030
Compensation associated with issuance of stock options.................... 7,373 --
--------------- ----------------
Net Cash Provided by Financing Activities.................................... 18,778,854 7,026,035
--------------- ----------------
Net Increase (Decrease) in Cash and Cash Equivalents......................... 6,564,867 (1,306,409)
Cash and Cash Equivalents at Beginning of Period............................. 7,390,825 30,856,697
--------------- ----------------
Cash and Cash Equivalents at End of Period................................... $ 13,955,692 $ 29,550,288
=============== ================
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for:
Interest................................................................ $ 1,832,237 $ 2,572,947
Income taxes............................................................ -- --
See notes to consolidated financial statements
4
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
March 31, 2004
Note A - Basis of Presentation
The consolidated financial statements include the accounts of Appalachian
Bancshares, Inc. (the "Company") (a Georgia corporation) and its wholly owned
subsidiaries, Appalachian Community Bank (the "Bank") and Appalachian
Information Management, Inc. ("AIM"). The Bank provides a full range of banking
services to individual and corporate customers in North Georgia and the
surrounding areas. AIM, a wholly owned subsidiary of the Bank, previously
provided in-house data services to the Bank and offered data processing services
to other institutions. In August 2002, management decided to discontinue
operations of AIM, which ceased operations on November 12, 2002. Accordingly,
the Bank entered into a data processing agreement with Fiserv Solutions, Inc.,
whereby the Bank outsourced those data services previously provided in-house by
AIM. Although AIM has ceased operations, the Bank continues to provide limited,
administrative services, formerly provided by AIM, to another bank on a
subcontract basis. The discontinuance of AIM's operations did not have a
material effect on the Company's operations or financial condition.
All significant intercompany transactions and balances have been eliminated
in consolidation. Unless otherwise indicated herein, the financial results of
the Company refer to the Company and the Bank on a consolidated basis. The
accompanying unaudited consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles 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.
The consolidated statement of financial condition at December 31, 2003, has
been derived from the audited consolidated financial statements at that date,
but does not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements.
For further information, refer to the Company's consolidated financial
statements for the year ended December 31, 2003, and footnotes thereto, included
in the Company's Form 10-K, filed with the Securities and Exchange Commission on
March 30, 2004.
Note B - Critical Accounting Policies
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 that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
5
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
March 31, 2004
The determination of the adequacy of the allowance for loan losses is based
on estimates that are particularly susceptible to significant changes in the
economic environment and market conditions. In connection with the determination
of the estimated losses on loans, management obtains independent appraisals for
significant collateral. While management uses available information to recognize
losses on loans, further reductions in the carrying amounts of loans may be
necessary based on changes in local economic conditions. In addition, regulatory
agencies, as an integral part of their examination process, periodically review
the estimated losses on loans. Such agencies may require the Bank to recognize
additional losses based on their judgments about information available to them
at the time of their examination. Because of these factors, it is reasonably
possible that the estimated losses on loans may change materially in the near
term. However, the amount of the change that is reasonably possible cannot be
estimated.
Note C - Income Taxes
The effective tax rates of approximately 32.2 percent and 29.0 percent for
the three months ended March 31, 2004 and 2003, respectively, are less than the
applicable statutory rate due primarily to the effects of tax-exempt income and
general business credits.
Note D - Investment Securities
The Company applies the accounting and reporting requirements of Statement
of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain
Investments in Debt and Equity Securities. This pronouncement requires that all
investments in debt securities be classified as either "held-to-maturity"
securities, which are reported at amortized cost; "trading" securities, which
are reported at fair value, with unrealized gains and losses included in
earnings; or "available-for-sale" securities, which are reported at fair value,
with unrealized gains and losses excluded from earnings and reported in a
separate component of shareholders' equity (net of deferred tax effect).
At March 31, 2004, the Company had net unrealized gains of $1,417,679 in
available-for-sale securities, which are reflected in the presented assets and
resulted in an increase in shareholders' equity of $935,669, net of deferred tax
benefit. There were no trading securities. The net increase in shareholders'
equity, as a result of the SFAS No. 115 adjustment from December 31, 2003 to
March 31, 2004, was $506,235.
Note E - Segment Information
All of the Company's offices offer similar products and services, are
located in the same geographic region, and serve the same customer segments of
the market. As a result, management considers all units as one operating segment
and therefore feels that the basic financial statements and related footnotes
provide details related to segment reporting.
6
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
March 31, 2004
Note F - Intangibles
Amortizable intangible assets and acquired goodwill as of March 31, 2004,
and December 31, 2003, are detailed as follows:
Amortizable Intangibles
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
--------------- ------------- -------------------
As of March 31, 2004:
Noncompete agreements.................................... $ 165,000 $ 165,000 $ --
Debt issuance costs...................................... 170,000 19,833 150,167
--------------- --------------- ----------------
Total.................................................... $ 335,000 $ 184,833 $ 150,167
=============== =============== ================
As of December 31, 2003:
Noncompete agreements.................................... $ 165,000 $ 158,125 $ 6,875
Debt issuance costs...................................... 170,000 11,333 158,667
--------------- --------------- ----------------
Total.................................................... $ 335,000 $ 169,458 $ 165,542
=============== =============== ================
Aggregate amortization expense for amortizable intangible assets for the
three months ended March 31, 2004 and the year ended December 31, 2003 was
$15,375 and $93,831, respectively. Aggregate annual amortization expense
estimated for the years ending December 31, 2004 and 2005 is $40,875 and
$34,000, respectively.
Acquired Goodwill
March 31, December 31,
2004 2003
--------------- ----------------
Goodwill from bank acquisition.............................................. $ 1,991,891 $ 1,991,891
=============== ================
Note G - Stock Based Compensation
The Company has long-term incentive stock option plans and an employee
stock purchase plan. Effective January 1, 2003, the Company adopted the fair
value recognition provisions of Statement of Financial Accounting Standards
("SFAS") No. 123, Accounting for Stock-Based Compensation, as provided by SFAS
No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure.
SFAS No. 148 allows for a prospective method of adoption of SFAS No. 123,
whereby the Company can prospectively account for the current expense of options
granted during 2003 and thereafter. Results of prior years have not been
restated. The difference between the compensation cost as reported and the
7
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
March 31, 2004
cost that would have been reported if SFAS No. 123 were applied to all options
was immaterial for the quarters ended March 31, 2004 and 2003.
The Company has adopted its 1997 Employee Stock Incentive Plan and its 1997
Directors' Non-qualified Stock Option Plan under which it has granted statutory
and nonstatutory stock options to certain directors and employees. The options
granted provide for these directors and employees to purchase shares of the
Company's common stock at the market value at the dates of grant. The options
granted may be exercised within ten years from the dates of grant subject to
vesting requirements. On April 1, 2003, the Company approved and adopted the
2003 Stock Option Plan, under which it has granted no options.
The Company has issued incentive stock options to certain key employees, of
which options to purchase 130,200 shares of the Company's common stock are
outstanding at March 31, 2004, at exercise prices ranging from $3.64 to $15.00
(the fair market values on the grant dates, adjusted for subsequent stock splits
and stock dividends). These options vest over a five-year period at 20% on each
of the first five anniversaries of the grant date and expire ten years from the
grant date.
The Company has also issued nonqualified stock options, primarily to
directors of the Company, of which 275,240 are outstanding at March 31, 2004, at
exercise prices ranging from $3.64 to $5.45 (the fair market value on the grant
dates, adjusted for subsequent stock splits and stock dividends). These options
vest over a five-year period at 20% on each of the first five anniversaries of
the grant date and expire ten years from the grant date.
Note H - Commitments and Contingencies
In the normal course of business, the Company offers a variety of financial
products to its customers to aid them in meeting their requirements for
liquidity, credit enhancement, and interest rate protection. Generally accepted
accounting principles recognize these transactions as contingent liabilities
and, accordingly, they are not reflected in the accompanying financial
statements. Commitments to extend credit, credit card arrangements, commercial
letters of credit, and standby letters of credit all include exposure to some
credit loss in the event of nonperformance of the customer. The Company's credit
policies and procedures for credit commitments and financial guarantees are the
same as those for extension of credit that are recorded on the statement of
financial condition. Because these instruments have fixed maturity dates, and
because many of them expire without being drawn upon, they do not generally
present any significant liquidity risk to the Company. Management conducts
regular reviews of these instruments on an individual customer basis, and the
results are considered in assessing the adequacy of the Company's allowance for
loan losses. Management does not anticipate any material losses as a result of
these commitments.
Following is a discussion of these commitments:
Standby Letters of Credit: These agreements are used by the Company's
customers as a means of improving their credit standings in their dealings with
others. Under these agreements, the Company agrees to honor certain financial
commitments in the event that its customers are unable to do so. The amount of
credit risk involved in issuing letters of credit in the event of nonperformance
by the other
8
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
March 31, 2004
party is the contract amount. As of March 31, 2004 and December 31, 2003, the
Company has issued standby letters of credit of approximately $1,355,000 and
$1,111,000, respectively. The Company records a liability for the estimated fair
value of these standby letters of credit based on the fees charged for these
arrangements.
Loan Commitments: As of March 31, 2004, and December 31, 2003, the Company
had commitments outstanding to extend credit totaling approximately $53,292,000
and $43,436,000, respectively. These commitments generally require the customers
to maintain certain credit standards. Management does not anticipate any
material losses as a result of these commitments.
Litigation: The Company is party to litigation and claims arising in the
normal course of business. Management, after consultation with legal counsel,
believes that the liabilities, if any, arising from such litigation and claims
are not material to the financial statements.
Note I - Subsequent Events
On April 7, 2004, the Company paid approximately $750,000 for additional
property to be used for future expansion. This site consists of a building on
approximately 6.3 acres of land directly across from the main office of the
Company.
Note J - Subordinated Long-term Capital Notes
On August 28, 2003, Appalachian Capital Trust I ("the Trust"), a Delaware
statutory trust established by the Company, received $6,000,000 principal amount
of the Trust's floating-rate, cumulative, trust-preferred securities (the "Trust
Preferred Securities") in a private placement of the Trust Preferred Securities.
The proceeds of that transaction were then used by the Trust to purchase an
equal amount of floating rate-subordinated debentures (the "Subordinated
Debentures") of the Company. The Company has fully and unconditionally
guaranteed all obligations of the Trust, on a subordinated basis, with respect
to the Trust Preferred Securities. In accordance with the provisions of
Financial Interpretation No. 46, the Company accounts for the Trust Preferred
Securities as a long-term debt liability to the Trust in the amount of
$6,186,000. Subject to certain limitations, the proceeds of the Trust Preferred
Securities qualify as additional Tier 1 capital for the Company.
The sole asset of the Trust is the Subordinated Debentures issued by the
Company. Both the Trust Preferred Securities and the Subordinated Debentures
have approximately 30-year lives. However, both the Company and the Trust have
options to call their respective securities after five years, subject to
regulatory capital requirements.
9
APPALACHIAN BANCSHARES, INC.
March 31, 2004
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
Certain of the statements made in this Report and in documents incorporated
by reference herein, as well as oral statements made by the Company or its
officers, directors or employees, may constitute forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). Such forward-looking statements are based on
management's beliefs, current expectations, estimates and projections about the
financial services industry, the economy and about the Company and the Bank. The
words "expect," "anticipate," "intend," "plan," "believe," "seek," "estimate"
and similar expressions are intended to identify such forward-looking
statements. Such forward-looking statements are not guarantees of future
performance and are subject to risks, uncertainties and other factors that may
cause the actual results, performance or achievements of the Company to differ
materially from historical results or from any results expressed or implied by
such forward-looking statements. Such factors include, without limitation, (i)
increased competition with other financial institutions, (ii) lack of sustained
growth in the economy in Gilmer, Fannin and Union Counties, (iii) rapid
fluctuations in interest rates, (iv) the inability of the Bank to maintain
regulatory capital standards, and (v) changes in the legislative and regulatory
environment. Many of these factors are beyond the Company's ability to control
or predict, and readers are cautioned not to put undue reliance on such
forward-looking statements. The Company disclaims any obligation to update or
revise any forward-looking statements contained in this Report, whether as a
result of new information, future events or otherwise.
This discussion is intended to assist in an understanding of the Company's
financial condition and results of operations. This analysis should be read in
conjunction with the financial statements and related notes appearing in Item 1
of this Report on Form 10-Q and Management's Discussion and Analysis of
Financial Condition and Results of Operations for the year ended December 31,
2003, appearing in the Company's Form 10-K filed with the Securities and
Exchange Commission on March 30, 2004.
The Company's operations are conducted through the Bank. Management
continuously monitors the financial condition of the Bank in order to protect
depositors, increase retained earnings and protect current and future earnings.
Significant items affecting the Company's financial condition and results of
operations are discussed in detail below.
FINANCIAL CONDITION
March 31, 2004 compared to December 31, 2003
Loans
Loans comprised the largest single category of the Company's earning assets
at March 31, 2004. Loans, net of unearned income and allowance for loan losses,
were 79.1% of total assets at March 31, 2004. Total net loans were $339,990,913
at March 31, 2003, representing a 3.4% increase from $328,696,652 at December
31, 2003. Loan demand in the local markets has increased due to the current
interest rate environment.
10
APPALACHIAN BANCSHARES, INC.
March 31, 2004
Investment Securities and Other Earning Assets
Investment securities at March 31, 2004 were $56,688,343 compared with
$55,363,327 at December 31, 2003, reflecting a 2.4% increase of $1,325,016.
Federal funds sold were $152,000 at March 31, 2004, compared to the December 31,
2003 total of $586,000, a 74.1% decrease. The investment securities portfolio is
used to make various term investments, to provide a source of liquidity and to
serve as collateral to secure certain government deposits. The Bank's federal
funds sold are used as a tool in managing the daily cash needs of the Bank. The
decrease in the federal funds sold is due to management's close monitoring of
the funding position of the bank. The funds were used to purchase investment
securities.
Asset Quality
Asset quality is measured by three key ratios. The ratio of the allowance
for loan losses to total nonperforming assets (defined as nonaccrual loans,
loans past due 90 days or greater, restructured loans, nonaccruing securities,
and other real estate) increased from 1.51% at December 31, 2003 to 2.14% at
March 31, 2004. Total non-performing assets at March 31, 2004, were $1,832,360,
which consisted of $114,700 in consumer loans, $697,710 in loans secured by real
estate, 17,250 in other loans and $1,002,700 of foreclosed real estate.
Nonperforming assets at December 31, 2003 were approximately $2.4 million. The
ratio of total nonperforming assets to total assets decreased from 0.58% at
December 31, 2003 to 0.43% at March 31, 2004, and the ratio of nonperforming
loans to total loans decreased from 0.50% at December 31, 2003 to 0.24% at March
31, 2004. The decrease in nonperforming assets is due to management's close
monitoring of the loan portfolio and active management of past due loans.
Management is closely monitoring the loan portfolio to identify any potential
loan quality issues.
Deposits
Total deposits at March 31, 2004 were $355,479,305, an increase of
$22,560,357 over total deposits of $332,918,948 at year-end 2003. Deposits are
the Company's primary source of funds with which to support its earning assets.
Noninterest-bearing deposits increased $4,885,044, or 20.5%, from year-end 2003
to $28,680,831 at March 31, 2004, and interest-bearing deposits increased
$17,675,313, or 5.7%, during the same period to $326,798,474. Over the past 12
months, the Company has focused on increasing its core deposit base and during
the first quarter of 2004 the Company recognized the benefits of developing
these relationships. The increase in the interest-bearing deposit base is
related to the supplementation of the Company's funding with the use of brokered
and national CDs.
Short-term Borrowings
Short-term borrowings at March 31, 2004 and December 31, 2003 consist of the
following:
March 31, December 31,
2004 2003
--------------- ----------------
Federal funds purchased..................................................... $ 1,133,000 $ 3,000,000
Securities sold under agreements to repurchase.............................. 2,549,099 4,085,992
--------------- ----------------
$ 3,682,099 $ 7,085,992
=============== ================
11
APPALACHIAN BANCSHARES, INC.
March 31, 2004
Securities sold under agreements to repurchase totaled $2,549,099 at March
31, 2004, a $1,536,893 decrease from the December 31, 2003 total of $4,085,992.
The total of securities sold under agreements to repurchase is associated with
the cash flow needs of the Bank's corporate customers that participate in
repurchase agreements.
The outstanding balance of federal funds purchased at March 31, 2004
decreased by $1,867,000 from December 31, 2003.
Shareholders' Equity
Shareholders' equity increased $1,675,078, from $31,082,353 at December 31,
2003 to $32,757,431 at March 31, 2004. This increase was mainly attributable to
net earnings of $896,453, an increase of $506,235 in the unrealized gain on AFS
securities, and proceeds from the issuance of stock of $265,018.
Liquidity Management
Liquidity is defined as the ability of a company to convert assets into
cash or cash equivalents without significant loss. Liquidity management involves
maintaining the Bank's ability to meet the day-to-day cash flow requirements of
its customers, whether they are depositors wishing to withdraw funds or
borrowers requiring funds to meet their credit needs. Without proper liquidity
management, the Bank would not be able to perform its primary function as a
financial intermediary and would, therefore, not be able to meet the production
and growth needs of the communities it serves.
The objective of assets and liabilities management is not only to assure
adequate liquidity in order for the Bank to meet the needs of its customer base,
but also to maintain an appropriate balance between interest-sensitive assets
and interest-sensitive liabilities, so that the Bank can meet the investment
objectives of the Company's shareholders. Daily monitoring of the sources and
uses of funds is necessary to maintain an acceptable cash position that meets
both requirements. In the banking environment, both assets and liabilities are
considered sources of liquidity funding and both are, therefore, monitored on a
daily basis.
The asset portion of the balance sheet provides liquidity primarily through
loan principal repayments or sales of investment and trading account securities.
Loans that mature in one year or less equaled approximately $224.8 million, or
65.4%, of the total loan portfolio at March 31, 2004, and investment securities
maturing in one year or less equaled approximately $10.4 million or 18.4% of the
portfolio. Other sources of liquidity include short-term investments such as
federal funds sold.
The liability portion of the balance sheet provides liquidity through
various customers' interest-bearing and noninterest-bearing deposit accounts. At
March 31, 2004, funds were also available through the purchase of federal funds
from correspondent commercial banks from available lines of up to an aggregate
of $21 million. Liquidity management involves the daily monitoring of the
sources and uses of funds to maintain an acceptable cash position. At March 31,
2004, the outstanding balance of the Bank's federal funds purchased was
$1,133,000.
In an effort to maintain and improve the liquidity position of the Bank,
management applied for, and obtained, membership with the Federal Home Loan Bank
of Atlanta. As a member of the Federal Home Loan Bank, the Bank is able to
improve its ability to manage liquidity and reduce interest rate risk
12
APPALACHIAN BANCSHARES, INC.
March 31, 2004
by having a funding source to match longer term loans. The Bank's credit line
stands at approximately $61,360,000 as of March 31, 2004. This line is subject
to collateral availability. At March 31, 2004, the outstanding balance of the
Bank's credit line was $30,042,858.
Capital Resources
A strong capital position is vital to the continued profitability of the
Company, because it promotes depositor and investor confidence and provides a
solid foundation for future growth of the organization.
Trust Preferred Securities. The Company received approval from the Federal
Reserve to issue trust-preferred securities. The Company issued $6 million in
floating rate securities on August 28, 2003. The issuance of the trust-preferred
securities (the "Trust-Preferred Securities") made the Company "well
capitalized" according to regulatory capital guidelines. Certain of the details
related to the Trust-Preferred Securities discussed in "Note J - Guaranteed
Preferred Beneficial Interest in the Company's Subordinated Debentures" under
"Notes to Consolidated Financial Statements," included under Item 1 of Part I of
this Quarterly Report on Form 10-Q and under "Item 2 Changes in Securities and
Use of Proceeds", in Part II hereof. The Trust Preferred Securities have a
maturity date of August 28, 2033, with quarterly interest payable on the 8th day
of each February, May, August and November, at the rate of 3% over the
three-month London Interbank Offered Rate, as reported at the end of the
preceding calendar quarter. The Company, in addition to the repayment, on
September 9, 2003, of its correspondent-bank credit lines, in the amount of
$4,009,634, also, on September 29, 2003, contributed $500,000 of the proceeds of
the issuance of the Trust-Preferred Securities to the capital of the Bank,
retaining the remaining balance thereof, in the amount of $1,490,366, for
operating expenses and as a future source of capital for the Bank.
Capital Standards. Regulatory authorities are placing increased emphasis on
the maintenance of adequate capital. The Company and the Bank are subject to
guidelines mandating minimum risk-based capital requirements. The guidelines
take into consideration risk factors associated with various categories of
assets, both on and off the balance sheet. Under the guidelines, capital
strength is measured in two tiers, which are used in conjunction with
risk-adjusted assets to determine the risk-based capital ratios. The Company's
Tier 1 capital, which consists of common equity, paid-in capital, proceeds of
the Trust Preferred Securities and retained earnings (less intangible assets),
amounted to $36 million at March 31, 2004. Tier 2 capital components include
supplemental capital components such as qualifying allowance for loan losses and
qualifying subordinated debt. Tier 1 capital plus the Tier 2 capital components
is referred to as Total Capital and was $39.9 million at March 31, 2004. The
Company's percentage ratios as calculated under regulatory guidelines for
risk-weighted assets were 10.5% and 11.6% for Tier 1 Capital and Total Capital,
respectively, at March 31, 2004, exceeding the minimum ratios of 4.0% and 8.0%,
respectively. Another important indicator of capital adequacy in the banking
industry is the Tier 1 leverage ratio. The Tier 1 leverage ratio is defined as
the ratio which (x) the Company's Tier 1 Capital bears to (y) the average total
consolidated assets minus intangibles. At March 31, 2004, the Company's Tier 1
leverage ratio was 8.7% exceeding the regulatory minimum requirement of 4.0%.
There have been no cash dividends during 2003 or 2004 paid by the Bank to
the Company.
13
APPALACHIAN BANCSHARES, INC.
March 31, 2004
RESULTS OF OPERATIONS
Three months ended March 31, 2004 and 2003
Summary
Net earnings for the three months ended March 31, 2004 were $896,453,
compared to net earnings of $626,635 for the same period in 2003. This 43.1%
increase in net earnings is primarily attributable to the interest and fee
income generated by an increase in the Bank's loan portfolio, as well as a
decrease in interest rates on deposit liabilities due to management's focus on
funds management. Net interest income increased $974,530, or 29.4%, during the
first three months of 2004, compared to the same period in 2003; noninterest
expenses increased $587,856, or 21.8%, during the same period, while noninterest
income increased by $53,844, or 8.7%. Total interest expense decreased $676,348,
or 28.0%, during the first three months of 2004, compared to the same period in
2003.
Net Interest Income
Net interest income, the difference between interest earned on assets and
the cost of interest-bearing liabilities, is the largest component of the
Company's net income. Revenue from earning assets of the Company during the
three months ended March 31, 2004 increased $298,182, or 5.2%, from the same
period in 2003. Interest expense for the three months ended March 31, 2004
decreased $676,348, or 28.0%, compared to the same period in 2003. The overall
increase in net interest income is the result of management's close monitoring
of the Company's cost of funds and the use of alternative funding sources to
supplement its funding needs. Loan demand has continued to be strong, and
management is working to maintain the spread between the yield on loans and the
cost of funding them.
Provision for Loan Losses
The provision for loan losses represents the charge against current
earnings necessary to maintain the allowance for loan losses at a level which
management considers appropriate. This level is determined based upon
management's assessment of current economic conditions, the composition of the
loan portfolio and the levels of nonaccruing and past due loans.
For the three months ended March 31, 2004 and 2003, the provision for loan
losses was $360,000. Management is comfortable with the controls in place to
identify potential credit problems and feels that at this time they have all
been identified and properly recognized.
Charge-offs exceeded recoveries by $54,166 for the three months ended March
31, 2004. The allowance for loan losses as a percent of outstanding loans, net
of unearned income, was 1.1% at both March 31, 2004 and year-end 2003.
Noninterest Income
Noninterest income for the three months ended March 31, 2004 was $675,389,
compared to $621,545 for the same period in 2003. This increase was primarily
due to an increase in the collection of service charges on deposit accounts.
14
Noninterest Expenses
APPALACHIAN BANCSHARES, INC.
March 31, 2004
Noninterest expenses increased by $587,856 for the quarter ended March 31,
2004, compared to the same period in 2003. Salaries and employee benefits
increased by $273,327 for the three months ended March 31, 2004, or 21.1%,
compared to the same period in 2003. This increase was due to the Company's
decision to strengthen its management in anticipation of future growth, as well
as the continued staff increases necessary for the Bank's new branch in Blue
Ridge, Georgia. Occupancy costs increased by $21,368, and furniture and
equipment expense increased by $15,279, compared to the same period in 2003.
Other operating expenses increased by $277,882 for the first quarter of 2004, as
compared to the same period in 2003, due mainly to the additional growth of the
Blue Ridge branch and the overall growth of the Company.
Income Taxes
The Company attempts to maximize its net income through active tax
planning. The provision for income taxes for the three months ended March 31,
2004 was $426,700, an increase of $170,700, compared to the same period in 2003.
The increase in the provision is associated with the Company's larger taxable
net earnings for the first quarter 2004, in addition to the fact that the
non-taxable items remained relatively constant.
Recently Issued Accounting Standards
In January 2003, the Auditing Standards Board issued Statement on Auditing
Standards ("SAS") No. 101, Auditing Fair Value Measurements and Disclosures.
This statement establishes standards on auditing the measurement and disclosure
of assets, liabilities, and specific components of equity presented or disclosed
at fair value in financial statements. This SAS is effective for audits of
financial statements for periods beginning on or after June 15, 2003. The
adoption of SAS No. 101 did not have a material impact on the Company's
consolidated financial statements.
In April 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging Activities. The provisions
of this statement are effective for contracts entered into or modified after
June 20, 2003, and hedging relationships designated after June 30, 2003, and
generally require that contracts with comparable characteristics be accounted
for similarly. Except for the provisions related to FASB Statement 133,
Accounting for Derivative Instruments and Hedging Activities, all provisions of
this statement should be applied prospectively. The provisions of the statement
related to Statement 133 Implementation Issues that have been effective for
fiscal quarters that begin prior to June 15, 2003, should continue to be applied
in accordance with their respective effective dates. The adoption of the
provisions of this statement did not have a material effect on the Company's
operating results or financial position.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. This statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires liability treatment for certain financial instruments which had
previously been recognized as equity. The provisions of this statement are
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise are effective at the beginning of the first interim period
beginning after June 15, 2003. It is to be implemented by reporting the
cumulative effect of a change in
15
APPALACHIAN BANCSHARES, INC.
March 31, 2004
accounting principle for financial instruments created before May 15, 2003, and
still existing at the beginning of the interim period of adoption. Restatement
is not permitted. The adoption of the provisions of this statement did not have
a material effect on the Company's operating results or financial position.
In December 2003, the FASB revised previously issued SFAS No. 132,
Employers' Disclosures about Pensions and Other Postretirement. This statement
revises employers' disclosures about pension plans and other postretirement
benefit plans. It does not change the measurement or recognition of those plans
required by FASB Statements No. 87, Employers' Accounting for Pensions, No. 88,
Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits, and No 106, Employers' Accounting
for Postretirement Benefits Other Than Pensions. This statement retains the
disclosure requirements contained in FASB Statement No. 132, Employers'
Disclosures about Pensions and Other Postretirement Benefits, which it replaces.
It requires additional disclosures to those in the original Statement 132 about
the assets, obligations, cash flows, and net periodic benefit cost of defined
benefit pension plans and other defined benefit postretirement plans. The
required information should be provided separately for pension plans and for
other postretirement benefit plans. The provisions of this statement are
effective for financial statements with fiscal years ending after December 15,
3003. The interim-period disclosures required by this statement are effective
for interim periods beginning after December 15, 2003. The adoption of the
provisions of this revised statement did not have a material effect on the
Company's operating results or financial position.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This interpretation changes the current
practice of accounting for, and the disclosures related to guarantees.
Interpretation No. 45 requires certain guarantees to be recorded at fair value,
which is a change from the current practice of generally only recording a
liability when a loss is probable and reasonably estimable. The interpretation
also requires a guarantor to make new disclosures, even when the likelihood of
making any payments under the guarantee is remote, which is another change from
current practice. The disclosure requirements of this interpretation are
effective for financial statements of interim or annual periods ending after
December 15, 2002. The interpretation's initial recognition and initial
measurement provisions are applicable on a prospective basis to guarantees
issued or modified after December 31, 2002. The guarantor's previous accounting
for guarantees issued prior to the date of Interpretation No. 45 are not to be
revised or restated to reflect the interpretation's provisions. The adoption of
the disclosure requirements of Interpretation No. 45 did not have a material
impact on the Company's consolidated financial statements. The adoption of the
initial recognition and initial measurement provisions of Interpretation No. 45
did not have a material impact on the Company's consolidated financial
statements.
In December 2003, the FASB revised previously issued FIN 46, Consolidation
of Variable Interest Entities, which clarifies the application of Accounting
Research Bulletin ("ARB") 51, Consolidated Financial Statements, to certain
entities (called variable interest entities) in which equity investors do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. The reporting and
disclosure requirements of this Interpretation are effective for all financial
statements of public companies for the first period ending after December 15,
2003 and for all other types of entities for periods ending after March 15,
2004. The adoption of this interpretation did not have a material impact on the
Company's consolidated financial statements.
16
APPALACHIAN BANCSHARES, INC.
March 31, 2004
Off-Balance Sheet Arrangements
For a discussion of the Company's off-balance sheet arrangements, please
see the discussion in "Note H - Commitments and Contingencies" under "Notes to
Consolidated Financial Statements," included in Item 1 of Part I in this
Quarterly Report on Form 10-Q.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
At March 31, 2004, there have been no material changes in information that
would be provided under this Item 3, from the quantitative and qualitative
disclosures about market risk provided in Company's Annual Report on Form 10-K
for the year ended December 31, 2003. Consequently, the information provided in
this Item 3 is the same as that provided in Items 7 and 7A of the Company's
Annual Report on Form 10-K for the year ended December 31, 2003.
Interest Rate Sensitivity Management
Interest rate sensitivity is a function of the repricing characteristics of
the Bank's portfolios of assets and liabilities. These repricing characteristics
are the time frames within which the interest-bearing assets and liabilities are
subject to changes in interest rates, either at replacement or maturity during
the life of the instruments. Sensitivity is measured as the difference between
the volume of assets and liabilities in the Bank's current portfolio that is
subject to repricing in future time periods. The differences are known as
interest rate sensitivity gaps and are usually calculated separately for
segments of time, ranging from zero to thirty days, thirty-one to ninety days,
ninety-one days to one year, one to five years, over five years and on a
cumulative basis.
17
APPALACHIAN BANCSHARES, INC.
March 31, 2004
The following tables show interest rate sensitivity gaps for these
different intervals, as of December 31, 2003.
Interest Rate Sensitivity Analysis
0-30 31-90 90-365 1-5 Over 5
Days Days Days Years Years Total
----------- ----------- ----------- ----------- ----------- -----------
(In thousands, except ratios)
Interest-earning assets (1)
Loans............................ $ 22,353 $ 112,122 $ 82,653 $ 105,881 $ 8,171 $ 331,180
Securities:
Taxable........................ 415 -- 6,947 23,652 9,994 41,008
Tax-exempt..................... -- -- -- 276 14,079 14,355
Time deposits in other banks..... 274 -- -- -- -- 274
Federal funds sold............... 586 -- -- -- -- 586
----------- ----------- ----------- ----------- ----------- -----------
23,628 112,122 89,600 129,809 32,244 387,403
----------- ----------- ----------- ----------- ----------- -----------
Interest-bearing liabilities (2)
Demand deposits (3).............. 25,236 25,236 25,236 -- -- 75,708
Savings deposits (3)............. 16,202 16,203 16,203 -- -- 48,608
Time deposits.................... 12,230 26,714 95,827 50,036 -- 184,807
Other short-term borrowings...... 7,086 -- -- -- -- 7,086
Long-term debt................... 100 550 6,593 18,450 11,186 36,879
----------- ----------- ----------- ----------- ----------- -----------
60,854 68,703 143,859 68,486 11,186 353,088
----------- ----------- ----------- ----------- ----------- -----------
Interest sensitivity gap............ $ (37,226) $ 43,419 $ (54,259) $ 61,323 $ 21,058 $ 34,315
=========== =========== =========== =========== =========== ===========
Cumulative interest sensitivity gap. $ (37,226) $ 6,193 $ (48,066) $ 13,257 $ 34,315
=========== =========== =========== =========== ===========
Ratio of interest-earning assets to
interest-bearing liabilities..... 0.39 1.63 0.62 1.90 2.88
=========== =========== ============ ============ ===========
Cumulative ratio.................... 0.39 1.05 0.82 1.06 1.10
=========== =========== ============ ============ ===========
Ratio of cumulative gap to total
interest-earning assets.......... (0.10) 0.02 (0.12) 0.03 0.09
=========== =========== ============ ============ ===========
(1) Excludes nonaccrual loans and securities.
(2) Excludes matured certificates which have not been redeemed by the customer
and on which no interest is accruing.
(3) Demand and savings deposits are assumed to be subject to movement into
other deposit instruments in equal amounts during the 0-30 day period, the
31-90 day period, and the 91-365 day period.
The above table indicates that, in a rising interest rate environment, the
Company's earnings may be adversely affected in the 0-365 day periods, where
liabilities will reprice faster than assets. As seen in the preceding table, for
the first 30 days of repricing opportunity, there is an excess of
interest-bearing liabilities over earning assets of approximately $37 million.
For the first 365 days, interest-bearing liabilities exceed earning assets by
approximately $48 million. During this one-year time frame, 77.4% of all
interest-bearing liabilities will reprice, compared to 58.2% of all
interest-earning assets. Changes in the mix of earning assets or supporting
liabilities can either increase or decrease the net interest margin without
affecting interest rate sensitivity. In addition, the interest rate spread
between an asset and its supporting liability can vary significantly, while the
timing of repricing for both the asset and the liability remain the same, thus
impacting net interest income. It should be noted, therefore, that a matched
interest-sensitive position by itself would not ensure maximum net interest
income.
18
APPALACHIAN BANCSHARES, INC.
March 31, 2004
Management continually evaluates the condition of the economy, the pattern
of market interest rates and other economic data to determine the types of
investments that should be made and at what maturities. Using this analysis,
management from time to time assumes calculated interest rate sensitivity gap
positions to maximize net interest income based upon anticipated movements in
the general level of interest rates.
Market Risk
Market risk is the risk arising from adverse changes in the fair value of
financial instruments due to a change in interest rates, exchange rates and
equity prices. The Company's primary market risk is interest-rate risk.
The primary objective of Asset/Liability Management of the Company is to
manage interest-rate risk and achieve reasonable stability in net interest
income throughout interest rate cycles. This is achieved by maintaining the
proper balance of rate-sensitive earning assets and rate-sensitive liabilities.
The relationship of rate-sensitive earning assets to rate sensitive liabilities
is the principal factor in projecting the effect that fluctuating interest rates
will have on future net interest income. Rate-sensitive earning assets and
interest-bearing liabilities are those that can be repriced to current market
rates within a relatively short time period. Management monitors the rate
sensitivity of earning assets and interest-bearing liabilities over the entire
life of these instruments, but places particular emphasis on the first year and
through three years.
The Company has not experienced a high level of volatility in net interest
income, primarily because of the relatively large base of core deposits that do
not reprice on a contractual basis. These deposit products include regular
savings, interest-bearing transaction accounts and money market savings
accounts. Balances for these accounts are reported based on historical repricing
experienced at each bank. However, the rates paid are typically not directly
related to market interest rates, since management has some discretion in
adjusting these rates as market rates change.
The Company uses additional tools to monitor and manage interest rate
sensitivity. One of the primary tools is simulation analysis. Simulation
analysis is the primary method of estimating earnings at risk and capital at
risk under varying interest rate conditions. Simulation analysis is used to test
the sensitivity of the Company's net interest income and shareholders' equity to
both the level of interest rates and the slope of the yield curve. Simulation
analysis accounts for the expected timing and magnitude of assets and liability
cash flows, as well as the expected timing and magnitude of deposits that do not
reprice on a contractual basis. In addition, simulation analysis includes
adjustments for the lag between movements in market interest rates on loans and
interest-bearing deposits. These adjustments are made to reflect more accurately
possible future cash flows, repricing behavior and ultimately net interest
income. The estimated impact on the Company's net interest income before
provision for loan loss sensitivity over a one-year time horizon is shown below.
Such analysis assumes a sustained parallel shift in interest rates and the
Company's estimate of how interest-bearing transaction accounts will reprice in
each scenario. Actual results will differ from simulated results due to timing,
magnitude and frequency of interest rate changes and changes in market
conditions and management's strategies, among other factors.
19
APPALACHIAN BANCSHARES, INC.
March 31, 2004
Percentage Increase
(Decrease) in Interest
Income/Expense Given
Interest Rate Shifts
------------------------------
Down 200 Up 200
Basis Points Basis Points
-------------- ------------
For the Twelve Months After December 31, 2003
Projected change in:
Interest income .......................................................... (20.40)% 19.28%
Interest expense ......................................................... (35.54) 48.77
Net interest income....................................................... (13.64) 6.12
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company has evaluated the effectiveness of its disclosure controls and
procedures as of the end of the period covered by this Quarterly Report on Form
10-Q, pursuant to Exchange Act Rule 13a-15. The evaluation was performed under
the supervision and with the participation of management, including the chief
executive officer and the chief financial officer. Based on this evaluation, the
chief executive officer and chief financial officer have concluded that the
disclosure controls and procedures are effective in ensuring that all material
information required to be disclosed in this quarterly report has been
communicated to them in a manner appropriate to allow timely decisions regarding
required disclosure.
Changes in Internal Controls
There were no significant changes in internal controls or other factors
during the period covering this quarterly report that could significantly affect
internal controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
20
PART II - Other Information
Item 2. Changes in Securities, Use of Proceeds and Purchases of Equity
Securities
On August 28, 2003, the Company, through its affiliate Appalachian Capital
Trust I, issued $6,000,000 in variable-rate trust preferred securities known as
Appalachian Capital Trust I Preferred Securities (the "Trust Preferred
Securities"). The Trust Preferred Securities were issued and sold in reliance on
the exemption from registration provided by Section 4(2) of the Securities Act
of 1933, as amended, as a transaction by an issuer not involving a public
offering. An underwriting fee of 3% of the amount of issuance was payable to
Citigroup under the terms of the transaction. The Company, on September 9, 2003,
used $4,009,634 of the proceeds from the issuance of the Trust Preferred
Securities (the "Trust Preferred Proceeds") to prepay its outstanding
correspondent-bank lines of credit. The Company then, on September 29, 2003,
contributed $500,000 of the Trust Preferred Proceeds to the capital of the Bank,
retaining the remaining balance of the Trust Preferred Proceeds, in the amount
of $1,490,366, for operating expenses and as a future source of capital for the
Bank.
The Company did not repurchase any shares of its common stock during the
quarter ended March 31, 2004.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits. The following Exhibits are filed with this report:
Exhibit No. Exhibit
----------- --------------------------------------------------------------------------------
3.1 Articles of Incorporation of the Company, as Restated (incorporated by reference
to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q, dated August 15,
2003 (File No. 000-21383)).
3.2 Bylaws of the Company, as Restated (incorporated by reference to Exhibit 3.2 to
the Company's Quarterly Report on Form 10-Q, dated August 15, 2003 (File No.
000-21383)).
11 Computation of Earnings Per Share.
31.1 Certification of President and Chief Executive Officer Pursuant to Section 302
of Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to Section 302 of
Sarbanes-Oxley Act of 2002.
32 Certifications Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
(b) A current report on Form 8-K dated March 5, 2004 was furnished to the Securities and
Exchange Commission under Items 7 ("Financial Statements and Exhibits") and 12 ("Results
of Operation and Financial Condition") of such form, involving the Company's issuance of a
press release dated March 5, 2004 reporting the unaudited results of operations and
earnings for the three months and twelve months ended December 31, 2003.
21
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the Company has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
APPALACHIAN BANCSHARES, INC.
Dated: May 14, 2004 /s/ Tracy R. Newton
-----------------------
Tracy R. Newton
President and CEO
Dated: May 14, 2004 /s/ Darren M. Cantlay
-----------------------
Darren M. Cantlay
Chief Financial Officer
22
EXHIBIT INDEX
Exhibit No. Exhibit
----------- --------------------------------------------------------------------------------
3.1 Articles of Incorporation of the Company, as Restated (incorporated by reference to
Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q, dated August 15, 2003
(File No. 000-21383)).
3.2 Bylaws of the Company, as Restated (incorporated by reference to Exhibit 3.2 to the
Company's Quarterly Report on Form 10-Q, dated August 15, 2003 (File No. 000-21383)).
11 Computation of Earnings Per Share.
31.1 Certificate of President and Chief Executive Officer Pursuant to Section 302 of
Sarbanes-Oxley Act of 2002.
31.2 Certificate of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act
of 2002.
32 Certificates Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
23
Exhibit 11
APPALACHIAN BANCSHARES, INC.
STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE
The following tabulation presents the calculation of basic and diluted earnings
per common share for the three-month periods ended March 31, 2004 and 2003. All
share amounts for 2003 have been retroactively adjusted for the ten percent
stock dividend effective July 1, 2003.
Three Months Ended
March 31,
---------------------------------
2004 2003
--------------- ----------------
Basic Earnings Per Share:
Net Income................................................................ $ 896,453 $ 626,635
=============== ================
Earnings on common shares................................................. $ 896,453 $ 626,635
=============== ================
Weighted average common shares outstanding - basic........................ 3,689,545 3,484,964
=============== ================
Basic earnings per common share........................................... $ 0.24 $ 0.18
=============== ================
Diluted Earnings Per Share:
Net Income................................................................ $ 896,453 $ 626,635
=============== ================
Weighted average common shares outstanding - diluted...................... 3,862,309 3,659,692
=============== ================
Diluted earnings per common share......................................... $ 0.23 $ 0.17
=============== ================
24
EXHIBIT 31.1
CERTIFICATE
I, Tracy R. Newton, certify that:
I have reviewed this quarterly report on Form 10-Q of Appalachian
Bancshares, Inc.;
Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the Company as of,
and for, the periods presented in this report;
The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Company and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
Company, including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the period in
which this report is being prepared;
(b) [Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986];
and
(c) Disclosed in this report any change in the Company's internal controls
over financial reporting that occurred during the Company's most
recent fiscal quarter (the Company's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over
financial reporting; and
The Company's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
Company's auditors and the audit committee of Company's board of directors (or
persons performing the equivalent function):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the Company's ability to record,
process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal
control over financial reporting.
Date: May 14, 2004
/s/ Tracy R. Newton
- -------------------------------------
Tracy R. Newton
President and Chief Executive Officer
EXHIBIT 31.2
CERTIFICATE
I, Darren M. Cantlay, certify that:
I have reviewed this quarterly report on Form 10-Q of Appalachian
Bancshares, Inc.;
Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the Company as of,
and for, the periods presented in this report;
The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Company and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
Company, including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the period in
which this report is being prepared;
(b) [Paragraph omitted pursuant to SEC Release Nos. 33-8238 and 34-47986];
and
(c) Disclosed in this report any change in the Company's internal controls
over financial reporting that occurred during the Company's most
recent fiscal quarter (the Company's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over
financial reporting; and
The Company's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
Company's auditors and the audit committee of Company's board of directors (or
persons performing the equivalent function):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the Company's ability to record,
process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the Company's internal
control over financial reporting.
Date: May 14, 2004
/s/ Darren M. Cantlay
- -------------------------------------
Darren M. Cantlay
Chief Financial Officer
EXHIBIT 32
CERTIFICATE PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO SECTION 906 OF
THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Appalachian Bancshares, Inc. (the
"Company") on Form 10-Q for the quarterly period ended March 31, 2004 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
the undersigned, Tracy R. Newton, President and Chief Executive Officer of the
Company, and Darren C. Cantlay, Chief Financial Officer, do hereby certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that to the best of our knowledge:
1. The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
Date: May 14, 2004 By: /s/ Tracy R. Newton
-------------------------------------
Tracy R. Newton
President and Chief Executive Officer
Date: May 14, 2004 By: /s/ Darren M. Cantlay
-------------------------------------
Darren M. Cantlay
Chief Financial Officer