UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20529 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934 For the quarterly period ended June 30, 2003 [ ] Transition Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934 For the transition period from ___ to ___ Commission File Number 000-32955 --------------------------- LSB CORPORATION (Exact name of Registrant as specified in its Charter) --------------------------- MASSACHUSETTS 04-3557612 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 30 MASSACHUSETTS AVENUE, NORTH ANDOVER, MA 01845 (Address of principal executive offices) (Zip Code) --------------------------- (978) 725-7500 (Registrant's telephone number, including area code) --------------------------- 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 report), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ---- - -------------------------------------------------------------------------------- Indicate by a check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X ----- ----- - -------------------------------------------------------------------------------- Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Class Outstanding as of June 30, 2003 - ----- ------------------------------- Common Stock, par value $.10 per share 4,204,362 shares LSB CORPORATION AND SUBSIDIARY INDEX PART I - FINANCIAL INFORMATION Page ----- ITEM 1 FINANCIAL STATEMENTS: Consolidated Balance Sheets 3 Consolidated Statements of Income 4 Consolidated Statements of Changes in Stockholders' Equity 5 Consolidated Statements of Cash Flows 6 Notes to Consolidated Financial Statements 7-8 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS: Financial Condition: Investment Portfolio 9-10 Loan Portfolio 10 Loan Interest Income 11 Allowance for Loan Losses 11 Risk Assets 11-12 Deposit Portfolio 12 Deposit Interest Expense 12 Results of Operations: Three Months ended June 30, 2003 and 2002 13-14 Six Months ended June 30, 2003 and 2002 15-16 Liquidity and Capital Resources 17 ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 18 ITEM 4 CONTROLS AND PROCEDURES 18 PART II - OTHER INFORMATION ITEM 1 LEGAL PROCEEDINGS 19 ITEM 2 CHANGES IN SECURITIES 19 ITEM 3 DEFAULTS UPON SENIOR SECURITIES 19 ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 19 ITEM 5 OTHER INFORMATION 19 ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 19 SIGNATURES 20 EXHIBIT INDEX 21 2 PART 1 - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS LSB CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (UNAUDITED) June 30, December 31, 2003 2002 ---------- ---------- (In Thousands) ASSETS Assets: Cash and due from banks $ 7,923 7,136 Federal funds sold 6,456 9,633 ---------- ---------- Total cash and cash equivalents 14,379 16,769 Investment securities held to maturity (market value of $123,403 in 2003 and $116,321 in 2002) 120,680 113,325 Investment securities available for sale (amortized cost of $66,271 in 2003 and $52,055 in 2002) 67,279 53,084 Federal Home Loan Bank stock, at cost 5,950 5,950 Loans, net of allowance for loan losses 211,123 238,960 Bank premises and equipment 2,873 3,050 Accrued interest receivable 2,146 2,459 Deferred income tax asset 3,123 3,686 Other assets 1,438 1,851 ---------- ---------- Total assets $ 428,991 $ 439,134 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Interest bearing deposits $ 267,041 $ 265,283 Non-interest bearing deposits 13,297 14,182 Federal Home Loan Bank advances 86,317 94,237 Securities Sold under Agreements to Repurchase 2,694 3,950 Other borrowed funds 2,111 3,404 Advance payments by borrowers for taxes and insurance 470 518 Other liabilities 3,685 3,501 ---------- ---------- Total liabilities 375,615 385,075 ---------- ---------- Stockholders' equity: Preferred stock, $.10 par value per share: 5,000,000 shares authorized, none issued - - Common stock, $.10 par value per share; 20,000,000 shares authorized; 4,423,662 and 4,389,705 shares issued at June 30, 2003 and December 31, 2002, respectively, and 4,204,362 and 4,253,205 shares outstanding at June 30, 2003 and December 31, 2002 443 439 Additional paid-in capital 58,018 57,845 Accumulated deficit (2,992) (3,168) Treasury stock, at cost (219,300 and 136,500 shares at June 30, 2003 and December 31, 2002, respectively) (2,758) (1,736) Accumulated other comprehensive income 665 679 ---------- ---------- Total stockholders' equity 53,376 54,059 ---------- ---------- Total liabilities and stockholders' equity $ 428,991 $ 439,134 ========== ========== The accompanying notes are an integral part of these unaudited Consolidated Financial Statements. 3 LSB CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three months ended June 30, Six months ended June 30, 2003 2002 2003 2002 ----------- ----------- ----------- ----------- (In Thousands, except share data) Interest and dividend income: Loans $ 3,740 $ 4,176 $ 7,688 $ 8,432 Investment securities held to maturity 1,048 1,728 2,177 3,382 Investment securities available for sale 463 500 956 915 Federal Home Loan Bank stock 44 56 95 111 Other interest and dividend income 19 20 60 61 ----------- ----------- ----------- ----------- Total interest and dividend income 5,314 6,480 10,976 12,901 ----------- ----------- ----------- ----------- Interest expense: Deposits 1,096 1,483 2,246 3,077 Borrowed funds 1,181 1,390 2,384 2,801 Securities sold under agreements to repurchase 5 5 10 10 Other borrowed funds 34 58 75 151 ----------- ----------- ----------- ----------- Total interest expense 2,316 2,936 4,715 6,039 ----------- ----------- ----------- ----------- Net interest income 2,998 3,544 6,261 6,862 ----------- ----------- ----------- ----------- Provision for loan losses -- -- -- -- ----------- ----------- ----------- ----------- Net interest income after provision for loan losses 2,998 3,544 6,261 6,862 ----------- ----------- ----------- ----------- Non-interest income: Loan servicing fees (50) 12 (180) 88 Deposit account fees 180 163 343 319 Gains on sales of mortgage loans 165 65 314 176 Other income 88 109 186 195 ----------- ----------- ----------- ----------- Total non-interest income 383 349 663 778 ----------- ----------- ----------- ----------- Non-interest expense: Salaries and employee benefits 1,420 1,482 3,071 3,019 Occupancy and equipment expenses 202 214 422 413 Professional expenses 162 220 363 367 Data processing expenses 179 203 360 366 Other expenses 409 482 828 895 ----------- ----------- ----------- ----------- Total non-interest expenses 2,372 2,601 5,044 5,060 ----------- ----------- ----------- ----------- Income before income tax expense 1,009 1,292 1,880 2,580 Income tax expense 374 473 695 945 ----------- ----------- ----------- ----------- Net income $ 635 $ 819 $ 1,185 $ 1,635 =========== =========== =========== =========== Average shares outstanding 4,204,362 4,384,686 4,209,335 4,383,337 Average diluted shares outstanding 4,364,480 4,567,062 4,361,182 4,559,019 =========== =========== =========== =========== Basic earnings per share $ 0.15 $ 0.19 $ 0.28 $ 0.37 Diluted earnings per share $ 0.15 $ 0.18 $ 0.27 $ 0.36 =========== =========== =========== =========== The accompanying notes are an integral part of these unaudited Consolidated Financial Statements. 4 LSB CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND 2002 (UNAUDITED) Accumulated Additional Other Total Common Paid-In (Accumulated Treasury Comprehensive Stockholders' Stock Capital Deficit) Stock Income Equity ----------------------------------------------------------------------------------------- (In Thousands) Balance at December 31, 2001 $ 438 $ 57,813 $ (4,348) $ -- $ 189 $ 54,092 Net income -- -- 1,635 -- -- 1,635 Other comprehensive income: Unrealized gain on securities available for sale (tax effect $34) -- -- -- -- 66 66 -------- Total comprehensive income 1,701 Exercise of stock options 1 8 9 Dividends declared and paid ($0.22 per share) -- -- (964) -- -- (964) -------- -------- -------- -------- -------- -------- Balance at June 30, 2002 $ 439 $ 57,821 $ (3,677) $ -- $ 255 $ 54,838 ======== ======== ======== ======== ======== ======== Accumulated Additional Other Total Common Paid-In (Accumulated Treasury Comprehensive Stockholders' Stock Capital Deficit) Stock Income Equity ------------------------------------------------------------------------------------------- Balance at December 31, 2002 $ 439 $ 57,845 $ (3,168) $ (1,736) $ 679 $ 54,059 Net income -- -- 1,185 -- -- 1,185 Other comprehensive income: Unrealized loss on securities available for sale (tax effect $7) -- -- -- -- (14) (14) -------- Total comprehensive income 1,171 Exercise of stock options 4 173 -- -- -- 177 Dividends declared and paid ($0.24 per share) -- -- (1,009) -- -- (1,009) Purchase of 82,800 shares of Treasury Stock, at cost -- -- -- (1,022) -- (1,022) -------- -------- -------- -------- -------- -------- Balance at June 30, 2003 $ 443 $ 58,018 $ (2,992) $ (2,758) $ 665 $ 53,376 ======== ======== ======== ======== ======== ========= The accompanying notes are an integral part of these unaudited Consolidated Financial Statements. 5 LSB CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Six months ended June 30, ------------------------ 2003 2002 ---- ---- (In Thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,185 $ 1,635 Adjustments to reconcile net income to net cash provided by operating activities: Gains on sales of mortgage loans (314) (176) Net amortization of investment securities 1,005 437 Loss on sale of investment securities available for sale 14 -- Depreciation of premises and equipment 224 229 Loans originated for sale (17,043) (11,579) Proceeds from sales of mortgage loans 15,968 13,466 Decrease (increase) in accrued interest receivable 313 (128) Decrease in deferred income tax asset 570 871 Decrease (increase) in other assets 408 (11) Decrease in advance payments by borrowers (48) (75) Increase (decrease) in other liabilities 184 (635) --------- --------- Net cash provided by operating activities 2,466 4,034 - ------------------------------------------------------------------------------------------------------------------------------------ CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of mortgage backed securities available for sale 5,684 -- Proceeds from maturities of investment securities held to maturity 155,600 221,618 Proceeds from maturities of investment securities available for sale 7,000 3,993 Purchases of investment securities held to maturity (168,107) (231,885) Purchases of mortgage-backed securities held to maturity (17,937) (2,967) Purchases of investment securities available for sale (16,712) (18,092) Purchase of mutual fund available for sale (1,000) -- Purchases of mortgage-backed securities available for sale (14,775) -- Principal payments of securities held to maturity 22,477 15,175 Principal payments of securities available for sale 5,180 6,710 Decrease (increase) in loans, net 29,226 (2,017) Proceeds from payments on OREO 5 5 Purchases of Bank premises and equipment (47) (156) --------- --------- Net cash provided by (used in) investing activities 6,594 (7,616) - ------------------------------------------------------------------------------------------------------------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 873 9,759 Additions to Federal Home Loan Bank advances 6,000 -- Payments on Federal Home Loan Bank advances (7,920) (3,863) Net decrease in agreements to repurchase securities (1,256) (2,354) Net decrease in other borrowed funds (1,293) (450) Treasury stock purchased (1,022) -- Dividends paid (1,009) (964) Proceeds from exercise of stock options 177 9 --------- --------- Net cash (used in) provided by financing activities (11,450) 8,137 - ------------------------------------------------------------------------------------------------------------------------------------ Net (decrease) increase in cash and cash equivalents (2,390) 4,555 Cash and cash equivalents, beginning of period 16,769 13,162 --------- --------- Cash and cash equivalents, end of period $ 14,379 $ 17,717 =================================================================================================================================== Cash paid during the period for: Interest on deposits $ 2,245 $ 3,067 Interest on borrowed funds 2,515 2,992 Income taxes 245 230 Supplemental Schedule of non-cash activities: Net change in valuation of investment securities available for sale (21) 100 =================================================================================================================================== The accompanying notes are an integral part of these unaudited Consolidated Financial Statements 6 LSB CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2003 (UNAUDITED) 1. BASIS OF PRESENTATION LSB Corporation (the "Corporation" or the "Company") is a Massachusetts corporation and the holding company of the wholly-owned subsidiary Lawrence Savings Bank (the "Bank") a state-chartered Massachusetts savings bank. The Corporation was organized by the Bank on July 1, 2001 to be a bank holding company and to acquire all of the capital stock of the Bank. The Consolidated Financial Statements presented herein reflect the accounts of the Corporation and its predecessor, Lawrence Savings Bank. The Corporation is supervised by the Board of Governors of the Federal Reserve System ("FRB"), and it is also subject to the jurisdiction of the Massachusetts Division of Banks, while the Bank is subject to the regulations of, and periodic examination by, the Federal Deposit Insurance Corporation ("FDIC") and the Massachusetts Division of Banks. The Bank's deposits are insured by the Bank Insurance Fund of the FDIC up to $100,000 per account, as defined by the FDIC, and the Depositors Insurance Fund ("DIF") for customer deposit amounts in excess of $100,000. The Consolidated Financial Statements include the accounts of LSB Corporation and its wholly-owned consolidated subsidiary, Lawrence Savings Bank, and its wholly-owned subsidiaries, Shawsheen Security Corporation, Shawsheen Security Corporation II, Pemberton Corporation, and Spruce Wood Realty Trust. All inter-company balances and transactions have been eliminated in consolidation. The Company has one reportable operating segment. Certain amounts in prior periods have been re-classified to conform to the current presentation. The LSB Corporation's Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America. Accordingly, management is required to make estimates and assumptions that affect amounts reported in the balance sheets and statements of income. Actual results could differ significantly from those estimates and judgments. Material estimates that are particularly susceptible to change relate to the allowance for loan losses, income taxes and mortgage servicing rights. The interim results of consolidated income are not necessarily indicative of the results for any future interim period or for the entire year. These interim Consolidated Financial Statements do not include all disclosures associated with annual financial statements and, accordingly, should be read in conjunction with the annual Consolidated Financial Statements and accompanying notes included in the Company's Annual Report on Form 10-K as of and for the year ended December 31, 2002 filed with the Securities and Exchange Commission. 2. STOCK OPTIONS The Corporation measures compensation cost for stock-based plans using the intrinsic value method. The intrinsic value method measures compensation cost, if any, as the fair market value of the Company's stock at the grant date over the exercise price. All options granted have an exercise price equivalent to the fair market value at the date of grant and, accordingly, no compensation cost has been recorded. If the fair value based method of accounting for stock options had been used, the Company's net income and earnings per share would have been reduced to the proforma amounts for the three months and six months ended June 30, and are presented in the table which follows: Three months ended Six months ended 6/30/03 6/30/02 6/30/03 6/30/02 ------- ------- ------- ------- (In Thousands, except share data) Net income: As Reported $ 635 $ 819 $ 1,185 $ 1,635 Pro forma 590 680 1,096 1,438 Basic earnings per share: As Reported $ 0.15 $ 0.19 $ 0.28 $ 0.37 Pro forma 0.14 0.16 0.26 0.33 Diluted earnings per share: As Reported $ 0.15 $ 0.18 $ 0.27 $ 0.36 Pro forma 0.14 0.15 0.25 0.32 7 3. CONTINGENCIES The Bank is a defendant in litigation brought in Massachusetts Superior Court related to transactions completed at a branch of the Bank. The claims against the Bank approximate $200,000. While the case has not been fully adjudicated, the Bank has filed for Summary Judgment. While the outcome of the litigation is uncertain management does not believe that the resolution of the litigation will have material impact upon the financial condition of the Bank. The Bank has notified its insurance carrier in the event of a loss. 4. RECENT ACCOUNTING DEVELOPMENTS In December 2002, the FASB issued SFAS No. 148 Accounting for Stock-Based Compensation - Transition and Disclosure. SFAS 148 amends SFAS No. 123, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Companies are able to eliminate a "ramp-up" effect that the SFAS No. 123 transition rule creates in the year of adoption. Companies can choose to elect a method that will provide for comparability amongst years reported. In addition, this Statement amends the disclosure requirement of Statement 123 to require prominent disclosures in both annual and interim financial statements about the fair value based method of accounting for stock-based employee compensation and the effect of the method used on reported results. In April 2003, the FASB announced it will issue new rules requiring all companies to expense the value of employee stock options. Companies will be required to measure the cost according to the fair value of the options at the grant date. The FASB has not yet clarified how the fair value of the options is to be determined. The FASB plans to issue an exposure draft later this year that could become effective in 2004. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS The Company has made forward-looking statements (within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 as amended) in this document that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of the Company, projected or anticipated benefits or events related to other future developments involving the Company or the industry in which it operates. When verbs in the present tense such as "believes", "expects", "seeks", "anticipates", "continues", "attempts", or similar expressions are used, forward-looking statements are being made. Stockholders should note that many factors, some of which are discussed elsewhere in this document and in the documents which we incorporate by reference, could affect the future financial results of the Company and could cause the results to differ materially from those expressed in or incorporated by reference in this document. Those factors include fluctuations in interest rates, inflation, government regulations and economic conditions and competition, as well as, possible infrastructure disruptions due to weather, terrorist activity, computer capacity overload or other factors in the geographic and business areas in which the Company conducts its operations. As a result of such risks and uncertainties, the Company's actual results may differ materially from such forward-looking statements. The Company does not undertake, and specifically disclaims any obligation to publicly release revisions to any such forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. FINANCIAL CONDITION OVERVIEW The Company has maintained risk assets below 1% of total assets for the past several years. The Company maintains its commitment to servicing the needs of the local community in the Merrimack Valley area. The Company had total assets of $429.0 million at June 30, 2003 compared to $439.1 million at December 31, 2002. The decrease in asset size at June 30, 2003 from December 31, 2002 is due to the pay down of $10.5 million in borrowed funds as advances from the FHLB became due. The cash used came from the payoff of loans which declined by $27.8 million and the reduction of $3.2 million in Federal Funds. The additional cash was used to purchase investment securities which increased by $21.6 million since December 31, 2002. INVESTMENTS The investment securities portfolio totaled $188.0 million or 43.8% of total assets at June 30, 2003, compared to $166.4 million, or 37.9% of total assets at December 31, 2002, an increase of $21.6 million from year-end. The change in mix in the investment securities portfolio was the result of maturities in Commercial Paper and Corporate obligations. Funds were reinvested in Mortgage-backed Securities ("MBS"), U.S. Treasury Obligations and Collateralized Mortgage obligations ("CMO"). All CMO's are included in the Asset-backed Securities category. The increase in investment securities was the result of the utilization of excess funds from loan payoffs, which decreased the loan portfolio by $27.8 million, and a decrease in Federal funds of $3.2 million. During the second quarter of 2003, sales of mortgage-backed securities available for sale totaled $5.7 million resulting in a loss of $14 thousand, which is included in other income. 9 The following table reflects the components and carrying values of the investment securities portfolio at June 30, 2003 and December 31, 2002: 6/30/03 12/31/02 ------- -------- (In Thousands) Investment securities held to maturity (at amortized cost): US Treasury obligations $ - $ 6,002 US Government Agency obligations 32,544 26,243 Mortgage-backed securities 25,331 13,440 Asset-backed securities 46,538 32,551 Corporate obligations 13,267 33,068 Municipal obligations 3,000 2,021 ---------- ---------- Total investment securities held to maturity $ 120,680 $ 113,325 ========== ========== Investment securities available for sale (at market value): US Treasury obligations $ 5,153 $ - US Government Agency obligations 26,842 31,820 Mortgage-backed securities 9,584 2,850 Asset-backed securities 18,141 12,079 Corporate obligations 6,387 4,167 Municipal obligations - 2,000 Mutual Funds 1,004 - Equity securities 168 168 ---------- ---------- Total investment securities available for sale $ 67,279 $ 53,084 ========== ========== Total investment securities portfolio $ 187,959 $ 166,409 ========== ========== LOANS The following table reflects the loan portfolio at June 30, 2003 and December 31, 2002: 6/30/03 12/31/02 --------- ---------- (In Thousands) Residential mortgage loans $ 52,442 $ 60,140 Loans held for sale 3,968 2,579 Equity loans 9,650 11,490 Construction loans 16,923 23,502 Commercial real estate loans 109,149 112,745 Commercial loans 22,692 32,017 Consumer loans 475 654 --------- --------- Total loans 215,299 243,127 Allowance for loan losses (4,176) (4,167) --------- --------- Total loans, net $ 211,123 $ 238,960 ========= ========= Total loans decreased to $215.3 million or 50.2% of total assets at June 30, 2003 from $243.1 million or 55.4% of total assets at December 31, 2002. The residential mortgage loan balances have declined due to the current low interest rate environment in which mortgage borrowers are refinancing existing mortgages and sales into the secondary market. Construction, commercial real estate and commercial loans have declined due to payoffs. 10 The following table lists the components of loan interest income for the three months and six months ended June 30, 2003 and 2002: Three months ended Six months ended 6/30/03 6/30/02 6/30/03 6/30/02 ------- ------- ------- ------- (In Thousands) (In Thousands) Residential mortgage loans $ 855 $ 1,295 $ 1,796 $ 2,612 Loans held for sale 57 23 84 70 Equity loans 137 211 297 423 Construction loans 296 272 635 592 Commercial real estate loans 2,003 2,057 4,071 4,103 Commercial loans 382 300 783 595 Consumer loans 10 18 22 37 -------- -------- --------- --------- Total loan interest income $ 3,740 $ 4,176 $ 7,688 $ 8,432 ======== ======== ========= ========= ALLOWANCE FOR LOAN LOSSES The following table summarizes changes in the allowance for loan losses for the three months and six months ended June 30, 2003 and 2002: Three months ended Six months ended 6/30/03 6/30/02 6/30/03 6/30/02 ------- ------- ------- ------- (In Thousands) (In Thousands) Beginning balance $ 4,170 $ 4,071 $ 4,167 $ 4,070 Provision charged to operations - - - - Recoveries on loans previously 6 4 9 5 charged-off Loans charged-off - (1) - (1) -------- -------- --------- --------- Ending balance $ 4,176 $ 4,074 $ 4,176 $ 4,074 ======== ======== ========= ========= The balance of the allowance for loan losses reflects management's assessment of losses and is based on a review of the risk characteristics of the loan portfolio. The Company considers many factors in determining the adequacy of the allowance for loan losses. Collateral value on a loan by loan basis, trends of loan delinquencies on a portfolio segment level, risk classification identified in the Company's regular review of individual loans, and economic conditions are primary factors in establishing allowance levels. Management believes the allowance level is adequate to absorb estimated credit losses associated with the loan and lease portfolio, including all binding commitments to lend and off-balance sheet credit instruments. The allowance for loan losses reflects information available to management at the end of each period. RISK ASSETS Risk assets consist of non-performing loans and other real estate owned. Non-performing loans consist of both a) loans 90 days or more past due, and b) loans placed on non-accrual because full collection of the principal balance is in doubt. Other real estate owned (OREO) is comprised of foreclosed properties where the Company has formally received title or has possession of the collateral. Properties are carried at the lower of the investment in the related loan or the estimated fair value of the property or collateral less selling costs. Fair value of such property or collateral is determined based upon independent appraisals and other relevant factors. Management periodically reviews property values and makes adjustments as required. Gains from sales of properties, net operating expenses and any subsequent provisions to increase the allowance for losses on real estate acquired by foreclosure are charged to other real estate owned expenses. Losses are charged to the allowance. Total risk assets were $30 thousand at June 30, 2003. This represents an increase of $17 thousand from December 31, 2002 and an increase of $3 thousand from June 30, 2002. These changes were primarily attributable to an increase in non-performing loans to $23 thousand at June 30, 2003 from $1 thousand at December 31, 2002 and $10 thousand at June 30, 2002. The Company had no impaired loans at June 30, 2003, December 31, 2002 and June 30, 2002, respectively. 11 The following table summarizes the Company's risk assets at June 30, 2003, December 31, 2002 and June 30, 2002: 6/30/03 12/31/02 6/30/02 ------- -------- ------- (Dollars in Thousands) Non-performing loans $23 $ 1 $10 Other real estate owned 7 12 17 --- --- --- Total risk assets $30 $13 $27 === === === Risk assets as a percent of total assets 0.01% 0.00% 0.01% === === === The following table shows the allowance for loan losses as a percent of total loans at June 30, 2003, December 31, 2002 and June 30, 2002: 6/30/03 12/31/02 6/30/02 ------- -------- -------- (Dollars in Thousands) Allowance for loan losses $ 4,176 $ 4,167 $ 4,074 Allowance for loan losses as a percent of total loans 1.94% 1.71% 1.72% The allowance for loan losses has remained fairly consistent at $4.2 million at the end of June 30, 2003 and December 31, 2002. However, allowance for loan losses as a percent of total loans has increased to 1.94% up from 1.71%. This increase is due to the lower balances in the loan portfolio at June 30, 2003 compared to December 31, 2002. DEPOSITS Total interest bearing deposits amounted to $267.0 million at June 30, 2003 compared to $265.3 million at December 31, 2002, an increase of $1.8 million. Included in the certificates of deposit at June 30, 2003 were brokered deposits of $2.0 million. The change from December 31, 2002 is due to an increase in money market investment accounts partially offset by a decrease in certificates of deposit accounts. Although the total balance of interest bearing deposits remained fairly level, the mix of deposits has changed from higher interest bearing accounts to lower interest bearing accounts. The following table reflects the components of interest bearing deposits at June 30, 2003 and December 31, 2002: 6/30/03 12/31/02 ------- -------- (In Thousands) NOW and Super NOW accounts $36,129 $ 35,568 Savings accounts 44,730 44,839 Money market investment accounts 69,201 64,653 Certificates of deposit 88,597 92,241 Retirement accounts 28,384 27,982 ---------- ---------- Total interest bearing deposits $ 267,041 $ 265,283 ========== ========== The following table lists the components of deposit interest expense for the three months and six months ended June 30, 2003 and 2002: Three months ended Six months ended 06/30/03 06/30/02 6/30/03 6/30/02 -------- -------- ---------- ---------- (In Thousands) (In Thousands) NOW and Super NOW accounts $ 10 $ 22 $ 20 $ 44 Savings deposit accounts 56 112 113 219 Money market investment accounts 229 277 467 527 Certificates of deposit 560 793 1,154 1,709 Retirement accounts 241 279 492 578 ---------- ----------- ---------- --------- Total deposit interest expense $ 1,096 $ 1,483 $ 2,246 $ 3,077 ========== =========== ========== ========== 12 RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 2003 AND 2002 OVERVIEW The Company reported net income of $635 thousand or $0.15 diluted earnings per share and $819 thousand or $0.18 diluted earnings per share for the three months ended June 30, 2003 and 2002, respectively. The decrease in net income is primarily attributable to a decrease in net interest income of $546 thousand. Partially offsetting this decline were an increase of $34 thousand in non-interest income and non-interest expenses declining by $229 thousand. NET INTEREST INCOME FROM OPERATIONS Net interest income for the three months ended June 30, 2003 and 2002 was $3.0 million and $3.5 million, respectively. The net interest rate spread decreased to 2.51% for the quarter ended June 30, 2003 from 2.92% for the same quarter of 2002. Interest income in the second quarter of 2003 experienced an overall decrease due to a declining interest rate environment on interest earning assets and lower average loan balances outstanding from the second quarter of 2002. Interest expense incurred a similar decline in interest rates resulting in lower rates paid on deposits and borrowed funds; however, the rates paid on borrowed funds have declined at a slower pace than rates paid on deposits. The following table presents the components of net interest income and net interest rate spread: Income/Expense Yield/Rate ---------------------- ------------------------- Three Months Ended ------------------------------------------------------------- 6/30/03 6/30/02 6/30/03 6/30/02 ------- ------- ------- ------- (Dollars in Thousands) Interest income and average yield: Loans $3,740 $4,176 6.66% 7.26% Investments, mortgage-backed securities and other earning assets 1,574 2,304 3.24 4.79 ------ ------ Total 5,314 6,480 5.07 6.13 ------ ------ ---- ---- Interest expense and average rate paid: Deposits 1,096 1,483 1.65 2.28 Federal Home Loan Bank advances 1,181 1,390 5.19 5.59 Securities sold under agreements to repurchase and other borrowed funds 39 63 3.16 3.70 ------ ------ Total 2,316 2,936 2.56 3.21 ------ ------ ---- ---- Net interest income $2,998 $3,544 ====== ====== Net interest rate spread 2.51% 2.92% ==== ==== Net interest margin 2.86% 3.35% ==== ==== INTEREST INCOME Interest income for the second quarter of 2003 was $5.3 million as compared to $6.5 million for the same quarter of 2002. The decrease of $1.2 million in interest income is due to $1.1 million from lower yields earned on loans and investment securities. The decrease in interest income due to lower yields was coupled with lower average loan balances, which decreased interest income by $92 thousand. Partially offsetting these declines were higher average investment securities balances which increased interest income by $16 thousand. Yields on loans were 6.66% and 7.26% for the quarters ended June 30, 2003 and 2002, respectively. The impact to interest income due to lower yields was $344 thousand. Lower average loan balances of $225.3 million versus $230.8 million for the quarters ended June 30, 2003 and 2002, respectively, decreased interest income by $92 thousand. Yields on investment securities were 3.24% and 4.79% for the quarters ended June 30, 2003 and 2002, respectively, decreasing interest income by $746 thousand. Higher average investment securities balances of $195.1 million versus $193.1 million for the same periods increased interest income by $16 thousand. 13 INTEREST EXPENSE Interest expense for the second quarter of 2003 totaled $2.3 million, a decrease of $620 thousand from the same quarter of 2002. This decrease is primarily due to lower rates paid on interest bearing liabilities, which impacted interest expense by $521 thousand. Lower average balances in borrowed funds resulted in a $125 thousand decrease to interest expense; while higher average balances in deposits contributed $26 thousand to interest expense. Rates on deposits were 1.65% and 2.28% for the quarters ended June 30, 2003 and 2002, respectively. This decrease resulted in interest expense decreasing by $413 thousand. Average deposit balances were $267.1 million versus $260.8 million for the same periods, which resulted in a $26 thousand increase to interest expense. Rates on FHLB advances were 5.19% and 5.59% for the second quarters of 2003 and 2002, respectively. The decrease in rates paid on FHLB advances resulted in interest expense decreasing by $99 thousand. The average balances of FHLB advances decreased from quarter to quarter to $91.3 million in the second quarter 2003 from $99.8 million for the second quarter of 2002, which resulted in a decrease in interest expense of $110 thousand. Rates on repurchase agreements and other borrowed funds were 3.16% and 3.70% for the second quarters of 2003 and 2002, respectively. The decrease in rates paid on these interest bearing liabilities resulted in interest expense decreasing by $9 thousand. The average balance decreased to $4.9 million in 2003 from $6.8 million in 2002, which decreased interest expense by $15 thousand. PROVISION FOR LOAN LOSSES The provision for loan losses was zero for the quarters ended June 30, 2003 and 2002, respectively. The absence of a provision for loan losses was based on management's assessment of the adequacy of the allowance based on an evaluation of the Bank's loan portfolio. NON-INTEREST INCOME Non-interest income amounted to $383 thousand and $349 thousand for the quarters ended June 30, 2003 and 2002, respectively. The increase in non-interest income was primarily due to gains on the sale of mortgage loans of $165 thousand in the second quarter of 2003 up from $65 thousand in 2002 and an increase of $17 thousand in deposit account fees. Partially offsetting these increases was a decrease in loan fees to a loss of $50 thousand in 2003 compared to income of $12 thousand in 2002. The loss in loan fees can be attributed to provisions for losses on mortgage servicing rights ("MSR's") of $72 thousand in the second quarter of 2003 due to higher than normal prepayment speeds used in the fair value calculation of MSR's caused by the current low interest rate environment on mortgage loans. Other income also declined $21 thousand from June 30, 2002 to 2003, which includes a loss on sale of a mortgage-backed security available for sale in the amount of $14 thousand. NON-INTEREST EXPENSE Non-interest expense totaled $2.4 million and $2.6 million for the quarters ended June 30, 2003 and 2002, respectively. Salaries and employee benefits decreased by $62 thousand in the second quarter 2003 compared to the second quarter in 2002 mainly due to several salary reduction initiatives instituted during the second quarter of 2003 as a result of the net interest margin declining to 2.86%. Occupancy and equipment expenses totaled $202 thousand in 2003, a decrease of $12 thousand over 2002 due to fewer office space vacancies and lower building maintenance and repairs expenses. Professional expenses decreased to $162 thousand in the second quarter 2003 compared to $220 thousand in the same period in 2002. The decrease was due to decreased legal expenses. Data processing expenses decreased to $179 thousand in the second quarter of 2003 compared to $203 thousand in the same quarter in 2002. Other expenses declined to $409 thousand in 2003 from $482 thousand in 2002 due primarily to a reduction in marketing expenses of $55 thousand. INCOME TAXES The Company reported an income tax expense of $374 thousand for the quarter ended June 30, 2003 or an effective income tax rate of 37.1%. This compares to an income tax expense of $473 thousand for the quarter ended June 30, 2002 or effective income tax expense of 36.6%. 14 SIX MONTHS ENDED JUNE 30, 2003 AND 2002 Overview The Bank reported net income of $1.2 million or $0.27 diluted earnings per share and $1.6 million or $0.36 diluted earnings per share for the six months ended June 30, 2003 and 2002, respectively. During the first six months of 2003, net interest income declined to $6.3 million in 2003 down from $6.9 million in 2002. Non-interest income decreased to $663 thousand in 2003 down from $778 thousand in 2002. Non-interest expenses remained fairly consistent for the first six months of 2003 totaling $5.0 million compared to $5.1 million for the same period in 2002. Net Interest Income From Operations Net interest income for the six months ended June 30, 2003 and 2002 was $6.3 million and $6.9 million, respectively. The net interest rate spread decreased to 2.65% from 2.83%. The yield on interest bearing assets decreased more rapidly than the rates paid on interest bearing liabilities. The following table presents the components of net interest income and net interest spread: Income/Expense Yield/Rate ---------------------------- ------------------------------- Six Months Ended ---------------------------------------------------------------- 6/30/03 6/30/02 6/30/03 6/30/02 ------- ------- ------- ------- (In Thousands) Interest income and average yield: Loans $ 7,688 $ 8,432 6.74% 7.34% Investments, mortgage-backed securities and other earning assets 3,288 4,469 3.48 4.71 ---------- -------- Total 10,976 12,901 5.26 6.15 ---------- -------- ---- ---- Interest expense and average rate paid: Deposits 2,246 3,077 1.70 2.40 Federal Home Loan Bank advances 2,384 2,801 5.19 5.59 Securities sold under agreements to repurchase and other borrowed funds 85 161 3.27 4.21 --------- ------- Total 4,715 6,039 2.61 3.32 --------- ------- ---- ---- Net interest income $ 6,261 $ 6,862 ========= ======= Net interest rate spread 2.65% 2.83% ==== ===== Net interest margin 3.00% 3.27% ==== ===== INTEREST INCOME Interest income for the first six months of 2003 was $11.0 million as compared to $12.9 million for the same period of 2002. The decrease in interest income of $1.9 million is due to lower yields on loans and investment securities, which decreased interest income by $1.9 million. Lower average loan and investment securities balances decreased interest income by $72 thousand. Yields on loans were 6.74% and 7.34% for the six months ended June 30, 2003 and 2002, respectively. The impact on interest income due to lower yields was $684 thousand. Lower average loan balances of $229.9 million in 2003 versus $231.7 million in 2002 resulted in interest income decreasing by $60 thousand. Yields on investment securities decreased to 3.48% for the six months ended June 30, 2003. This compares to yields on investment securities of 4.71% for the same period in 2002. This resulted in interest income declining by $1.2 million. Lower average investment securities balances of $190.6 million in 2003 versus $191.3 million in 2002 resulted in interest income decreasing by $12 thousand. 15 INTEREST EXPENSE Interest expense for the first six months of 2003 and 2002 was $4.7 million and $6.0 million, respectively. The decrease of $1.3 million in interest expense is primarily due to lower rates paid on deposits and other interest bearing liabilities, which decreased interest expense by $1.1 million. Interest expense decreased $258 thousand due to lower average borrowed funds balances. Rates on deposits were 1.70% and 2.40% for the first six months of 2003 and 2002 respectively. This decrease resulted in interest expense decreasing by $894 thousand. Average deposit balances were $265.9 million in 2003 up from $258.5 million in 2002, which resulted in interest expense rising by $63 thousand. Rates on FHLB advances were 5.19% and 5.59% resulting in interest expense decreasing by $200 thousand in 2003 from 2002. The average balances for these interest bearing liabilities decreased to $92.6 million in 2003 from $101.1 million in 2002, which decreased interest expense by $218 thousand. Rates on repurchase agreements and other borrower funds were 3.27% and 4.21% for the first six months of 2003 and 2002, respectively. This decrease resulted in a decrease of $35 thousand in interest expense. The average balances of repurchase agreements and other borrowed funds decreased to $5.2 million in 2003's first half compared to $7.7 million for 2002's first half, resulting in a decrease of $40 thousand in interest expense. PROVISION FOR LOAN LOSSES The provision for loan losses was zero for the six months ended June 30, 2003 and 2002, respectively. The absence of a provision for loan losses was due to the overall asset quality of the Company as of June 30, 2003 and 2002. NON-INTEREST INCOME Non-interest income amounted to $663 thousand and $778 thousand for the six months ended June 30, 2003 and 2002, respectively. The decrease of $115 thousand in non-interest income primarily resulted from a decrease in loan fees to a loss of $180 thousand in 2003 from income of $88 thousand in 2002. The loss in loan fees can be attributed to provisions for losses on mortgage servicing rights (MSR's) due to higher prepayment speeds used in fair value calculation of MSR's caused by the current low interest rate environment on mortgage loans. Also contributing to the decrease was a decline in other income of $9 thousand primarily attributable to a loss on sale of a mortgage-backed security of $14 thousand. Partially offsetting these decreases were gains on the sale of mortgage loans totaling $314 thousand versus $176 thousand in the first six months of 2003 and 2002, respectively, and deposit account fees which increased to $343 thousand in the first six months of 2003 from $319 thousand for the same period in the prior year, resulting from a rise in NOW account fees. NON-INTEREST EXPENSE Non-interest expense remained consistent and totaled $5.0 million and $5.1 million for the six months ended June 30, 2003 and 2002, respectively. The decrease in non-interest expense is attributable to a decrease of $67 thousand in other expenses resulting mainly from a reduction in marketing expenses of $56 thousand. Salaries and employee benefits increased to $3.1 million in 2003 up by $52 thousand over the same period in 2002. Occupancy and equipment expenses have risen to $422 thousand for the first six months in 2003 from $413 thousand in 2002 due to increased building maintenance and repairs expenses due to snow plowing related to first quarter 2003 offset by lower vacancies of office space. Professional expense decreased slightly to $363 thousand for the six months ended of 2003 from $367 thousand over the same period in 2002 as the Bank's legal expenses relating to collection efforts have decreased slightly. Data processing expense decreased to $360 thousand from $366 thousand resulting from a slight decrease in service bureau charges. INCOME TAXES The Bank reported an income tax expense of $695 thousand and $945 thousand for the six months ended June 30, 2003 and 2002, respectively, representing an effective tax rate of 37.0% and 36.6%, respectively. 16 LIQUIDITY AND CAPITAL RESOURCES The Company's primary source of funds is cash dividends from its wholly-owned subsidiary, Lawrence Savings Bank (the "Bank"). The Bank paid dividends to the Company in the amount of $500 thousand and $2.5 million during the first half of 2003 and 2002, respectively. The Company made payments of dividends to shareholders in the amount of $1.0 million and $964 thousand in the first six months of 2003 and 2002, respectively. The Bank's primary sources of funds include collections of principal payments and repayments on outstanding loans, increases in deposits, advances from the Federal Home Loan Bank of Boston (FHLB) and securities sold under agreements to repurchase. The Bank has a line of credit of $6.8 million with the FHLB. The Bank also has a $5 million unsecured Federal Funds line of credit. At June 30, 2003, the Company's stockholder's equity was $53.4 million as compared to $54.1 million at December 31, 2002. The change during the first six months of 2003 occurred due to net income of $1.2 million, a $14 thousand decrease in market values on securities available for sale, net of taxes and was reduced by the declaration of dividends of $1.0 million and stock repurchases totaling $1.0 million. The Company's leverage ratio at June 30, 2003 and December 31, 2002 was 12.18% and 12.10%, respectively. The Company's and the Bank's total risk based capital ratios were 20.19% and 19.72% at June 30, 2003, respectively, compared with 17.74% and 16.93% at December 31, 2002, respectively. The Company exceeds all regulatory minimum capital ratio requirements set forth by the FRB, and the Bank exceeds all minimum capital ratio requirements as defined by the FDIC. 17 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The response is incorporated herein by reference to the discussion under the sub-caption "Interest Rate Sensitivity" of the caption "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" on pages 18 and 19 of the LSB Corporation's Annual Report for the fiscal year ended December 31, 2002. ITEM 4: CONTROLS AND PROCEDURES The Company's chief executive officer and chief financial officer, after evaluating the effectiveness of the Company's "disclosure controls and procedures" (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15-d-15(e)) as of the date of this report, have concluded that the Company's disclosure controls and procedures were adequate and designed to ensure that material information relating to the Company and its subsidiaries would be made known to them by others within those entities. There were no significant changes in the Company's internal controls or, to the Company's knowledge, in other factors that could significantly affect the Company's disclosure controls and procedures during the last fiscal quarter that have materially affected, or are reasonable likely to materially affect the internal controls over financial reporting. 18 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The response is incorporated herein by reference to the discussion under the caption "CONTINGENCIES" on page 41 of the LSB Corporation's Annual Report for the fiscal year ended December 31, 2002. The Bank is a defendant in litigation brought in Massachusetts Superior Court related to transactions completed at a branch of the Bank. The claims against the Bank approximate $200,000. While the case has been fully adjudicated, the Bank has filed for Summary Judgment. While the outcome of the litigation is uncertain management does not believe that the resolution of the litigation will have a material impact upon the financial condition of the Bank. The Bank has notified its insurance carrier in the event of a loss. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 6, 2003, LSB Corporation (the "Company") held its annual meeting (the "Annual Meeting"). The stockholders elected each of the following three individuals as Class A directors of the Company to serve until the 2006 Annual Meeting, with the following votes cast: Broker non-votes Nominees For Withheld and Abstentions - -------- --- -------- --------------- Thomas J. Burke 3,375,913 265,937 0 Marsha A. McDonough 3,375,713 266,137 0 Kathleen Boshar Reynolds 3,375,713 266,137 0 The following directors of the Company continued as directors after the Annual Meeting: Eugene A. Beliveau, Malcolm W. Brawn, Byron R. Cleveland, Jr., Neil H. Cullen, Richard Hart Harrington, Robert F. Hatem and Paul A. Miller Finally, the stockholders ratified the appointment of KPMG LLP ("KPMG") as the Company's independent auditors for the fiscal year ending December 31, 2003. KPMG received 3,569,240 affirmative votes, 68,410 negative votes, and 4,200 abstentions. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits. Please see the Exhibit Index attached hereto. b. Reports on Form 8-K. The following is a list of Form 8-K's that have been filed by LSB Corporation with the Securities and Exchange Commission during the quarter ended June 30, 2003: Date Filed Items reported ---------- ---------------------------------------------------- April 21, 2003 LSB Corporation's press release announcing the Company's Earnings for the quarter ended March 31, 2003. April 25, 2003 LSB Corporation's press release announcing the Company's Dividend to shareholders' for the second quarter 2003. 19 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. LSB CORPORATION AND SUBSIDIARY August 14, 2003 /S/ Paul A. Miller ------------------------------------- Paul A. Miller President and Chief Executive Officer August 14, 2003 /S/ John E. Sharland ------------------------------------ John E. Sharland Senior Vice President Chief Financial Officer 20 LSB CORPORATION AND SUBSIDIARY Quarterly Report on Form 10-Q For Quarter Ended June 30, 2003 EXHIBIT INDEX Page ---- 31.1 Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002 22 31.2 Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002 23 32.1 Certification Pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 24 32.2 Certification Pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 25 21