SouthFirst Bancshares (SZBI) 10QSB 2004 Q3 Quarterly report (small business)

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-QSB

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For Quarterly Period Ended:	Commission File Number
June 30, 2004	1-13640

SOUTHFIRST BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Delaware	63-1121255
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
126 North Norton Avenue, Sylacauga, Alabama	35150
(Address of principal executive offices)	(Zip Code)
Registrant’s telephone number, including area code:	256-245-4365

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the 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.

     [X] Yes                                         [  ] No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12(b)-2 of the Exchange Act).

     [  ] Yes                                          [X] No

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:

Common Stock, par value $.01 per share	709,033 shares
Class	Outstanding at August 2, 2004

Transitional Small Business Disclosure Format [  ] Yes [X] No

SOUTHFIRST BANCSHARES, INC.
FORM 10-QSB
For the Quarterly Period Ended June 30 2004

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION
Item 1: Financial Statements (Unaudited)	1
Consolidated Statements of Financial Condition at June 30, 2004 (Unaudited) and September 30, 2003	1
Consolidated Statements of Operations (Unaudited) for the Three and Nine Months Ended June 30, 2004 and 2003	2
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the Nine Months Ended June 30, 2004	3
Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended June 30, 2004 and 2003	4-5
Notes to Consolidated Financial Statements (Unaudited) — June 30, 2004 and 2003	6-9
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations	10-14
Item 3: Controls and Procedures	15
PART II — OTHER INFORMATION
Item 1: Legal Proceedings	16
Item 6: Exhibits and Reports on Form 8-K	16
SIGNATURES	17
EXHIBIT INDEX	18
CERTIFICATIONS	19-21
EX-31.1 SECTION 302 CERTIFICATION OF CEO
EX-31.2 SECTION 302 CERTIFICATION OF CFO
EX-32.1 SECTION 906 CERTIFICATION OF CEO & CFO

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

PART 1: FINANCIAL INFORMATION

Consolidated Statements of Financial Condition
June 30, 2004 (Unaudited) and September 30, 2003

	June 30,			September 30,
	2004			2003
	(Unaudited)
Assets
Cash and cash equivalents	$	7,901,099		$	6,049,325
Interest-bearing deposits in other financial institutions		637,242			533,003
Securities available-for-sale, at fair value		14,231,502			32,599,988
Securities held-to-maturity at amortized cost, fair value of $15,056,165		15,046,166			—
Loans receivable		90,117,275			85,573,736
Less allowance for loan losses		(831,664	)		(1,191,033	)
Net loans		89,285,611			84,382,703
Loans held for sale at cost (which approximates fair value)		803,720			1,107,805
Foreclosed assets, net		526,743			77,680
Premises and equipment, net		4,658,605			4,298,889
Federal Home Loan Bank stock, at cost		1,117,000			1,117,000
Goodwill		543,706			543,706
Accrued interest receivable		734,119			679,402
Other assets		3,293,288			2,264,952
Total Assets	$	138,778,801		$	133,654,453
Liabilities And Stockholders’ Equity
Liabilities:
Deposits:
Non-interest bearing	$	3,167,448		$	3,657,079
Interest bearing		94,882,694			89,900,902
Total deposits		98,050,142			93,557,981
Advances by borrowers for property taxes and insurance		204,782			213,042
Accrued interest payable		493,642			576,676
Borrowed funds		29,021,011			27,000,861
Accrued expenses and other liabilities		829,701			628,522
Total liabilities		128,599,278			121,977,082
Stockholders’ Equity:
Common stock, $.01 par value, 2,000,000 shares authorized, 990,284 shares issued and 709,033 shares outstanding at June 30, 2004;
989,868 shares issued and 713,944 shares outstanding at September 30, 2003		10,000			9,996
Additional paid-in capital		9,843,959			9,837,058
Treasury stock, at cost (281,251 shares at June 30, 2004; 275,924 shares at September 30, 2003)		(3,894,382	)		(3,809,839	)
Deferred compensation on common stock employee benefit plans		(165,364	)		(183,179	)
Shares held in trust at cost (9,775 shares at June 30, 2004 and September 30, 2003)		(107,161	)		(107,161	)
Retained earnings		5,267,323			6,148,255
Accumulated comprehensive other income (loss)		(774,852	)		(217,759	)
Total stockholders’ equity		10,179,523			11,677,371
Total Liabilities and Stockholders’ Equity	$	138,778,801		$	133,654,453

See accompanying notes to consolidated financial statements.

1

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Operations (Unaudited)
for the Three and Nine Months Ended June 30, 2004 and 2003

	Nine Months Ended					Three Months Ended
	June 30,					June 30,
	2004			2003		2004			2003
Interest and dividend income:
Interest and fees on loans	$	4,040,405		$	4,496,951	$	1,350,769		$	1,451,490
Interest income on deposits in other financial institutions		27,184			77,650		8,172			20,372
Interest and dividend income on securities available for sale		1,129,723			984,759		265,699			341,068
Interest income on securities held to maturity		131,724			—		131,724			—
Total interest and dividend income		5,329,036			5,559,360		1,756,364			1,812,930
Interest expense:
Interest on deposits		1,294,193			1,999,088		422,000			610,036
Interest on borrowed funds		801,279			759,978		265,347			254,281
Total interest expense		2,095,472			2,759,066		687,347			864,317
Net interest income before provision for loan losses		3,233,564			2,800,294		1,069,017			948,613
Provision for loan losses		1,244,958			118,451		9,268			29,488
Net interest income after provision for loan losses		1,988,606			2,681,843		1,059,749			919,125
Other income:
Service charges and other fees		412,140			405,890		147,965			149,536
Employee benefit trust and consulting fees		1,152,793			866,438		443,132			326,225
Gain on sale of loans		560,333			872,409		266,729			329,291
Gain (loss) on sale of foreclosed assets		1,868			5,700		3,404			22,595
Gain (loss) on sale of equipment		927			13,890		—			2,725
Gain (loss) on sale of investment securities available-for-sale		79,024			236,150		(78,906	)		2,412
Other		243,375			268,981		71,464			94,840
Total other income		2,450,460			2,669,458		853,788			927,624
Other expenses:
Compensation and benefits		3,355,748			3,138,281		1,228,274			1,056,364
Net occupancy expense		297,077			295,654		104,552			95,139
Furniture and fixtures		356,319			340,043		129,587			109,426
Data processing		288,048			202,165		117,761			58,380
Office supplies and expense		327,857			328,303		114,683			113,430
Deposit insurance premiums		76,233			82,028		26,539			27,163
Legal		126,250			126,350		48,750			66,350
Other		515,252			510,772		158,178			195,378
Total other expenses		5,342,784			5,023,596		1,928,324			1,721,630
Income (loss) before income taxes		(903,718	)		327,705		(14,787	)		125,119
Income tax expense (benefit)		(342,029	)		124,597		(4,345	)		47,485
Net income (loss)	$	(561,689	)	$	203,108	$	(10,442	)	$	77,634
Earnings (loss) per share:
Basic		(0.79	)		0.27		(0.01	)		0.11
Diluted		(0.76	)		0.26		(0.01	)		0.11
Cash dividends declared		0.45			0.45		0.15			0.15
Weighted average shares outstanding:
Basic		709,131			752,700		709,070			711,819
Diluted		739,481			767,263		739,107			727,766

See accompanying notes to consolidated financial statements. 2

2

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
for the Nine Months Ended June 30, 2004

								Deferred
								Compensation
								on Common									Accumulated
			Additional					Stock			Shares						Comprehensive			Total
	Common		Paid-in		Treasury			Employee			Held in			Retained			Other Income			Stockholders'
	Stock		Capital		Stock			Benefit Plans			Trust			Earnings			(Loss)			Equity
Balance at September 30, 2003	$	9,996	$	9,837,058	$	(3,809,839	)	$	(183,179	)	$	(107,161	)	$	6,148,255		$	(217,759	)	$	11,677,371
Comprehensive income:
Net income (loss)		—		—		—			—			—			(561,689	)		—			(561,689	)
Change in net unrealized gain on available-for-sale securities, net of reclassification adjustments and income taxes of $341,444		—		—		—			—			—			—			(557,093	)		(557,093	)
Total comprehensive income (loss)		—		—		—			—			—			—			—			(1,118,782	)
Vesting of deferred compensation shares		—		—		—			17,815			—			—			—			17,815
Acquisition of Treasury stock				—		(84,543	)		—			—			—			—			(84,543	)
Stock options exercised		4		6,901		—			—			—			—			—			6,905
Cash dividends declared		—		—		—			—			—			(319,243	)		—			(319,243	)
Balance at June 30, 2004	$	10,000	$	9,843,959	$	(3,894,382	)	$	(165,364	)	$	(107,161	)	$	5,267,323		$	(774,852	)	$	10,179,523

See accompanying notes to consolidated financial statements.

3

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)
for the Nine Months Ended June 30, 2004 and 2003

	2004			2003
Operating activities:
Net income (loss)	$	(561,689	)	$	203,108
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		1,244,958			118,451
Depreciation and amortization		265,891			255,712
Gain on sale of securities		(79,024	)		(236,150	)
Gain on sale of loans		(560,333	)		(872,409	)
Increase (decrease) in deferred loan origination fees		(5,032	)		(2,125	)
Net amortization of premium/discount on investment securities		(537	)		(9,818	)
(Gain) loss on sale of other property owned		(927	)		(13,890	)
(Gain) loss on sale of foreclosed assets		(1,868	)		(5,700	)
Loans originated for sale		(24,122,621	)		(41,732,909	)
Proceeds from sale of loans		24,987,039			40,846,799
(Increase) decrease in accrued interest receivable		(54,717	)		124,271
(Increase) decrease in other assets		(1,028,336	)		23,806
Deferred compensation expense		17,815			71,904
Increase (decrease) in accrued interest payable		(83,034	)		(80,160	)
Increase (decrease) in accrued expenses and other liabilities		542,623			(137,140	)
Net cash used in operating activities		560,208			(1,446,250	)
Investing activities:
Net change in interest-bearing deposits in other financial institutions		(104,239	)		358,985
Proceeds from calls and maturities of investment securities available-for-sale		2,468,580			14,981,500
Purchase of investment securities available-for-sale		(8,503,846	)		(23,713,384	)
Proceeds from sale of investment securities available-for-sale		8,538,610			6,409,574
Proceeds from sale of Federal Home Loan Bank stock		—			1,112,800
Net (increase) decrease in loans		(6,108,153	)		2,780,111
Purchase of premises and equipment		(635,056	)		(170,631	)
Proceeds from sale of foreclosed assets		81,185			267,386
Proceeds from sale of other assets		10,376			452,059
Transfer from loans of real estate owned property		(508,605	)		(780,364	)
Transfer from loans of other repossessed assets		(54,456	)		2,901
Net cash provided by investment activities		(4,815,604	)		1,700,937

(Continued)

See accompanying notes to consolidated financial statements.

4

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)
for the Nine Months Ended June 30, 2004 and 2003

	2004			2003
Financing activities:
Increase (decrease) in deposits	$	4,492,161		$	3,767,115
Proceeds from borrowed funds		49,168,299			4,589,000
Repayment of borrowed funds		(47,148,149	)		(7,988,750	)
Cash dividends paid		(319,243	)		(345,752	)
Acquisition of treasury stock		(84,543	)		(1,312,530	)
Proceeds from exercise of stock options		6,905
Decrease in advances by borrowers for property taxes and insurance		(8,260	)		(62,589	)
Net cash provided (used) by financing activities		6,107,170			(1,353,506	)
Increase (decrease) in cash and cash equivalents		1,851,774			(1,098,819	)
Cash and cash equivalents at beginning of period		6,049,325			8,122,898
Cash and cash equivalents at end of period	$	7,901,099		$	7,024,079
Supplemental information on cash payments:
Interest paid	$	2,178,506		$	2,839,226
Income taxes paid	$	124,917		$	185,375
Supplemental information on non-cash transactions:
Change in net unrealized gain on investment securities available-for-sale	$	33,178		$	4,927
Real estate obtained through foreclosure	$	508,605		$	780,364

See accompanying notes to consolidated financial statements.

5

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

(1)Basis of Presentation

The accounting and reporting policies of SouthFirst Bancshares, Inc. (“SouthFirst”) conform with accounting principles generally accepted in the United States and with general financial services industry practices.

Information filed on this Form 10-QSB as of and for the quarter ended June 30, 2004, was derived from the financial records of SouthFirst and its wholly-owned subsidiaries, First Federal of the South (“First Federal”), and SouthFirst Financial Services, Inc. (“SouthFirst Financial”) and First Federal’s wholly owned subsidiaries, Pension & Benefit Trust Company (“Pension & Benefit”), a Montgomery, Alabama-based employee benefits consulting firm, and SouthFirst Mortgage, Inc. (“SouthFirst Mortgage”), a Birmingham, Alabama based residential construction loan and mortgage loan origination office. Collectively, SouthFirst Bancshares, Inc. and its subsidiaries are referred to herein as the “Company” and as “SouthFirst.”

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions for Form 10-QSB and, therefore, do not include all information and footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States. For a summary of significant accounting policies that have been consistently followed, see Note 1 to the consolidated financial statements included under Item 7 on Form 10-KSB. It is management’s opinion that all adjustments, consisting of only normal and recurring items necessary for a fair presentation, have been included. The results contained in these statements are not necessarily indicative of the results which may be expected for the entire year.

(2)Stock-Based Compensation Plans

During 1995, the Company adopted a Stock Option and Incentive Plan for directors and key employees of the Company. The exercise price cannot be less than the market price on the grant date and number of shares available for options cannot exceed 83,000. Stock appreciation rights may also be granted under the plan. During 1998, the Company adopted the 1998 Stock Option & Incentive Plan for directors and key employees of the Company. Under the 1998 plan, options to acquire 63,361 shares had been granted. The term of the options range from seven to ten years and they vest equally over periods from three to five years.

Following is a summary of the status of the 1995 and 1998 plans:

	1995 Plan				1998 Plan
	Number		Weighted Average		Number			Weighted Average
	of Shares		Exercise Price		of Shares			Exercise Price
Outstanding at September 30, 2003		73,700	$	12.40		61,971		$	13.36
Exercised		—		—		(416	)		10.22
Forfeited		—		—		(1,256	)		13.55
Outstanding at June 30, 2004		73,700	$	12.40		60,299		$	13.38

6

Information pertaining to options outstanding at June 30, 2004 is as follows:

			Options Outstanding				Options Exercisable
			Weighted
			Average		Weighted				Weighted
			Remaining		Average				Average
	Number		Contractual		Exercise		Number		Exercise
Exercise Price	Outstanding		Life		Price		Exercisable		Price
$ 9.75		20,905		3.35 years				20,905
9.92		9,000		7.42 years				3,600
12.10		43,760		8.29 years				8,752
14.00		29,880		1.18 years				29,880
15.75		30,454		3.58 years				30,454
Outstanding at June 30, 2004		133,999		4.80 years	$	12.84		93,591	$	13.29

The Company accounts for these plans under the recognition and measurement principles of APB Opinion No. 25,Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123,Accounting for Stock-Based Compensation, to stock-based employee compensation.

	Nine Months Ended						Three Months Ended
	June 30,						June 30,
	2004			2003			2004			2003
Net income (loss), as reported	$	(561,689	)	$	203,108		$	(10,442	)	$	77,634
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(2,094	)		(6,104	)		(649	)		(2,035	)
Pro forma net income (loss)	$	(563,783	)	$	197,004		$	(11,091	)	$	75,599
Earnings (loss) per share:
Basic — as reported	$	(.79	)	$	.27		$	(.01	)	$	.11
Basic — pro forma		(.80	)		.26			(.02	)		.11
Diluted — as reported		(.76	)		.26			(.01	)		.11
Diluted — pro forma		(.76	)		.26			(.02	)		.10

Because the SFAS No. 123 method of accounting has not been applied to options granted prior to October 1, 1995, the resulting pro forma compensation costs may not be representative of that to be expected in future years.

The weighted average fair value of options granted during the nine months ended June 30, 2004 and 2003 was $.00 and $12.10, respectively. The fair value of each grant is estimated on the date of grant using the Black-Sholes option pricing model with the following assumptions used for grants in 2003: expected dividend yield of 4.96%; expected option life of 10 years; expected volatility of 7.21%; and a risk-free interest rate of 4.03%.

7

(3)Business Segment Information

The Company organizes its business units into two reportable segments: traditional banking activities and employee benefits consulting and trust activities. The banking segment provides a full range of banking services within its primary market areas of central Alabama. The employee benefits trust company operates primarily in the state of Alabama. The Company’s reportable business segments are strategic business units that offer different products and services. Each segment is managed separately, because each unit is subject to different marketing and regulatory environments.

The accounting policies used by each reportable segment are the same as those discussed in Note 1 to the Consolidated Financial Statements included under Item 13 of the Annual Report on Form 10-KSB. The following table presents financial information for each reportable segment:

	Nine Months Ended June 30, 2004								Nine Months Ended June 30, 2003
				Employee							Employee
	Banking			Benefits					Banking		Benefits
	Activities			Activities		Total			Activities		Activities		Total
Interest and dividend income	$	5,311,161		$	17,875	$	5,329,036		$	5,543,858	$	15,502	$	5,559,360
Interest expenses		2,095,472			—		2,095,472			2,759,066		—		2,759,066
Net interest income		3,215,689			17,875		3,233,564			2,784,792		15,502		2,800,294
Provision for loan losses		1,244,958			—		1,244,958			118,451		—		118,451
Net interest income after provision for loan losses		1,970,731			17,875		1,988,606			2,666,341		15,502		2,681,843
Other income		1,285,041			1,165,419		2,450,460			1,794,020		875,438		2,669,458
Other expenses		4,366,321			976,463		5,342,784			4,212,629		810,967		5,023,596
Income (loss) before income taxes		(1,110,549	)		206,831		(903,718	)		247,732		79,973		327,705
Income taxes		(420,789	)		78,760		(342,029	)		94,199		30,398		124,597
Net income (loss)	$	(689,760	)	$	128,071	$	(561,689	)	$	153,533	$	49,575	$	203,108

	Three Months Ended June 30, 2004								Three Months Ended June 30, 2003
				Employee							Employee
	Banking			Benefits					Banking		Benefits
	Activities			Consulting		Total			Activities		Consulting		Total
Interest and dividend income	$	1,749,801		$	6,563	$	1,756,364		$	1,808,773	$	4,157	$	1,812,930
Interest expenses		687,347			—		687,347			864,317		—		864,317
Net interest income		1,062,454			6,563		1,069,017			944,456		4,157		948,613
Provision for loan losses		9,268			—		9,268			29,488		—		29,488
Net interest income after provision for loan losses		1,053,186			6,563		1,059,749			914,968		4,157		919,125
Other income		407,656			446,132		853,788			598,399		329,225		927,624
Other expenses		1,589,148			339,176		1,928,324			1,462,606		259,024		1,721,630
Income (loss) before income taxes		(128,306	)		113,519		(14,787	)		50,761		74,358		125,119
Income taxes		(47,565	)		43,220		(4,345	)		19,350		28,135		47,485
Net income (loss)	$	(80,741	)	$	70,299	$	(10,442	)	$	31,411	$	46,223	$	77,634

8

There have been no differences from the last annual report in the basis of measuring segment profit or loss. There have been no material changes in the amount of assets for any operating segment since the last annual report.

(4) Subsequent Event

On July 28, 2004, the Company declared a regular $0.15 per share cash dividend on the Company’s outstanding stock, payable on August 20, 2004, to stockholders of record as of August 11, 2004.

9

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

REVIEW OF RESULTS OF OPERATIONS

Overview

Net income for the three months ended June 30, 2004 decreased $88,076, or 113.4%, and decreased for the nine months ended June 30, 2004 by $764,497, or 376.5%, compared to the same periods in fiscal 2003. Net interest income, after the provision for loan losses for the three months ended June 30, 2004 increased $140,624, or 15.3%, and decreased $693,237, or 25.8%, for the nine month period ended June 30, 2004 compared to the same period in fiscal 2003. This decrease is attributable primarily to a provision for loan losses of $1,244,958, the reasons for which are discussed below under the heading “Provision for Loan Losses.” Non-interest income decreased $73,836, or 8.0%, for the three month period ended June 30, 2004, and decreased $218,998, or 8.2%, for the nine month period ended June 30, 2004, when compared to the same periods in fiscal 2003. Non-interest expense increased $206,694, or 12.0%, for the three month period ended June 30, 2004 and increased $319,188, or 6.4%, for the nine month period ended June 30, 2004, compared to the same periods in fiscal 2003.

Primary earnings (loss) per common share, based on weighted average shares outstanding was ($.01) and $.11 for the three months ended June 30, 2004 and 2003, respectively, and ($.79) and $.27 for the nine months ended June 30, 2004 and 2003, respectively.

Those items significantly affecting net earnings are discussed in detail below.

Net Interest Income

Net interest income is the difference between the interest and fees earned on loans, securities, and other interest-bearing assets (interest income) and the interest paid on deposits and borrowed funds (interest expense). Net interest income is directly related to the interest rate spread, which is the difference between the interest rates on interest-earning assets and interest-bearing liabilities.

As of June 30, 2004, the interest rate spread increased 46 basis points as rates earned on interest-earning assets decreased 18 basis points to 5.71% while the cost of funds decreased 64 basis points to 2.23% compared to the same three-month period ending June 30, 2003. The decrease in rates paid and the decrease in rates received during this three-month interval reflects the downward trend in the repricing of higher yielding certificates of deposit, as well as a downward trend of the overall interest rate environment. While the cost of funds has been steadily decreasing over the past several months, interest rates on consumer loans, construction loans and mortgages have also decreased. The average balance of interest-earning assets remained constant at approximately $123.0 million while the average balance of interest-bearing liabilities increased $2.8 million, or 2.3%, from $120.6 million to $123.4 million. The combined effect of the changes in average balances and the changes in rates discussed above resulted in an increase in the interest rate spread from 3.02% to 3.48%, and an increase in net interest income of approximately $120,404, or 12.7%, and $433,270, or 15.5%, for the three and nine months ended June 30, 2004, respectively, compared to the same periods in fiscal 2003.

Provision for Loan Losses

The provision for loan losses reflects an increase in the amount of $1,126,507, or 951.0%, for the nine month period ending June 30, 2004, when compared to the same period in fiscal 2003. This increase is primarily the result of the write down of an acquisition and development loan, which entered into foreclosure in January 2004. At the date of foreclosure, this loan had a disbursed balance of approximately $1,948,000, with previously recognized allowances of approximately $525,000. At the time of foreclosure, the fair value of the property was estimated to be $500,000. At June 30, 2004, the allowance for loan losses to total average loans outstanding was 0.90% compared to 1.00% for the same period ended June 30, 2003.

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The year to date provision also includes an additional $200,000 general loan loss provision recorded to increase the balance in allowance for loan losses to an appropriate level, based on continuing reviews of asset quality.

Other Income

Total other income for the nine months ended June 30, 2004, decreased approximately $219,000 to $2,450,000, compared to $2,669,000 for the nine months ended June 30, 2003. A portion of the decrease in total non-interest income was attributable to a decrease of approximately $312,000 in gains on sales of loans as a result of the decline of the refinancing boom occurring in 2003. Other decreases included $157,000 from the sale of investment securities available-for-sale, decreases in the gain from the sale of foreclosed real estate and other assets of approximately $17,000 and a decrease in other income of approximately $26,000. These decreases in other income are partially offset by an increase in fee income generated from employee benefit trust and consulting of approximately $286,000 and an increase in service charges and other fees of approximately $6,000 when compared to the same period ended June 30, 2003.

For the three months ended June 30, 2004, total non-interest income decreased by approximately $74,000 to $854,000, compared to $927,000 for the same period in fiscal 2003. This decrease was primarily the result of a decrease of approximately $63,000 in gains on sales of loans, a decrease of approximately $81,000 from the sale of investment securities available-for-sale, decreases in the gain from the sale of foreclosed real estate and other assets of approximately $22,000 and a decrease in other income of approximately $23,000. These decreases in non-interest income are partially offset by an increase in fee income generated from employee benefit trust and consulting of approximately $117,000.

Other Expense

Total other expense for the nine months ended June 30, 2004, increased by approximately $319,000 to $5,343,000, as compared to $5,024,000 for the nine months ended June 30, 2003. The changes in other non-interest expense are attributable to an increase in compensation and benefits of approximately $217,000 and an increase in other occupancy expenses of approximately $18,000. The increase in compensation and benefit was primarily due to the acquisition of Walton Mortgage in the prior quarter and certain severance payments made in connection with the restructuring of SouthFirst Mortgage. Increases also occurred in data processing expenses of approximately $86,000 as a result of the company’s recent conversion from Kirchman to FiServ Vision in May 2004. Expenses related to office supplies and expenses, legal and other remained approximately the same for the periods ending June 30, 2004 and 2003 at $328,000, $126,000 and $515,000, respectively. Deposit insurance premiums decreased approximately $6,000 to approximately $76,000 when compared to the same period ended June 30, 2003.

For the three months ended June 30, 2004, total non-interest expense increased approximately $207,000 to $1,928,000 from $1,722,000 for the three months ended June 30, 2003. This increase resulted primarily from an increase in compensation and benefits of approximately $172,000, and an increase in other occupancy of approximately $30,000. An increase also occurred in data processing of approximately $59,000 as a result of the computer conversion discussed above. These increases are partially offset by decreases in legal and other expenses of approximately $18,000 and $37,000, respectively. Expenses related to office supplies and deposit insurance premiums remained constant between the two periods at approximately $114,000 and $27,000, respectively.

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Income Taxes

The Company’s effective tax rate for the nine month periods ended June 30, 2004 and 2003 was 37.8% and 38.0%, respectively, compared to the federal statutory rate of 34.0%. SouthFirst’s effective tax rate was higher than the statutory rate due primarily to state income taxes. Income tax expense decreased approximately $467,000 to ($342,029) for the nine months ended June 30, 2004, as compared to $124,597 for the nine months ended June 30, 2003, due to the decrease in pre-tax earnings.

REVIEW OF FINANCIAL CONDITION

Overview

Management continuously monitors the financial condition of SouthFirst in order to protect depositors, increase retained earnings, and protect current and future earnings.

Return on average stockholders’ equity is one way of assessing the return SouthFirst has generated for its stockholders. The table below sets forth the return on average stockholders’ equity and other performance ratios of SouthFirst for the periods indicated.

	At or for the three
	months ended
	June 30,
	2004			2003
Return on assets		(0.03	)%		0.22	%
Return on equity		(0.40	)%		2.48	%
Equity to asset ratio		7.47	%		8.99	%
Interest rate spread		3.48	%		3.02	%
Net interest margin		3.48	%		3.08	%
Total risk based capital		15.32	%		15.90	%
Non-performing loans to loans		0.88	%		0.49	%
Allowance for loan losses to loans		0.90	%		1.00	%
Allowance for loan losses to average non-performing loans		101.43	%		205.20	%
Ratio of net charge offs to average loans outstanding		0.02	%		0.03	%
Book value per common share outstanding	$	14.36		$	17.59

Significant factors affecting SouthFirst’s financial condition during the nine months ended June 30, 2004 are detailed below:

Assets

Total assets increased approximately $5,125,000, or 3.8%, from $133,654,000 at September 30, 2003 to $138,779,000 at June 30, 2004. Net loans increased approximately $4,903,000, or 5.8%, which occurred primarily in commercial construction and other types of real estate lending. Cash and amounts due from banks increased approximately $1,852,000 as a result of new deposit growth during the period. Investment securities available-for-sale decreased approximately $18,368,000, of which $16,000,000 was re-classified from available-for-sale to held-to-maturity due to management’s decision to hold such securities and its ability to do so during a changing interest rate environment. Other significant changes in assets occurring included an increase in premises and fixed assets, foreclosed assets and other assets of approximately $360,000, $449,000, and $1,028,000, respectively. Other assets increased primarily as a result of deferred taxes from market value adjustments of investments.

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Liabilities

Total liabilities increased approximately $6,622,000, or 5.4%, from $121,977,000 at September 30, 2003 to $128,599,000 at June 30, 2004. Deposits increased approximately $4,492,000, or 4.8%, during the period, which represents an increase in certificates of deposit of approximately $4,090,000 and an increase in checking and other savings accounts of approximately $402,000. Borrowed funds increased approximately $2,000,000, which represents an increase of approximately $1,565,000 in short-term reverse repurchase agreements with Morgan Keegan and an increase in the balance of an existing line of credit with First Commercial Bank of $435,000.

Loan Quality

Key to long-term earnings growth is maintenance of a high-quality loan portfolio. SouthFirst’s directive in this regard is carried out through its policies and procedures for review of loans. The goal and result of these policies and procedures is to provide a sound basis for new credit extensions and an early recognition of problem assets to allow the greatest flexibility in their timely disposition.

At June 30, 2004, the allowance for loan losses was $831,664, compared to $1,191,033 at September 30, 2003, which represents a decrease of approximately $359,000. Non-performing loans at June 30, 2004 were approximately $820,000 as compared to approximately $2,299,000 at September 30, 2003. At June 30, 2004 and September 30, 2003, the allowance for loan losses represented 0.90% and 1.39% of average loan balances, respectively. The allowance for loan losses is based upon management’s continuing evaluation of the collectibility of the loan portfolio under current economic conditions and includes analysis of underlying collateral value and other factors, which could affect collectibility. Management considers the allowance for loan losses to be adequate based upon the evaluations of the averages of specific loans, internal loan rating systems, and guidelines provided by the banking regulatory authorities governing First Federal.

Liquidity and Funding Sources

The Asset and Liability Committee of First Federal’s board of directors monitors and manages the liquidity needs of the Company to ensure that there is sufficient cash flow to satisfy demand for credit and deposit withdrawals, to fund operations and to meet other Company obligations and commitments on a timely and cost effective basis. Under current regulations, First Federal is required to maintain sufficient liquidity to assure its safe and sound operation. The requirement to maintain a specific minimum amount of liquid assets, established by previous regulation, has been eliminated. Presently, there is no specific standard or guideline regarding the application of the current regulatory requirement.

Under the previous regulation, First Federal was required to maintain an average daily balance of liquid assets, in each calendar quarter, of not less than 4% of (i) the amount of its liquidity base at the end of the preceding calendar quarter, or (ii) the average daily balance of its liquidity base during the preceding quarter. For purposes of this computation, liquid assets included specified short-term assets (e.g., cash, certain time deposits, certain banker’s acceptances and short-term U.S. Government, state or federal agency obligations), and long-term assets (e.g., U.S. Government obligations of more than one and less than five years and state agency obligations maturing in two years or less).

As of June 30, 2004, First Federal’s average daily balance of liquid assets was approximately 24.0% of its March 31, 2004 liquidity base, far exceeding the 4% requirement set by the previous regulation. These liquid assets included approximately $6,271,000 in cash and cash equivalents, and approximately $19,044,000 in other qualifying assets. In addition, as of June 30, 2004, the fair market value of the company’s investment securities portfolio, which is held for sale, was $14,232,000, which represents a decrease of approximately $18,368,000. Of this amount, on May 13, 2004, $16,000,000 was re-classified from available-for-sale to held-to-maturity due to management’s decision discussed above. In addition, during the quarter ending June 30, 2004, $5,000,000 of the Company’s investment portfolio was sold at an after tax loss of approximately $49,000. The Company uses its investment securities portfolio to manage liquidity and interest rate risk, whereby liquidity is available through those securities that are not pledged. Further, cash flows from operations, resulting primarily from net income adjusted for certain items such as interest expense and provision for loan loss, are an additional source of liquidity for the Company.

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With respect to current funding sources, deposits provide a significant portion of the Company’s cash flow needs and continue to provide a relatively stable, low cost source of funds. As of June 30, 2004, the amount of deposits was $98,050,000, which represents an increase of $4,492,000 from the amount of deposits at September 30, 2003.

Other sources of funding used by the Company include commercial lines of credit, and advances from the Federal Home Loan Bank of Atlanta (the “FHLBA”). As of June 30, 2004, the Company had a line of credit, based on prime, with First Commercial Bank in the amount of $2,500,000 which matures on June 1, 2005, and of which there is an outstanding balance at June 30, 2004 for approximately $2,353,000. At June 30, 2004, the Company had outstanding balances with the FHLBA of $22,340,000.

First Federal also has short-term borrowings through reverse repurchase agreements with Morgan Keegan & Co. As of June 30, 2004, the balance outstanding on these borrowings was approximately $4,328,000.

Management believes that the Company’s significant liquidity and existing funding sources are more than adequate to ensure sufficient cash flow to satisfy demand for credit and any deposit withdrawals, to fund operations, and, otherwise, to meet other Company obligations and commitments on a timely and cost-effective basis.

Capital Adequacy and Resources

Management is committed to maintaining First Federal’s capital at a level that would be sufficient to protect depositors, provide for reasonable growth, and comply fully with all regulatory requirements. Management’s strategy to meet this commitment is to retain sufficient earnings while providing a reasonable return on equity.

The Office of Thrift Supervision has issued guidelines identifying minimum regulatory “tangible” capital equal to 1.50% of adjusted total assets, a minimum of 4.0% core capital ratio, and a minimum risk-based capital of 8.0% of risk-weighted assets. First Federal has satisfied its capital requirements primarily through the retention of earnings.

As of June 30, 2004, First Federal has satisfied all regulatory capital requirements. First Federal’s compliance with the current standards is as follows:

			Percent of
	Amount		Asset Base
Tangible capital	$	12,857,000		9.23	%
Core capital		12,857,000		9.23	%
Tier-based capital		13,330,000		15.32	%

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Item 3: Controls and Procedures

Within 90 days prior to the filing date of this quarterly report, pursuant to Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”), the Company’s Chief Executive Officer and Controller (principal financial officer) evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-14(c) of the Exchange Act). Based on their evaluation, the Chief Executive Officer and Controller have concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information, relating to the Company and the Company’s consolidated subsidiaries, required to be included in periodic reports, including this quarterly report, filed by the Company with the SEC.

There have not been any significant changes in the Company’s internal controls, or in other factors that could significantly affect these controls, subsequent to the date of the Chief Executive Officer’s and Controller’s evaluation.

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SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

PART II. OTHER INFORMATION

Item 1: Legal Proceedings

In the normal course of business, SouthFirst and First Federal from time to time are involved in legal proceedings. Management believes that there are no pending or threatened legal proceedings which, upon resolution, are expected to have a material effect upon SouthFirst’s or First Federal’s financial condition.

Item 6: Exhibits and Reports on Form 8-K

(a)  Exhibits. The Following Exhibits are filed with this report.

Exhibit	Number Description
31.1	Certificate of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated August 16, 2004.
31.2	Certificate of the equivalent of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated August 16, 2004.
32	Certificate of the Chief Executive Officer and the equivalent of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated August 16, 2004.

The certificate listed as Exhibit 32 is being furnished pursuant to the final rule issued by the Securities and Exchange Commission in Release No. 33-8238 to accompany this quarterly report and shall not be deemed “filed” for the purposes of Section 18 of the Securities and Exchange Act of 1934 (the “Exchange Act”), or otherwise subject to the liability of such section or Section 11 of the Securities Act of 1933 (the “Securities Act”), nor shall such certificates be deemed incorporated by reference in any filing under the Securities Act or the Exchange Act, regardless of the general incorporation language of such filings, except as shall be expressly set forth by specific reference in such filing.

(b)  Reports on Form 8-K.

     No reports on Form 8-K were filed during the quarter ended June 30, 2004.

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SIGNATURES

     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.

	SOUTHFIRST BANCSHARES, INC.
Date: August 16, 2004	By:	/s/ Joe K. McArthur Joe K. McArthur Chief Executive Officer (principal executive officer)
Date: August 16, 2004	By:	/s/ Janice Browning Janice Browning Controller, Treasurer (principal accounting officer)

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Exhibit Index

Exhibit Number	Description of Exhibit
31.1	Certificate of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated August 16, 2004.
31.2	Certificate of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated August 16, 2004.
32.1	Certificate of the Chief Executive Officer and the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated August 16, 2004.

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