SouthFirst Bancshares (SZBI) 10QSB 2006 Q1 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
December 31, 2005	1-13640

SOUTHFIRST BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Delaware	63-1121255
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	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)

Check 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.

þ Yeso No

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yesþ No

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

Common Stock, par value $.01 per share	708,871 shares
Class	Outstanding at January 31, 2006

Transitional Small Business Disclosure Formato Yes    þ No

SOUTHFIRST BANCSHARES, INC.

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION
Item 1: Financial Statements (Unaudited)	1
Consolidated Statements of Financial Condition at December 31, 2005 (Unaudited) and September 30, 2005	1
Consolidated Statements of Operations (Unaudited) for the Three Months Ended December 31, 2005 and 2004	2
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the Three Months Ended December 31, 2005	3
Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended December 31, 2005 and 2004	4-5
Notes to Consolidated Financial Statements (Unaudited) — December 31, 2005 and 2004	6-10
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations	11-15
Item 3: Controls and Procedures	15
PART II — OTHER INFORMATION	16
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 THE CEO
EX-31.2 SECTION 302, CERTIFICATION OF THE CFO
EX-32 SECTION 906 CERTIFICATION OF THE CEO AND CFO

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

PART 1: FINANCIAL INFORMATION

Item 1: Financial Statements

Consolidated Statements of Financial Condition

December 31, 2005 (Unaudited) and September 30, 2005

	December 30,			September 30,
	2005			2005
	(Unaudited)
Assets
Cash and cash equivalents	$	4,589,587		$	5,042,170
Interest-bearing deposits in other financial institutions		857,967			871,801
Securities available-for-sale, at fair value		25,413,874			26,482,705
Loans receivable		95,640,826			95,907,301
Less allowance for loan losses		(532,964	)		(518,572	)
Net loans		95,107,862			95,388,729
Loans held for sale at cost (which approximates fair value)		—			948,250
Foreclosed assets, net		374,063			255,470
Premises and equipment, net		4,620,173			4,645,624
Federal Home Loan Bank stock, at cost		1,479,200			1,218,200
Goodwill		543,706			543,706
Accrued interest receivable		548,579			656,455
Other assets		2,582,844			3,084,414
Total Assets	$	136,117,855		$	139,137,524
Liabilities And Stockholders’ Equity
Liabilities:
Deposits:
Non-interest bearing	$	5,338,184		$	4,232,573
Interest bearing		91,267,403			96,892,239
Total deposits		96,605,587			101,124,812
Advances by borrowers for property taxes and insurance		196,702			237,052
Accrued interest payable		717,369			641,075
Borrowed funds		27,872,861			26,015,861
Accrued expenses and other liabilities		523,318			694,781
Total liabilities		125,915,837			128,713,581
Stockholders’ Equity:
Common stock, $.01 par value, 2,000,000 shares authorized; 990,241 shares issued and 708,871 shares outstanding at December 31, 2005; 990,241 shares issued and 708,971 shares outstanding at September 30, 2005		9,996			9,996
Additional paid-in capital		9,839,851			9,839,851
Treasury stock, at cost (281,370 shares at December 31, 2005 and 281,270 at September 30, 2005)		(3,893,823	)		(3,892,598	)
Deferred compensation on common stock employee benefit plans		(129,737	)		(135,675	)
Shares held in trust at cost (9,402 shares at December 31, 2005 and September 30, 2005)		(103,483	)		(103,483	)
Retained earnings		4,828,007			4,874,445
Accumulated comprehensive other income (loss)		(348,793	)		(168,593	)
Total stockholders’ equity		10,202,018			10,423,943
Total Liabilities and Stockholders’ Equity	$	136,117,855		$	139,137,524

See accompanying notes to consolidated financial statements.

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SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Operations (Unaudited)

for the Three Months Ended December 31, 2005 and 2004

	2005			2004
Interest and dividend income:
Interest and fees on loans	$	1,630,788		$	1,493,102
Interest income on deposits in other financial institutions		24,624			16,750
Interest and dividend income on securities available-for-sale		319,869			165,338
Interest income on securities held-to-maturity		—			211,648
Total interest and dividend income		1,975,281			1,886,838
Interest expense:
Interest on deposits		635,063			476,497
Interest on borrowed funds		343,464			293,216
Total interest expense		978,527			769,713
Net interest income		996,754			1,117,125
Provision for loan losses		53,237			25,000
Net interest income after provision for loan losses		943,517			1,092,125
Other income:
Service charges and other fees		141,278			126,928
Employee benefit trust and consulting fees		375,322			365,049
Gain on sale of loans		133,950			186,690
Gain (loss) on sale of foreclosed assets		(862	)		(2,102	)
Gain (loss) on sale of equipment		—			3,500
Other		100,354			92,806
Total other income		750,042			772,871
Other expenses:
Compensation and benefits		949,666			985,861
Net occupancy expense		109,624			109,120
Furniture and fixtures		133,199			123,030
Data processing		68,706			85,381
Office supplies and expense		116,846			96,320
Deposit insurance premiums		27,502			26,795
Legal		24,996			52,800
Other professional services		61,173			67,815
Other		161,987			120,817
Total other expenses		1,653,699			1,667,939
Income before income taxes		39,860			197,057
Income tax expense		15,411			74,882
Net income	$	24,449		$	122,175
Earnings per share:
Basic		0.03			0.17
Diluted		0.03			0.17
Cash dividends declared		0.10			0.15
Weighted average shares outstanding:
Basic		708,885			709,406
Diluted		713,003			732,548

See accompanying notes to consolidated financial statements.

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SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)

for the Three Months Ended December 31, 2005

								Deferred
								Compensation
								on Common									Accumulated
			Additional					Stock			Shares						Other			Total
	Common		Paid-in		Treasury			Employee			Held in			Retained			Comprehensive			Stockholders’
	Stock		Capital		Stock			Benefit Plans			Trust			Earnings			Income (Loss)			Equity
Balance at September 30, 2005	$	9,996	$	9,839,851	$	(3,892,598	)	$	(135,675	)	$	(103,483	)	$	4,874,445		$	(168,593	)	$	10,423,943
Comprehensive income:
Net income															24,449						24,449
Change in net unrealized gain on available-for-sale securities, net of reclassification adjustments and income taxes of $110,446																		(180,200	)		(180,200	)
Total comprehensive income																					(155,751	)
Vesting of deferred compensation shares									5,938												5,938
Acquisition of treasury stock						(1,225	)														(1,225	)
Cash dividends declared															(70,887	)					(70,887	)
Balance at December 31, 2005	$	9,996	$	9,839,851	$	(3,893,823	)	$	(129,737	)	$	(103,483	)	$	4,828,007		$	(348,793	)	$	10,202,018

See accompanying notes to consolidated financial statements.

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SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

for the Three Months Ended December 31, 2005 and 2004

	2005			2004
Operating activities:
Net income	$	24,449		$	122,175
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Provision for loan losses		53,237			25,000
Depreciation and amortization		95,794			99,232
Gain on sale of loans		(133,950	)		(186,690	)
Increase (decrease) in deferred loan origination fees		(11,470	)		34,806
Net amortization of premium/discount on investment securities		8,479			(343	)
Loss on sale of foreclosed assets		862			2,102
Gain on sale of premises and equipment		—			(3,500	)
Loans originated for sale		(4,846,691	)		(7,997,975	)
Proceeds from sale of loans		5,928,891			7,821,272
(Increase) decrease in accrued interest receivable		107,876			(89,367	)
(Increase) decrease in other assets		501,570			391,343
Deferred compensation expense		5,938			5,938
Increase (decrease) in accrued interest payable		76,294			50,308
Increase (decrease) in accrued expenses and other liabilities		(61,018	)		(430,697	)
Net cash provided (used) by operating activities		1,750,261			(156,396	)
Investing activities:
Net change in interest-bearing deposits in other financial institutions		13,834			(6,678	)
Proceeds from calls and maturities of securities available-for-sale		769,707			439,587
Purchase of Federal Home Loan Bank stock		(261,000	)		(79,500	)
Net (increase) decrease in loans		239,100			(2,176,267	)
Purchase of premises and equipment		(70,343	)		(50,427	)
Proceeds from sale of foreclosed assets		8,613			3,800
Proceeds from sale of other assets		—			3,500
Transfer from loans of repossessed assets		(128,068	)		(73,922	)
Net cash provided (used) by investing activities		571,843			(1,939,907	)

(Continued)

See accompanying notes to consolidated financial statements.

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SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)
for the Three Months Ended December 31, 2005 and 2004

	2005			2004
Financing activities:
Increase (decrease) in deposits	$	(4,519,225	)	$	6,254,014
Decrease in advances by borrowers for property taxes and insurance		(40,350	)		(113,573	)
Proceeds from borrowed funds		16,479,000			20,747,448
Repayment of borrowed funds		(14,622,000	)		(24,199,580	)
Cash dividends paid		(70,887	)		(106,485	)
Acquisition of Treasury shares		(1,225	)		—
Net cash provided (used) by financing activities		(2,774,687	)		2,581,824
Increase (decrease) in cash and cash equivalents		(452,583	)		485,521
Cash and cash equivalents at beginning of period		5,042,170			5,015,108
Cash and cash equivalents at end of period	$	4,589,587		$	5,500,629
Supplemental information on cash payments:
Interest paid	$	902,233		$	719,405
Income taxes paid	$	3,600		$	36,000
Supplemental information on non-cash transactions:
Real estate obtained through foreclosure	$	98,513		$	66,284

See accompanying notes to consolidated financial statements.

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SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)
December 31, 2005 and 2004

(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 December 31, 2005, was derived from the financial records of SouthFirst and its wholly-owned subsidiaries, SouthFirst Bank, a federally chartered savings association (“SouthFirst Bank”), and SouthFirst Financial Services, Inc., an insurance product and financial services provider (“SouthFirst Financial”), and SouthFirst Bank’s wholly-owned subsidiaries, Pension & Benefit Trust Company, a Montgomery, Alabama-based employee benefits consulting firm (“Pension & Benefit”), and SouthFirst Mortgage, Inc., a Birmingham, Alabama based residential construction loan and mortgage loan origination office (“SouthFirst Mortgage”). 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.

The accounting principles and reporting policies of the Company, and the methods of applying these principles, conform with generally accepted accounting principles and with general practice within the savings and loan industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of financial condition and revenues and expenses for the period. Actual results could differ significantly from those estimates.

(2)New Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004)Share-Based Payment(“SFAS No. 123(R)”). SFAS No. 123(R) is a revision of FASB Statement No. 123,Accounting for Stock-Based Compensation,SFAS No. 123(R) supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123(R) establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to

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provide service in exchange for the award — the requisite service period (usually the vesting period). No compensation cost is recognized for equity instruments for which employees do not render the requisite service. SFAS No. 123(R) eliminates the alternative to use APB Opinion 25’s intrinsic value method of accounting that was provided in Statement 123 as originally issued. Under Opinion 25, issuing stock options to employees generally resulted in recognition of no compensation cost. SFAS No. 123(R) requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards (with limited exceptions). SFAS No. 123(R) is effective for public entities that do not file as small business issuers as of the beginning of the first interim or annual reporting period that begins after June 15, 2005, and for public entities that file as small business issuers as of the beginning of the first interim or annual reporting period of the registrant’s first fiscal year that begins after December 15, 2005. The Company currently accounts for its stock options under APB No. 25, as further explained in Note 3, and is currently evaluating the impact the adoption of SFAS No. 123(R) will have on its statement of condition and results of operations.

(3)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 the 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 have been granted. The term of the options range from seven to ten years, and the options vest equally over periods ranging in length from three to five years.

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

	1995 Plan				1998 Plan
			Weighted					Weighted
			Average					Average
	Number		Exercise		Number			Exercise
	of Shares		Price		of Shares			Price
Outstanding at September 30, 2005		38,796	$	11.51		46,477	$	13.15
Exercised		—				—
Forfeited		—				—
Outstanding at December 31, 2005		38,796	$	11.51		46,477	$	13.15

     Information pertaining to options outstanding at December 31, 2005, is as follows:

			Options Outstanding
			Weighted			Options Exercisable
			Average	Weighted				Weighted
			Remaining	Average				Average
	Number		Contractual	Exercise		Number		Exercise
Exercise Price	Outstanding		Life	Price		Exercisable		Price
$9.75		15,547	1.84 years				15,547
$9.92		9,000	5.92 years				7,200
$12.10		38,200	6.79 years				22,920
$15.75		22,526	2.07 years				22,526
Outstanding at December 31, 2005		85,273	4.55 years	$	12.41		68,193	$	12.54

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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.

	Three Months Ended
	December 31,
	2005			2004
Net income, as reported	$	24,449		$	122,175
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(580	)		(643	)
Pro forma net income	$	23,869		$	121,532
Earnings per share:
Basic —    as reported		.03			.17
Basic —    pro forma		.03			.17
Diluted — as reported		.03			.17
Diluted — pro forma		.03			.17

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.

There were no options granted during the three months ended December 31, 2005 or 2004.

(4)  Earnings Per Share

Basic earnings per share were computed by dividing net income by the weighted average number of             shares of common stock outstanding during the three month periods ended December 31, 2005 and 2004. Common stock outstanding consists of issued shares less treasury stock and shares owned by the Management Recognition Plan and Stock Option plan trusts. Diluted earnings per share for the three month periods ended December 31, 2005 and 2004, were computed by dividing net income by the weighted average number of shares of common stock and the dilutive effects of the shares awarded under the Stock Option plan, based on the treasury stock method using an average fair market value of the stock during the respective periods.

The following table represents the earnings per share calculations for the three months ended December 31, 2005 and 2004:

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					Earnings
	Income		Shares		Per Share
For the Three Months Ended December 31, 2005:
Basic earnings	$	24,449		708,885	$	0.03
Dilutive Securities:
Stock Option Plan shares		—		4,118
Dilutive earnings	$	24,449		713,003	$	0.03
For the Three Months Ended December 31, 2004:
Basic earnings	$	122,175		709,406	$	0.17
Dilutive Securities:
Stock Option Plan shares		—		23,142
Dilutive earnings	$	122,175		732,548	$	0.17

(5)   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 7 on Form 10-KSB. The following table presents financial information for each reportable segment:

	Three Months Ended December 31, 2005							Three Months Ended December 31, 2004
			Employee							Employee
	Banking		Benefits					Banking		Benefits
	Activities		Activities			Total		Activities		Activities		Total
Interest and dividend income	$	1,965,292	$	9,989		$	1,975,281	$	1,879,496	$	7,342	$	1,886,838
Interest expenses		978,527		—			978,527		769,713		—		769,713
Net interest income		986,765		9,989			996,754		1,109,783		7,342		1,117,125
Provision for loan losses		53,237		—			53,237		25,000		—		25,000
Net interest income after provision for loan losses		933,528		9,989			943,517		1,084,783		7,342		1,092,125
Other income		371,720		378,322			750,042		404,760		368,111		772,871
Other expenses		1,242,217		411,482			1,653,699		1,298,876		369,063		1,667,939
Income (loss) before income taxes		63,031		(23,171	)		39,860		190,667		6,390		197,057
Income taxes		24,215		(8,804	)		15,411		72,453		2,429		74,882
Net income (loss)	$	38,816	$	(14,367	)	$	24,449	$	118,214	$	3,961	$	122,175

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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.

(6)   Subsequent Event

On January 25, 2006, the Company declared a regular $0.10 per share cash dividend on the Company’s outstanding stock, payable on February 20, 2006, to stockholders of record as of February 4, 2006.

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

REVIEW OF RESULTS OF OPERATIONS

Overview

Net income for the first quarter of fiscal year 2006, which ended December 31, 2005, decreased $97,726, or 80.0%, to $24,449 when compared to the same period in fiscal year 2005. Net interest income decreased $120,371, or 10.8%, for the first quarter of fiscal year 2006, compared to the same period in fiscal year 2005. Non-interest income decreased $22,829, or 3.0%, for the first quarter of fiscal year 2006 compared to the same period in fiscal year 2005, while non-interest expense decreased $14,240, or 0.9%.

Primary earnings per common share, based on weighted average shares outstanding, was $.03 and $.17 for the three months ended December 31, 2005 and 2004, respectively.

Those items significantly affecting 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 December 31, 2005, the interest rate spread decreased 28 basis points as rates earned on interest-earning assets increased 54 basis points to 6.43%, while the cost of funds increased 82 basis points to 3.25% compared to the same three-month period ending December 31, 2004. The change in the interest rate spread occurring during the three-month interval is a result of increases in interest rates. The average balance of interest-earning assets decreased approximately $5.2 million, or 4.1%, from approximately $128.1 million to approximately $122.9 million while the average balance of interest-bearing liabilities decreased approximately $6.3 million, or 5.0%, from approximately $126.7 million to approximately $120.4 million. The combined effect of the decreases in average balances and the changes in rates discussed above resulted in a decrease in net interest income of approximately $120,000, or 10.8%, for the three months ended December 31, 2005.

Provision for Loan Losses

Provision for loan losses reflects an increase in the amount of $28,237 for the three-month period ending December 31, 2005, when compared to the same period in fiscal year 2004.

Other Income

For the three-month period ended December 31, 2005, total non-interest income decreased by approximately $23,000 to $750,042, compared to the same period in fiscal year 2004. This decrease was primarily the result of a decrease of approximately $53,000 in gains on sales of loans. This decrease was partially offset by increases in service charges and other fees, employee benefit consulting fees and other income of approximately $14,000, $10,000 and $8,000, respectively. The loss from the sale of assets decreased approximately $2,000 between the two periods ended December 31, 2005 and 2004.

Other Expenses

For the three month period ended December 31, 2005, total non-interest expense decreased approximately $14,000 to $1,653,699 from $1,667,939 for the three-month period ended December 31, 2004. This

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decrease resulted primarily from a decrease in compensation and benefits, data processing and legal expenses of approximately $36,000, $17,000 and $28,000, respectively. Offsetting these decreases in expenses are increases in furniture and fixtures expense, office supplies and other expenses of approximately $10,000, $20,000 and $41,000, respectively. Net occupancy expenses and deposit insurance premiums expense remained constant between the two periods ended December 31, 2005 and 2004, at $109,000 and $27,000, respectively.

Income Taxes

The Company’s effective tax rate for the three-month periods ended December 31, 2005 and 2004, was 38.7% 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 $59,000, or 79.4%, to $15,411 for the three months ended December 31, 2005, as compared to $74,882 for the three months ended December 31, 2004, 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 periods indicated.

	At or for the three months
	ended December 31,
	2005			2004
Return on assets		0.07	%		0.34	%
Return on equity		0.96	%		4.72	%
Equity to asset ratio		7.46	%		7.20	%
Interest rate spread		3.18	%		3.46	%
Net interest margin		3.24	%		3.49	%
Total risk-based capital		13.22	%		13.19	%
Non-performing loans to loans		1.56	%		1.19	%
Allowance for loan losses to loans		0.55	%		0.95	%
Allowance for loan losses to average non-performing loans		35.47	%		80.29	%
Ratio of net charge-offs to average loans outstanding		0.04	%		0.00	%
Book value per common share outstanding	$	14.39		$	14.60

Significant factors affecting SouthFirst’s financial condition during the three months ended December 31, 2005 are detailed below:

Assets

Total assets decreased approximately $3,020,000, or 2.2%, from $139,137,524 at September 30, 2005, to $136,117,855 at December 31, 2005. Cash and amounts due from banks decreased approximately $453,000, or 9.0%, as a result of a decrease in total deposits which occurred during the period. Investment securities, available for sale, decreased approximately $1,069,000, or 4.0%, which occurred primarily in mortgage-backed securities as a result of faster pre-payment speeds. Net loans decreased

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slightly from $95,388,729 at September 30, 2005, to $95,107,862 at December 31, 2005, while loans held for sale decreased approximately $948,000, or 100.0%, during the quarter. Other decreases in assets occurred in interest earning assets in other financial institutions, premises and equipment, accrued interest receivable and other for approximately $14,000, or 1.6%, $25,000, or 0.5%, $108,000, or 16.4%, and $502,000, or 16.3%, respectively. Increases in assets occurred in Federal Home Loan Bank stock and foreclosed assets of approximately $261,000, or 21.4%, and $119,000, or 46.4%, respectively. Goodwill remained the same during the period at approximately $544,000.

Liabilities

Total liabilities decreased approximately $2,798,000, or 2.2%, from $128,713,581 at September 30, 2005, to $125,915,837 at December 31, 2005. Deposits decreased approximately $4,519,000, or 4.5%, during the period, which represents a decrease in certificates of deposit of approximately $5,900,000, and an increase in checking and other savings accounts of approximately $1,381,000. The large decrease in certificates of deposit represents the maturity and roll off of various types of brokered certificates of deposit which occurred during the period. Borrowed funds increased $1,857,000, or 7.1%, which represents an increase in short term borrowings from the Federal Home Loan Bank of Atlanta (the “FHLBA”) of $5,800,000 and a decrease of $3,943,000 in short-term reverse repurchase agreements with Morgan Keegan & Company. The increase in borrowed funds was used primarily to meet deposit demand in the roll off of the above-mentioned brokered certificates of deposit. Other decreases in liabilities occurred in advances by borrowers for property taxes and insurance and other liabilities of approximately $40,000, or 17.0%, and $171,000, or 24.7%, respectively. Accrued interest payable increased approximately $76,000, or 11.9%.

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 December 31, 2005, the allowance for loan losses was $532,964 compared to $518,572 at September 30, 2005, which represents an increase of approximately $14,000. Non-performing loans at December 31, 2005, were approximately $1,503,000 as compared to approximately $875,000 at September 30, 2005. At December 31, 2005, and September 30, 2005, the allowance for loan losses represented 0.55% and 0.53% 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 SouthFirst Bank.

Liquidity and Funding Sources

The Asset and Liability Committee of SouthFirst Bank’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, SouthFirst Bank 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, SouthFirst Bank was required to maintain an average daily balance of

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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 December 31, 2005, SouthFirst Bank’s average daily balance of liquid assets was approximately 18.1% of its September 30, 2005, liquidity base, exceeding the 4% requirement set by the previous regulation. These liquid assets included approximately $5,066,000 in cash and cash equivalents and approximately $20,038,000 in other qualifying assets. In addition, as of December 31, 2005, the fair market value of the company’s investment securities portfolio available-for-sale was approximately $25,414,000. 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.

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 December 31, 2005, the amount of deposits was $96,605,587, which represents a decrease of approximately $4,519,000 from the amount of deposits at September 30, 2005.

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 December 31, 2005, the Company had a line of credit, based on prime, with First Commercial Bank in the amount of $2,500,000, which presently is scheduled to mature in June 2006, and of which there is an outstanding balance at December 31, 2005, of approximately $1,403,000. At December 31, 2005, the Company had outstanding balances with the FHLBA of approximately $26,470,000.

SouthFirst Bank also has the approval for short-term borrowings through reverse repurchase agreements with Morgan Keegan & Company. As of December 31, 2005, there was no outstanding borrowings in reverse repurchase agreements.

Management believes that the Company’s liquidity and existing funding sources are 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 SouthFirst Bank’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. SouthFirst Bank has satisfied its capital requirements primarily through the retention of earnings.

As of December 31, 2005, SouthFirst Bank has satisfied all regulatory capital requirements. SouthFirst Bank’s compliance with the current standards is as follows:

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			Percent of
	Amount		Asset Base
Tangible capital	$	11,635,000		8.55	%
Core capital		11,635,000		8.55	%
Tier-based capital		12,134,000		13.22	%

Cautionary Statement Concerning Forward-Looking Statements

Certain statements in this Quarterly Report on Form 10-QSB contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, which statements generally can be identified by the use of forward-looking terminology, such as “may,” “will,” “expect,” “estimate,” “anticipate,” “believe,” “target,” “plan,” “project,” or “continue” or the negatives thereof or other variations thereon or similar terminology, and are made on the basis of management’s plans and current analyses of the Company, its business and the industry as a whole. These forward-looking statements are subject to risks and uncertainties, including, but not limited to, economic conditions, competition, interest rate sensitivity and exposure to regulatory and legislative changes. The above factors, in some cases, have affected, and in the future could affect, the Company’s financial performance and could cause actual results to differ materially from those expressed or implied in such forward-looking statements. The Company does not undertake to publicly update or revise its forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.

Item 3: Controls and Procedures

The Company’s management, with the participation of 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 such term is defined in Rule 13a-14(c) and 15d-14(c) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Controller have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective.

There have not been any significant changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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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 SouthFirst Bank 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 SouthFirst Bank’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 February 14, 2006.
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 February 14, 2006.
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 February 14, 2006.

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 current quarter.

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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: February 14, 2006	By:	/s/ Sandra H. Stephens
		Sandra H. Stephens
		Chief Executive Officer (principal executive officer)
Date: February 14, 2006	By:	/s/ Janice Browning
		Janice Browning
		Controller, Treasurer (principal accounting officer)

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EXHIBIT INDEX

Exhibit No.	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 February 14, 2006.
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 February 14, 2006.
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 February 14, 2006.

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