U. S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q [ X ] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2004 [ ] Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period ended ------------------ Commission File Number 0-22787 ------- FOUR OAKS FINCORP, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) NORTH CAROLINA 56-2028446 - ------------------------------- ----------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification Number) 6114 U.S. 301 SOUTH, FOUR OAKS, NC 27524 - -------------------------------------------------------------------------------- (Address of principal executive office, including zip code) (919) 963-2177 - -------------------------------------------------------------------------------- (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 Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No -- -- Indicate by 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 issuer's classes of common stock, as of the latest practicable date: Common Stock, 2,724,765 par value $1.00 per share (Number of shares outstanding (Title of Class) as of August 12, 2004) -1- Page No. ---------- Part I. FINANCIAL INFORMATION Item 1 - Financial Statements (Unaudited) Consolidated Balance Sheets June 30, 2004 and December 31, 2003...................... 3 Consolidated Statements of Income Three Months and Six Months Ended June 30, 2004 and 2003.. 4 Consolidated Statements of Comprehensive Income Three Months and Six Months Ended June 30, 2004 and 2003... 5 Consolidated Statement of Shareholders' Equity Six Months Ended June 30, 2004............................. 6 Consolidated Statements of Cash Flows Six Months Ended June 30, 2004 and 2003..................... 7 Notes to Consolidated Financial Statements.................. 8 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations....................................... 10 Item 4 - Controls and Procedures......................................... 13 Part II. OTHER INFORMATION Item 2 - Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities............................................. 14 Item 4 - Submission of Matters to a Vote of Security Holders.............. 14 Item 6 - Exhibits and Reports on Form 8-K................................. 15 -2- Part I. FINANCIAL INFORMATION Item 1 - Financial Statements FOUR OAKS FINCORP, INC. CONSOLIDATED BALANCE SHEETS - -------------------------------------------------------------------------------- June 30, 2004 December 31, (Unaudited) 2003* -------------- ------------- ASSETS (In thousands) Cash and due from banks $ 12,125 $ 10,548 Interest-earning deposits 4,075 5,277 Investment securities available for sale 50,591 38,203 Loans 300,511 272,623 Allowance for loan losses (3,805) (3,430) -------------- ------------- Net loans 296,706 269,193 Accrued interest receivable 2,163 1,893 Bank premises and equipment, net 10,196 10,582 FHLB stock 2,150 1,923 Investment in life insurance 4,489 2,897 Other assets 2,445 1,205 -------------- ------------- Total assets $ 384,940 $ 341,721 ============== ============= LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest-bearing demand $ 57,144 $ 50,829 Money market and NOW accounts 55,804 43,927 Savings 14,106 13,038 Time deposits, $100,000 and over 97,844 85,100 Other time deposits 78,922 80,024 -------------- ------------- Total deposits 303,820 272,918 Borrowings 43,160 33,160 Accrued interest payable 1,342 1,284 Other liabilities 2,771 1,479 -------------- ------------- Total liabilities 351,093 308,841 -------------- ------------- Shareholders' equity: Common stock; $1.00 par value, 10,000,000 shares authorized; 2,722,991 and 2,676,263 shares issued and outstanding at June 30, 2004 and December 31, 2003, respectively 2,723 2,676 Additional paid-in capital 8,932 8,029 Retained earnings 23,043 21,867 Accumulated other comprehensive income (loss) (851) 308 -------------- ------------- Total shareholders' equity 33,847 32,880 -------------- ------------- Total liabilities and shareholders' equity $ 384,940 $ 341,721 ============== ============= * Derived from audited consolidated financial statements. The accompanying notes are an integral part of the consolidated financial statements. -3- FOUR OAKS FINCORP, INC. CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) - -------------------------------------------------------------------------------- Three Months Ended Six Months Ended June 30, June 30, ----------------------- ------------------------ 2004 2003 2004 2003 --------- ----------- ---------- ------------ (In thousands, except per share data) Interest income: Loans, including fees $ 4,773 $ 4,187 $ 9,463 $ 8,273 Investment securities: Taxable 354 403 654 830 Tax-exempt 45 52 96 107 Dividends 32 22 54 47 Interest-earning deposits 11 26 16 47 --------- ----------- ------------ ----------- Total interest income 5,215 4,690 10,283 9,304 --------- ----------- ------------ ----------- Interest expense: Deposits 983 1,125 1,925 2,399 Borrowings 418 386 814 767 --------- ----------- ------------ ----------- Total interest expense 1,401 1,511 2,739 3,166 --------- ----------- ------------ ----------- Net interest income 3,814 3,179 7,544 6,138 Provision for loan losses 422 423 990 766 --------- ----------- ------------ ----------- Net interest income after provision for loan losses 3,392 2,756 6,554 5,372 --------- ----------- ------------ ----------- Non-interest income: Service charges on deposit accounts 511 460 1,007 903 Other service charges, commissions and fees 363 204 620 455 Gain on sale of investment securities available for sale 50 48 106 213 Gain on sale of loans 15 148 15 148 Increase in cash surrender value of life insurance 43 - 92 - --------- ----------- ------------ ----------- Total non-interest income 982 860 1,840 1,719 --------- ----------- ------------ ----------- Non-interest expense: Salaries 1,332 1,284 2,655 2,449 Employee benefits 232 259 525 532 Occupancy expenses 120 120 255 230 Equipment expenses 320 273 596 556 Professional and consulting fees 147 206 299 377 Other taxes and licenses 48 58 110 118 Merchant fees 87 79 152 147 Other operating expenses 574 474 1,058 888 --------- ----------- ------------ ----------- Total non-interest expense 2,860 2,753 5,650 5,297 --------- ----------- ------------ ----------- Income before income taxes 1,514 863 2,744 1,794 --------- ----------- ------------ ----------- Income taxes 532 245 963 548 --------- ----------- ------------ ----------- Net income $ 982 $ 618 $ 1,781 $ 1,246 ========= =========== ============ =========== Net income per common share: Basic $ .36 $ .23 $ .66 $ .46 ========= =========== ============ =========== Diluted $ .36 $ .23 $ .65 $ .46 ========= =========== ============ =========== The accompanying notes are an integral part of the consolidated financial statements. -4- Four Oaks Fincorp, Inc. Consolidated Statements of Comprehensive Income (UNAUDITED) - -------------------------------------------------------------------------------- Three Months Ended Six Months Ended June 30, June 30, ------------------- ------------------- 2004 2003 2004 2003 ---------- --------- --------- --------- (Amounts in thousands) Net income $ 982 $ 618 $ 1,781 $ 1,246 --------- --------- ---------- --------- Other comprehensive income (loss): Securities available for sale: Unrealized holding gains (losses) on available for sale securities (1,754) 258 (1,383) 538 Tax effect 701 (102) 553 (216) Reclassification of gains recognized in net income (50) (48) (106) (213) Tax effect 20 19 43 85 --------- --------- ---------- --------- Net of tax amount (1,083) 127 (893) 194 --------- --------- ---------- --------- Cash flow hedging activities: Unrealized holding losses on cash flow hedging activities (796) - (444) - Tax effect 318 - 178 - --------- --------- ---------- --------- Net of tax amount (478) - (266) - --------- --------- ---------- --------- Total other comprehensive income (loss) (1,561) 127 (1,159) 194 --------- --------- ---------- --------- Comprehensive income (loss) $ (579) $ 745 $ 622 $ 1,440 ========= ========= ========== ========= The accompanying notes are an integral part of the consolidated financial statements. -5- Four Oaks Fincorp, Inc. Consolidated Statement of Shareholders' Equity (unaudited) - -------------------------------------------------------------------------------- Accumulated Additional other Total Common stock paid-in Retained comprehensive shareholders' Shares Amount capital earnings income (loss) equity ------ ------ ------- --------- ------------- ------ (Amounts in thousands, except share and per share data) Balance, December 31, 2003 2,676,263 $ 2,676 $ 8,029 $21,867 $ 308 $32,880 Comprehensive income: Net income - - - 1,781 - 1,781 Other comprehensive loss - - - - (1,159) (1,159) Common stock issued pursuant to: Issuance of common stock 16,879 17 354 - - 371 Exercise of stock options 32,649 33 508 - - 541 Current income tax benefit - - 41 - - 41 Purchases and retirement of common stock (2,800) (3) - (62) - (65) Cash dividends of $.20 per share - - - (543) - (543) --------- ------- -------- ------- ------ ------- Balance, June 30, 2004 2,722,991 $ 2,723 $ 8,932 $23,043 $ (851) $33,847 ========= ======= ======== ======= ====== ======= The accompanying notes are an integral part of the consolidated financial statements. -6- FOUR OAKS FINCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) - -------------------------------------------------------------------------------- Six Months Ended June 30, ----------------------- 2004 2003 --------- --------- (In thousands) Operating activities: Net income $ 1,781 $ 1,246 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 990 766 Provision for depreciation and amortization 474 447 Net amortization of bond premiums and discounts 108 283 Gain on sale of securities (106) (213) Gain on sale of loans (15) (148) Loss on disposal of capital assets 29 - Gain on sale of foreclosed assets - (4) Increase in cash surrender value of life insurance (92) - Changes in assets and liabilities: Increase in other assets (408) (374) (Increase) decrease in interest receivable (270) 131 Increase in other liabilities 1,236 3,214 Increase (decrease) in interest payable 58 (243) ---------- ---------- Net cash provided by operating activities 3,785 5,105 ---------- ---------- Investing activities: Proceeds from sales and calls of securities available for sale 11,444 29,674 Proceeds from maturities of securities available for sale 9,955 - Purchase of securities available for sale (35,278) (21,413) Net increase in loans (28,771) (24,336) Purchases of premises and equipment (110) (694) Investment in life insurance (1,500) (3,000) Purchase of Federal Home Loan Bank stock (227) (175) Proceeds from sales of foreclosed assets 161 418 Expenditures on foreclosed assets - (3) ---------- ---------- Net cash used in investment activities (44,326) (19,529) ---------- ---------- Financing activities: Net proceeds from borrowings 10,000 3,500 Net increase in deposit accounts 30,612 7,242 Proceeds from issuance of common stock 912 641 Purchase and retirement of common stock (65) (271) Cash dividends (543) (475) ---------- ---------- Net cash provided by financing activities 40,916 10,637 ---------- ---------- Increase (decrease) in cash and cash equivalents 375 (3,787) Cash and cash equivalents at beginning of period 15,825 19,054 ---------- ---------- Cash and cash equivalents at end of period $ 16,200 $ 15,267 ========== ========== The accompanying notes are an integral part of the consolidated financial statements. -7- FOUR OAKS FINCORP, INC. Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- NOTE 1 - BASIS OF PRESENTATION In management's opinion, the financial information contained in the accompanying consolidated financial statements, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three month and six month periods ended June 30, 2004 and 2003, in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements include the accounts of Four Oaks Fincorp, Inc. (the "Company") and its wholly-owned subsidiaries, Four Oaks Bank & Trust Company (the "Bank"), and Four Oaks Mortgage Services, LLC, a mortgage origination subsidiary. All significant intercompany transactions and balances have been eliminated in consolidation. Operating results for the three month and six month periods ended June 30, 2004 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2004. The organization and business of the Company, accounting policies followed by the Company and other information are contained in the notes to the consolidated financial statements filed as part of the Company's annual report on Form 10-KSB for the year ended December 31, 2003. This quarterly report should be read in conjunction with such annual report. NOTE 2 - NET INCOME PER SHARE Basic and diluted net income per common share is computed based on the weighted average number of shares outstanding during each period after retroactively adjusting for a 5-for-4 stock split paid on November 10, 2003. Diluted net income per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that would then share in the net income of the Company. Basic and diluted net income per common share have been computed based upon net income as presented in the accompanying consolidated statements of income divided by the weighted average number of common shares outstanding or assumed to be outstanding as summarized below: Three Months Ended Six Months Ended June 30, June 30, ------------------ ----------------- 2004 2003 2004 2003 -------- --------- --------- -------- Weighted average number of common shares used in computing basic net income per share 2,718,000 2,698,750 2,706,000 2,690,000 Effect of dilutive stock options 16,207 8,669 14,896 7,815 --------- --------- --------- --------- Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share 2,734,207 2,707,419 2,720,896 2,697,815 ========= ========= ========= ========= As of June 30, 2004 and 2003, there were no antidilutive shares outstanding for both three month and six month periods. -8- FOUR OAKS FINCORP, INC. Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- NOTE 3 - STOCK COMPENSATION PLANS SFAS No. 123, Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Company's stock option plans have no intrinsic value at the grant date as they are granted with an exercise price equal to the fair market value on that date and, under Opinion No. 25, no compensation cost is recognized for them. The Company has elected to continue with the accounting methodology in Opinion No. 25 and, as a result, has provided the following pro forma disclosures of net income and earnings per share and other disclosures as if the fair value based method of accounting had been applied. Three Months Ended Six Months Ended June 30, June 30, ------------------ ----------------- 2004 2003 2004 2003 ------- ------- ------- ------- (Amounts in thousands, except per share data) Net income: As reported $ 982 $ 618 $1,781 $1,246 Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects (16) (9) (31) (23) ----- ----- ------ ------ Pro forma $ 966 $ 609 $1,750 $1,223 ===== ===== ====== ====== Basic earnings per share: As reported $ .36 $ .23 $ .66 $ .46 Pro forma .36 .23 .65 .45 Diluted earnings per share: As reported $ .36 $ .23 $ .65 $ .46 Pro forma .35 .22 .64 .45 NOTE 4 - COMMITMENTS At June 30, 2004 loan commitments were as follows (in thousands): Commitment to extend credit $ 50,348 Undisbursed lines of credit 19,851 -9- ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion provides information about the major components of the financial condition and results of operations of the Company and its subsidiaries and should be read in conjunction with our Consolidated Financial Statements and Notes thereto. Comparison of Financial Condition at June 30, 2004 and December 31, 2003 During the six months ended June 30, 2004, the Company's total assets grew from $341.7 million at December 31, 2003 to $384.9 million, an increase of $43.2 million or 12.65%. This increase in our assets resulted primarily from the increase in our net loans of $27.5 million from $269.2 million at December 31, 2003 to $296.7 million at June 30, 2004. The growth in our loan portfolio resulted primarily from increases in our loans secured by real estate, which increased $29.7 million. In addition, our liquid assets, consisting of cash and cash equivalents and investment securities available for sale, experienced a net increase of $12.8 million. This growth in our assets was funded by increases in both deposits and borrowings, which increased by $30.9 million and $10.0 million, respectively. Our investment in life insurance increased from $1.5 million at December 31, 2004 to $4.5 million at June 30, 2004. This insurance provides the Company favorable tax-equivalent returns as means for offsetting a portion of the cost of employee benefit plans. Deposits continue to be our primary funding source. During the six months ended June 30, 2004, we had an increase in deposits of $30.9 million, from $272.9 million at December 31, 2003 to $303.8 million. This increase occurred primarily within our demand deposit and savings accounts, which increased by $19.3 million. Also during the six months ended June 30, 2004, our borrowings, which consist almost entirely of advances from the Federal Home Loan Bank, increased $10.0 million to $43.2 million. Total shareholders' equity increased approximately $1.0 million from $32.9 million at December 31, 2003 to $33.8 million at June 30, 2004. This increase in shareholders' equity resulted principally from income from operations during the period of $1.8 million, net proceeds from the exercise of stock options and employee stock purchases of $953,000, and decreased as the result of the other comprehensive loss during the period of $1.2 million and dividends paid of $543,000. At June 30, 2004, both the Company and the Bank were considered to be well capitalized, as such term is defined in applicable federal regulations. Results of Operations for the Three Months Ended June 30, 2004 and 2003 Net Income. Net income for the three months ended June 30, 2004 was $982,000 or $.36 per basic share, as compared with net income of $618,000 or $.23 per basic share for the three months ended June 30, 2003, an increase of $364,000 or $.13 per share. For the three months ended June 30, 2004, the increase resulted primarily from an increase in the Company's net interest income of $635,000, which was partially offset by increases of $107,000 in other non-interest expenses and $287,000 in income taxes. Net Interest Income. Like most financial institutions, the primary component of earnings for the Bank is net interest income. Net interest income is the difference between interest income, principally from loan and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in -10- volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities and margin refers to net interest income divided by average interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of non-interest-bearing liabilities and capital. Net interest income for the three months ended June 30, 2004 was $3.8 million and increased $635,000, compared to the three months ended June 30, 2003. Our average interest-earning assets increased $47.1 million for the three months ended June 30, 2004 compared to the same period in 2003, while during the same period, our average interest-bearing liabilities increased $38.9 million, thereby resulting in an increase in the level of our net interest-earning assets during the current year period of $8.2 million. The Company increased the percentage of earning assets to total assets from 91.3% at June 30, 2003 to 92.8% at June 30, 2004. Additionally, the percentage of our deposits comprised of lower rate demand deposit accounts increased from 39.5% at June 30, 2003 to 41.8% at June 30, 2004. Also, subsequent to the second quarter of 2003, the Bank entered into an interest rate swap agreement that was used to hedge prime-based loans. This interest rate swap increased interest income by $111,000 for the three months ended June 30, 2004. As of June 30, 2004, the Bank also utilized interest rate swaps to hedge its exposure to changes in the interest rates related to a $19.0 million notional amount of brokered deposits. All of the aforementioned factors combined to increase our net interest margin by 16 basis points from 4.20% for the three month ended June 30, 2003 to 4.36% for the three months ended June 30, 2004. Provision for Loan Losses. The provision for loan losses for the three months ended June 30, 2003 and 2004 were essentially equal at $423,000 and $422,000, respectively. Net loan charge-offs during the three months ended June 30, 2004 were $482,000 as compared to $218,000 for the three months ended June 30, 2003. Non-performing loans aggregated $3.1 million at June 30, 2004, increasing from the $1.8 million at December 31, 2003, while the allowance for loan losses, expressed as a percentage of gross loans, was 1.27% and 1.25% at June 30, 2004 and December 31, 2003, respectively. We increased the allowance relative to our gross loans principally due to the increased levels of non-performing loans. Based on historic results, management believes that the allowance is adequate to absorb probable losses inherent in the loan portfolio. Non-Interest Income. Non-interest income increased $122,000 to $982,000 for the three months ended June 30, 2004 compared to $860,000 for the same period in 2003. Increases for the three months ended June 30, 2004 included increases of $51,000 in services charges and fees on deposit accounts and $159,000 in other service charges, commissions and fees as a result of the Company's growth. Offsetting these increases was a decrease in the gain on the sale of loans in the amount of $133,000, from $148,000 for the three month period ended June 30, 2003 to $15,000 for the same period in 2004. Non-Interest Expense. Non-interest expense increased $107,000 to $2.9 million for the three months ended June 30, 2004 compared to $2.8 million for the three months ended June 30, 2003. This increase was primarily due to an increase in other operating expenses of $100,000 due to the Company's growth. Provision for Income Taxes. The Company's provision for income taxes, as a percentage of income before income taxes, was 35.0% and 28.4% for the quarters ended June 30, 2004 and 2003, respectively. -11- Results of Operations for the Six Months Ended June 30, 2004 and 2003 Net Income. Net income for the six months ended June 30, 2004 was $1.8 million, or $.66 per basic share, as compared with net income of $1.2 million, or $.46 per basic share for the six months ended June 30, 2003, an increase of $535,000 or $.20 per share. For the six months ended June 30, 2004, the increase resulted primarily from an increase in the Company's net interest income of $1.4 million, which was partially offset by increases of $224,000 in the provision for loan losses, $415,000 in the provision for income taxes and $353,000 in other non-interest expenses. Net Interest Income. Net interest income for the six months ended June 30, 2004 was $7.5 million, as compared with $6.1 million during the six months ended June 30, 2003, an increase of $1.4 million, which resulted primarily from the increase in the level of our average interest-earning assets relative to the increase in the level of our average interest-bearing liabilities during the quarter. Our average interest-earning assets increased $42.0 million for the six months ended June 30, 2004 compared to the six months ended June 30, 2003, while during the same period, our average interest-bearing liabilities increased $30.7 million, thereby resulting in an increase in the level of our net interest-earning assets during the current year period of $11.3 million. The Company increased the percentage of earning assets to total assets from 91.3% at June 30, 2003 to 92.8% at June 30, 2004. Additionally, the percentage of our deposits comprised of lower rate demand deposit accounts increased from 39.5% at June 30, 2003 to 41.8% at June 30, 2004. Also, subsequent to the second quarter of 2003, the Bank entered into an interest rate swap agreement that was used to hedge prime-based loans. This interest rate swap increased interest income by $222,000 for the six months ended June 30, 2004. As of June 30, 2004, the Bank also utilized interest rate swaps to hedge its exposure to changes in the interest rates related to a $19.0 million notional amount of brokered deposits. All of the aforementioned factors combined to increase our net interest margin by 32 basis points from 4.16% for the six months ended June 30, 2003 to 4.48% for the six months ended June 30, 2004. Provision for Loan Losses. The provision for loan losses was $990,000 and $766,000 for the six months ended June 30, 2004 and 2003, respectively, an increase of $224,000. This increase in provision for loan losses was primarily due to $615,000 of net loan charge-offs during the six months ended June 30, 2004 compared to $461,000 of net charge-offs in the six months ended June 30, 2003 and due to increasing the level of the allowance for loan losses from 1.25% to 1.27%. Based upon historic results, management believes that the allowance is adequate to absorb probable losses inherent in the loan portfolio. Non-Interest Income. Non-interest income increased $121,000 for the six months ended June 30, 2004 to $1.8 million as compared to $1.7 million for the six months ended June 30, 2003. Increases for the six months ended June 30, 2004 include increases of $104,000 in service charges and fees on deposit accounts and $165,000 in other service charges, commission and fees as a result of the Company's growth. During 2004, the Company has earned income of $92,000 from its investment in life insurance products in which it had invested in during 2003. Offsetting these increases were decreases in the gain on sale of investment and gain on sale of loans in the amounts of $107,000 and $133,000, respectively. Non-Interest Expense. Non-interest expense increased $353,000 to $5.7 million for the six months ended June 30, 2004 compared to $5.3 million for the six months ended June 30, 2003. This increase was primarily due to an increase in salaries and employee benefits of $199,000, which resulted from normal salary adjustments, the addition of new personnel, and rising insurance costs. The remaining non-interest expenses increased by $154,000 due to the Company's continued growth. Provision for Income Taxes. The Company's provision for income taxes, as a percentage of income before income taxes, was 35.1% and 30.5% for the six months ended June 30, 2004 and 2003, respectively. -12- Liquidity and Capital Resources Our liquidity position is primarily dependent upon the Bank's need to respond to loan demand, the short-term demand for funds caused by withdrawals from deposit accounts (other than time deposits) and the liquidity of its assets. The Bank's primary liquidity sources include cash and amounts due from other banks, federal funds sold, and U.S. Government Agency and other short-term investment securities. In addition, the Bank has the ability to borrow funds from the Federal Reserve Bank and the Federal Home Loan Bank of Atlanta and to purchase federal funds from other financial institutions. Our management believes that our liquidity sources are adequate to meet our operating needs and the operating needs of the Bank for the next eighteen months. Total shareholders' equity was $33.8 million or 8.8% of total assets at June 30, 2004 and $32.9 million or 9.6% of total assets at December 31, 2003. Forward Looking Information Information set forth in this Quarterly Report on Form 10-Q, under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains various "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which statements represent our judgment concerning the future and are subject to risks and uncertainties that could cause our actual operating results and financial position to differ materially. Such forward looking statements can be identified by the use of forward looking terminology, such as "may," "will," "expect," "anticipate," "estimate," or "continue" or the negative thereof, or other variations thereof, or comparable terminology. We caution that any such forward looking statements are further qualified by important factors that could cause our actual operating results to differ materially from those in the forward looking statements, including, without limitation, the effects of future economic conditions, governmental fiscal and monetary policies, legislative and regulatory changes, the risks of changes in interest rates on the level and composition of deposits, the effects of competition from other financial institutions, the failure of assumptions underlying the establishment of the allowance for loan losses, the low trading volume of our common stock, other considerations described in connection with specific forward looking statements and other cautionary elements specified in our periodic filings with the Securities and Exchange Commission, including without limitation, our Annual Report on Form 10-KSB, Quarterly Reports on Form 10-Q, and current Reports on Form 8-K. Item 4 - Controls and Procedures - -------------------------------- As required by paragraph (b) of Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), an evaluation was carried out under the supervision and with the participation of the Company's management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that as of the end of the period covered by this report, the Company's disclosure controls and procedures are effective, in that they provide reasonable assurances that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods required by the Commission's rules and forms. There have been no 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) -13- during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Part II. OTHER INFORMATION Item 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES The following table provides information with respect to purchases made by or on behalf of the Company or any "affiliated purchaser" (as defined in Rule 10b-18(a)(3) under the Exchange Act), of the Company's common stock during the three months ended June 30, 2004. Total Number of Shares Purchased as Maximum Number Part of of Shares That Total Number Average Price Publicly May Yet Be of Shares Paid per Announced Purchased Under Period Purchased Share Program the Program April 1, 2004 to April 30, 2004 - $ - - - May 1, 2004 to May 31, 2004 4,595 $ 23.25 2,800 36,611 June 1, 2004 to June 30, 2004 - $ - - - Year-to-date 4,595 $ 23.25 2,800 The table above includes purchases and retirement of common stock by the Company. On December 10, 2001, we announced the authorization by our Board of Directors of a program to repurchase up to 100,000 shares of our outstanding common stock. As of June 30, 2004, there were an aggregate of 100,000 shares of our common stock that have been approved for repurchase under the program, of which an aggregate of 63,389 shares have already been repurchased. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On April 26, 2004, the Company held its Annual Meeting of Shareholders. Of 2,706,538 shares entitled to vote at the meeting, 1,859,220 shares voted. The following proposals were submitted to the shareholders and voted on at the meeting: Proposal 1: To elect eight nominees to the Company's Board of Directors to serve until the 2005 Annual Meeting of Shareholders or until their successors are elected and qualified. The votes were cast as follows: For Withheld --------- -------- M. S. Canaday 1,859,220 0 Ayden R. Lee, Jr. 1,859,220 0 Paula Canaday Bowman 1,859,220 0 William J. Edwards 1,859,220 0 Percy Y. Lee 1,859,220 0 Warren L. Grimes 1,859,220 0 Dr. R. Max Raynor 1,856,716 2,504 William Ashley Turner 1,838,419 20,791 -14- Proposal 2: To approve the amendment to the Company's Articles of Incorporation to increase the aggregate number of shares of common stock that we are authorized to issue from 5,000,000 shares to 10,000,000 shares. The votes were cast as follows: For Against Withheld --------- ------- -------- 1,790,924 68,295 1 Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. Exhibit Description - ------- ----------- 10.1 Amended and Restated Employee Stock Purchase and Bonus Plan* 10.2 Amended and Restated Nonqualified Stock Option Plan* 31.1 Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-4(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification 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 32.1 Certification by the Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification by the Chief Financial Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ____________ *Management Contract or Compensatory Plan (b) Reports on Form 8-K. On April 27, 2004, the Company furnished a Form 8-K to the SEC attaching a press release dated April 26, 2004 announcing first quarter results for the quarter ended March 31, 2004. Information furnished in the Form 8-K referenced in the prior sentence is not deemed to be filed with the SEC. -15- SIGNATURES Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FOUR OAKS FINCORP, INC. Date: August 16, 2004 By: /s/ Ayden R. Lee, Jr. --------------------------------- Ayden R. Lee, Jr. President and Chief Executive Officer Date: August 16, 2004 By: /s/ Nancy S. Wise --------------------------------- Nancy S. Wise Senior Vice President and Chief Financial Officer -16- Exhibit Index ------------- Exhibit No. Description - ----------- ----------- 10.1 Amended and Restated Employee Stock Purchase and Bonus Plan* 10.2 Amended and Restated Nonqualified Stock Option Plan* 31.1 Certification 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 31.2 Certification 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 32.1 Certification by the Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification by the Chief Financial Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 _______ *Management Contract or Compensatory Plan -17-