<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended June 30, 1998 Commission File No. 0-22361
NET.B@NK, INC.
(Exact name of registrant as specified in its charter)
Georgia 58-2224352
- ----------------------- ---------------------------------------
(State of incorporation) (I.R.S. Employer Identification Number)
950 North Point Parkway
Suite 350
Alpharetta, Georgia 30005
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (770) 343-6006
-------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO ___
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
<TABLE>
<CAPTION>
Class Shares Outstanding at August 7, 1998
------------------------------------- ------------------------------------
<S> <C>
Common Stock, par value $.01 6,147,637
</TABLE>
<PAGE>
FINANCIAL INFORMATION
Financial Statements
The following financial statements are included in this report:
1. Consolidated balance sheets as of June 30, 1998 (unaudited)
and as of December 31, 1997.
2. Consolidated statements of operations and comprehensive income
(unaudited) for the three months and six months ended June 30,
1998 and 1997.
3. Statements of shareholders' equity (unaudited) from December 31,
1997 to June 30, 1998.
4. Consolidated statements of cash flows (unaudited) for the six
months ended June 30, 1998 and 1997.
5. Notes to consolidated financial statements as of June 30, 1998
and December 31, 1997 and for the three-months and the
six-months ended June 30, 1998 and 1997.
<PAGE>
Submission of Matters to a Vote of Security Holders
At the annual meeting of shareholders held on April 23, 1998, the
shareholders of the Company took the following actions by the votes indicated:
1. Election of the following persons as directors of the Company for the
terms indicated:
<TABLE>
<CAPTION>
Votes Votes Broker
Class I (for a term expiring in 2001) For Withheld Abstentions Non-Votes
------------------------------------- ------- -------- ----------- ---------
<S> <C> <C> <C> <C>
D.R. Grimes 4,930,537 4,910 N/A N/A
T. Stephen Johnson 4,930,537 4,910 N/A N/A
Mack I. Whittle, Jr. 4,930,537 4,910 N/A N/A
H. Bryce Solomon, Jr. 4,927,862 7,585 N/A N/A
Class II (for a term expiring in 1999)
Robert E. Bowers 4,930,537 4,910 N/A N/A
Ward H. Clegg 4,930,537 4,910 N/A N/A
J. Stephen Heard 4,930,337 5,110 N/A N/A
W. James Stokes 4,929,837 5,610 N/A N/A
Class III (for a term expiring in 2000)
Robin C. Kelton 4,930,537 4,910 N/A N/A
John T. Moore 4,929,837 5,610 N/A N/A
Thomas H. Muller, Jr. 4,930,337 5,110 N/A N/A
Donald S. Shapleigh, Jr. 4,930,537 4,910 N/A N/A
</TABLE>
2. Increase the number of shares of Common Stock issuable under the
Company's 1996 Stock Incentive Plan from 397,500 to 600,000:
<TABLE>
<CAPTION>
Votes Votes Broker
For Against Abstentions Non-Votes
<S> <C> <C> <C> <C>
4,883,932 43,330 8,185 -0-
</TABLE>
3. Ratification of Deloitte & Touche LLP as the Company's independent auditors:
<TABLE>
<CAPTION>
Votes Votes Broker
For Against Abstentions Non-Votes
<S> <C> <C> <C> <C>
4,909,247 1,750 24,450 -0-
</TABLE>
3
<PAGE>
Other Information
Pursuant to Rule 14a-4(c)(1) promulgated under the Securities Exchange
Act of 1934, shareholders desiring to present a proposal for consideration at
the Company's 1999 Annual Meeting of Shareholders must notify the Company in
writing at its principal office, 950 North Point Parkway, Alpharetta, Georgia
30005, attn: Corporate Secretary, of the contents of such proposal no later than
February 8, 1999. Failure to timely submit such a proposal will enable the
proxies appointed by management to exercise their discretionary voting authority
if the proposal is raised at the Annual Meeting of Shareholders.
Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule (for SEC use only)
(b) No reports on Form 8-K were filed during the quarter
for which this report is filed.
4
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NET.B@NK, INC.
By: /s/ Robert E. Bowers
----------------------
Robert E. Bowers
Chief Financial Officer
Dated: August 11, 1998
<PAGE>
NET.B@NK, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
ASSETS 1998 1997
<S> <C> <C>
CASH AND CASH
EQUIVALENTS:
Cash $ 162,310 $ 250,535
Federal Funds Sold 3,015,169 28,853,057
------------- -------------
Total cash and cash equivalents 3,177,479 29,103,592
SECURITIES AVAILABLE FOR SALE - At fair value (amortized
cost of $42,383,108 and $18,137,209) 42,353,426 18,054,146
STOCK OF FEDERAL HOME LOAN BANK OF ATLANTA - At cost 251,500 225,000
LOANS RECEIVABLE - Net of allowance for doubtful
accounts of $3,710,871 and $453,444 188,134,408 44,479,963
ACCRUED INTEREST RECEIVABLE 1,448,796 372,237
FURNITURE AND EQUIPMENT - Net 793,573 388,508
BANK CHARTER 337,167 344,167
DEFFERED TAXES 3,058,476
OTHER ASSETS 7,159,319 252,196
------------- -------------
$ 246,714,144 $ 93,219,809
------------- -------------
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Deposits $ 186,845,624 $ 58,726,763
Short-term borrowings 20,500,000
Other payables and accrued liabilities 2,048,944 375,649
------------- -------------
209,394,568 59,102,412
SHAREHOLDERS' EQUITY:
Preferred stock, no par (10,000,000 shares authorized,
none outstanding)
Common stock, $.01 par (100,000,000 shares authorized,
6,145,962 and 6,145,562 shares issued and outstanding) 61,460 61,456
Additional paid-in capital 43,632,759 43,631,314
Unamortized stock plan expense (45,699) (75,689)
Accumulated deficit (6,299,262) (9,416,621)
Accumulated other comprehensive loss, net of tax (29,682) (83,063)
------------- -------------
Total shareholders' equity 37,319,576 34,117,397
------------- -------------
Total liabilities and shareholders' equity $ 246,714,144 $ 93,219,809
------------- -------------
------------- -------------
</TABLE>
See notes to financial statements.
F-1
<PAGE>
NET.B@NK, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (UNAUDITED)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
INTEREST INCOME:
Loans $ 3,442,783 $ 4,801,018
Investment securities 702,098 1,155,475
Short-term investments 107,656 $ 841 502,659 $ 6,616
----------- ----------- ----------- -----------
Total interest income 4,252,537 841 6,459,152 6,616
INTEREST EXPENSE:
Deposits 2,279,515 37,482 3,583,143 140,007
Short-term borrowings 434,333 434,333
----------- ----------- ----------- -----------
Total interest expense 2,713,848 37,482 4,017,476 140,007
----------- ----------- ----------- -----------
NET INTEREST INCOME (LOSS) 1,538,689 (36,641) 2,441,676 (133,391)
PROVISION FOR LOAN LOSSES 6,011 9,672
----------- ----------- ----------- -----------
NET INTEREST INCOME (LOSS) AFTER
PROVISION FOR LOAN LOSSES 1,532,678 (36,641) 2,432,004 (133,391)
NON-INTEREST INCOME - Service charges and fees 103,727 226,218
NON-INTEREST EXPENSES:
Salaries and benefits 310,823 552,837 745,176 1,077,808
Marketing 180,238 24,203 420,256 84,698
Depreciation and amortization 58,279 8,389 98,316 15,268
Outside services 359,908 20,178 551,569 41,455
Other 302,150 135,614 389,022 255,607
Data processing 78,888 53,812 170,114 125,318
Occupancy 39,996 5,950 66,089 35,700
Office expenses 42,792 90,358
Travel and entertainment 23,584 6,481 39,026 10,885
Amortization of service contract with affiliate 576,000 1,440,000
----------- ----------- ----------- -----------
Total non-interest expenses 1,396,658 1,383,464 2,569,926 3,086,739
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES 239,747 (1,420,105) 88,296 (3,220,130)
INCOME TAX BENEFIT 3,029,063 3,029,063
----------- ----------- ----------- -----------
NET INCOME (LOSS) 3,268,810 (1,420,105) 3,117,359 (3,220,130)
OTHER COMPREHENSIVE INCOME, NET OF TAX:
Unrealized holding gains (losses) on
securities arising during period (82,634) 76,440
Less reclassification adjustment
for gains (losses)included
in net income (loss) 25,067 (23,059)
----------- -----------
Total other comprehensive income (57,567) 53,381
----------- ----------- ----------- -----------
COMPREHENSIVE INCOME (LOSS) $ 3,211,243 $(1,420,105) $ 3,170,740 $(3,220,130)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
NET INCOME (LOSS) PER COMMON AND
COMMON EQUIVALENT SHARE:
BASIC $ 0.53 $ (1.11) $ 0.51 $ (2.55)
DILUTED $ 0.51 $ (1.11) $ 0.49 $ (2.55)
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES
OUTSTANDING:
BASIC 6,145,936 1,278,888 6,145,949 1,264,196
DILUTED 6,446,303 1,278,888 6,422,794 1,264,196
</TABLE>
See notes to financial statements
F-2
<PAGE>
NET.B@NK, INC.
STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PREFERRED COMMON ADDITIONAL UNAMORTIZED
STOCK COMMON STOCK PAID-IN STOCK PLAN ACCUMULATED
(NO PAR) SHARES ($.01 PAR) CAPITAL EXPENSE DEFICIT
<S> <C> <C> <C> <C> <C> <C>
BALANCE - December 31, 1997 $ -- 6,145,562 $61,456 $43,631,314 $ (75,689) $(9,416,621)
Exercised stock options 400 4 1,445
Net income for the six months
ended June 30, 1998 3,117,359
Other comprehensive income:
Unrealized holding gains arising
during the six-month
period ended June 30, 1998
Less reclassification adjustment
for losses included
in net income
Amortization of stock plan expense 29,990
---------- --------- ------- ----------- -------- -----------
BALANCE - June 30, 1998 $ -- 6,145,962 $61,460 $43,632,759 $(45,699) $(6,299,262)
---------- --------- ------- ----------- -------- -----------
---------- --------- ------- ----------- -------- -----------
</TABLE>
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME
(LOSS) TOTAL
<S> <C> <C>
BALANCE - December 31, 1997 $(83,063) $34,117,397
Exercised stock options 1,449
Net income for the six months
ended June 30, 1998 3,117,359
Other comprehensive income:
Unrealized holding gains arising
during the six-month
period ended June 30, 1998 76,440 76,440
Less reclassification adjustment
for losses included
in net income (23,059) (23,059)
Amortization of stock plan expense 29,990
-------- -----------
BALANCE - June 30, 1998 $(29,682) $37,319,576
-------- -----------
-------- -----------
</TABLE>
F-3
<PAGE>
NET.B@NK, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
1998 1997
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $3,117,359 $(3,220,130)
Adjustments to reconcile net income
(loss) to net cash used in operating activities:
Depreciation 91,316 15,268
Amortization of service contract 1,440,000
Amortization of stock plan expense 29,990 112,772
Amortization of premiums on investment securities 169,379
Amortization of premiums on purchased loans 810,428
Amortization of Bank Charter 7,000
Provision for loan losses 9,672
Changes in assets and liabilities which provide (use) cash:
Accrued interest receivable (1,076,559)
Other assets (6,907,123) 13,368
Offering costs (452,560)
Organizational costs - net (57,793)
Premier advance (55,000)
License agreements 76,564
Payables and accrued liabilities 1,673,295 363,828
Deferred tax asset (3,058,476)
---------- ----------
Net cash used in operating activities (5,133,719) (1,763,683)
INVESTING ACTIVITIES:
Purchases of securities available for sale (32,816,802)
Purchase of Federal
Home Loan Bank stock (26,500)
Principal repayments on mortgage backed
securities 8,401,524
Purchase of loans and premiums (184,355,136)
Principal
payments on loans 39,880,591
Capital expenditures (361,381) (8,255)
Capitalized software costs (135,000)
Proceeds from return of equipment 17,738
---------- ----------
Net cash provided by (used in)
investing activities (169,412,704) 9,483
FINANCING ACTIVITIES:
Increase in deposits 128,118,861
Advances from affiliate 1,017,734
Net proceeds from the sale of common stock 1,449 4,185
Short-term borrowing, net of repayments 20,500,000
---------- ----------
Net cash provided by financing activities 148,620,310 1,021,919
---------- ----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (25,926,113) (732,281)
CASH AND CASH EQUIVALENTS:
Beginning of period 29,103,592 768,666
---------- ----------
End of period $3,177,479 $36,385
---------- ----------
---------- ----------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION - Cash paid during the year for interest $918,416 $ --
---------- ----------
---------- ----------
See notes to financial statements.
</TABLE>
F-4
<PAGE>
NET.B@NK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF JUNE 30, 1998 AND DECEMBER 31, 1997 AND FOR THE
THREE-MONTH AND SIX-MONTH PERIODS ENDED JUNE 30, 1998 AND 1997
- --------------------------------------------------------------------------------
1. ORGANIZATION AND BASIS OF PRESENTATION
Net.B@nk, Inc. (the "Company") is a bank holding company that wholly owns
the outstanding stock of Atlanta Internet Bank ("AIB"), a federally
chartered savings and loan. The Company was incorporated February 20, 1996
for the primary purpose of forming and, ultimately, operating AIB. As of
January 1, 1997, pending regulatory approval and the acquisition of a bank
charter, the Company was operating as a development stage enterprise under
an agreement with Carolina First Bank ("CFB") whereby CFB agreed to hold
and service the deposit accounts generated by the Internet banking
operations of the Company in exchange for 1,325,000 shares of the
Company's common stock valued at $3,840,000. In addition, as of January 1,
1997, the Company was a party to an agreement with First Alliance/Premier
Bancshares, Inc. ("First Alliance") pursuant to which the Company had
agreed to purchase the charter of First Alliance's subsidiary, Premier
Bank, $5 million of loans, $5 million of certificates of deposit, and $2
million in unimpaired capital for $2,150,000 in cash, 41,406 shares of the
Company's common stock valued at $125,000, and $75,000 in additional cash
for reimbursement of direct out-of-pocket expenses.
On July 11, 1997, the final regulatory approval from the Office of Thrift
Supervision was received. On July 28, 1997, the Company sold 3,500,000
shares of its common stock to the public in an Initial Public Offering
(the "Offering"). On July 31, 1997, the Company received approximately
$38.4 million in net proceeds from the Offering and consummated its
agreements with both First Alliance and CFB. As a result AIB, a federal
savings bank, became a wholly owned subsidiary of the Company.
In the opinion of management, the unaudited condensed consolidated
financial statements included herein reflect all adjustments, consisting
only of normal recurring accruals, which are necessary for the fair
statement of the results for the interim periods presented. Certain
information and footnote disclosures normally included in financial
statements have been condensed or omitted pursuant to applicable rules and
regulations of the Securities and Exchange Commission ("SEC"). The
financial statements included herein should be read in conjunction with
the financial statements and notes thereto, included in the Company's Form
10-K filed with the SEC on March 27, 1998. The results of operations for
the interim periods reported herein are not necessarily indicative of
results to be expected for the full year. Certain 1997 amounts have been
reclassified for comparability with 1998 amounts.
F-5
<PAGE>
2. ACCOUNTING POLICIES
Reference is made to the accounting policies of the Company described in
the notes to financial statements contained in the Company's Form 10-K for
the year ended December 31, 1997. The Company has followed those policies
in preparing this report. In addition, the following accounting policies
were adopted during the six-month period June 30, 1998:
COMPREHENSIVE INCOME - As of January 1, 1998, the Company adopted
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"). SFAS 130 establishes new rules for the
reporting and display of comprehensive income and its components. SFAS 130
requires unrealized gains or losses on the Company's available-for-sale
securities, which prior to adoption were reported separately in
shareholders' equity, to be included in other comprehensive income. The
adoption of the Statement had no impact on the Company's net income or
shareholders' equity.
CAPITALIZED SOFTWARE - As of April 1, 1998, the Company adopted Statement
of Position No. 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 allows for
the capitalization of costs related to the development and implementation
of software obtained for internal use including materials, payroll, and
interest costs once the criteria of the SOP have been met. As of June 30,
1998, $135,000 of these related costs have been capitalized.
3. LOANS
During the three-month period ended June 30, 1998, the Company purchased
approximately $80 million in home equity loans. The purchase included a
premium of $5 million. In connection with the purchase, an estimate of the
loss inherent in the purchased portfolio was made and an allowance for
loan losses of $1.2 million was recorded by adjusting the premium
associated with the purchased loans. The interest rates range from 7.5% to
13.5% on these loans.
During the three-month period ended March 31, 1998, the Company purchased
approximately $71 million in first and second mortgages, home equity
loans, and construction loans. The purchases included premiums of
approximately $4.8 million. In connection with these purchases, an
estimate of the loss inherent in the purchased portfolio was made and an
allowance for loan losses of $2.0 million was recorded by adjusting the
premium associated with the purchased loans. Interest rates range from 6%
to 16% on these loans.
An analysis of the allowance for loan losses for the six-month period
ended June 30, 1998 follows:
F-6
<PAGE>
<TABLE>
<S> <C>
Balance, January 1, 1998 $453,444
Allowance recorded in connection with the purchase
of loan pools 3,335,498
Provision for loan losses 9,672
Loan charge-offs (87,743)
----------
Balance, June 30, 1998 $3,710,871
----------
----------
</TABLE>
4. INCOME TAXES
During the three months ended June 30, 1998, the Company reversed the
valuation allowance previously associated with its deferred tax assets.
The majority of the assets relate to future tax benefits associated with
previous net operating losses of the Company. As the Company achieved
profitability in the second quarter of 1998, management now believes that
it is more likely than not that such assets will be realized, and thus
reversed the valuation allowance in accordance with Statement of Financial
Accounting Standard No. 109, "Accounting for Income Taxes."
As of June 30, 1998, the Company has deferred tax assets and liabilities
as follows:
<TABLE>
<S> <C>
Net operating loss carryforwards $2,504,127
Allowance for loan losses 154,171
Loan premium amortization 153,996
Start-up costs 132,414
Stock option compensation expense 118,896
Other liability, net (5,128)
----------
Total $3,058,476
----------
</TABLE>
5. NET LOSS PER COMMON AND COMMON EQUIVALENT SHARE
In February 1997, Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" ("SFAS 128") was issued. SFAS 128 establishes
standards for computing and presenting earnings per share information for
entities with publicly held common stock. In accordance with SFAS 128, net
loss per share is computed based on the weighted average number of common
shares outstanding during the period. All previously reported per share
amounts have been restated to conform to SFAS 128.
6. STOCK OPTIONS
The Company has a 1996 Stock Incentive Plan (the "Plan") which provides
that key employees, officers, directors, and consultants of the Company
may be granted nonqualified and incentive stock options to purchase shares
of common stock of the Company, derivative securities related to the value
of the common stock, or cash awards. Previously, the Plan limited the
total number of shares which
F-7
<PAGE>
could be awarded to 397,500. Effective with shareholder approval on
April 23, 1998, the Plan was amended to increase the total number of
shares reserved for the Plan to 600,000.
During the six-month period ended June 30, 1998, the Company awarded
23,000 incentive stock options at an exercise price of $11.25 per share on
January 12, 1998, 3,000 incentive stock options at an exercise price of
$16.75 per share on February 12, 1998, and 10,000 incentive stock options
at an exercise price of $24.38 per share on June 18, 1998. Grant prices
approximated fair value of the stock at the grant date. Also, during the
six-month period ended June 30, 1998, 400 stock options were exercised at
a price of $3.62. Subsequent to June 30, 1998, the Company granted 54,000
options at an exercise price of $27.50, which approximated fair value,
1,675 options were exercised at $3.62 per share, and 8,281 options were
terminated.
7. IMPACT OF NEW ACCOUNTING STANDARDS
In June 1997, Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131") was issued. SFAS 131 establishes annual and interim reporting
standards for an enterprise's business segments and related disclosures
about its products, services, geographic areas and major customers.
Adoption of this statement will not impact the Company's consolidated
financial position, results of operations or cash flows. The Company will
adopt this Statement in its annual financial statements for the year
ending December 31, 1998.
In February 1998, Statement of Financial Accounting Standards No. 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits"
("SFAS 132") was issued. SFAS 132 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 disclosures that are no longer useful. SFAS 132 is
effective for fiscal years beginning after December 15, 1997. The
Statement is not expected to have an effect on the Company's financial
statements.
In June 1998, Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133") was issued. SFAS 133 establishes standards for derivative
instruments and hedging activities and requires that an entity recognize
all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. This
statement is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. The Statement is not expected to have an effect on
the Company's financial statements.
8. LOAN ORIGINATION AGREEMENT
On April 1, 1998, the Company entered into an agreement with First
Mortgage Network, Inc. ("FMN") whereby the Company acts as a loan
originator on behalf of FMN. Under the terms of the agreement, FMN may
purchase, at the Company's option, loans originated by the Company. As a
result of the agreement's structure, loans originated for FMN for which
the purchase price has not yet been received are accounted for as
receivables.
9. BORROWING AGREEMENTS
During the quarter ended June 30, 1998, the Company and AIB entered into
various line of credit agreements with Georgia Banker's Bank ("GBB").
Under the terms of the Company's agreement, the
F-8
<PAGE>
Company may borrow 50% of the tangible equity of AIB, up to $17
million, using the stock of AIB as collateral. The line bears interest
at a fixed rate of 8% per annum. During the quarter, the Company
borrowed and repaid $12 million under the line.
AIB entered into two line of credit agreements with GBB, one for a $5
million unsecured general purpose line and one for 99% of the value of its
investment securities. There were no amounts outstanding under the general
purpose line of credit at June 30, 1998. During the quarter, AIB borrowed
$45 million under the investment securities line of credit and repaid
$24.5 million, leaving $20.5 million outstanding at June 30, 1998. Both of
the lines bear interest 25 basis points above the Fed Funds rate, or 5.65%
at June 30, 1998.
F-9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General - The Company is a holding company that wholly owns Atlanta
Internet Bank ("AIB"), a federally chartered savings and loan. The Company
was incorporated as a Georgia corporation on February 20, 1996 for the
purpose of forming and, ultimately, operating AIB as a wholly owned
federal savings bank subsidiary. As of January 1, 1997, pending regulatory
approval and the acquisition of a bank charter, the Company was operating
as a development stage enterprise under an agreement with Carolina First
Bank ("CFB") whereby CFB agreed to hold and service the deposit accounts
generated by the Internet banking operations of the Company in exchange
for 1,325,000 shares of the Company's common stock valued at $3,840,000.
In addition, as of January 1, 1997, the Company was a party to an
agreement with First Alliance/Premier Bancshares, Inc. ("First Alliance")
pursuant to which the Company had agreed to purchase the charter of First
Alliance's subsidiary, Premier Bank (the "Charter"), and $5 million in
loans, $5 million in certificates of deposit, and $2 million in unimpaired
capital for $2,150,000 in cash, 41,406 shares of the Company's common
stock valued at $125,000, and $75,000 in additional cash for reimbursement
of direct out-of-pocket expenses.
On July 11, 1997, the final regulatory approval from the Office of Thrift
Supervision ("OTS") was received. On July 28, 1997, the Company sold
3,500,000 shares of its common stock to the public in an Initial Public
Offering (the "Offering"). On July 31, 1997, the Company received
approximately $38.4 million in net proceeds from the Offering and
consummated its agreements with both First Alliance and CFB. As a result
AIB, a federal savings bank, became a wholly owned subsidiary of the
Company. As of June 30, 1998, the Company had 11,832 accounts and
approximately $187 million in deposits.
FINANCIAL CONDITION - The Company's assets were $246.7 million at June 30,
1998, compared to $93.2 million at December 31, 1997, an increase of
$153.5 million. This increase in total assets was primarily due to growth
in the Company's loan portfolio resulting from the purchase of
approximately $143.7 million in home equity loans, second mortgages,
construction loans, and other participation loans. In addition, the
Company recorded a $3.0 million deferred tax asset related primarily to
previous net operating loss carryforwards expected to be realized for tax
purposes. As the Company achieved profitability in the second quarter of
1998, management now believes that it is more likely than not that its
deferred tax assets will be realized. Receivables of $7.0 million related
to a loan origination agreement with a third party have been recorded in
other assets. See Note 8 of Notes to Consolidated Financial Statements.
Total liabilities increased $150.3 million from December 31, 1997 to June
30,1998 primarily due to the receipt of approximately $128 million in
customer deposits as a result of marketing programs introduced by the
Company in the fourth quarter of 1997 and continued through June 30, 1998.
In addition, during the second quarter of 1998 the Company borrowed $20.5
million under a new line of credit agreement. See Note 9 of Notes to
Consolidated Financial Statements.
Total shareholders' equity increased approximately $3.2 million from
December 31, 1997 to June 30, 1998. The increase resulted from net income
of approximately $3.1 million, $53,000 in other comprehensive income, and
a reduction of $30,000 in unamortized stock plan expense.
LIQUIDITY AND CAPITAL RESOURCES - The Company's liquidity, represented by
cash and cash equivalents, is a product of its operating, investing, and
financial activities. The Company's primary sources of funds are deposits,
borrowings, prepayments and maturities of outstanding loans, sales of
loans,
F-10
<PAGE>
maturities of investment securities and other short-term
investments, and funds provided from operations. While scheduled loan
payments and maturing investment securities and short-term investments are
relatively predictable sources of funds, deposit flows and loan
prepayments are greatly influenced by general interest rates, economic
conditions, and competition. The Company invests excess funds in overnight
deposits and other short-term interest-earning assets. The Company can use
cash generated through the retail deposit market, its traditional funding
source, to offset the cash utilized in investing activities. The Company's
available for sale securities and short term interest-earning assets can
also be used to provide liquidity for lending and other operational
requirements. As an additional source of funds, the Company has three
line of credit agreements. See Note 9 of Notes to Consolidated Financial
Statements.
AIB is required by OTS regulations to maintain tangible capital equal to
at least 1.5% of adjusted total assets, core capital equal to at least
3.0% of adjusted total assets, and total capital equal to at least 8.0% of
risk-weighted assets. To be categorized as "well capitalized" under a
prompt corrective action plan, AIB must maintain minimum Tier I, core, and
risk-based capital ratios of at least 6%, 5%, and 10%, respectively. AIB
exceeded such requirements with tangible, core, total, and Tier I capital
ratios of 10.01%, 10.01%, 13.33%, and 11.84%, respectively, at June 30,
1998.
MARKET RISK.
ASSET AND LIABILITY MANAGEMENT - The Company's principal business is the
making of loans, funded primarily by customer deposits and, to the extent
necessary, other borrowed funds. Consequently, a significant portion of
the Company's assets and liabilities are monetary in nature and
fluctuations in interest rates will affect the Company's future net
interest income and cash flows. This interest rate risk is the Company's
primary market risk exposure. The Company does not enter into derivative
financial instruments such as futures, forwards, swaps, and options.
Also, the Company has no market risk-sensitive instruments held for
trading purposes. The Company's exposure to market risk is reviewed on a
regular basis by its management.
INTEREST RATE SENSITIVITY - The Company measures interest rate
sensitivity as the difference between amounts of interest-earning assets
and interest-bearing liabilities which either reprice or mature within a
given period of time. The difference, or the interest rate repricing
"gap," provides an indication of the extent to which an institution's
interest rate spread will be affected by changes in interest rates. A gap
is considered positive when the amount of interest-rate sensitive assets
exceeds the amount of interest-rate sensitive liabilities and is
considered negative when the amount of interest-rate sensitive
liabilities exceeds the amount of interest-rate sensitive assets.
Generally, during a period of rising interest rates, a negative gap
within shorter maturities would adversely affect net interest income,
while a positive gap within shorter maturities would result in an
increase in net interest income, and during a period of falling interest
rates, a negative gap within shorter maturities would result in an
increase in net interest income while a positive gap within shorter
maturities would have the opposite effect.
F-11
<PAGE>
The table below shows the interest rate sensitivity of the Company's
assets and liabilities as of June 30, 1998:
<TABLE>
<CAPTION>
Term to Repricing or Maturity
------------------------------------------------------------------------
Over Three Over One Over Five
Less Than Months Through Year Through Years and
Three Months One Year Five Years Insensitive Total
<S> <C> <C> <C> <C> <C>
Interest Earning Assets:
Cash and cash equivalents $ 162,310 $ 162,310
Federal fund sold 3,015,169 3,015,169
Investment securities 1,872,175 $ 40,481,251 42,353,426
Stock of Federal Home
Loan Bank of Atlanta 251,500 251,500
Other interest bearing
receivable 1,477,974 1,477,974
Loans receivable 133,460,144 $ 3,705,436 $ 16,256,020 34,712,808 188,134,408
------------ ------------ ------------ ------------ ------------
Total interest
earning assets 140,239,272 3,705,436 16,256,020 75,194,059 235,394,787
Noninterest earning assets 11,319,357 11,319,357
------------ ------------ ------------ ------------ ------------
Total assets $140,239,272 $ 3,705,436 $ 16,256,020 $ 86,513,416 $246,714,144
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Interest Bearing Liabilities -
Interest-bearing deposits $ 58,239,557 $121,655,822 $ 5,192,436 $185,087,815
Short-term borrowings 20,500,000 20,500,000
Interest free deposits $ 1,757,809 1,757,809
Other interest free
liabilities and equity 39,368,520 39,368,520
------------ ------------ ------------ ------------ ------------
Total liabilities
and equity $ 78,739,557 $121,655,822 $ 5,192,436 $ 41,126,329 $ 246,714,144
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Net Interest Rate
Sensitivity Gap $ 61,499,715 $(117,950,386) $ 11,063,584 $ 45,387,087
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Cumulative Gap $ 61,499,715 $ (56,450,671) $(45,387,087) $ --
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Net Interest Rate
Sensitivity Gap as a
Percent of Interest
Earning Assets 43.85% (3183.17)% 68.06% 52.46%
Cumulative Gap as a
Percent of Cumulative
Interest Earning Assets 43.85% (1523.46)% (279.20)%
</TABLE>
F-12
<PAGE>
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 1998 COMPARED
TO THE THREE MONTHS ENDED JUNE 30, 1997.
GENERAL - Net income for the three months ended June 30, 1998 amounted to
$3.3 million, an increase of $4.7 million when compared to the $1.4
million loss for the quarter ended June 30, 1997. A substantial portion of
the income for the three months ended June 30, 1998 resulted from the
recognition of approximately $3.0 million in tax benefits. The benefits
resulted from the reversal of a valuation allowance previously associated
with the Company's deferred tax assets. As the Company achieved
profitability during the quarter, management now believes it is more
likely than not that such deferred tax assets will be realized. The
statement of operations for the quarter ended June 30, 1997 reflects the
Company's operations before the acquisition of the bank charter. As the
charter was not acquired until July 31, 1997, the Company had no earning
assets.
INTEREST INCOME - Interest income related to the Company's loan and
investment portfolio for the three months ended June 30, 1998 was $4.3
million. No significant amount of interest income was recorded for the
three months ended June 30, 1997, as the Company had no significant
investments or loans at that time.
INTEREST EXPENSE - For the quarter ended June 30, 1998, $2.3 million in
interest expense was recorded as a result of the Company's increase in
customer deposits. As the Company did not maintain its own deposit
accounts until July 31, 1997, $37,000 in interest expense was recorded for
the quarter ended June 30, 1997 related to the CFB servicing agreement.
This interest expense represents the difference between interest expense
paid to customers and interest income paid to the Company by CFB at
contractual rates prior to the transfer of customer deposits and was
included in the Company's operations. In addition, in the quarter ended
June 30, 1998, the Company recorded approximately $434,000 in interest
expense associated with short-term borrowings under its line of credit
agreement.
NET INTEREST INCOME - Net interest income is determined by the Company's
interest rate spread (i.e., the difference between the yields earned on
its interest-earning assets and the rates paid on its interest-bearing
liabilities) and the relative amounts of interest-earning assets and
interest-bearing liabilities. Net interest income was $1.5 million for the
three months ended June 30, 1998. As the Company did not have any
significant investments, loans, or customer deposits during the three
months ended June 30, 1997, no significant amount of net interest income
was recorded for that period.
PROVISION FOR LOAN LOSSES - In connection with the purchase of various
loan portfolios, the Company assesses the inherent loss in the portfolio
and records the necessary allowance by adjusting the premium associated
with the portfolio. In addition to this allowance, the Company then
records an additional allowance pervasive to all loans. The Company
recorded a $6,000 provision for loan loss for the three months ended June
30, 1998. As the Company had no loans for the three months ended June 30,
1997, a provision was not recorded for that period. The allowance for loan
losses is maintained at a level estimated to be adequate to provide for
potential losses in the loan portfolio. Management determines the adequacy
of the allowance based upon reviews of individual loans, recent loss
experience, current economic conditions, the risk characteristics of the
various categories of loans, and other pertinent factors.
NON-INTEREST INCOME - For the three-month period ended June 30, 1998, the
Company recorded approximately $104,000 in loan and deposit service
charges and fees. As the Company did not have
F-13
<PAGE>
any loans, or customer deposits during the three months ended June 30,
1997, no such service fees were recorded. No amount of non-interest
income was recorded for the three months ended June 30, 1997.
NON-INTEREST EXPENSES - Non-interest expenses include all operating
expenses including salaries and benefits, marketing, general and
administrative expenses (excluding interest expense, provision for loan
losses and income taxes) of the Company. Non-interest expenses increased
less than 1%, only $13,000, for the three months ended June 30, 1998 as
compared with the three months ended June 30, 1997 as the Company was able
to leverage its existing infrastructure. From 1997 to 1998, the Company
did replace many of its services provided by an affiliate with outside
vendor relationships.
F-14
<PAGE>
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1998 COMPARED
TO THE SIX MONTHS ENDED JUNE 30, 1997.
GENERAL - Net income for the six months ended June 30, 1998 amounted to
$3.1 million, an increase of $6.3 million when compared to the $3.2
million loss for the six months ended June 30, 1997. The statement of
operations for the six months ended June 30, 1997 reflects the Company's
operations before the acquisition of the bank charter. As the charter was
not acquired until July 31, 1997, the Company had no earning assets. A
substantial portion of the income for the six months ended June 30, 1998
resulted from the recognition of approximately $3.0 million in tax
benefits. The benefits resulted from the reversal of a valuation allowance
previously associated with the Company's deferred tax assets. As the
Company achieved profitability during the quarter, management now believes
it is more likely than not that such deferred tax assets will be realized.
INTEREST INCOME - Interest income related to the Company's loan and
investment portfolio for the six months ended June 30, 1998 was $6.5
million. No significant amount of interest income was recorded for the six
months ended June 30, 1997, as the Company had no significant investments
or loans at that time.
INTEREST EXPENSE - For the six months ended June 30, 1998, $3.6 million in
interest expense was recorded as a result of the Company's increase in
customer deposits. As the Company did not maintain its own deposit
accounts until July 31, 1997, $140,000 in interest expense was recorded
for the six months ended June 30, 1997 related to the CFB servicing
agreement. This interest expense represents the difference between
interest expense paid to customers and interest income paid to the Company
by CFB at contractual rates prior to the transfer of customer deposits and
was included in the Company's operations. In addition, in the six months
ended June 30, 1998, the Company recorded approximately $434,000 in
interest expense associated with short-term borrowings under its line of
credit agreement.
NET INTEREST INCOME - Net interest income is determined by the Company's
interest rate spread (i.e., the difference between the yields earned on
its interest-earning assets and the rates paid on its interest-bearing
liabilities) and the relative amounts of interest-earning assets and
interest-bearing liabilities. Net interest income was $2.4 million for the
six months ended June 30, 1998. As the Company did not have any
significant investments, loans, or customer deposits during the six months
ended June 30, 1997, no significant amount of net interest income was
recorded for that period.
PROVISION FOR LOAN LOSSES - In connection with the purchase of various
loan portfolios, the Company assesses the inherent loss in the portfolio
and records the necessary allowance by adjusting the premium or discount
associated with the portfolio. In addition to this allowance, the Company
then records an additional allowance pervasive to all loans. The Company
recorded a $10,000 provision for loan loss for the six months ended June
30, 1998. As the Company had no loans for the six months ended June 30,
1997, a provision was not recorded for that period. The allowance for loan
losses is maintained at a level estimated to be adequate to provide for
potential losses in the loan portfolio. Management determines the adequacy
of the allowance based upon reviews of individual loans, recent loss
experience, current economic conditions, the risk characteristics of the
various categories of loans, and other pertinent factors.
NON-INTEREST INCOME - For the six-month period ended June 30, 1998, the
Company recorded approximately $226,000 in loan and deposit service
charges and fees. As the Company did not have
F-15
<PAGE>
any loans, or customer deposits during the six months ended June 30,
1997, no such service fees were recorded. No amount of non-interest
income was recorded for the six months ended June 30, 1997.
NON-INTEREST EXPENSES - Non-interest expenses decreased approximately
$500,000 from $3.1 million to $2.6 million for the six months ended June
30, 1998 as compared with the six months ended June 30, 1997. The primary
component of the decrease during the six months ended June 30, 1998 was a
$1.4 million decrease in the amortization of service contract with
affiliate as the service contract was fully amortized during the second
quarter of 1997. The decrease was offset by a $336,000 increase in
marketing expense related to the Company's marketing campaign initiated in
the fourth quarter of 1997, an increase of $511,000 in outside service
fees related to the operation of the bank, and an increase of $133,000 in
other miscellaneous expenses.
STOCK OPTIONS.
The Company has a 1996 Stock Incentive Plan (the "Plan"), which provides
that key employees, officers, directors, and consultants of the Company
may be granted nonqualified and incentive stock options to purchase shares
of common stock of the Company, derivative securities related to the value
of the common stock, or cash awards. Previously, the Plan limited the
total number of shares that could be awarded to 397,500. Effective upon
shareholder approval on April 23, 1998, the Plan was amended to increase
the total number of shares reserved for the Plan to 600,000. These shares
have been reserved for the Plan.
During the six-month period ended June 30, 1998, the Company awarded
23,000 incentive stock options at an exercise price of $11.25 per share on
January 12, 1998, 3,000 incentive stock options at an exercise price of
$16.75 per share on February 12, 1998, and 10,000 incentive stock options
at an exercise price of $24.38 per share on June 18, 1998. Grant prices
were determined to equal fair market value of the stock at the grant date.
Also, during the six-month period ended June 30, 1998, 400 stock options
were exercised at a price of $3.62. Subsequent to June 30, 1998, the
Company granted 54,000 options at an exercise price of $27.50, which were
determined to equal fair market value; 1,675 options were exercised at
$3.62 per share; and 8,281 options were terminated.
NEW ACCOUNTING STANDARDS.
In June 1997, Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131") was issued. SFAS 131 establishes annual and interim reporting
standards for an enterprise's business segments and related disclosures
about its products, services, geographic areas and major customers.
Adoption of this statement will not impact the Company's consolidated
financial position, results of operations or cash flows. The Company will
adopt this Statement in its annual financial statements for the year
ending December 31, 1998.
In February 1998, Statement of Financial Accounting Standards No. 132,
"Employers' Disclosures about Pensions and Other Post-retirement Benefits"
("SFAS 132") was issued. SFAS 132 standardizes the disclosure requirements
for pensions and other post-retirement 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 disclosures that are no longer useful. SFAS 132 is
effective for fiscal years beginning after December 15, 1997. The
Statement is not expected to have an effect on the Company's financial
statements.
F-16
<PAGE>
In June 1998, Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133") was issued. SFAS 133 establishes standards for derivative
instruments and hedging activities and requires that an entity recognize
all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. This
statement is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. The Statement is not expected to have an effect on
the Company's financial statements.
YEAR 2000
The Company is working to resolve the potential impact of the Year 2000 on
the ability of the computerized information systems it uses to accurately
process information that may be date sensitive. Any of the programs it
uses that recognize a date using "00" as the year 1900 rather than the
year 2000 could result in errors or system failures that could ultimately
cause AIB or its service providers to become unable to process customer
transactions and could thereby require AIB to cease operations pending
resolution of the problem. Such an eventuality would materially adversely
affect the Company's business, financial condition and results of
operations. Accordingly, management is devoting significant attention to
identifying Year 2000 issues and testing its in-house and external systems
for Year 2000 compliance. To date, the Company has incurred Year 2000
remediation costs of approximately $7,000 and has budgeted approximately
$25,000 for total remediation costs. The Company has been utilizing
working capital to fund its Year 2000 compliance program and anticipates
that it will continue to do so.
The Company began testing its in-house information technology ("IT")
systems during the second quarter of 1998 and is continuing such testing
during the third and fourth quarters of 1998, with an OTS- mandated
completion date of December 31, 1998. Management has not identified, and
does not anticipate, any significant risks or issues relating to non-IT
systems.
The Company is also assessing the Year 2000 compliance of its outside
vendors and service providers, who include but are not limited to BISYS
and CheckFree. Because the Company primarily contracts with outside
vendors for its computer application programs, management believes the
Company's principal risk relating to Year 2000 issues lies in the
potential inability of those vendors to process date sensitive information
involving the Year 2000. The Company expects to begin testing the systems
provided by these vendors for Year 2000 compliance beginning in the fourth
quarter of 1998, with an OTS-mandated completion date of June 30, 1999. In
addition, management is contacting each of the Company's vendors to obtain
a commitment that they are or will timely be Year 2000 complaint. If such
assurances are not forthcoming, or if management believes for any reason
that any of its vendors will not be Year 2000 compliant when required,
management plans to contract with other vendors that would be able to
provide similar services at similar costs. Although no assurances can be
given, management believes that such vendors are and will be available.
Alternatively, the Company could bring the outsourced services in-house by
licensing the applicable software and converting it to run on the
Company's platforms or form a correspondent relationship with an
unaffiliated Year 2000-compliant bank that could service AIB's customers
and accounts until the Company could provide such services on a Year
2000-compliant basis. Management believes that the Company could implement
any of the forgoing contingency plans without a material interruption in
its business and without a material adverse effect on the Company's
results of operations.
F-17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 162,310
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 3,015,169
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 42,353,426
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 191,845,279
<ALLOWANCE> 3,710,871
<TOTAL-ASSETS> 246,714,144
<DEPOSITS> 186,845,624
<SHORT-TERM> 20,500,000
<LIABILITIES-OTHER> 2,048,944
<LONG-TERM> 0
0
0
<COMMON> 61,460
<OTHER-SE> 37,258,116
<TOTAL-LIABILITIES-AND-EQUITY> 246,714,144
<INTEREST-LOAN> 4,801,018
<INTEREST-INVEST> 1,658,134
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 6,459,152
<INTEREST-DEPOSIT> 3,583,143
<INTEREST-EXPENSE> 4,017,476
<INTEREST-INCOME-NET> 2,441,676
<LOAN-LOSSES> (9,672)
<SECURITIES-GAINS> 10,146
<EXPENSE-OTHER> (2,353,854)
<INCOME-PRETAX> 88,296
<INCOME-PRE-EXTRAORDINARY> 88,296
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,117,359
<EPS-PRIMARY> $0.51
<EPS-DILUTED> $0.49
<YIELD-ACTUAL> 2.744
<LOANS-NON> 0
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,344,478
<ALLOWANCE-OPEN> 453,444
<CHARGE-OFFS> 87,743
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 3,710,871
<ALLOWANCE-DOMESTIC> 3,710,871
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
