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 SEPTEMBER 30, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____ TO _____
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 - Rule12b-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 November 1, 2004; 3,737,979 Shares
Form 10-Q
APPALACHIAN BANCSHARES, INC.
September 30, 2004
TABLE OF CONTENTS
Page No.
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Financial Condition at September 30, 2004
and December 31, 2003..................................................................... 1
Consolidated Statements of Income For the Three Months
and Nine Months Ended September 30, 2004 and 2003......................................... 2
Consolidated Statements of Comprehensive Income For the Three Months
and Nine Months Ended September 30, 2004 and 2003......................................... 3
Consolidated Statements of Cash Flows For the Nine Months Ended
September 30, 2004 and 2003............................................................... 4
Notes to Consolidated Financial Statements.................................................. 5
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations..................................................................... 11
Item 3 Quantitative and Qualitative Disclosures about Market Risk.................................. 19
Item 4 Controls and Procedures..................................................................... 22
Part II. Other Information
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds................................. 23
Item 6 Exhibits.................................................................................... 23
Signatures........................................................................................... 24
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, 2004 (Unaudited) and December 31, 2003
September 30,
2004 December 31,
(Unaudited) 2003
Assets
Cash and due from banks...................................................... $ 7,154,144 $ 6,530,984
Interest bearing deposits with other banks................................... 9,720,789 273,841
Federal funds sold........................................................... 1,790,000 586,000
Cash and Cash Equivalents............................................. 18,664,933 7,390,825
Securities available-for-sale................................................ 56,198,872 55,363,327
Loans........................................................................ 370,062,492 332,306,446
Allowance for loan losses.................................................... (4,256,628) (3,609,794)
Net Loans............................................................. 365,805,864 328,696,652
Premises and equipment, net.................................................. 12,923,619 9,161,652
Accrued interest............................................................. 2,522,125 2,289,994
Cash surrender value of life insurance....................................... 7,753,072 2,592,416
Intangibles, net............................................................. 2,125,058 2,157,433
Other assets................................................................. 1,379,917 1,965,179
Total Assets.......................................................... $ 467,373,460 $ 409,617,478
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Noninterest-bearing..................................................... $ 31,780,016 $ 23,795,787
Interest-bearing........................................................ 339,285,086 309,123,161
Total Deposits........................................................ 371,065,102 332,918,948
Short-term borrowings..................................................... 13,018,035 7,085,992
Accrued interest.......................................................... 586,151 670,614
Long-term debt............................................................ 40,371,429 30,692,858
Subordinated long-term capital notes...................................... 6,186,000 6,186,000
Other liabilities......................................................... 1,549,953 980,713
Total Liabilities..................................................... 432,776,670 378,535,125
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 September 30, 2004,
and 3,734,686 shares issued at December 31, 2003........................ 38,121 37,347
Paid-in capital........................................................... 23,170,052 22,727,208
Retained earnings......................................................... 11,532,519 8,588,160
Accumulated other comprehensive income: net unrealized
holding gains on securities available-for-sale, net of
deferred income tax..................................................... 555,894 429,434
Treasury stock, at cost (75,973 shares at September 30,
2004 and at December 31, 2003).......................................... (699,796) (699,796)
Total Shareholders' Equity............................................ 34,596,790 31,082,353
Total Liabilities and Shareholders' Equity............................ $ 467,373,460 $ 409,617,478
See notes to consolidated financial statements
1
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the Three Months and Nine Months Ended September 30, 2004 and 2003
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
Interest Income
Interest and fees on loans............. $ 6,028,139 $ 5,357,283 $ 17,309,728 $ 15,909,412
Interest on investment securities:
Taxable securities................... 335,412 182,740 1,006,195 707,463
Nontaxable securities................ 162,881 182,017 487,847 539,051
Interest on deposits in other banks.... 623 104 2,073 28,816
Interest on federal funds sold......... 8,589 5,261 15,789 34,384
Total Interest Income.............. 6,535,644 5,727,405 18,821,632 17,219,126
Interest Expense
Interest on deposits................... 1,585,469 1,572,091 4,508,485 5,516,094
Interest on federal funds purchased
and securities sold under
agreements to repurchase............. 35,884 20,443 76,850 64,338
Interest expense on long-term debt..... 235,204 283,254 675,616 945,209
Interest on subordinated debentures.... 70,000 21,300 198,400 21,300
Total Interest Expense............. 1,926,557 1,897,088 5,459,351 6,546,941
Net Interest Income....................... 4,609,087 3,830,317 13,362,281 10,672,185
Provision for loan losses................. 274,000 385,000 925,107 1,105,000
Net Interest Income After
Provision for Loan Losses.............. 4,335,087 3,445,317 12,437,174 9,567,185
Noninterest Income
Customer service fees.................. 312,051 207,362 887,375 598,120
Insurance commissions.................. 12,736 8,507 39,067 55,219
Mortgage origination fees.............. 196,357 358,585 640,273 1,060,205
Other operating income................. 204,779 147,712 540,141 380,772
Investment securities losses........... -- -- (22,633) (16,978)
Total Noninterest Income........... 725,923 722,166 2,084,223 2,077,338
Noninterest Expenses
Salaries and employee benefits......... 1,786,710 1,467,070 5,029,721 4,161,198
Occupancy expense...................... 229,557 149,708 604,176 464,317
Furniture and equipment expense........ 301,597 236,636 844,484 724,569
Other operating expenses............... 1,190,044 1,152,216 3,744,957 3,312,456
Total Noninterest Expenses......... 3,507,908 3,005,630 10,223,338 8,662,540
Income before income taxes................ 1,553,102 1,161,853 4,298,059 2,981,983
Income tax expense........................ 485,000 365,000 1,353,700 912,000
Net Income................................ $ 1,068,102 $ 796,853 $ 2,944,359 $ 2,069,983
Earnings Per Common Share
Basic.................................. $ 0.29 $ 0.22 $ 0.79 $ 0.58
Diluted................................ 0.27 0.21 0.76 0.55
Cash Dividends Declared
Per Common Share....................... $ 0.00 $ 0.00 $ 0.00 $ 0.00
Weighted Average Shares Outstanding
Basic.................................. 3,736,079 3,660,485 3,719,312 3,599,384
Diluted................................ 3,894,699 3,822,959 3,879,415 3,771,632
See notes to consolidated financial statements
2
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Three Months and Nine Months Ended September 30, 2004 and 2003
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
Net Income........................................ $ 1,068,102 $ 796,853 $ 2,944,359 $ 2,069,983
Other comprehensive, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)
arising during the period.................. 1,336,709 (779,005) 168,973 (280,024)
Reclassification adjustments for losses
included in net income..................... -- -- 22,633 16,978
Net unrealized gains (losses).............. 1,336,709 (779,005) 191,606 (263,046)
Income tax expense related to items of
other comprehensive income (loss)............ (454,481) 264,862 (65,146) 89,436
Other comprehensive income (loss)................. 882,228 (514,143) 126,460 (173,610)
Comprehensive Income.............................. $ 1,950,330 $ 282,710 $ 3,070,819 $ 1,896,373
See notes to consolidated financial statements
3
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2004 and 2003
(Unaudited)
Nine Months Ended
September 30,
2004 2003
Operating Activities
Net income................................................................ $ 2,944,359 $ 2,069,983
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for loan losses............................................... 925,107 1,105,000
Net depreciation and amortization....................................... 774,826 638,095
Realized investment security losses..................................... 22,633 16,978
Loss on disposition of other real estate................................ 180,717 --
(Increase) decrease in accrued interest receivable...................... (232,131) 10,134
Increase in cash surrender value of life insurance...................... (160,656) (81,880)
Decrease in accrued interest payable.................................... (84,463) (339,449)
Other, net.............................................................. 645,569 1,296,377
Net Cash Provided by Operating Activities............................. 5,015,961 4,715,238
Investing Activities
Purchase of securities available-for-sale, net............................ (783,192) (11,103,857)
Net increase in loans to customers........................................ (38,511,591) (27,777,409)
Capital expenditures, net................................................. (4,387,419) (470,659)
Purchase of insurance contracts........................................... (5,000,000) --
Proceeds from the disposition of foreclosed real estate................... 739,963 698,113
Net Cash Used in Investing Activities................................. (47,942,239) (38,653,812)
Financing Activities
Net increase in demand deposits, NOW accounts,
and savings accounts.................................................... 33,627,223 7,008,132
Net increase (decrease) in certificates of deposit........................ 4,518,931 (3,519,970)
Net increase (decrease) in short-term borrowings.......................... 5,932,043 (416,819)
Proceeds from long-term debt.............................................. 40,400,000 33,550,000
Repayment of long-term debt............................................... (30,721,429) (24,571,428)
Proceeds from issuance of common stock.................................... 405,958 302,800
Payments to repurchase common stock....................................... -- (54,900)
Proceeds from sale of treasury stock...................................... -- 1,923,595
Cash paid in lieu of fractional shares on stock dividend.................. -- (1,931)
Compensation associated with issuance of stock options.................... 37,660 13,599
Net Cash Provided by Financing Activities.................................... 54,200,386 14,233,078
Net Increase (Decrease) in Cash and Cash Equivalents......................... 11,274,108 (19,705,496)
Cash and Cash Equivalents at Beginning of Period............................. 7,390,825 30,856,697
Cash and Cash Equivalents at End of Period................................... $ 18,664,933 $ 11,151,201
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for:
Interest................................................................ $ 5,543,814 $ 6,886,390
Income taxes............................................................ 1,270,000 230,000
See notes to consolidated financial statements
4
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 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 nine-month period ended September 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)
September 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 31.5% and 30.6% for the nine
months ended September 30, 2004 and 2003, respectively, and 31.2 % and 31.4% for
the three months ended September 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 September 30, 2004, the Company had net unrealized gains of $842,264 in
available-for-sale securities, which are reflected in the presented assets and
resulted in an increase in shareholders' equity of $555,894, net of deferred tax
benefit for the nine months ended September 30, 2004. 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 September 30, 2004, was $126,460.
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)
September 30, 2004
Note F - Intangibles
Amortizable intangible assets and acquired goodwill as of September 30,
2004, and December 31, 2003, are detailed as follows:
Amortizable Intangibles
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
As of September 30, 2004:
Noncompete agreements.................................... $ 165,000 $ 165,000 $ --
Debt issuance costs...................................... 170,000 36,833 133,167
Total.................................................... $ 335,000 $ 201,833 $ 133,167
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
nine months ended September 30, 2004 and the year ended December 31, 2003 was
$32,375 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
September 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 following table 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)
September 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 129,700 shares of the Company's common stock are
outstanding at September 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). The majority of 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 September 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 Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
Net Income
As Reported......................... $ 1,068,102 $ 796,853 $ 2,944,359 $ 2,069,983
Add: Stock-based compensation expense
included in net income, net of
related taxes................. 24,092 7,056 37,660 13,599
Deduct: Total stock-based employee
compensation expense
determined under fair value
based method for all awards,
net of tax................. (28,650) (17,006) (51,320) (45,775)
Pro forma net income................ $ 1,063,544 $ 786,903 $ 2,930,699 $ 2,037,807
8
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 2004
Note G - Stock Based Compensation - Continued
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
Basic earnings per share:
As Reported......................... $ 0.29 $ 0.22 $ 0.79 $ 0.58
Pro forma........................... $ 0.28 $ 0.21 $ 0.79 $ 0.57
Diluted earnings per share:
As Reported......................... $ 0.27 $ 0.21 $ 0.76 $ 0.55
Pro forma........................... $ 0.27 $ 0.21 $ 0.76 $ 0.54
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 are agreements 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 September 30, 2004 and December
31, 2003, the Company has issued standby letters of credit of approximately
$1,285,000 and $1,111,000, respectively. The Company records the contract amount
of the letters of credit as an asset and records a corresponding liability in
the same amount until the letters of credit are exercised. Upon exercise, the
amount exercised is recorded as a loan.
9
APPALACHIAN BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 2004
Note H - Commitments and Contingencies - Continued
Loan Commitments: As of September 30, 2004, and December 31, 2003, the
Company had commitments outstanding to extend credit totaling approximately
$56,515,000 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 that arise in the
normal course of business. Management, after consultation with legal counsel,
believes that the liabilities, if any, relating to 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 in Ellijay, Georgia, to be used for a new corporate office facility.
During the quarter ended September 30, 2004, the Company began site preparation,
and completion of this facility is expected in the summer of 2005.
During August 2004, the Company paid approximately $1 million for
additional property to be used for a new branch office. The property consists of
approximately 2 acres located in the new Highlands Shopping Center, in East
Ellijay on Highway 515 South.
10
APPALACHIAN BANCSHARES, INC.
September 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
September 30, 2004 compared to December 31, 2003
Loans
Loans comprised the largest single category of the Company's earning assets
at September 30, 2004. Loans, net of unearned income and allowance for loan
losses, were 78.3% of total assets at September 30, 2004. Total net loans were
$365,805,864 at September 30, 2004, representing an 11.3% increase from
$328,696,652 at December 31, 2003. Loan demand in the local markets has remained
strong due to the current interest rate environment, the amount of development
occurring in the markets that we serve, and the relationships that our employees
have built within the communities that we serve.
11
APPALACHIAN BANCSHARES, INC.
September 30, 2004
Investment Securities and Other Earning Assets
Investment securities at September 30, 2004 were $56,198,872 compared with
$55,363,327 at December 31, 2003, reflecting a 1.5% increase of $835,545.
Federal funds sold were $1,790,000 at September 30, 2004, compared to the
December 31, 2003 total of $586,000, a 205.5% 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 1.5% at December 31, 2003 to 1.9% at
September 30, 2004. Total non-performing assets at September 30, 2004, were
$2,283,740, which consisted of: $1,751,920 in loans secured by real estate;
$24,629 in consumer loans; $12,964 in commercial, financial and agricultural
loans; $189,287 in other loans; and $304,940 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 0.49% at September 30, 2004, and the ratio of nonperforming
loans to total loans increased from 0.50% at December 31, 2003 to 0.53% at
September 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 September 30, 2004 were $371,065,102, an increase of
$38,146,154 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 $7,984,229, or 33.6%, from year-end 2003
to $31,780,016 at September 30, 2004, and interest-bearing deposits increased
$30,161,925, or 9.8%, during the same period to $339,285,086. Over the past 12
months, the Company has focused on increasing its core deposit base and during
the first three 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, as well as local CD deposit specials.
Short-term Borrowings
Short-term borrowings at September 30, 2004 and December 31, 2003 consist of the
following:
September 30, December 31,
2004 2003
Federal funds purchased..................................................... $ -- $ 3,000,000
Securities sold under agreements to repurchase.............................. 13,018,035 4,085,992
$ 13,018,035 $ 7,085,992
12
APPALACHIAN BANCSHARES, INC.
September 30, 2004
Securities sold under agreements to repurchase totaled $13,018,035 at
September 30, 2004, an $8,932,043 increase 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 September 30, 2004
decreased by $3,000,000 from December 31, 2003.
Shareholders' Equity
Shareholders' equity increased $3,514,437, from $31,082,353 at December 31,
2003 to $34,596,790 at September 30, 2004. This increase was mainly attributable
to net earnings of $2,944,359, proceeds from the issuance of stock of $443,618,
as well as an increase of 126,460 in the unrealized gains on available for sale
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 or reprice in one year or less equaled approximately $253.3
million, or 68.4%, of the total loan portfolio at September 30, 2004, and
investment securities that are estimated to mature or reprice in one year or
less equaled approximately $6.9 million or 12.3% 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
September 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
September 30, 2004, the outstanding balance of the Bank's federal funds
purchased was $-0-.
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,
13
APPALACHIAN BANCSHARES, INC.
September 30, 2004
the Bank is able to improve its ability to manage liquidity and reduce interest
rate risk by having a funding source to match longer-term loans. The Bank's
credit line stands at $68,060,000 as of September 30, 2004. This line is subject
to collateral availability. At September 30, 2004, the outstanding balance of
the Bank's credit line was $40,371,429.
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" and
under "Notes to Consolidated Financial Statements," included under Item 1 of
Part I of this Quarterly Report on Form 10-Q. 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
regulatory guidelines mandating minimum "risk-based" and "leverage" 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 $38.2 million at September 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 $42.5
million at September 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 September 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
September 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 or by the Company to its shareholders.
14
APPALACHIAN BANCSHARES, INC.
September 30, 2004
RESULTS OF OPERATIONS
Three and nine months ended September 30, 2004 and 2003
Summary
Net earnings for the nine months ended September 30, 2004 were $2,944,359,
compared to net earnings of $2,069,983 for the same period in 2003. This 42.2%
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 $2,690,096, or 25.2%, during the
first nine months of 2004, compared to the same period in 2003; noninterest
expenses increased $1,560,798, or 18.0%, during the same period, while
noninterest income increased by only $6,885, or 0.3%. Total interest expense
decreased $1,087,590, or 16.6%, during the first nine months of 2004, compared
to the same period in 2003.
Net earnings for the three months ended September 30, 2004, were
$1,068,102, compared to net earnings of $796,853 for the three months ended
September 30, 2003. This represents a 34.0% increase as compared to the same
period in 2003 and is a result of the same causes noted for the nine months
ended September 30, 2004 and 2003. Total interest expense increased by $29,469
compared to the same period in 2003. Net interest income increased $778,770
during the three months ended September 30, 2004, as compared to the same period
in 2003; noninterest expenses increased $502,278 during the same period, while
noninterest income increased by $3,757.
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 nine
months ended September 30, 2004 increased $1,602,506, or 9.3%, from the same
period in 2003. Interest expense for the nine months ended September 30, 2004
decreased $1,087,590, or 16.6%, compared to the same period in 2003.
Net interest income increased $778,770 or 20.3% during the three months
ended September 30, 2004, as compared to the same period in 2003, resulting from
an increase of $808,239, or 14.1%, in revenue from earning assets, coupled with
an increase in total interest expense of $29,469, or 1.6%.
Generally, the overall increase in net interest income, for the three
months and nine months ended September 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
15
APPALACHIAN BANCSHARES, INC.
September 30, 2004
for loan losses was $925,107 for the nine months ended September 30, 2004,
compared to $1,105,000 for the same period of 2003. Charge-offs exceeded
recoveries by $278,273 for the nine months ended September 30, 2004. The
allowance for loan losses as a percent of outstanding loans, net of unearned
income, was 1.15% and 1.09% at September 30, 2004, and at year-end 2003,
respectively.
For the three months ended September 30, 2004 and 2003, the provision for
loan losses was $274,000 and $385,000, 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 $197,008 for the three months ended September 30, 2004.
Noninterest Income
Noninterest income for the nine months ended September 30, 2004 was
$2,084,223, compared to $2,077,338 for the same period in 2003. There was an
increase of $289,255 in the collection of service charges on deposit accounts,
and a decrease of $419,932 in mortgage origination fees. Other operating income
increased by $159,369 for the first nine months of 2004, as compared to the same
period in 2003. These increases consisted of approximately $81,000 in additional
earnings on the cash surrender value of life insurance and approximately $40,000
in additional income related to our merchant credit card program, as well as
increases in various other fees. Due to the drop off in mortgage originations,
the Company is looking for other ways to supplement the income. Additional
products and services will be added to supplement our earnings and limit our
reliance on market conditions.
Noninterest income increased by only $3,757 or 0.5% in the three months
ended September 30, 2004, as compared to the same period in 2003. Although
mortgage origination fees dropped $162,228 during the quarter, service charges
on deposit accounts increased by $104,689. Other operation income increased by
$57,067 for the quarter ended September 30, 2004, as compared to the same period
in 2003. These increases consisted of additional earnings on the cash surrender
value of life insurance of approximately $54,000, and additional income related
to our merchant credit card program of approximately $18,000.
Noninterest Expenses
Noninterest expenses increased by $1,560,798, or 18.0%, for the nine months
ended September 30, 2004, compared to the same period in 2003, relating, in part
to an increase in salaries and employee benefits of $868,523, or 20.9%, for the
nine months ended September 30, 2004, compared to the same period in 2003. This
increase in 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 $139,859, and furniture and equipment
expense increased by $119,915, compared to the same period in 2003. Other
operating expenses increased by $432,501 for the first nine months of 2004, as
compared to the same period in 2003, due in part to compliance with the
Sarbanes-Oxley Act of 2002, as well as the overall growth of the Company.
Noninterest expenses increased by $502,278, or 16.7%, for the quarter ended
September 30, 2004, as compared to the same period in 2003. Salaries and
employee benefits increased by $319,640, or 21.8%, for the three months ended
September 30, 2004, compared to the same period in 2003. Occupancy costs
increased by $79,849, furniture and equipment expense increased $64,961 and
16
APPALACHIAN BANCSHARES, INC.
September 30, 2004
other operating expenses increased by $37,828 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 nine months ended September 30,
2004 was $1,353,700, an increase of $441,700, 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 nine months of 2004, in addition to the fact
that the non-taxable items remained relatively constant. The effective tax rates
were 31.5% and 30.6% for the nine months ended September 30, 2004 and 2003,
respectively.
The provision for income taxes for the quarter ended September 30, 2004 was
$485,000 compared to $365,000 for the same quarter in 2003. The effective tax
rates were 31.2% and 31.4% for the quarters ended September 30, 2004 and 2003,
respectively.
Recently Issued Accounting Standards
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. Neither the
adoption of the disclosure requirements of Interpretation No. 45 nor the
adoption of the initial recognition and initial measurement provisions of
Interpretation No. 45 had a material impact on the Company's consolidated
financial statements.
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,
17
APPALACHIAN BANCSHARES, INC.
September 30, 2004
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
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 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 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
18
APPALACHIAN BANCSHARES, INC.
September 30, 2004
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 the application of SOP 03-03
to have a material impact on our consolidated financial position or results of
operations.
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 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.
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 September 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
19
APPALACHIAN BANCSHARES, INC.
September 30, 2004
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. 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.
September 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.
September 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.
September 30, 2004
PART II - Other Information
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The Company did not sell any unregistered equity securities of the Company
or repurchase any shares of its common stock during the quarter ended
September 30, 2004.
Item 6. 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 Companyss
Quarterly Report on Form 10-Q, dated August 15, 2003 (File No. 000-21383)).
10.1 Form of Change in Control Agreement for Named Executive Officers (and description of benefits
for each Named Executive Officer).
10.2 Form of Salary Continuation Agreement for Named Executive Officers (and description of benefits
for each Named Executive Officer).
10.3 Form of Salary Continuation Agreement for the Directors of Appalachian Community Bank (and
description of benefits for each of the Directors).
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.
23
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: November 12, 2004 /s/ Tracy R. Newton
----------------------------------
Tracy R. Newton
President and CEO
Dated: November 12, 2004 /s/ Darren M. Cantlay
----------------------------------
Darren M. Cantlay
Chief Financial Officer
24
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)).
10.1 Form of Change in Control Agreement for Named Executive Officers (and description of benefits for each
Named Executive Officer).
10.2 Form of Salary Continuation Agreement for Named Executive Officers (and description of benefits for
each Named Executive Officer).
10.3 Form of Salary Continuation Agreement for the Directors of Appalachian Community Bank (and description
of benefits for each of the Directors).
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.
25
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 nine-month periods ended September 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 Nine Months
Ended September 30, Ended September 30,
2004 2003 2004 2003
Basic Earnings Per Share:
Net Income.................................... $ 1,068,102 $ 796,853 $ 2,944,359 $ 2,069,983
Earnings on common shares..................... $ 1,068,102 $ 796,853 $ 2,944,359 $ 2,069,983
Weighted average common shares
outstanding - basic......................... 3,736,079 3,660,485 3,719,312 3,599,384
Basic earnings per common share............... $ 0.29 $ 0.22 $ 0.79 $ 0.58
Diluted Earnings Per Share:
Net Income.................................... $ 1,068,102 $ 796,853 $ 2,944,359 $ 2,069,983
Weighted average common shares
outstanding - diluted....................... 3,894,699 3,822,959 3,879,415 3,771,632
Diluted earnings per common share............. $ 0.27 $ 0.21 $ 0.76 $ 0.55
26
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: November 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: November 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 September 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: November 12, 2004 By: /s/ Tracy R. Newton
-----------------------------------------
Tracy R. Newton
President and Chief Executive Officer
Date: November 12, 2004 By: /s/ Darren M. Cantlay
------------------------------------------
Darren M. Cantlay
Chief Financial Officer