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 JUNE 30, 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 July 31, 2004; 3,736,079 Shares
Form 10-Q
APPALACHIAN BANCSHARES, INC.
June 30, 2004
TABLE OF CONTENTS
Page No.
Part I. Financial Information --------
Item 1.Financial Statements (Unaudited)
Consolidated Statements of Financial Condition at June 30, 2004
and December 31, 2003..................................................................... 1
Consolidated Statements of Income For the Three Months
and Six Months Ended June 30, 2004 and 2003............................................... 2
Consolidated Statements of Comprehensive Income For the Three Months
and Six Months Ended June 30, 2004 and 2003............................................... 3
Consolidated Statements of Cash Flows For the Six Months Ended
June 30, 2004 and 2003.................................................................... 4
Notes to Consolidated Financial Statements.................................................. 5
Item 2.Management's Discussion and Analysis of Financial Condition and
Results of Operation...................................................................... 11
Item 3.Quantitative and Qualitative Disclosures about Market Risk................................. 19
Item 4.Controls and Procedures.................................................................... 22
Part II. Other Information
Item 2.Changes in Securities, Use of Proceeds and Purchases of Equity Securities.................. 23
Item 4.Submission of Matters to a Vote of Security Holders........................................ 23
Item 6.Exhibits and Reports on Form 8-K........................................................... 24
Signatures........................................................................................... 25
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, 2004 (Unaudited) and December 31, 2003
June 30,
2004 December 31,
(Unaudited) 2003
--------------- ----------------
Cash and due from banks...................................................... $ 11,180,006 $ 6,530,984
Interest bearing deposits with other banks................................... 92,621 273,841
Federal funds sold........................................................... 788,000 586,000
--------------- ----------------
Cash and Cash Equivalents............................................. 12,060,627 7,390,825
Securities available for sale................................................ 56,393,630 55,363,327
Loans........................................................................ 363,881,269 332,306,446
Allowance for loan losses.................................................... (4,179,636) (3,609,794)
--------------- ----------------
Net Loans............................................................. 359,701,633 328,696,652
Premises and equipment, net.................................................. 11,799,692 9,161,652
Accrued interest............................................................. 2,467,547 2,289,994
Cash surrender value on life insurance....................................... 7,672,693 2,592,416
Intangibles, net............................................................. 2,133,558 2,157,433
Other assets................................................................. 1,975,793 1,965,179
--------------- ----------------
Total Assets.......................................................... $ 454,205,173 $ 409,617,478
=============== ================
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Noninterest-bearing..................................................... $ 28,758,447 $ 23,795,787
Interest-bearing........................................................ 336,012,706 309,123,161
--------------- ----------------
Total Deposits........................................................ 364,771,153 332,918,948
Short-term borrowings..................................................... 7,646,011 7,085,992
Accrued interest.......................................................... 527,819 670,614
Long-term debt............................................................ 41,421,429 30,692,858
Subordinated long-term capital notes...................................... 6,186,000 6,186,000
Other liabilities......................................................... 1,030,392 980,713
--------------- ----------------
Total Liabilities..................................................... 421,582,804 378,535,125
Shareholders' Equity
Preferred stock, 20,000,000 shares authorized, none issued................ -- --
Common stock, par value $0.01 per share, 20,000,000 shares
authorized, 3,812,052 shares issued at June 30, 2004,
and 3,734,686 shares issued at December 31, 2003........................ 38,121 37,347
Paid-in capital........................................................... 23,145,961 22,727,208
Retained earnings......................................................... 10,464,417 8,588,160
Accumulated other comprehensive income (loss): net unrealized
holding gains (losses) on securities available-for-sale, net of
deferred income tax..................................................... (326,334) 429,434
Treasury stock, at cost (75,973 shares at June 30,
2004 and at December 31, 2003).......................................... (699,796) (699,796)
--------------- ----------------
Total Shareholders' Equity............................................ 32,622,369 31,082,353
--------------- ----------------
Total Liabilities and Shareholders' Equity............................ $ 454,205,173 $ 409,617,478
=============== ================
See notes to consolidated financial statements
1
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the Three Months and Six Months Ended June 30, 2004 and 2003
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ----------------------------------
2004 2003 2004 2003
------------- ------------- -------------- ----------------
Interest Income
Interest and fees on loans............. $ 5,776,538 $ 5,351,780 $ 11,281,589 $ 10,552,129
Interest on investment securities:
Taxable securities................... 316,348 217,317 670,783 524,723
Nontaxable securities................ 162,576 177,617 324,966 357,034
Interest on deposit in other banks..... 1,055 4,549 1,450 28,712
Interest on federal funds sold......... 3,810 12,979 7,200 29,123
------------- ------------- -------------- ----------------
Total Interest Income.............. 6,260,327 5,764,242 12,285,988 11,491,721
Interest Expense
Interest on deposits................... 1,470,413 1,909,119 2,923,016 3,944,003
Interest on federal funds purchased
and securities sold under
agreements to repurchase............. 24,198 18,992 40,966 43,895
Interest expense on long-term debt..... 234,289 306,000 440,412 661,955
Interest on subordinated debentures.... 64,500 -- 128,400 --
------------- ------------- -------------- ----------------
Total Interest Expense............. 1,793,400 2,234,111 3,532,794 4,649,853
Net Interest Income....................... 4,466,927 3,530,131 8,753,194 6,841,868
Provision for loan losses................. 291,107 360,000 651,107 720,000
Net Interest Income After
Provision for Loan Losses.............. 4,175,820 3,170,131 8,102,087 6,121,868
Noninterest Income
Customer service fees.................. 292,106 202,651 575,324 390,758
Insurance commissions.................. 17,366 5,719 26,331 46,712
Mortgage origination fees.............. 223,547 411,321 443,916 701,620
Other operating income................. 172,525 113,936 335,362 233,060
Investment securities gains (losses)... (22,633) -- (22,633) (16,978)
------------- ------------- -------------- ----------------
Total Noninterest Income........... 682,911 733,627 1,358,300 1,355,172
Noninterest Expenses
Salaries and employee benefits......... 1,675,991 1,366,235 3,243,011 2,694,128
Occupancy expense...................... 196,976 158,334 374,619 314,609
Furniture and equipment expense........ 277,012 237,337 542,887 487,933
Other operating expenses............... 1,286,948 1,204,357 2,554,913 2,160,240
------------- ------------- -------------- ----------------
Total Noninterest Expenses......... 3,436,927 2,966,263 6,715,430 5,656,910
Income before income taxes................ 1,421,804 937,495 2,744,957 1,820,130
Income tax expense........................ 442,000 291,000 868,700 547,000
------------- ------------- -------------- ----------------
Net Income................................ $ 979,804 $ 646,495 $ 1,876,257 $ 1,273,130
============= ============= ============== ================
Earnings Per Common Share
Basic.................................. $ 0.26 $ 0.18 $ 0.51 $ 0.36
Diluted................................ 0.25 0.17 0.48 0.34
Cash Dividends Declared
Per Common Share....................... $ 0.00 $ 0.00 $ 0.00 $ 0.00
Weighted Average Shares Outstanding
Basic.................................. 3,731,399 3,632,324 3,710,836 3,559,051
Diluted................................ 3,885,700 3,815,640 3,874,363 3,753,174
See notes to consolidated financial statements
2
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Three Months and Six Months Ended June 30, 2004 and 2003
(Unaudited)
Three Months Ended Six Months Ended
----------------------------- -----------------------------
June 30, June 30,
2004 2003 2004 2003
------------- ------------- ------------- --------------
Net Income........................................ $ 979,804 $ 646,495 $ 1,876,257 $ 1,273,130
Other comprehensive, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)
arising during the period.................. (1,934,756) 717,951 (1,167,736) 498,981
Reclassification adjustments for (gains)
losses included in net income.............. 22,633 -- 22,633 16,978
------------- ------------- ------------- --------------
Net unrealized gains (losses).............. (1,912,123) 717,951 (1,145,103) 515,959
Income tax expense related to items of
other comprehensive income (loss)............ 650,122 (244,103) 389,335 (175,426)
------------- ------------- ------------- --------------
Other comprehensive income (loss)................. (1,262,001) 473,848 (755,768) 340,533
------------- ------------- ------------- --------------
Comprehensive Income (Loss)....................... $ (282,197) $ 1,120,343 $ 1,120,489 $ 1,613,663
============= ============= ============= ==============
See notes to consolidated financial statements
3
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2004 and 2003
(Unaudited)
June 30,
2004 December 31,
(Unaudited) 2003
--------------- ----------------
Operating Activities
Net income................................................................ $ 1,876,257 $ 1,273,130
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan losses............................................... 651,107 720,000
Net depreciation and amortization....................................... 503,975 429,448
Realized investment security losses..................................... 22,633 16,978
Loss on disposition of other real estate................................ 183,857 --
(Increase) decrease in accrued interest receivable...................... (177,553) 64,497
Increase in cash surrender value of life insurance...................... (80,277) (54,586)
Decrease in accrued interest payable.................................... (142,795) (202,566)
Other, net.............................................................. (23,957) 830,131
--------------- ----------------
Net Cash Provided by (Used in) Operating Activities................... 2,813,247 3,077,032
Investing Activities
Purchase of securities available for sale, net............................ (2,276,808) (11,605,631)
Net increase in loans to customers........................................ (32,455,297) (15,344,003)
Capital expenditures, net................................................. (3,028,562) (342,121)
Purchase of insurance contracts.......................................... (5,000,000) --
Proceeds from the disposition of foreclosed real estate................... 1,056,900 375,000
--------------- ----------------
Net Cash Used in Investing Activities................................. (41,703,767) (26,916,755)
Financing Activities
Net increase in demand deposits, NOW accounts,
and savings accounts.................................................... 30,015,865 6,494,412
Net increase (decrease) in certificates of deposit........................ 1,836,340 5,240,120
Net increase (decrease) in short-term borrowings.......................... 560,019 (796,973)
Proceeds from long-term debt.............................................. 25,400,000 16,000,000
Repayment of long-term debt............................................... (14,671,429) (16,928,428)
Proceeds from issuance of common stock.................................... 405,959 302,800
Proceeds from sale of treasury stock...................................... -- 1,923,595
Compensation associated with issuance of stock options.................... 13,568 6,543
--------------- ----------------
Net Cash Provided by Financing Activities.................................... 43,560,322 12,242,069
Net Increase (Decrease) in Cash and Cash Equivalents......................... 4,669,802 (11,597,654)
Cash and Cash Equivalents at Beginning of Period............................. 7,390,825 30,856,697
--------------- ----------------
Cash and Cash Equivalents at End of Period................................... $ 12,060,627 $ 19,259,043
=============== ================
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for:
Interest................................................................ $ 3,675,589 $ 4,852,419
Income taxes............................................................ 955,000 50,000
See notes to consolidated financial statements
4
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
June 30, 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 six-month period ended June 30, 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)
June 30, 2004
Note B - Critical Accounting Policies - Continued
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 31.6% and 30.0% for the six months
ended June 30, 2004 and 2003, respectively, and 31.1 % and 31.0% for the three
months ended June 30, 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 June 30, 2004, the Company had net unrealized losses of $494,444 in
available-for-sale securities, which are reflected in the presented assets and
resulted in a decrease in shareholders' equity of $326,334, net of deferred tax
benefit for the six months ended June 30, 2004. There were no trading
securities. The net decrease in shareholders' equity, as a result of the SFAS
No. 115 adjustment from December 31, 2003 to June 30, 2004, was $755,768.
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)
June 30, 2004
Note F - Intangibles
Amortizable intangible assets and acquired goodwill as of June 30, 2004,
and December 31, 2003, are detailed as follows:
Amortizable Intangibles
- -----------------------
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
--------------- --------------- ----------------
As of June 30, 2004:
Noncompete agreements.................................... $ 165,000 $ 165,000 $ --
Debt issuance costs...................................... 170,000 28,333 141,667
--------------- --------------- ----------------
Total.................................................... $ 335,000 $ 193,333 $ 141,667
=============== =============== ================
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
six months ended June 30, 2004 and the year ended December 31, 2003 was $23,875
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
- -----------------
June 30, 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 table below illustrates the effects on net income and earnings per
share if the fair value based method had been applied to all outstanding awards
each period.
7
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
June 30, 2004
Note G - Stock Based Compensation - Continued
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 June 30, 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 236,520 are outstanding at June 30, 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.
The Company's actual and pro forma information follows:
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- -----------------------------
2004 2003 2004 2003
------------ ------------ ------------- -------------
Net Income
As Reported......................... $ 979,804 $ 646,495 $ 1,876,257 $ 1,273,130
Add: Stock-based compensation
expense included in net income,
net of related taxes........... 6,195 4,623 13,568 6,543
Deduct: Total stock-based employee
compensation expense
determined under fair value
based method for all
awards, net of tax.......... (15,521) (9,758) (32,323) (28,769)
------------ ------------ ------------- -------------
Pro forma net income................ $ 970,478 $ 641,360 $ 1,857,502 $ 1,250,904
============ ============ ============= =============
8
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
June 30, 2004
Note G - Stock Based Compensation - Continued
Three Months Ended June 30, Six Months Ended June 30,
----------------------------- -----------------------------
2004 2003 2004 2003
------------ ------------ ------------- -------------
Basic earnings per share:
As Reported......................... $ 0.26 $ 0.18 $ 0.51 $ 0.36
============ ============ ============ ============
Pro forma........................... $ 0.26 $ 0.18 $ 0.50 $ 0.35
============ ============ ============ ============
Diluted earnings per share:
As Reported......................... $ 0.25 $ 0.17 $ 0.48 $ 0.34
============ ============ ============ ============
Pro forma........................... $ 0.25 $ 0.17 $ 0.48 $ 0.33
============ ============ ============ ============
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 and contingencies.
Following is a discussion of these commitments and contingencies:
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 party is the contract amount. As of June 30, 2004 and December 31,
2003, the Company has issued standby letters of credit of approximately
$1,293,000 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.
9
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
June 30, 2004
Note H - Commitments and Contingencies - Continued
Loan Commitments: As of June 30, 2004, and December 31, 2003, the Company
had commitments outstanding to extend credit totaling approximately $58,437,000
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 - 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.
Note J - Other Developments
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.
Appalachian Community Bank, during the quarter ended June 30, 2004,
purchased, for a single-premium payment, cash-value life insurance on the lives
of each of its directors and officers, the total number of these insured persons
being twenty-five. The Bank is the owner and beneficiary of the life insurance
coverage on each of these insured persons, including the surrender value
thereof. The amount paid by the Bank for the coverage of each insured person was
the same amount of premium for each of the insured persons, although the amount
of insurance coverage on each of the insured persons differs, depending upon,
among other things, the age of the particular insured person. The single premium
amount paid by the Bank for the purchase of the life insurance during the
quarter was $5 million.
10
APPALACHIAN BANCSHARES, INC.
June 30, 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
June 30, 2004 compared to December 31, 2003
Loans
Loans comprised the largest single category of the Company's earning assets
at June 30, 2004. Loans, net of unearned income and allowance for loan losses,
were 79.2% of total assets at June 30, 2004. Total net loans were $359,701,633
at June 30, 2004, representing a 9.4% increase from $328,696,652 at December 31,
2003. Loan demand in the local markets has increased due to the current interest
rate environment, as well as the amount of development occurring in the markets
that we serve.
11
APPALACHIAN BANCSHARES, INC.
June 30, 2004
Investment Securities and Other Earning Assets
Investment securities at June 30, 2004 were $56,393,630 compared with
$55,363,327 at December 31, 2003, reflecting a 1.9% increase of $1,030,303.
Federal funds sold were $788,000 at June 30, 2004, compared to the December 31,
2003 total of $586,000, a 34.5% increase. 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.
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 2.13% at
June 30, 2004. Total non-performing assets at June 30, 2004, were $1,959,655,
which consisted of: $1,538,078 in loans secured by real estate; $70,787 in
consumer loans; $12,845 in commercial, financial and agricultural loans; $31,145
in other loans; and $306,800 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 June 30, 2004, and the ratio of nonperforming loans to total loans
decreased from 0.50% at December 31, 2003 to 0.45% at June 30, 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 June 30, 2004 were $364,771,153, an increase of
$31,852,205 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 $4,962,660, or 20.9%, from year-end 2003
to $28,758,447 at June 30, 2004, and interest-bearing deposits increased
$26,889,545, or 8.7%, during the same period to $336,012,706. Over the past 12
months, the Company has focused on increasing its core deposit base and during
the first two quarters 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 June 30, 2004 and December 31, 2003 consist of the
following:
June 30, December 31,
2004 2003
--------------- ----------------
Federal funds purchased..................................................... $ 4,000,000 $ 3,000,000
Securities sold under agreements to repurchase.............................. 3,646,011 4,085,992
--------------- ----------------
$ 7,646,011 $ 7,085,992
=============== ================
12
APPALACHIAN BANCSHARES, INC.
June 30, 2004
Securities sold under agreements to repurchase totaled $3,646,011 at June
30, 2004, a $439,981 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 June 30, 2004
increased by $1,000,000 from December 31, 2003.
Shareholders' Equity
Shareholders' equity increased $1,540,016, from $31,082,353 at December 31,
2003 to $32,622,369 at June 30, 2004. This increase was mainly attributable to
net earnings of $1,876,257, and proceeds from the issuance of stock of $419,527.
These funds offset the decrease of $755,768 in the unrealized gains/losses on
AFS securities.
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 $241.5 million, or
66.4%, of the total loan portfolio at June 30, 2004, and investment securities
maturing in one year or less equaled approximately $7.2 million or 12.8% 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
June 30, 2004, funds were also available through the purchase of federal funds
from correspondent commercial banks from available lines of up to an aggregate
of $24 million. Liquidity management involves the daily monitoring of the
sources and uses of funds to maintain an acceptable cash position. At June 30,
2004, the outstanding balance of the Bank's federal funds purchased was
$4,000,000.
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
13
APPALACHIAN BANCSHARES, INC.
June 30, 2004
by having a funding source to match longer term loans. The Bank's credit line
stands at approximately $64,410,000 as of June 30, 2004. This line is subject to
collateral availability. At June 30, 2004, the outstanding balance of the Bank's
credit line was $41,421,429.
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 $37.1 million at June 30, 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 $41.3 million at June 30, 2004. The
Company's percentage ratios as calculated under regulatory guidelines for
risk-weighted assets were 10.1% and 11.2% for Tier 1 Capital and Total Capital,
respectively, at June 30, 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 June 30, 2004, the Company's Tier 1
leverage ratio was 8.4%, 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.
14
APPALACHIAN BANCSHARES, INC.
June 30, 2004
RESULTS OF OPERATIONS
Three and six months ended June 30, 2004 and 2003
Summary
Net earnings for the six months ended June 30, 2004 were $1,876,257,
compared to net earnings of $1,273,130 for the same period in 2003. This 47.4%
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 $1,911,326, or 27.9%, during the
first six months of 2004, compared to the same period in 2003; noninterest
expenses increased $1,058,520, or 18.7%, during the same period, while
noninterest income increased by only $3,128, or 0.23%. Total interest expense
decreased $1,117,059, or 24.0%, during the first six months of 2004, compared to
the same period in 2003.
Net earnings for the three months ended June 30, 2004, were $979,804
compared to net earnings of $646,495 for the three months ended ended June 30,
2003. This represents a 51.6% increase as compared to the same period in 2003
and is a result of the same causes noted for the six months ended June 30, 2004
and 2003. Total interest expense decreased by $440,711 compared to the same
period in 2003. Net interest income increased $936,796 during the three months
ended June 30, 2004, as compared to the same period in 2003; noninterest
expenses increased $470,664 during the same period, while noninterest income
decreased by $50,716.
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 six
months ended June 30, 2004 increased $794,267, or 6.9%, from the same period in
2003. Interest expense for the six months ended June 30, 2004 decreased
$1,117,059, or 24.0%, compared to the same period in 2003.
Net interest income increased $936,796 or 26.5% during the three months
ended ended June 30, 2004, as compared to the same period in 2003, resulting
from an increase of $496,085, or 8.6%, in revenue from earning assets, coupled
with a decrease in total interest expense of $440,711, or 19.7%.
Generally, the overall increase in net interest income, for the three
months and six months ended June 30, 2004, 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. The provision
for loan losses was
15
APPALACHIAN BANCSHARES, INC.
June 30, 2004
$651,107 for the six months ended June 30, 2004, compared to $720,000 for the
same period of 2003. Charge-offs exceeded recoveries by $81,265 for the six
months ended June 30, 2004. The allowance for loan losses as a percent of
outstanding loans, net of unearned income, was 1.1% at June 30, 2004, and at
year-end 2003.
For the three months ended June 30, 2004 and 2003, the provision for loan
losses was $291,107 and $360,000, respectively. 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 $27,099 for the three months ended June 30, 2004.
Noninterest Income
Noninterest income for the six months ended June 30, 2004 was $1,358,300,
compared to $1,355,172 for the same period in 2003. There was an increase of
approximately $185,000 in the collection of service charges on deposit accounts,
a decrease of approximately $258,000 in mortgage origination fees, as well as an
increase in income related to our merchant credit card program.
Noninterest income decreased by $50,716 or 6.9% in the three months ended
June 30, 2004, as compared to the same period in 2003. The primary reason for
the decrease was related to the drop in mortgage originations, compared to the
same period in 2003, which resulted in a reduction in mortgage origination fees
of approximately $188,000, or 45.7%, compared to the same period in 2003.
Noninterest Expenses
Noninterest expenses increased by $1,058,520, or 18.7%, for the six months
ended June 30, 2004, compared to the same period in 2003, relating, in part to
an increase in salaries and employee benefits of $548,883, or 20.4%, for the six
months ended June 30, 2004, compared to the same period in 2003. This increase
salaries and employee benefits 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 $60,010, and furniture and equipment expense increased by
$54,954, compared to the same period in 2003. Other operating expenses increased
by $394,673 for the half of 2004, as compared to the same period in 2003, due
mainly to the opening of the Blue Ridge branch as well as the overall growth of
the Company.
Noninterest expenses increased by $470,664, or 15.9%, for the quarter ended
June 30, 2004, as compared to the same period in 2003. Salaries and employee
benefits increased by $309,756, or 22.7% for the three months ended June 30,
2004, compared to the same period in 2003. Occupancy costs increased by $38,642,
furniture and equipment expense increased $39,675 and other operating expenses
increased by $82,591 for the second quarter of 2004 as compared to the same
period in 2003.
Income Taxes
The Company attempts to maximize its net income through active tax
planning. The provision for income taxes for the six months ended June 30, 2004
was $868,700, an increase of $321,700, 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 six months of 2004, in addition to the fact that the
non-taxable items remained relatively constant. The effective tax rates were
31.6% and 30.0% for the six months ended June 30, 2004 and 2003, respectively.
16
APPALACHIAN BANCSHARES, INC.
June 30, 2004
The provision for income taxes for the quarter ended June 30, 2004 was
$442,000 compared to $291,000 for the same quarter in 2003. The effective tax
rates were 31.1% and 31.0% for the quarters ended June 30, 2004 and 2003,
respectively.
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 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
17
APPALACHIAN BANCSHARES, INC.
June 30, 2004
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,
2003. 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.
In March 2004, the Emerging Issues Task Force (EITF) reached a consensus on
the remaining portions of EITF 03-01, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments, effective for the first
fiscal year or interim period beginning after June 15, 2004. EITF 03-01 provides
new disclosure requirements for other-than-temporary impairments on debt and
equity investments. Investors are required to disclose quantitative information
about: (i) the aggregate amount of unrealized losses, and (ii) the aggregate
related fair values of investments with unrealized losses, segregated into time
periods during which the investment has been in an unrealized loss position of
less than 12 months and greater than 12 months. In addition, investors are
required to disclose the qualitative information that supports their conclusion
that the impairments noted in the qualitative disclosure are not
other-than-temporary. The adoption of this EITF is not expected to have a
material impact on our results of operations or financial condition.
In March 2004, the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) issued SAB No. 105, Application of Accounting
Principles to Loan Commitments. SAB 105
18
APPALACHIAN BANCSHARES, INC.
June 30, 2004
requires that the fair value measurement of mortgage loan commitments, which are
derivatives, exclude any expected future cash flows related to the customer
relationship or servicing rights. The guidance in SAB 105 must be applied to
mortgage loan commitments entered into after March 31, 2004. The impact on the
Company is not material given the declines in mortgage banking volume but could
be in the future. The impact is primarily the timing of when gains should be
recognized in the financial statements.
In December 2003, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
(SOP) 03-3, Accounting for Certain Loans or Debt Securities Acquired in a
Transfer, which addresses the accounting for differences between contractual
cash flows and expected cash flows for loans acquired in a transfer when those
differences are attributable at least in part to a decline in credit quality.
The scope of SOP 03-3 includes loans where there is evidence of deterioration in
credit quality since origination, and includes loans acquired individually, in
pools or as part of a business combination. Under SOP 03-3, the difference
between expected cash flows and the purchase price is accreted as an adjustment
to yield over the life. The Company does not expect its application to have a
material impact on our consolidated financial position or results of operations.
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 June 30, 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.
19
APPALACHIAN BANCSHARES, INC.
June 30, 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.
20
APPALACHIAN BANCSHARES, INC.
June 30, 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.
21
APPALACHIAN BANCSHARES, INC.
June 30, 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.
22
APPALACHIAN BANCSHARES, INC.
June 30, 2004
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 June 30, 2004.
Item 4. Submission of Matters to a Vote for Security Holders
The annual meeting of the shareholders of the Company was held on May 18,
2004 (the "Annual Meeting"), for the purposes of electing the Class I directors
to the Board of Directors of the Company.
The Company's bylaws provide that the Board of Directors shall consist of
not less than four nor more than twenty-five directors, with the exact number to
be fixed by resolution of the Board of Directors from time to time. The Board of
Directors has fixed the number of directors at nine. The Company's Articles of
Incorporation provide for a classified Board of Directors, consisting of three
classes - Class I, Class II and Class III, whereby one-third of the Company's
directors are elected each year, as a class, at the Company's annual meeting of
shareholders to serve a three-year term. The Class I directors were elected at
the Annual Meeting. Each of the Class I director nominees served as a Class I
director prior to the Annual Meeting.
The following persons were nominated and elected to the Board of Directors
as Class I directors, for a term expiring at the 2007 Annual Meeting:
Term
Director Class Of Office Number of Votes:
- -------------------- ----- --------- -------------------------------
For Withheld
--------- ---------
Alan S. Dover I Three Years 2,637,424 88
Charles A. Edmondson I Three Years 2,637,424 88
Roger E. Futch I Three Years 2,637,336 176
23
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) Reports on Form 8-K. The Company filed no reports on Form 8-K during
the quarter ended June 30, 2004, the period for which this report is
filed.
24
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: August 12, 2004 /s/ Tracy R. Newton
-------------------------------
Tracy R. Newton
President and CEO
Dated: August 12, 2004 /s/ Darren M. Cantlay
-------------------------------
Darren M. Cantlay
Chief Financial Officer
25
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 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.
26
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 and six-month periods ended June 30, 2004
and 2003. All share amounts for 2003 have been retroactively adjusted for the
ten percent stock dividend effective July 1, 2003.
Three Months Six Months
Ended June 30, Ended June 30,
----------------------------- -----------------------------
2004 2003 2004 2003
------------- ------------- ------------- --------------
Basic Earnings Per Share:
Net Income................................. $ 979,804 $ 646,495 $ 1,876,257 $ 1,273,130
============= ============= ============= ==============
Earnings on common shares.................. $ 979,804 $ 646,495 $ 1,876,257 $ 1,273,130
============= ============= ============= ==============
Weighted average common shares
outstanding - basic...................... 3,731,399 3,632,324 3,710,836 3,559,051
============= ============= ============= ==============
Basic earnings per common share............ $ 0.26 $ 0.18 $ 0.51 $ 0.36
============= ============= ============= ==============
Diluted Earnings Per Share:
Net Income................................. $ 979,804 $ 646,495 $ 1,876,257 $ 1,273,130
============= ============= ============= ==============
Weighted average common shares
outstanding - diluted.................... 3,885,700 3,815,640 3,874,363 3,753,174
============= ============= ============= ==============
Diluted earnings per common share.......... $ 0.25 $ 0.17 $ 0.48 $ 0.34
============= ============= ============= ==============
27
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: August 12, 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: August 12, 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 June 30, 2004 (the
"Report"), the undersigned, Tracy R. Newton, President and Chief Executive
Officer of the Company, and Darren M. 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: August 12, 2004 By: /s/ Tracy R. Newton
-------------------------------------
Tracy R. Newton
President and Chief Executive Officer
Date: August 12, 2004 By: /s/ Darren M. Cantlay
-------------------------------------
Darren M. Cantlay
Chief Financial Officer