<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[ X ] Quarterly Report Pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934 for the period
ended September 30, 1998
[ ] Transition report under Section 13 or 15(d) of the Exchange Act
for the transition period from to
----- -----
Commission file number: 000-21383
APPALACHIAN BANCSHARES, INC.
(Exact name of small business issuer as specified in its charter)
Georgia 58-2242407
(State of Incorporation) (I.R.S. Employer Identification No.)
829 Industrial Blvd.
Ellijay, Georgia 30540
(Address of principal executive offices)
(706) 276-8000
(Issuer's telephone number, including area code)
Check whether the issuer (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 [ ]
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
<TABLE>
<CAPTION>
Class Outstanding at October 30, 1998
----- -------------------------------
<S> <C>
Common Stock, $5.00 par value 1,153,620
</TABLE>
Transitional Small Business Disclosure Format: Yes [ ] No [ X ]
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APPALACHIAN BANCSHARES, INC.
September 30, 1998 Form 10-QSB
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
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<S> <C> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets . . . . . . . . . . . . . . . . 3
Consolidated Statements of Income . . . . . . . . . . . . . 4
Consolidated Statements of Comprehensive Income . . . . . . 5
Consolidated Statements of Cash Flows . . . . . . . . . . . 6
Notes to Consolidated Financial Statements . . . . . . . . 7
Item 2. Management's Discussion and Analysis or Plan of Operation . 8
PART II. OTHER INFORMATION
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . 17
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . 17
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
APPALACHIAN BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, 1998 December 31,
ASSETS (Unaudited) 1997
------------------ -------------
<S> <C> <C>
Cash ................................................................... $ 1,238,228 $ 1,040,359
Due from banks ......................................................... 2,777,318 2,343,174
Federal funds sold ..................................................... 7,256,801 1,828,000
Securities available for sale .......................................... 18,906,938 15,144,585
Securities held to maturity (fair market value $5,461,489 at
September 30, 1998 and $4,308,947 at December 31, 1997) ............ 5,268,711 4,181,021
Loans .................................................................. 94,502,411 84,583,853
Allowance for loan losses .............................................. (1,089,714) (929,590)
------------- -------------
Net Loans .............................................................. 93,412,697 83,654,263
Premises and equipment, net ............................................ 1,965,813 1,653,043
Cash surrender value on life insurance ................................. 608,011 585,615
Accrued interest ....................................................... 1,051,028 971,550
Other assets ........................................................... 458,524 779,180
------------- -------------
TOTAL ASSETS .................................................. $ 132,944,069 $ 112,180,790
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits:
Noninterest-bearing ............................................. $ 5,205,139 $ 3,800,911
Interest-bearing ................................................ 108,681,716 91,547,035
------------- -------------
TOTAL DEPOSITS ................................................ 113,886,855 95,347,946
Securities sold under agreements to repurchase ..................... 3,809,051 4,228,129
Accrued interest ................................................... 200,405 188,230
Long-term debt ..................................................... 6,598,571 5,320,000
Other liabilities .................................................. 541,686 116,432
------------- -------------
TOTAL LIABILITIES ............................................... 125,036,568 105,200,737
------------- -------------
SHAREHOLDERS' EQUITY:
Common stock ($5.00 par value; 20,000,000 shares authorized,
1,197,620 and 1,184,574 shares issued at September 30, 1998
and December 31, 1997, respectively) ............................ 5,988,100 5,922,870
Treasury Stock (44,000 shares at cost at September 30, 1998;
30,000 shares at cost at December 31, 1997) ..................... (428,000) (274,000)
Capital surplus ..................................................... 202,290 135,051
Retained earnings ................................................... 2,024,964 1,186,359
Accumulated comprehensive income: unrealized gains on investment
securities available for sale, net of tax ....................... 120,147 9,773
------------- -------------
TOTAL SHAREHOLDERS' EQUITY .................................... 7,907,501 6,980,053
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .................... $ 132,944,069 $ 112,180,790
============= =============
</TABLE>
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APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
----------------------------- -----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUE FROM EARNING ASSETS:
Interest and fees on loans .............................. $ 2,339,850 $ 1,934,133 $ 6,764,262 $ 5,516,722
Interest on investment securities:
Taxable securities .................................. 163,808 279,530 723,380 902,183
Nontaxable securities ............................. 204,610 49,129 313,838 117,326
Interest on federal funds sold .......................... 53,019 35,392 151,248 107,554
----------- ----------- ----------- -----------
TOTAL REVENUE FROM EARNING ASSETS ................. 2,761,287 2,298,184 7,952,728 6,643,785
INTEREST EXPENSE:
Interest on deposits .................................... 1,477,048 1,254,801 4,240,734 3,606,407
Interest on federal funds purchased and
securities sold under agreements to repurchase ...... 47,610 53,102 136,928 153,749
Interest expense - long term debt ...................... 95,449 38,996 288,134 75,111
----------- ----------- ----------- -----------
TOTAL INTEREST EXPENSE ............................ 1,620,107 1,346,899 4,665,796 3,835,267
NET INTEREST INCOME: ....................................... 1,141,180 951,285 3,286,932 2,808,518
Provision for loan losses ............................... 60,000 85,000 240,000 300,000
----------- ----------- ----------- -----------
AFTER PROVISION FOR LOAN LOSSES ......................... 1,081,180 866,285 3,046,932 2,508,518
NONINTEREST INCOME:
Service charges on deposits ............................. 54,638 47,811 165,583 143,498
Insurance commissions ................................... 7,321 4,110 16,822 16,255
Other operating income .................................. 65,550 46,371 178,477 124,715
Investment securities gains ............................. 1,475 838 15,950 203
----------- ----------- ----------- -----------
TOTAL NONINTEREST INCOME .......................... 128,984 99,130 376,832 284,671
NONINTEREST EXPENSES:
Salaries and employee benefits .......................... 371,016 288,884 1,037,601 836,171
Occupancy expense ....................................... 35,604 27,228 100,719 73,554
Furniture and equipment expense ......................... 45,991 35,392 133,214 114,263
Other operating expenses ................................ 330,563 254,947 913,625 731,113
----------- ----------- ----------- -----------
TOTAL NONINTEREST EXPENSES ........................ 783,174 606,451 2,185,159 1,755,101
Income before income taxes ................................. 426,990 358,964 1,238,605 1,038,088
Income tax provision ....................................... (120,000) (120,000) (400,000) (335,000)
----------- ----------- ----------- -----------
NET INCOME .................................... $ 306,990 $ 238,964 $ 838,605 $ 703,088
=========== =========== =========== ===========
EARNINGS PER COMMON SHARE -BASIC AND DILUTED
Basic earnings per common share ......................... $ .27 $ .21 $ .73 $ .61
Basic weighted average shares outstanding ............... 1,150,321 1,147,588 1,150,050 1,147,588
Diluted earnings per common share ....................... $ .25 $ .20 $ .70 $ .60
Diluted weighted average shares outstanding ............. 1,237,276 1,179,260 1,194,275 1,179,260
</TABLE>
See notes to financial statements
4
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APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
------------------------- -------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net Income ........................................... $ 306,990 $ 238,964 $ 838,605 $ 703,088
Other comprehensive income, net of tax:
Unrealized gains on securities: Unrealized holding 215,389 103,215 183,184 45,821
gains (losses) arising during the period
Less: reclassification adjustments for gains
(losses) included in net income .................. 1,475 838 15,950 203
--------- --------- --------- ---------
213,914 102,377 167,234 45,618
Income tax benefit related to items of other
comprehensive income .............................. (72,731) (34,808) (56,860) (15,510)
--------- --------- --------- ---------
Other comprehensive income ........................... 141,183 67,569 110,374 30,108
--------- --------- --------- ---------
COMPREHENSIVE INCOME ................................. $ 448,173 $ 306,533 $ 948,979 $ 733,196
========= ========= ========= =========
</TABLE>
See notes to financial statements.
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APPALACHIAN BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30
-------------------------------
1998 1997
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income ................................................................ $ 838,605 $ 703,088
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses ................................................. 240,000 300,000
Provision for depreciation and amortization ............................... 139,342 124,785
Amortization of investment security premiums
and accretion of discounts ............................................ 4,256 6,195
Deferred tax .............................................................. 0 (1,475)
Realized investment security (gains) ...................................... (15,950) (203)
Increase in accrued interest receivable ................................... (79,479) (199,265)
Increase in accrued interest payable ...................................... 12,175 37,786
Increase in cash surrender value on life insurance ........................ (22,396) 0
Purchase of key man life insurance ........................................ 0 (570,871)
Other ..................................................................... 273,340 382,554
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES ........................... 1,389,893 782,595
INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale ...................... 18,413,419 6,040,735
Purchase of securities available for sale ................................. (21,054,964) (2,996,019)
Purchase of securities held to maturity ................................... (1,629,570) (1,285,848)
Net increase in loans to customers ........................................ (9,998,434) (14,421,377)
Capital expenditures ...................................................... (436,401) (49,966)
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES ............................... (14,705,950) (12,712,475)
FINANCING ACTIVITIES:
Net increase in demand deposits, NOW accounts,
and savings accounts .................................................. 13,592,968 8,657,631
Net increase in certificates of deposit ................................... 4,945,941 2,046,587
Net increase(decrease)in securities sold under agreement to repurchase .... (419,078) 755,307
Proceeds from issuance of common stock ................................... 132,469 388,608
Purchase of treasury stock ................................................ (154,000) (274,000)
Proceeds from notes payable ............................................... 1,278,571 300,000
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES ........................... 19,376,871 11,874,133
------------ ------------
Net increase (decrease) in cash and cash equivalents ......................... 6,060,814 (55,747)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ............................. 9,707,049 3,674,393
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ................................... $ 15,767,863 $ 3,618,646
------------ ------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period
for:
Interest .............................................................. $ 4,653,621 $ 3,643,020
Income taxes .......................................................... 452,000 62,278
</TABLE>
See notes to financial statements
6
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APPALACHIAN BANCSHARES, INC.
NOTES TO FINANCIAL STATEMENTS
(unaudited)
September 30, 1998
NOTE A - BASIS OF PRESENTATION
The consolidated financial statements include the accounts of
Appalachian Bancshares, Inc. (the "Company") and its wholly-owned subsidiary,
Gilmer County Bank (the "Bank"). The accompanying unaudited financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-QSB and
Regulation S-B. 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,
1998 are not necessarily indicative of the results that may be expected for the
year ending December 31, 1998. For further information, refer to the financial
statements for Appalachian Bancshares, Inc. for the year ended December 31,
1997, and footnotes thereto included in Form 10-KSB, filed with the Securities
and Exchange Commission on March 31, 1998.
NOTE B - INCOME TAXES
The effective tax rate of approximately 32 percent for the three months
ended September 30, 1998 approximates the federal and state statutory rates less
an adjustment for the effect of tax exempt securities.
NOTE C - INVESTMENT SECURITIES
The Company applies the accounting and reporting requirements of
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities ("SFAS 115"). 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 Shareholder's equity (net of deferred tax effect).
At September 30, 1998, the Company had net unrealized gains of $182,041
in available-for-sale securities which are reflected in the presented assets and
resulted in a increase in Shareholder's equity of $120,147, net of deferred tax
liability. There were no trading securities. The net increase in Shareholder's
Equity as a result of the SFAS 115 adjustment from December 31, 1997 to
September 30, 1998 was $110,374.
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NOTE D - STOCK SPLIT
In May 1998, the Company effected a two-for-one share split of its
Common Stock in the form of a common stock dividend, payable on or about May 15,
1998 to shareholders of record as of the close of business on May 1, 1998. All
amounts presented in the financial statements are adjusted to reflect this share
split. The common stock was increased by $2,983,050 and capital surplus
decreased by $2,983,050 as of May 1, 1998, the effective date of the split.
Retroactive statement of the stock split has been applied to the December 31,
1997 financial statements which resulted in a $2,961,435 increase to common
stock and corresponding decrease of $2,961,435 to capital surplus effective
December 31, 1997. This net effect did not change total stockholders' equity.
NOTE E - SUBSEQUENT EVENTS
On July 10, 1998, the Company executed a definitive agreement with
Century South Banks, Inc. ("Century South") for the acquisition by the Company
of First National Bank of Union County ("First National"), a wholly-owned
subsidiary of Century South. The agreement provides that, subject to regulatory
approval, the Company will acquire First National from Century South, in a cash
transaction, for $6.1 million, with the assumption of certain existing
liabilities and assets of First National by Century South or certain of its
affiliates. First National will operate as a wholly-owned subsidiary of the
Company and will continue its business and operations in Union County, Georgia.
On September 28, 1998 the Company filed applications with Federal Reserve Bank
of Atlanta and the DBF for approval of the acquisition.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Report, including the Management's Discussion and Analysis which
follows, contains forward-looking statements in addition to historical
information, including but not limited to statements regarding Management's
beliefs, current expectations, estimates and projections about the financial
services industry, the economy, and about the Company and the Bank in general.
Such forward-looking statements are subject to certain factors that could cause
actual results to differ materially from historical results or anticipated
events, trends or results. These factors include, but are not limited to, (i)
increased competition with other financial institutions, (ii) lack of sustained
growth in the economy in Gilmer County, primarily in the local poultry industry,
(iii) rapid fluctuations in interest rates, (iv) the inability of the Bank to
maintain regulatory capital standards, (v) changes in the legislative and
regulatory environment, and (vi) potential adverse effects on the economy and
the Bank of the Year 2000 computer problem.
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 the September 30, 1998 Form 10-QSB and Management's Discussion and
Analysis of Financial Condition and Results of Operations for the year ended
December 31, 1997 appearing in the Company's Form 10-KSB filed with the
Securities and Exchange Commission on March 31, 1998.
8
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FINANCIAL CONDITION
SEPTEMBER 30, 1998 COMPARED TO DECEMBER 31, 1997
LOANS
Loans comprised the largest single category of the Company's earning
assets on September 30, 1998. Loans, net of unearned income and reserve for loan
losses, were 70.3% of total assets at September 30, 1998. Total net loans were
$93,412,697 at September 30, 1998, representing a 11.7% increase from the
December 31, 1997 total of $83,654,263. This increase reflects the continued
increase in loan demand for the Bank's market area coupled with an increase in
the Bank's market share for this area.
INVESTMENT SECURITIES AND OTHER EARNING ASSETS
Investment securities and federal funds sold increased $10,278,844, or
48.6%, from December 31, 1997 to September 30, 1998. Investment securities at
September 30, 1998 were $24,175,649 compared with $19,325,606 at December 31,
1997, reflecting a 25.1% increase of $4,850,043. Federal funds sold were
$7,256,801 at September 30, 1998 compared to the December 31, 1997 total of
$1,828,000, a 297.0% 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. Federal funds sold are
maintained as a tool in managing the daily cash needs of the Company. The
increases are the result of Management's plan to improve the Company's liquidity
position relative to the current size of the Company.
ASSET QUALITY
Asset quality is measured by three key ratios. The ratio of loan loss
allowance to total nonperforming assets (defined as nonaccrual loans, loans past
due 90 days or greater, restructured loans, nonaccruing securities, and other
real estate) decreased from 33.21 to 7.23. Total nonperforming assets at
September 30, 1998 were $150,791, which consisted of three collateralized
residential real estate loans. Nonperforming assets at December 31, 1997 were
$28,000. The ratio of total nonperforming assets to total assets was 0.0011 and
the ratio of nonperforming loans to total loans increased slightly from 0.0003
to 0.0016 as compared to December 31, 1997. All of these ratios remain favorable
as compared with industry averages.
DEPOSITS
Total deposits of $113,886,855 at September 30, 1998 increased
$18,538,909 (19.4%) over total deposits of $95,347,946 at year-end 1997.
Deposits are the Company's primary source
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of funds with which to support its earning assets. Noninterest-bearing deposits
increased $1,404,228 or 36.9% from year-end 1997 to September 30, 1998, and
interest-bearing deposits increased $17,134,681 or 18.7% during the same period.
Time deposits of $100,000 or more increased $3,587,893 (24.4%) as compared to
year-end 1997.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
Securities sold under agreements to repurchase totaled $3,809,051 at
September 30, 1998, a $419,078 decrease from the December 31, 1997 total of
$4,228,129. 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 decreased balances reflect the needs
of these customers to increase their cash balances on hand.
SHAREHOLDERS' EQUITY
Shareholders' equity increased $927,448 from December 31, 1997 to
September 30, 1998, due to net earnings of $838,605, the issuance of 4,323
shares of common stock to the Company's 401(k) Profit Sharing Plan for an
aggregate price of $97,269, the issuance of 4,400 shares of common stock upon
the exercise of stock options at an aggregate exercise price of $35,200, and the
increase in the measurement for unrealized gains or losses on securities
available for sale totaling $110,374 (net of deferred tax liability), all offset
by the cost of stock repurchases totaling $154,000.
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 the primary function of a
financial intermediary and would, therefore, not be able to meet the production
and growth needs of the communities it serves.
The primary function 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 to maintain an appropriate balance between interest-sensitive
assets and interest-sensitive liabilities so that the Bank can also meet the
investment requirements of its 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 $59.8
million or 63.3% of the total loan portfolio at September 30, 1998 and
investment securities maturing in one year or less equaled $567,000 or 2.4% of
the portfolio. Other sources of liquidity include short-term investments such as
federal funds sold
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and maturing interest-bearing deposits with other banks.
The liability portion of the balance sheet provides liquidity through
various customers' interest-bearing and noninterest-bearing deposit accounts. At
September 30, 1998, funds were also available through the purchase of federal
funds from correspondent commercial banks from available lines of up to an
aggregate of $1,000,000. Liquidity management involves the daily monitoring of
the sources and uses of funds to maintain an acceptable cash position.
The Bank was approved as a member of the Federal Home Loan Bank in
April 1997, with an initial line of credit of $8 million. The line of credit was
increased to $12 million in March 1998. At September 30, 1998, the outstanding
balance of the line of credit was $5,628,571.
YEAR 2000
The Company utilizes and is dependent upon data processing systems and
software to conduct its business. The approach of the Year 2000 presents a
problem in that many computer programs have been written using two digits rather
than four to define the applicable year. Computer programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than the Year 2000. For example, computer systems may compute payment, interest,
delinquency or other figures important to the operations of the Company based on
the wrong date. This could result in internal system failure or miscalculation,
and also creates risk for the Company from third parties with whom the Company
deals on financial transactions.
The FDIC has issued guidelines for insured financial institutions with
respect to Year 2000 compliance. The Company has developed a Year 2000 action
plan based in part on the guidelines and timetables issued by the FDIC. The
Company's action plan focuses on four primary areas: (1) information systems,
(2) embedded systems located at the Bank's offices and within its off-site ATM
machines, (3) third party and customer relationships, and (4) contingency
planning. The Company has designated a Year 2000 compliance team, headed by its
Chief Financial Officer and Chief Operating Officer, who reports to the board of
directors. In addition, the Company has engaged outside consultants for purposes
of conducting Year 2000 readiness assessments and remediation where necessary.
Information Systems. The Company has identified all mission critical
information ("IT") systems and has developed a schedule for testing and
remediation of such systems. Testing of key computer hardware has been
completed, and the Company expects to have mission critical hardware
modification or replacement completed during the fourth quarter of 1998. The
Company has completed its inventory of mission critical software and is in the
process of contacting software vendors for certification of Year 2000
compliance. The Company plans to complete any programming changes to critical
systems and commence testing of the new programming in the fourth quarter of
1998. Testing of internal mission-critical systems is scheduled to take place
during the first quarter of 1999 and implementation is scheduled to be complete
by June 30, 1999.
Embedded Systems. The Company is performing a comprehensive inventory
of its embedded systems, such as microcontrollers used to operate security
systems and elevators, and has completed its inventory of mission critical
non-IT systems. The Company is in the process of contacting manufacturers and
vendors of those components utilized in operations to determine
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whether such components are Year 2000 compliant. The Company intends to
remediate or replace, as applicable, any non-compliant components and expects to
complete this process for mission critical systems by June 30, 1999. The quality
of the responses from manufacturers and vendors, the estimated impact of the
individual system or component on the Bank's operations, and the ability of the
Company to perform meaningful and verifiable tests will influence its decision
regarding whether to have independent tests conducted on its embedded systems.
Third Party and Customer Relationships. The Company is in the process
of initiating communications with all suppliers and vendors to determine the
potential impact of such third parties' failure to remediate their own Year 2000
issues. These third parties include other financial institutions, office supply
vendors and telephone, electric and other utility companies. The Company is
encouraging its counterparties and customers to conduct their own Year 2000
assessment and take appropriate steps to become Year 2000 compliant.
The Company outsources its principal data processing activities to
another financial institution, and the Company is actively communicating with
and monitoring the progress of such institution to assess the impact of Year
2000 issues on such institution and its ability to provide such data processing
services. The Company will consider new business relationships with alternate
providers of products and services if necessary. Additionally, the Company has
initiated communications with its larger and commercial borrowers to assess the
potential impact of Year 2000 on them and their ability to remain current on
loan repayments.
Contingency Plans. As part of the Company's normal business practice,
it maintains contingency plans to follow in the event of emergency situations,
some of which could arise from Year 2000-related problems. The Company is in the
process of formulating a detailed Year 2000 contingency plan, which will assess
several possible scenarios to which the Company may be required to react. The
Company's formal Year 2000 contingency plan is expected to be completed by the
end of first quarter 1999.
Financial Implications. The Company believes that, since a majority of
its equipment is relatively new, the Year 2000 problem will not pose significant
internal operational problems or generate material additional expenditures.
Maintenance, testing, and modification costs will be expensed as incurred, while
the costs of new software or hardware will be capitalized and amortized over
their useful lives. Management currently does not expect the amounts required to
be expensed to resolve Year 2000 issues to have a material effect on its
financial position or results of operations. The Company currently estimates
that the costs of assessing, testing and remediation of Year 2000 issues will
total approximately $50,000 in 1998 and $50,000 in 1999. The anticipated costs
associated with the Company's Year 2000 compliance program do not include time
and costs that may be incurred as a result of any potential failure of third
parties to become Year 2000 compliant or costs to implement the Company's
contingency plans.
Potential Risks. The Year 2000 issue presents a number of risks to the
business and financial condition of the Company and the Bank. External factors,
which include but are not limited to electric and telephone service, are beyond
the control of the Company and the failure of such systems could have a material
adverse effect on the Company, its customers and third parties on whom the
Company relies for its day-to-day operations. The business of many of the
Company's customers may be negatively affected by the Year 2000 issue, and any
financial difficulties incurred by the Company's customers in connection with
the century change could negatively affect such customers' ability to repay
loans to the Company. The failure of the
12
<PAGE> 13
Bank's computer system or applications or those operated by customers or third
parties could have a material adverse effect on the Company's results of
operations and financial condition.
The foregoing are forward-looking statements reflecting management's
current assessment and estimates with respect to the Company's Year 2000
compliance efforts and the impact of Year 2000 issues on the Company's business
and operations. Various factors could cause actual plans and results to differ
materially from those contemplated by such assessments, estimates and
forward-looking statements, many of which are beyond the control of the Company.
Some of these factors include, but are not limited to, representations by the
Company's vendors and counterparties, technological advances, economic
considerations, and consumer perceptions. The Company's Year 2000 compliance
program is an ongoing process involving continual evaluation and may be subject
to change in response to new developments.
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. A majority of
the Company's and Bank's capital requirements has been provided from the
proceeds from the Bank's initial stock offering in 1994, through draws by the
Company on a line of credit with Hardwick Bank and Trust Company (described
below), through the retention of earnings and the sale of Company stock to the
Company's 401(k) plan.
Line of Credit. In November 1996, the Company obtained a $1 million
unsecured line of credit ("the Credit Agreement") with Hardwick Bank & Trust
Company ("Hardwick"). On October 29, 1997 the Company and Hardwick agreed to a
modification of the Credit Agreement increasing the amount of credit available
to the Company to $1.5 million. At September 30, 1998, the balance on the line
of credit was $970,000. Interest on the outstanding amounts under the line of
credit is payable on a quarterly basis at the prime rate (as defined in the
Credit Agreement with Hardwick) less 3/4 of a percentage point. The Company
began making interest payments on April 1, 1997. Principal is due in five equal
annual installments beginning January 1, 1999 with the last payment due January
1, 2003. The Credit Agreement contains certain restrictive covenants, including
but not limited to certain restrictions on (i) additional indebtedness; (ii)
creating or allowing liens on the capital stock of the Bank; (iii) guaranteeing
certain obligations of other persons; (iv) merging, consolidating or exchanging
shares with, or acquiring the stock or assets of, any Person (as defined in the
Credit Agreement); (v) payment of dividends; and (vi) disposing of the stock of
the Bank. The Company also covenanted to cause its depository institution
subsidiaries (presently only the Bank) at all times to be classified as "well
capitalized" under FDICIA capital ratios, maintain nonperforming assets below a
specified level, and maintain a minimum ratio of consolidated loan loss reserves
to total loans. The Credit Agreement also contains certain customary affirmative
covenants.
Federal Capital Standards. Bank regulatory authorities are placing
increased emphasis on the maintenance of adequate capital. In 1990, new
risk-based capital requirements became effective under FDICIA. The guidelines
take into consideration risk factors, as defined by regulators, associated with
various categories of assets, both on and off the balance sheet. Under the
guidelines, capital strength is measured in two tiers that are used in
conjunction with risk-adjusted assets to determine the risk-based capital
ratios. The Bank's Tier 1 capital, which consists of common equity, paid-in
capital and retained earnings (less intangible assets), amounted to $8.7 million
at September 30, 1998. Tier 2 capital components include
13
<PAGE> 14
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 Risk-based capital and was $9.8 million at September 30,
1998. The percentage ratios as calculated under FDICIA guidelines were 9.1
percent and 10.2 percent for Tier 1 and Total Risk-based capital, respectively,
at September 30, 1998. Both levels exceeded the minimum ratios of four percent
and eight percent, respectively. At September 30, 1998, the Bank's leverage
ratio was 6.6 percent and its tangible leverage ratio was 6.6 percent, exceeding
the regulatory minimum requirements which are generally 3% plus an additional
cushion of at least 100-200 basis points depending on risk profiles and other
factors.
DBF Capital Requirement. In addition to the capital standards imposed
by federal banking regulators, the Georgia Department of Banking and Finance
(the "DBF") imposed an 8% primary capital ratio as a condition to the approval
of the Bank's charter. This standard, which exceeds the FDIC capital standards,
is calculated as the ratio of total equity to total assets, each as adjusted for
unrealized gains and losses on securities and allowance for loan losses. This
heightened requirement was imposed during the first three years of the Bank's
operation. Accordingly, on March 3, 1998 the Bank became subject to a 6% primary
capital ratio. At September 30, 1998 the capital ratio as calculated under the
DBF standard was 7.31%.
In March 1998, the Bank paid a $500,000 dividend to the Company, which
was used by the Company for repayment of debt and other expenses.
In the first quarter of 1998 the Bank completed several expansion and
renovation projects on its offices and grounds, including construction of a
community center. Total expenditures on these projects aggregated $243,138 and
were funded through current operations cash flow.
NEW ACCOUNTING STANDARDS
The Company has adopted Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income." Statement No. 130 establishes
standards for reporting and displaying comprehensive income, as defined therein,
and its components in financial statements issued for the fiscal years beginning
after December 15, 1997. Statement No. 130 requires the inclusion in
comprehensive income of the change in certain previously recognized components
of shareholders's equity. In compliance with Statement No. 130, the Company has
included, as an additional financial statement, Consolidated Statements of
Comprehensive Income for the periods ended September 30, 1998 and 1997. For the
Company, this required the inclusion of unrealized gains (losses) on investment
and available for sale securities, net of taxes, arising during the respective
periods. For the nine months ended September 30, 1998, the change in unrealized
gains on securities represented a decrease in net income, as reported, by
$110,374 (13.2 %), net of tax. For the nine months ended September 30, 1997, the
change in unrealized gains on securities represented an increase in net income,
as reported, of $30,108 (4.2%), net of tax.
Effective for years beginning after December 15, 1998, Statement of
Position (SOP) 98-5 requires costs of start up activities and organization costs
to be expensed as incurred. Initial application of the SOP is to reported as the
cumulative effect of a change in accounting principle. Management does not
believe that the adoption of SFAS will have a material impact on the Company's
financial statements.
14
<PAGE> 15
Effective for years ending after December 15, 1998, SFAS 132,
"Employers Disclosures about Pensions and Other Postretirement Benefits" was
issued by FASB which standardizes the disclosure requirements for pensions and
other postretirement benefits to the extent practicable, requires additional
information on changes in the benefit obligations and fair values of plan assets
that will facilitate financial analysis, and eliminates certain other
disclosures previously required. Management does not believe that the adoption
of SFAS 132 will have a material impact on the Company's consolidated financial
statements.
RESULTS OF OPERATIONS
NINE MONTHS AND THREE MONTHS ENDED SEPTEMBER 30, 1998
SUMMARY
Net earnings for the nine months ended September 30, 1998 were $838,605
compared to net earnings of $703,088 for the same period in 1997. The increase
in net earnings is partially attributable to an increase of the Company's
revenue from earning assets of 19.7% over the same period in 1997. Net interest
income increased $478,414 (17.0%) during the first nine months of 1998 as
compared to the same period in 1997; noninterest expenses increased $430,058
(24.5%) during same period, while noninterest income increased by $92,161
(32.4%).
Net earnings for the quarter ended September 30, 1998 were $306,990
compared to net earnings of $238,964 for the third quarter of 1997, representing
a 28.5% increase, as compared to the same period in 1997. This increase is
primarily attributable to an increase in total revenue from earning assets of
$463,103 or 20.2% as compared to the same period in 1997. Net interest income
increased $188,895 during the three months ended September 30, 1998 as compared
to the same period in 1997; noninterest expenses increased $176,723 during the
same period, while noninterest income increased by $29,854.
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, 1998 increased $1,308,943 (19.7%) from the same
period in 1997. This increase was due to the continued growth of earning assets
which averaged $119.1 million for the nine months ended September 30, 1998.
Interest expense for the nine months ended September 30, 1998 increased $830,529
or (21.7%) compared to the same period of 1997. This increase was primarily due
to an increase of $634,327 in interest expense accrued on deposit accounts. The
remaining increase is attributed to interest expense on advances from the
Federal Home Loan Bank.
Net interest income increased $189,895 or 20.0% during the quarter
ended September 30, 1998 as compared to the same period in 1997. The primary
reason for this increase was due to the continued growth of the Bank's net
earning assets.
15
<PAGE> 16
PROVISION FOR LOAN LOSSES
The provision for loan losses represents the charge against current
earnings necessary to maintain the reserve for loan losses at a level which
management considers appropriate. This level is determined based upon
management's assessment of current economic condition, the composition of the
loan portfolio and the levels of nonaccruing and past due loans. The provision
for loan losses was $240,000 for the nine months ended September 30, 1998
compared to $300,000 for the same period of 1997. Charge-offs exceeded
recoveries by $79,876 for the nine months ended September 30, 1998. The reserve
for loan losses as a percent of outstanding loans, net of unearned income, was
1.15 percent at September 30, 1998 compared to 1.10 percent at year-end 1997.
The provision for loan losses was $60,000 for the three months ended
September 30, 1998 compared to $85,000 for the same period in 1997.
NONINTEREST INCOME
Noninterest income for the nine months ended September 30, 1998 was
$376,832 compared to $284,671 for the same period of 1997. This increase was
primarily due to an increase in service charges on deposit accounts of $22,085
in the first nine months of 1998 as compared to the same period of 1997, and
increases in other operating income of $53,762. Significant components of
noninterest income changed as follows: Service charges on deposits increased
$22,085 (15.4%), insurance commissions increased $567 (3.5%), and other
operating income increased $53,762 (43.1%) to $178,477. Earnings on cash
surrender value of life insurance policies provided $14,394 of the increase to
other operating income. There was a $2,680 increase to other operating income in
safe deposit box rental fees due to the recent addition of approximately 400 new
boxes. There was also an increase of $7,683 to other operating income due to the
roll-out of a business enhancement program offered to the Bank's small business
customers. There was a $14,957 increase in visa/mastercard income and a $15,747
increase in gains on investment securities during this same period.
Noninterest income increased by $29,854 or 30.1% in the third quarter
of 1998 as compared to the same period in 1997. The primary components of this
increase included a $6,590 increase in visa/mastercard income, a $5,827 increase
in service charge on deposits income and a $3,211 increase in insurance
commissions.
NONINTEREST EXPENSES
Noninterest expenses for the nine months ended September 30, 1998 were
$2,185,159, reflecting a 24.5% increase over the same period of 1997. The
primary components of noninterest expenses are salaries and employee benefits,
which increased to $1,037,601 for the nine months ended September 30, 1998,
24.1% higher than in the same period of 1997. The increase in salaries and
employee benefits is due to increased staffing to meet the growth level of the
Bank. Occupancy costs increased $27,165 (36.9%), and furniture and equipment
expenses increased by $18,951 (16.6%). Other operating expenses rose by 25.0% to
$913,625. The increase in other operating expenses is largely the result of an
increase in data processing fees of
16
<PAGE> 17
$33,950 and an expense of $20,715 due to the addition of the Bank's second ATM
machine.
Noninterest expenses increased by $176,723 for the quarter ended
September 30, 1998 as compared to the same period in 1997. The primary
components of noninterest expense are salaries and employee benefits, which
increased by $82,132 for the three months ended September 30, 1998, 28.4% higher
than the same period of 1997. Occupancy costs increased by $8,376 and other
operating expenses increased by $75,616 for the third quarter of 1998 as
compared with the same period in 1997. The increase in other operating expenses
for such period is largely due to an increase in data processing fees.
INCOME TAXES
The Company attempts to maximize its net income through active tax
planning. Management is attempting to reduce its tax burden by purchasing
tax-exempt securities. The provision for income taxes of $400,000 for the nine
months ended September 30, 1998 increased $65,000 compared to the same period of
1997 due to increased profit levels.
PART II - OTHER INFORMATION
ITEM 5. OTHER INFORMATION
On July 10, 1998, the Company executed a definitive agreement with
Century South Banks, Inc. ("Century South") for the acquisition by the Company
of First National Bank of Union County ("First National"), a wholly-owned
subsidiary of Century South. The agreement provides that, subject to regulatory
approval, the Company will acquire First National from Century South, in a cash
transaction, for $6.1 million, with the assumption of certain existing
liabilities and assets of First National by Century South or certain of its
affiliates. First National will operate as a wholly-owned subsidiary of the
Company and will continue its business and operations in Union County, Georgia.
On September 28, 1998 the Company filed applications with Federal Reserve Bank
of Atlanta and the DBF for approval of the acquisition.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
11 Computation of Net Income Per Share
27 Financial Data Schedule (for SEC use only)
(b) On July 13, 1998, the Company filed a report on Form 8-K with
respect to the Company's proposed acquisition of First National.
17
<PAGE> 18
SIGNATURES
Under 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.
Dated: October 30, 1998
APPALACHIAN BANCSHARES, INC.
/s/ Tracy R. Newton
------------------------------------
Tracy R. Newton
President and CEO
(Duly authorized officer)
/s/ Kent W. Sanford
------------------------------------
Kent W. Sanford
Executive Vice President
(Principal financial officer)
18
<PAGE> 1
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 nine month period ended September 30, 1998 and 1997.
<TABLE>
<CAPTION>
Nine Months Ended September 30
------------------------------
1998 1997
------------ ----------
<S> <C> <C>
Basic net income ................................... $ 838,605 $ 703,088
Basic earnings on common shares .................... $ 838,605 $ 703,088
============ ==========
Weighted average common shares outstanding - basic . 1,150,050 1,147,588
============ ==========
Basic earnings per common share .................... $ .73 $ .61
============ ==========
Basic net income per common share .................. $ .73 $ .61
============ ==========
Diluted net income ................................. $ 838,605 $ 703,088
Diluted earnings on common shares .................. $ 838,605 $ 703,088
============ ==========
Weighted average common shares outstanding - diluted 1,194,275 1,179,260
============ ==========
Diluted earnings per common share .................. $ .70 $ .60
============ ==========
Diluted net income per common share ................ $ .70 $ .60
============ ==========
</TABLE>
19
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF APPALACHIAN BANCSHARES, INC. FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 4,015,546
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 7,256,801
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 18,906,938
<INVESTMENTS-CARRYING> 5,268,711
<INVESTMENTS-MARKET> 5,461,489
<LOANS> 94,502,411
<ALLOWANCE> (1,089,714)
<TOTAL-ASSETS> 132,944,069
<DEPOSITS> 113,886,855
<SHORT-TERM> 5,205,139
<LIABILITIES-OTHER> 742,091
<LONG-TERM> 6,598,571
0
0
<COMMON> 5,988,100
<OTHER-SE> 1,919,401
<TOTAL-LIABILITIES-AND-EQUITY> 132,944,069
<INTEREST-LOAN> 6,764,262
<INTEREST-INVEST> 465,086
<INTEREST-OTHER> 151,248
<INTEREST-TOTAL> 7,952,728
<INTEREST-DEPOSIT> 4,240,734
<INTEREST-EXPENSE> 4,665,796
<INTEREST-INCOME-NET> 3,286,932
<LOAN-LOSSES> 240,000
<SECURITIES-GAINS> 15,950
<EXPENSE-OTHER> 2,185,159
<INCOME-PRETAX> 1,238,605
<INCOME-PRE-EXTRAORDINARY> 1,238,605
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 838,605
<EPS-PRIMARY> .73
<EPS-DILUTED> .70
<YIELD-ACTUAL> 9.2
<LOANS-NON> 150,791
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 379,744
<ALLOWANCE-OPEN> 929,500
<CHARGE-OFFS> 108,170
<RECOVERIES> 28,293
<ALLOWANCE-CLOSE> 1,089,714
<ALLOWANCE-DOMESTIC> 1,089,714
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
