================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2006 ----------------------- Commission File Number 0-15572 FIRST BANCORP ------------------------------------------------------ (Exact Name of Registrant as Specified in its Charter) North Carolina 56-1421916 - ------------------------------------------- --------------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 341 North Main Street, Troy, North Carolina 27371-0508 - ------------------------------------------- --------------------------- (Address of Principal Executive Offices) (Zip Code) (Registrant's telephone number, including area code) (910) 576-6171 --------------------------- 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 twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] YES [ ] NO Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. [ ] Large Accelerated Filer [X] Accelerated Filer [ ] Non-Accelerated Filer Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] YES [X] NO The number of shares of the registrant's Common Stock outstanding on April 30, 2006 was 14,306,284. ================================================================================
INDEX FIRST BANCORP AND SUBSIDIARIES Page Part I. Financial Information Item 1 - Financial Statements Consolidated Balance Sheets - March 31, 2006 and 2005 (With Comparative Amounts at December 31, 2005) 3 Consolidated Statements of Income - For the Periods Ended March 31, 2006 and 2005 4 Consolidated Statements of Comprehensive Income - For the Periods Ended March 31, 2006 and 2005 5 Consolidated Statements of Shareholders' Equity - For the Periods Ended March 31, 2006 and 2005 6 Consolidated Statements of Cash Flows - For the Periods Ended March 31, 2006 and 2005 7 Notes to Consolidated Financial Statements 8 Item 2 - Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition 16 Item 3 - Quantitative and Qualitative Disclosures About Market Risk 28 Item 4 - Controls and Procedures 29 Part II. Other Information Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 30 Item 6 - Exhibits 30 Signatures 33 Page 2
<TABLE> <CAPTION> Part I. Financial Information Item 1 - Financial Statements First Bancorp and Subsidiaries Consolidated Balance Sheets March 31, December 31, March 31, ($ in thousands-unaudited) 2006 2005 (audited) 2005 - ------------------------------------------------------------------------------------------------ <S> <C> <C> <C> ASSETS Cash & due from banks, noninterest-bearing $ 32,687 32,985 32,409 Due from banks, interest-bearing 82,331 41,655 25,938 Federal funds sold 25,294 28,883 23,252 ----------- ----------- ----------- Total cash and cash equivalents 140,312 103,523 81,599 ----------- ----------- ----------- Securities available for sale (costs of $113,840, $114,662, and $114,703) 112,695 113,613 114,575 Securities held to maturity (fair values of $15,427, $14,321, and $13,670) 15,331 14,172 13,376 Presold mortgages in process of settlement 2,086 3,347 2,400 Loans 1,553,371 1,482,611 1,395,324 Less: Allowance for loan losses (16,610) (15,716) (15,066) ----------- ----------- ----------- Net loans 1,536,761 1,466,895 1,380,258 ----------- ----------- ----------- Premises and equipment 35,339 34,840 30,133 Accrued interest receivable 8,993 8,947 7,096 Intangible assets 49,131 49,227 49,445 Other 7,239 6,486 8,278 ----------- ----------- ----------- Total assets $ 1,907,887 1,801,050 1,687,160 =========== =========== =========== LIABILITIES Deposits: Demand - noninterest-bearing $ 213,661 194,051 175,698 Savings, NOW, and money market 473,655 458,221 477,838 Time deposits of $100,000 or more 372,232 356,281 361,567 Other time deposits 505,492 486,024 433,589 ----------- ----------- ----------- Total deposits 1,565,040 1,494,577 1,448,692 Securities sold under agreements to repurchase 32,939 33,530 -- Borrowings 131,739 100,239 76,239 Accrued interest payable 4,312 3,835 3,030 Other liabilities 14,886 13,141 8,420 ----------- ----------- ----------- Total liabilities 1,748,916 1,645,322 1,536,381 ----------- ----------- ----------- SHAREHOLDERS' EQUITY Common stock, No par value per share Issued and outstanding: 14,291,060, 14,229,148, and 14,138,379 shares 54,994 54,121 52,459 Retained earnings 104,926 102,507 98,660 Accumulated other comprehensive income (loss) (949) (900) (340) ----------- ----------- ----------- Total shareholders' equity 158,971 155,728 150,779 ----------- ----------- ----------- Total liabilities and shareholders' equity $ 1,907,887 1,801,050 1,687,160 =========== =========== =========== See notes to consolidated financial statements. Page 3 </TABLE>
<TABLE> <CAPTION> First Bancorp and Subsidiaries Consolidated Statements of Income Three Months Ended March 31, ---------------------------- ($ in thousands, except share data-unaudited) 2006 2005 - ----------------------------------------------------------------------------------------- <S> <C> <C> INTEREST INCOME Interest and fees on loans $ 26,762 21,359 Interest on investment securities: Taxable interest income 1,329 1,155 Tax-exempt interest income 127 129 Other, principally overnight investments 497 272 ------------ ------------ Total interest income 28,715 22,915 ------------ ------------ INTEREST EXPENSE Savings, NOW and money market 1,333 881 Time deposits of $100,000 or more 3,677 2,345 Other time deposits 4,432 2,474 Securities sold under agreements to repurchase 262 -- Borrowings 1,158 930 ------------ ------------ Total interest expense 10,862 6,630 ------------ ------------ Net interest income 17,853 16,285 Provision for loan losses 1,015 580 ------------ ------------ Net interest income after provision for loan losses 16,838 15,705 ------------ ------------ NONINTEREST INCOME Service charges on deposit accounts 2,074 2,008 Other service charges, commissions and fees 1,205 1,054 Fees from presold mortgages 267 238 Commissions from sales of insurance and financial products 439 295 Data processing fees 36 147 Securities gains -- -- Other gains (losses) (67) (32) ------------ ------------ Total noninterest income 3,954 3,710 ------------ ------------ NONINTEREST EXPENSES Salaries 5,785 5,372 Employee benefits 1,781 1,514 ------------ ------------ Total personnel expense 7,566 6,886 Net occupancy expense 816 739 Equipment related expenses 811 695 Intangibles amortization 61 73 Other operating expenses 3,475 3,322 ------------ ------------ Total noninterest expenses 12,729 11,715 ------------ ------------ Income before income taxes 8,063 7,700 Income taxes 3,072 2,984 ------------ ------------ NET INCOME $ 4,991 4,716 ============ ============ Earnings per share: Basic 0.35 0.33 Diluted 0.35 0.33 Weighted average common shares outstanding: Basic 14,254,785 14,105,577 Diluted 14,421,639 14,363,606 See notes to consolidated financial statements. Page 4 </TABLE>
First Bancorp and Subsidiaries Consolidated Statements of Comprehensive Income Three Months Ended March 31, ------------------- ($ in thousands-unaudited) 2006 2005 - -------------------------------------------------------------------------------- Net income $ 4,991 4,716 ------- ------- Other comprehensive income (loss): Unrealized gains (losses) on securities available for sale: Unrealized holding gains (losses) arising during the period, pretax (96) (1,314) Tax benefit 37 512 Adjustment to minimum pension liability: Additional pension charge related to unfunded pension liability 16 (90) Tax benefit (expense) (6) 35 ------- ------- Other comprehensive income (loss) (49) (857) ------- ------- $ 4,942 3,859 ======= ======= See notes to consolidated financial statements. Page 5
<TABLE> <CAPTION> First Bancorp and Subsidiaries Consolidated Statements of Shareholders' Equity Accumulated Common Stock Other Share- --------------------------- Retained Comprehensive holders' (In thousands, except per share - unaudited) Shares Amount Earnings Income (Loss) Equity - --------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Balances, January 1, 2005 14,084 $ 51,614 96,347 517 148,478 Net income 4,716 4,716 Cash dividends declared ($0.17 per share) (2,403) (2,403) Common stock issued under stock option plan 38 452 452 Common stock issued into dividend reinvestment plan 16 393 393 Other comprehensive loss (857) (857) ------------ ------------ ------------ ------------ ------------ Balances, March 31, 2005 14,138 $ 52,459 98,660 (340) 150,779 ============ ============ ============ ============ ============ Balances, January 1, 2006 14,229 $ 54,121 102,507 (900) 155,728 Net income 4,991 4,991 Cash dividends declared ($0.18 per share) (2,572) (2,572) Common stock issued under stock option plan 44 429 429 Common stock issued into dividend reinvestment plan 18 397 397 Stock-based compensation -- 47 47 Other comprehensive loss (49) (49) ------------ ------------ ------------ ------------ ------------ Balances, March 31, 2006 14,291 $ 54,994 104,926 (949) 158,971 ============ ============ ============ ============ ============ See notes to consolidated financial statements. Page 6 </TABLE>
<TABLE> <CAPTION> First Bancorp and Subsidiaries Consolidated Statements of Cash Flows Three Months Ended March 31, ---------------------- ($ in thousands-unaudited) 2006 2005 - --------------------------------------------------------------------------------------------------- <S> <C> <C> Cash Flows From Operating Activities Net income $ 4,991 4,716 Reconciliation of net income to net cash provided by operating activities: Provision for loan losses 1,015 580 Net security premium amortization 21 6 Other losses 67 32 Decrease (increase) in net deferred loan fees and costs 107 (131) Depreciation of premises and equipment 688 668 Stock-based compensation expense 47 -- Amortization of intangible assets 61 73 Deferred income tax benefit (416) (196) Origination of presold mortgages in process of settlement (15,623) (13,872) Proceeds from sales of presold mortgages in process of settlement 16,884 13,243 Increase in accrued interest receivable (46) (264) Increase in other assets (62) (146) Increase in accrued interest payable 477 353 Increase in other liabilities 1,778 1,382 --------- --------- Net cash provided by operating activities 9,989 6,444 --------- --------- Cash Flows From Investing Activities Purchases of securities available for sale (6,495) (37,624) Purchases of securities held to maturity (1,968) -- Proceeds from maturities/issuer calls of securities available for sale 7,300 10,283 Proceeds from maturities/issuer calls of securities held to maturity 751 632 Net increase in loans (71,238) (29,429) Purchases of premises and equipment (1,187) (483) --------- --------- Net cash used by investing activities (72,837) (56,621) --------- --------- Cash Flows From Financing Activities Net increase in deposits and repurchase agreements 69,872 59,924 Proceeds from (repayments of) borrowings, net 31,500 (16,000) Cash dividends paid (2,561) (2,394) Proceeds from issuance of common stock 826 845 --------- --------- Net cash provided by financing activities 99,637 42,375 --------- --------- Increase (decrease) in cash and cash equivalents 36,789 (7,802) Cash and cash equivalents, beginning of period 103,523 89,401 --------- --------- Cash and cash equivalents, end of period $ 140,312 81,599 ========= ========= Supplemental Disclosures Of Cash Flow Information: Cash paid during the period for: Interest $ 10,385 6,277 Income taxes 1,243 1 Non-cash transactions: Unrealized gain (loss) on securities available for sale, net of taxes (59) (802) Foreclosed loans transferred to other real estate 250 1,058 See notes to consolidated financial statements. Page 7 </TABLE>
First Bancorp and Subsidiaries Notes to Consolidated Financial Statements (unaudited) For the Periods Ended March 31, 2006 and 2005 - -------------------------------------------------------------------------------- Note 1 - Basis of Presentation In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments necessary to present fairly the consolidated financial position of the Company as of March 31, 2006 and 2005 and the consolidated results of operations and consolidated cash flows for the periods ended March 31, 2006 and 2005. Reference is made to the 2005 Annual Report on Form 10-K filed with the SEC for a discussion of accounting policies and other relevant information with respect to the financial statements. The results of operations for the periods ended March 31, 2006 and 2005 are not necessarily indicative of the results to be expected for the full year. Note 2 - Accounting Policies Note 1 to the 2005 Annual Report on Form 10-K filed with the SEC contains a description of the accounting policies followed by the Company and discussion of recent accounting pronouncements. The following paragraph updates that information as necessary. On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004) (Statement 123(R)), "Share-Based Payment." Statement 123(R) replaces FASB Statement No. 123 (Statement 123), "Accounting for Stock-Based Compensation," and supersedes Accounting Principles Board Opinion No. 25 (Opinion 25), "Accounting for Stock Issued to Employees." Statement 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in the financial statements. Statement 123(R) permits public companies to adopt its requirements using one of two methods. The "modified prospective" method recognizes compensation for all stock options granted after the date of adoption and for all previously granted stock options that become vested after the date of adoption. The "modified retrospective" method includes the requirements of the "modified prospective" method described above, but also permits entities to restate prior period results based on the amounts previously presented under Statement 123 for purposes of pro-forma disclosures. The Company has elected to adopt Statement 123(R) under the "modified prospective" method and accordingly will not restate prior period results. See Note 4 for a more detailed description the Company's adoption of Statement 123(R). In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154 (Statement 154), "Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3." Statement 154 applies to all voluntary changes in accounting principle as well as to changes required by an accounting pronouncement that does not include specific transition provisions. Statement 154 eliminates the previous requirement that the cumulative effect of changes in accounting principle be reflected in the income statement in the period of change. Instead, to enhance the comparability of prior period financial statements, Statement 154 requires that changes in accounting principle be retrospectively applied. Under retrospective application, the new accounting principle is applied as of the beginning of the first period presented, as if that principle had always been used. Statement 154 carries forward the requirement that an error be reported by restating prior period financial statement as of the beginning of the first period. Statement 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The initial adoption of Statement 154 did not have a material impact on the Company's financial statements; however the adoption of this statement could result in a material change to the way the Company reflects future changes in accounting principles, depending on the nature of future changes in accounting principles and whether specific transition provisions are included. Page 8
In December 2005, the FASB issued Staff Position SOP 94-6-1, "Terms of Loan Products that May Give Rise to a Concentration of Credit Risk" ("FSP SOP 94-6-1"). FSP SOP 94-6-1 addresses 1) the circumstances under which the terms of loan products give rise to a concentration of credit risk, and 2) the disclosures or other accounting considerations that apply for entities that originate, hold, guarantee, service, or invest in loan products with terms that may give rise to a concentration of credit risk. The disclosures required by FSP SOP 94-6-1 are required for interim and annual periods ending after December 19, 2005. Note 12 of the Company's 2005 Form 10-K contains this discussion and there have been no material changes since that time. Note 3 - Reclassifications Certain amounts reported in the period ended March 31, 2005 have been reclassified to conform with the presentation for March 31, 2006. These reclassifications had no effect on net income or shareholders' equity for the periods presented, nor did they materially impact trends in financial information. Note 4 - Equity-Based Compensation Plans At March 31, 2006, the Company had the following equity-based compensation plans, all of which are stock option plans: the First Bancorp 2004 Stock Option Plan, the First Bancorp 1994 Stock Option Plan, and four plans that were assumed from acquired entities, which are all described below. The Company's shareholders approved all equity-based compensation plans, except for those assumed from acquired companies. As of March 31, 2006, the First Bancorp 2004 Stock Option Plan is the only plan that had shares available for future grants. The First Bancorp 2004 Stock Option Plan and its predecessor plan, the First Bancorp 1994 Stock Option Plan, were intended to serve as a means of attracting, retaining and motivating key employees and directors and to associate the interests of the plans' participants with those of the Company and its shareholders. Stock option grants to non-employee directors have historically had no vesting requirements, whereas, except as discussed below, stock option grants to employees have generally had five-year vesting schedules (20% vesting each year). In April 2004, the Company granted 128,000 options to employees with no vesting requirements. These options were granted without any vesting requirements for two reasons - 1) the options were granted primarily as a reward for past performance and therefore had already been "earned" in the view of the Committee, and 2) to potentially minimize the impact that any change in accounting standards for stock options could have on future years' reported net income. Employee stock option grants since the April 2004 grant have reverted to having five year vesting periods. The Company's options provide for immediate vesting if there is a change in control (as defined in the plans). Under the terms of these two plans, options can have a term of no longer than ten years, and all options granted thus far under these plans have had a term of ten years. Except for grants to directors (see below), the Company cannot estimate the amount of future stock option grants at this time. In the past, stock option grants to employees have been irregular, generally falling into three categories - 1) to attract and retain new employees, 2) to recognize changes in responsibilities of existing employees, and 3) to periodically reward exemplary performance. As it relates to directors, the Company has historically granted 2,250 stock options to each of the Company's non-employee directors in June of each year, and expects to continue doing so for the foreseeable future. At March 31, 2006, there were 647,220 options outstanding related to these two plans with exercise prices ranging from $4.45 to $22.12. At March 31, 2006, there were 1,211,590 shares remaining available to grant under the 2004 First Bancorp Stock Option Plan. The Company also has four stock option plans as a result of assuming plans of acquired companies. At March 31, 2006, there were 53,686 stock options outstanding in connection with these plans, with option prices ranging from $4.17 to $11.49. The Company issues new shares when options are exercised. Prior to January 1, 2006, the Company accounted for all of these plans using the intrinsic value method prescribed by Opinion 25 and related interpretations. Because all of the Company's stock options had an exercise price equal to Page 9
the market value of the underlying common stock on the date of grant, no compensation cost had ever been recognized. On January 1, 2006, the Company adopted Statement 123(R). Statement 123(R) supersedes Opinion 25 (and related interpretations) and requires that the compensation cost relating to share-based payment transactions be recognized in the financial statements. Statement 123(R) permits public companies to adopt its requirements using one of two methods. The "modified prospective" method recognizes compensation for all stock options granted after the date of adoption and for all previously granted stock options that become vested after the date of adoption. The "modified retrospective" method includes the requirements of the "modified prospective" method described above, but also permits entities to restate prior period results based on the amounts previously presented under Statement 123 for purposes of pro-forma disclosures. The Company has elected to adopt Statement 123(R) under the "modified prospective" method and accordingly will not restate prior period results. The Company measures the fair value of each option award on the date of grant using the Black-Scholes option-pricing model. The Company determines the assumptions used in the Black-Scholes option pricing model as follows: the risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant; the dividend yield is based on the Company's dividend yield at the time of the grant (subject to adjustment if the dividend yield on the grant date is not expected to approximate the dividend yield over the expected life of the option); the volatility factor is based on the historical volatility of the Company's stock (subject to adjustment if historical volatility is reasonably expected to differ from the past); the weighted-average expected life is based on the historical behavior of employees related to exercises, forfeitures and cancellations. As noted above, prior to the adoption of Statement 123(R), the Company applied Opinion 25 to account for its stock options. The following table illustrates the effect on net income and earnings per share had the Company accounted for share-based compensation in accordance with Statement 123(R) for the period indicated: Three Months Ended March 31, (In thousands except per share data) 2005 ------------ Net income, as reported $ 4,716 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (52) ------------ Pro forma net income $ 4,664 ============ Earnings per share: Basic - As reported $ 0.33 Basic - Pro forma 0.33 Diluted - As reported 0.33 Diluted - Pro forma 0.32 In the first quarter of 2006, the adoption of Statement 123(R) resulted in stock-based compensation expense of $47,000, with no associated tax benefits, which was classified as "salaries expense" on the Consolidated Statements of Income and reduced both income before income taxes and net income by that same amount. The impact on basic and diluted earnings per share was approximately one-third of one cent per share. This expense related to the vesting of several stock option grants made prior to January 1, 2006, as there were no option grants in the first quarter of 2006. This compensation expense was reflected as an adjustment to cash flows from operating activities on the Company's Consolidated Statement of Cash Flows. At March 31, 2006, the Company had $136,000 of unrecognized compensation costs related to unvested stock options. The cost is expected to be amortized over a weighted-average life of 1.12 years, with $46,000 being expensed in the second quarter of 2006, $22,000 being expensed in the third quarter of 2006, $12,000 being expensed in the fourth quarter of 2006, $47,000 being expensed in 2007 equally distributed among each of the four quarters, and $3,000 being expensed in each of 2008, 2009 and 2010, equally distributed among each of the four quarters of each year. In addition, as discussed above, the Company expects to grant 2,250 options, without vesting Page 10
requirements, to each of its non-employee directors on June 1, 2006 and on June 1 of each year thereafter. In 2005, the amount of pro forma expense associated with the June director grants was $127,000. As noted above, certain of the Company's stock option grants contain terms that provide for a graded vesting schedule whereby portions of the award vest in increments over the requisite service period. As provided for under Statement 123(R), the Company has elected to recognize compensation expense for awards with graded vesting schedules on a straight-line basis over the requisite service period for the entire award. Statement 123(R) requires companies to recognize compensation expense based on the estimated number of stock options and awards for which service is to be rendered. Over the past five years, there has been only one forfeiture or expiration, totaling 600 options, and therefore the Company assumes that all options granted will become vested. There were no option grants during either of the first quarters of 2005 or 2006. The following table presents information regarding the activity during the first three months of 2006 related to all of the Company's stock options outstanding: <TABLE> <CAPTION> All Options Outstanding --------------------------------------------------------- Weighted- Average Weighted- Remaining Aggregate Number of Average Contractual Intrinsic Value Three months ended March 31, 2006 Shares Exercise Price Term ($000) - ------------------------------------------ ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> Outstanding at the beginning of the period 746,882 $ 15.75 Granted during the period -- -- Exercised during the period 45,976 10.22 Forfeited or expired during the period -- -- ------------ Outstanding at end of period 700,906 $ 16.12 5.7 $ 4,449 ============ ============ ============ ============ Exercisable at March 31, 2006 649,281 $ 16.14 5.6 $ 4,104 ============ ============ ============ ============ </TABLE> The Company received $429,000 and $452,000 as a result of stock option exercises during the three months ended March 31, 2006 and 2005, respectively. The intrinsic value of the stock options exercised during the three months ended March 31, 2006 and 2005 was $527,000 and $444,000, respectively. No nonqualified stock options were exercised during the first quarter of 2006, and thus the Company did not record any associated tax benefits. The following table presents information regarding the activity during the first three months of 2006 related to the Company's stock options outstanding that are nonvested: <TABLE> <CAPTION> Nonvested Options Weighted-Average Number of Grant-Date Three months ended March 31, 2006 Shares Fair Value - ------------------------------------------------------------ ------------ ------------ <S> <C> <C> Nonvested options outstanding at the beginning of the period 67,999 $ 4.75 Granted during the period -- -- Vested during the period (16,374) 4.83 Forfeited or expired during the period -- -- ------------ Nonvested options outstanding at end of period 51,625 $ 4.74 ============ ============ </TABLE> Page 11
Note 5 - Earnings Per Share Basic earnings per share were computed by dividing net income by the weighted average common shares outstanding. Diluted earnings per share includes the potentially dilutive effects of the Company's stock option plan. The following is a reconciliation of the numerators and denominators used in computing basic and diluted earnings per share: <TABLE> <CAPTION> For the Three Months Ended March 31, --------------------------------------------------------------------------- 2006 2005 ------------------------------------ ------------------------------------ Income Shares Income Shares ($ in thousands except per (Numer- (Denom- Per Share (Numer- (Denom- Per Share share amounts) ator) inator) Amount ator) inator) Amount - ----------------------------- ---------- ---------- ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> <C> Basic EPS Net income $ 4,991 14,254,785 $ 0.35 $ 4,716 14,105,577 $ 0.33 ========== ========== Effect of Dilutive Securities -- 166,854 -- 258,029 ---------- ---------- ---------- ---------- Diluted EPS $ 4,991 14,421,639 $ 0.35 $ 4,716 14,363,606 $ 0.33 ========== ========== ========== ========== ========== ========== </TABLE> For the three months ended March 31, 2006 there were 191,730 options that were antidilutive because the exercise price exceeded the average market price for the period, and these options were excluded from the calculation of the effect of dilutive securities. For the three months ended March 31, 2005, there were no antidilutive options. Note 6 - Asset Quality Information Nonperforming assets are defined as nonaccrual loans, loans past due 90 or more days and still accruing interest, restructured loans and other real estate. Nonperforming assets are summarized as follows: <TABLE> <CAPTION> March 31, December 31, March 31, ($ in thousands) 2006 2005 2005 - --------------------------------------------------------------------------------------- <S> <C> <C> <C> Nonperforming loans: Nonaccrual loans $ 3,283 1,640 4,249 Restructured loans 12 13 15 Accruing loans > 90 days past due -- -- -- ------------ ------------ ------------ Total nonperforming loans 3,295 1,653 4,264 Other real estate 1,451 1,421 2,401 ------------ ------------ ------------ Total nonperforming assets $ 4,746 3,074 6,665 ============ ============ ============ Nonperforming loans to total loans 0.21% 0.11% 0.31% Nonperforming assets as a percentage of loans and other real estate 0.31% 0.21% 0.48% Nonperforming assets to total assets 0.25% 0.17% 0.40% Allowance for loan losses to total loans 1.07% 1.06% 1.08% </TABLE> Note 7 - Deferred Loan Fees Loans are shown on the Consolidated Balance Sheets net of net deferred loan costs (fees) of approximately $76,000, $184,000, and ($82,000) at March 31, 2006, December 31, 2005, and March 31, 2005, respectively. Page 12
Note 8 - Goodwill and Other Intangible Assets The following is a summary of the gross carrying amount and accumulated amortization of amortizable intangible assets as of March 31, 2006, December 31, 2005, and March 31, 2005 and the carrying amount of unamortized intangible assets as of those same dates. <TABLE> <CAPTION> March 31, 2006 December 31, 2005 March 31, 2005 ---------------------------- ---------------------------- ---------------------------- Gross Carrying Accumulated Gross Carrying Accumulated Gross Carrying Accumulated ($ in thousands) Amount Amortization Amount Amortization Amount Amortization ------------- ------------ ------------- ------------ ------------- ------------ <S> <C> <C> <C> <C> <C> <C> Amortizable intangible assets: Customer lists $ 394 123 394 115 394 93 Noncompete agreements 50 50 50 50 50 50 Core deposit premiums 2,441 1,064 2,441 1,011 2,441 816 ------------ ------------ ------------ ------------ ------------ ------------ Total $ 2,885 1,237 2,885 1,176 2,885 959 ============ ============ ============ ============ ============ ============ Unamortizable intangible assets: Goodwill $ 47,247 47,247 47,247 ============ ============ ============ Pension $ 237 273 272 ============ ============ ============ </TABLE> Amortization expense totaled $61,000 and $73,000 for the three months ended March 31, 2006 and 2005, respectively. The following table presents the estimated amortization expense for each of the five calendar years ending December 31, 2010 and the estimated amount amortizable thereafter. These estimates are subject to change in future periods to the extent management determines it is necessary to make adjustments to the carrying value or estimated useful lives of amortized intangible assets. Estimated Amortization (Dollars in thousands) Expense ---------------------- ----------------------- 2006 $ 242 2007 220 2008 219 2009 218 2010 218 Thereafter 592 ---------- Total $ 1,709 ========== Page 13
Note 9 - Pension Plans The Company sponsors two defined benefit pension plans - a qualified retirement plan (the "Pension Plan") which is generally available to all employees, and a Supplemental Executive Retirement Plan (the "SERP Plan"), which is for the benefit of certain senior management executives of the Company. The Company recorded pension expense totaling $581,000 and $447,000 for the three months ended March 31, 2006 and 2005, respectively, related to the Pension Plan and the SERP Plan. The following table contains the components of the pension expense. <TABLE> <CAPTION> For the Three Months Ended March 31, ---------------------------------------------------------------------------------- 2006 2005 2006 2005 2006 Total 2005 Total (in thousands) Pension Plan Pension Plan SERP Plan SERP Plan Both Plans Both Plans ------------ ------------ ----------- ----------- ----------- ----------- <S> <C> <C> <C> <C> <C> <C> Service cost - benefits earned during the period $ 341 284 79 62 420 346 Interest cost on projected benefit obligation 227 192 52 38 279 230 Expected return on plan assets (268) (237) -- -- (268) (237) Net amortization and deferral 119 86 31 22 150 108 ----------- ----------- ----------- ----------- ----------- ----------- Net periodic pension cost $ 419 325 162 122 581 447 =========== =========== =========== =========== =========== =========== </TABLE> The Company's contributions to the Pension Plan are based on computations by independent actuarial consultants and are intended to provide the Company with the maximum deduction for income tax purposes. The contributions are invested to provide for benefits under the Pension Plan. The Company estimates that its contribution to the Pension Plan will be $945,000 during 2006. The Company's funding policy with respect to the SERP Plan is to fund the related benefits through investments in life insurance policies, which are not considered plan assets for the purpose of determining the SERP Plan's funded status. The cash surrender values of the life insurance policies are included in the line item "other assets." The Company estimates that its payments to participants of the SERP Plan will be $164,000 in 2006. Page 14
Note 10 - Contingency The Company recorded a loss amount of $6,320,000, or $0.44 per diluted share, in the third quarter of 2005 to accrue for contingent tax loss exposure involving the North Carolina Department of Revenue. In February 2006, the North Carolina Department of Revenue announced a "Settlement Initiative" that offered companies with certain transactions that had been challenged by the North Carolina Department of Revenue the opportunity to resolve such matters with reduced penalties by agreeing to participate in the initiative by June 15, 2006. Although the Company believed that its tax returns complied with the relevant statutes, the board of directors of the Company decided that it was in the best interests of the Company to settle this matter by participating in the initiative. Based on the terms of the initiative, the Company estimated that its total liability to settle the matter will be approximately $4.3 million, net of the federal tax benefit, or $2.0 million less than the amount that was originally accrued. Accordingly, in March 2006, the Company adjusted its originally reported 2005 earnings to reflect the impact of this subsequent event by reducing originally reported tax expense for the three and twelve months ended December 31, 2005 by $1,982,000, or $0.14 per diluted share. The Company believes it has fully reserved for this liability and does not have any additional state income tax exposure other than the ongoing interest that will continue to accrue ($65,000 per quarter on an after-tax basis) until the Settlement Initiative is completed and the Company pays the amounts due in accordance with the settlement, which is expected to occur in the fourth quarter of this year. Note 11 - Pending Acquisitions and Subsequent Events On January 20, 2006, the Company reported that it had agreed to purchase a bank branch in Dublin, Virginia with approximately $20 million in deposits from another financial institution. This transaction is expected to close in July 2006. On April 26, 2006, the Company reported that it had agreed to purchase a bank branch in Carthage, North Carolina from another financial institution. This transaction is expected to close in September 2006. On April 13, 2006, the Company borrowed $25.8 million in the form of trust preferred capital securities. These securities have a floating interest rate of 3-month LIBOR plus 1.39% and qualify as regulatory capital. These securities have a thirty year maturity, but can be redeemed at par by the Company after five years. Page 15
Item 2 - Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition CRITICAL ACCOUNTING POLICIES The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practices followed by the banking industry. Certain of these principles involve a significant amount of judgment and/or use of estimates based on the Company's best assumptions at the time of the estimation. The Company has identified three policies as being more sensitive in terms of judgments and estimates, taking into account their overall potential impact to the Company's consolidated financial statements - 1) the allowance for loan losses, 2) tax uncertainties, and 3) intangible assets. Allowance for Loan Losses Due to the estimation process and the potential materiality of the amounts involved, the Company has identified the accounting for the allowance for loan losses and the related provision for loan losses as an accounting policy critical to the Company's consolidated financial statements. The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb losses inherent in the portfolio. Management's determination of the adequacy of the allowance is based primarily on a mathematical model that estimates the appropriate allowance for loan losses. This model has two components. The first component involves the estimation of losses on loans defined as "impaired loans." A loan is considered to be impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The estimated valuation allowance is the difference, if any, between the loan balance outstanding and the value of the impaired loan as determined by either 1) an estimate of the cash flows that the Company expects to receive from the borrower discounted at the loan's effective rate, or 2) in the case of a collateral-dependent loan, the fair value of the collateral. The second component of the allowance model is to estimate losses for all loans not considered to be impaired loans. First, loans that have been risk graded by the Company as having more than "standard" risk but are not considered to be impaired are assigned estimated loss percentages generally accepted in the banking industry. Loans that are classified by the Company as having normal credit risk are segregated by loan type, and estimated loss percentages are assigned to each loan type, based on the historical losses, current economic conditions, and operational conditions specific to each loan type. The reserve estimated for impaired loans is then added to the reserve estimated for all other loans. This becomes the Company's "allocated allowance." In addition to the allocated allowance derived from the model, management also evaluates other data such as the ratio of the allowance for loan losses to total loans, net loan growth information, nonperforming asset levels and trends in such data. Based on this additional analysis, the Company may determine that an additional amount of allowance for loan losses is necessary to reserve for probable losses. This additional amount, if any, is the Company's "unallocated allowance." The sum of the allocated allowance and the unallocated allowance is compared to the actual allowance for loan losses recorded on the books of the Company and any adjustment necessary for the recorded allowance to equal the computed allowance is recorded as a provision for loan losses. The provision for loan losses is a direct charge to earnings in the period recorded. Although management uses the best information available to make evaluations, future adjustments may be necessary if economic, operational, or other conditions change. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on the examiners' judgment about information available to them at the time of their examinations. Page 16
For further discussion, see "Nonperforming Assets" and "Summary of Loan Loss Experience" below. Tax Uncertainties The Company reserves for tax uncertainties in instances when it has taken a position on a tax return that may differ from the opinion of the applicable taxing authority. In accounting for tax contingencies, the Company assesses the relative merits and risks of certain tax transactions, taking into account statutory, judicial and regulatory guidance in the context of the Company's tax position. For those matters where it is probable that the Company will have to pay additional taxes, interest or penalties and a loss or range of losses can be reasonably estimated, the Company records reserves in the consolidated financial statements. For those matters where it is reasonably possible but not probable that the Company will have to pay additional taxes, interest or penalties and the loss or range of losses can be reasonably estimated, the Company only makes disclosures in the notes and does not record reserves in the consolidated financial statements. The process of concluding that a loss is reasonably possible or probable and estimating the amount of loss or range of losses and related tax reserves is inherently subjective, and future changes to the reserve may be necessary based on changes in management's intent, tax law or related interpretations, or other functions. See Note 10 to the Consolidated Financial Statements above for information related to a tax loss contingency accrual that was recorded in 2005. Intangible Assets Due to the estimation process and the potential materiality of the amounts involved, the Company has also identified the accounting for intangible assets as an accounting policy critical to the Company's consolidated financial statements. When the Company completes an acquisition transaction, the excess of the purchase price over the amount by which the fair market value of assets acquired exceeds the fair market value of liabilities assumed represents an intangible asset. The Company must then determine the identifiable portions of the intangible asset, with any remaining amount classified as goodwill. Identifiable intangible assets associated with these acquisitions are generally amortized over the estimated life of the related asset, whereas goodwill is tested annually for impairment, but not systematically amortized. Assuming no goodwill impairment, it is beneficial to the Company's future earnings to have a lower amount assigned to identifiable intangible assets and a higher amount to goodwill as opposed to having a higher amount considered to be identifiable intangible assets and a lower amount classified as goodwill. For the Company, the primary identifiable intangible asset typically recorded in connection with a whole bank or bank branch acquisition is the value of the core deposit intangible, whereas when the Company acquires an insurance agency, the primary identifiable intangible asset is the value of the acquired customer list. Determining the amount of identifiable intangible assets and their average lives involves multiple assumptions and estimates and is typically determined by performing a discounted cash flow analysis, which involves a combination of any or all of the following assumptions: customer attrition/runoff, alternative funding costs, deposit servicing costs, and discount rates. The Company typically engages a third party consultant to assist in each analysis. For the whole bank and bank branch transactions recorded to date, the core deposit intangible in each case has been estimated to have a ten year life, with an accelerated rate of amortization. For the 2003 insurance agency acquisition, the identifiable intangible asset related to the customer list was determined to have a ten year life, with amortization occurring on a straight-line basis. Subsequent to the initial recording of the identifiable intangible assets and goodwill, the Company amortizes the identifiable intangible assets over their estimated average lives, as discussed above. In addition, on at least an annual basis, goodwill is evaluated for impairment by comparing the fair value of the Company's reporting units to their related carrying value, including goodwill (the Company's community banking operation is its only material reporting unit). At its last evaluation, the fair value of the Company's community banking operation exceeded its Page 17
carrying value, including goodwill. If the carrying value of a reporting unit were ever to exceed its fair value, the Company would determine whether the implied fair value of the goodwill, using a discounted cash flow analysis, exceeded the carrying value of the goodwill. If the carrying value of the goodwill exceeded the implied fair value of the goodwill, an impairment loss would be recorded in an amount equal to that excess. Performing such a discounted cash flow analysis would involve the significant use of estimates and assumptions. The Company reviews identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The Company's policy is that an impairment loss is recognized, equal to the difference between the asset's carrying amount and its fair value, if the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset. Estimating future cash flows involves the use of multiple estimates and assumptions, such as those listed above. Current Accounting Matters See Note 2 to the Consolidated Financial Statements above as it relates to accounting standards that have been recently adopted by the Company. RESULTS OF OPERATIONS Overview Net income for the three months ended March 31, 2006 was $4,991,000, a 5.8% increase from the $4,716,000 recorded in the first quarter of 2005. The net income for the three month period ended March 31, 2006 amounted to $0.35 per diluted share, a 6.1% increase over the $0.33 net income per diluted share for the same period in 2005. Total assets at March 31, 2006 amounted to $1.91 billion, 13.1% higher than a year earlier. Total loans at March 31, 2006 amounted to $1.55 billion, an 11.3% increase from a year earlier, and total deposits were $1.57 billion, an 8.0% increase from a year earlier. The increase in loans and deposits over the past twelve months resulted in an increase in the Company's net interest income when comparing the first quarter of 2006 to the first quarter of 2005. Net interest income for the first quarter of 2006 amounted to $17.9 million, a 9.6% increase over the $16.3 million recorded in the first quarter of 2005. The Company's net interest margin (tax-equivalent net interest income divided by average earning assets) was 4.33% for the first quarter of 2006, which is the same as it was in the first quarter of 2005. This net interest margin was a four basis point decrease from the 4.37% realized in the fourth quarter of 2005. The slight decrease in margin from the previous quarter was primarily a result of the average rates paid on deposits rising by more than the corresponding increases in average yields realized from loans. The Company's provision for loan losses amounted to $1,015,000 in the first quarter of 2006 compared to $580,000 in the first quarter of 2005. The increase was primarily the result of strong loan growth in 2006, as asset quality ratios remained stable. Loan growth was $71 million in the first quarter of 2006 compared to $28 million in the first quarter of 2005. The Company's ratio of annualized net charge-offs to average loans amounted to 3 basis points for the first quarter of 2006 compared to 7 basis points for the first quarter of 2005. The Company's ratio of nonperforming assets to total assets was 0.25% at March 31, 2006 compared to 0.40% at March 31, 2005. Noninterest income amounted to $4.0 million for the first quarter of 2006, a 6.6% increase from the first quarter of 2005. Noninterest expenses amounted to $12.7 million in the first quarter of 2006, an 8.7% increase over 2005. There were no unusual items of noninterest income or expense that were significant in either period. In Page 18
accordance with the new accounting requirements regarding stock-based compensation (FASB Statement 123(R)) that were effective on January 1, 2006, the Company recorded $47,000 in expense related to stock options in the first quarter of 2006. The Company's effective tax rate remained relatively unchanged in comparing the first quarter of 2006 to the first quarter of 2005 - 38.1% in the first quarter of 2006 compared to 38.8% for the first quarter of 2005. The Company's annualized return on average assets for the first quarter of 2006 was 1.12% compared to 1.16% for the first quarter of 2005. The Company's annualized return on average equity for the first quarter of 2006 was 12.78% compared to 12.57% for the first quarter of 2005. Components of Earnings Net interest income is the largest component of earnings, representing the difference between interest and fees generated from earning assets and the interest costs of deposits and other funds needed to support those assets. Net interest income for the three month period ended March 31, 2006 amounted to $17,853,000, an increase of $1,568,000, or 9.6% from the $16,285,000 recorded in the first quarter of 2005. Net interest income on a taxable equivalent basis for the three month period ended March 31, 2006 amounted to $17,979,000, an increase of $1,581,000, or 9.6% from the $16,398,000 recorded in the first quarter of 2005. Management believes that analysis of net interest income on a tax-equivalent basis is useful and appropriate because it allows a comparison of net interest income amounts in different periods without taking into account the different mix of taxable versus non-taxable investments that may have existed during those periods. There are two primary factors that cause changes in the amount of net interest income recorded by the Company - 1) growth in loans and deposits, and 2) the Company's net interest margin. For the three months ended March 31, 2006, the increase in net interest income was caused by growth in loans and deposits, as the Company's net interest margin of 4.33% in the first quarter of 2006 was unchanged from the first quarter of 2005. The following table presents net interest income analysis on a taxable-equivalent basis. Page 19
<TABLE> <CAPTION> For the Three Months Ended March 31, ----------------------------------------------------------------------------- 2006 2005 ------------------------------------- ------------------------------------- Interest Interest Average Average Earned Average Average Earned ($ in thousands) Volume Rate or Paid Volume Rate or Paid ---------- ---------- ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> <C> Assets Loans (1) $1,516,456 7.16% $ 26,762 $ 1,383,216 6.26% $ 21,359 Taxable securities 114,910 4.69% 1,329 103,248 4.54% 1,155 Non-taxable securities (2) 11,822 8.68% 253 11,340 8.65% 242 Short-term investments, principally federal funds 39,347 5.12% 497 39,361 2.80% 272 ---------- ---------- ---------- ---------- Total interest-earning assets 1,682,535 6.95% 28,841 1,537,165 6.08% 23,028 ---------- ---------- Liabilities Savings, NOW and money market deposits $ 467,760 1.16% $ 1,333 $ 474,683 0.75% $ 881 Time deposits >$100,000 365,465 4.08% 3,677 342,487 2.78% 2,345 Other time deposits 494,847 3.63% 4,432 424,878 2.36% 2,474 ---------- ---------- ---------- ---------- Total interest-bearing deposits 1,328,072 2.88% 9,442 1,242,048 1.86% 5,700 Securities sold under agreements to repurchase 30,314 3.51% 262 -- -- -- Borrowings 73,550 6.39% 1,158 76,683 4.92% 930 ---------- ---------- ---------- ---------- Total interest-bearing liabilities 1,431,936 3.08% 10,862 1,318,731 2.04% 6,630 ---------- ---------- Non-interest-bearing deposits 197,095 172,673 Net yield on interest-earning assets and net interest income 4.33% $ 17,979 4.33% $ 16,398 ========== ========== Interest rate spread 3.87% 4.04% Average prime rate 7.42% 5.44% - -------------------------------------------------------------------------------------------------------------------- </TABLE> (1) Average loans include nonaccruing loans, the effect of which is to lower the average rate shown. (2) Includes tax-equivalent adjustments of $126,000 and $113,000 in 2006 and 2005, respectively, to reflect the tax benefit that the Company receives related to its tax-exempt securities, which carry interest rates lower than similar taxable investments due to their tax exempt status. This amount has been computed assuming a 39% tax rate and is reduced by the related nondeductible portion of interest expense. Average loans outstanding for the first quarter of 2006 were $1.516 billion, which was 9.6% higher than the average loans outstanding for the first quarter of 2005 ($1.383 billion). The mix of the Company's loan portfolio remained substantially the same at March 31, 2006 compared to December 31, 2005, with approximately 86% of the Company's loans being real estate loans, 9% being commercial, financial, and agricultural loans, and the remaining 5% being consumer installment loans. The majority of the Company's real estate loans are primarily various personal and commercial loans where real estate provides additional security for the loan. Average deposits outstanding for the first quarter of 2006 were $1.525 billion, which was 7.8% higher than the average amount of deposits outstanding in the first quarter of 2005 ($1.415 billion). Generally, the Company can reinvest funds from deposits at higher yields than the interest rate being paid on those deposits, and therefore increases in deposits typically result in higher amounts of net interest income for the Company. See additional discussion regarding the nature of the growth in loans and deposits in the section entitled "Financial Condition" below. The effect of the higher amounts of average loans and deposits was to increase net interest income in 2006. As shown in the table above, yields on interest earning assets and liabilities both generally increased in 2006 compared to 2005 as a result of the rising rate environment that began in the third quarter of 2004. In 2005, the Federal Reserve increased interest rates eight times totaling 200 basis points, which followed five rate increases totaling 125 basis points that occurred in the second half of 2004. In the first quarter of 2006, the Federal Reserve increased interest rates two times by a total of 50 basis points. Page 20
See additional information regarding net interest income in the section entitled "Interest Rate Risk." The Company's provision for loan losses increased significantly in 2006 compared to 2005, amounting to $1,015,000 in the first quarter of 2006 versus $580,000 in the first quarter of 2005. The increase was primarily the result of the strong loan growth realized in 2006, as asset quality ratios remained stable. Loan growth was $71 million in the first quarter of 2006 compared to $28 million in the first quarter of 2005. The Company's ratio of annualized net charge-offs to average loans amounted to 3 basis points for the first quarter of 2006 compared to 7 basis points for the first quarter of 2005. The Company's ratio of nonperforming assets to total assets was 0.25% at March 31, 2006 compared to 0.40% at March 31, 2005. Noninterest income amounted to $3,954,000 for the first quarter of 2006, a 6.6% increase from the $3,710,000 recorded in the first quarter of 2005. The increase was primarily a result of general growth in the Company's customer base, increased usage of credit cards and debit cards by the Company's customers (which impacted the line item "other service charges, commissions and fees"), and increased commissions from financial product sales resulting from increased sales, as well as $55,000 more in "experience bonuses" recorded by the Company. Experience bonuses are received annually in the first quarter of each year from the insurance companies that the Company acts as an agent for and can fluctuate depending on the actual loss experience that the insurance companies experience related to the Company's customers. These increases were partially offset by a $111,000 decrease in data processing income in the first quarter of 2006 compared to 2005. The Company's data processing subsidiary makes its excess data processing capabilities available to area financial institutions for a fee. At January 1, 2005, the Company had five community bank customers using this service. Three of these customers terminated their contracts with the Company in the latter half of 2005, which resulted in the decrease in data processing fee income. The Company intends to continue to market this service to area banks, but does not currently have any near-term prospects for additional business. Noninterest expenses for the three months ended March 31, 2006 increased 8.7% to $12,729,000 from $11,715,000 in the first quarter of 2005. The increase in noninterest expenses occurred in all categories and is associated with the overall growth of the Company in terms of branch network, employees and customer base. In accordance with the new accounting requirements regarding stock-based compensation that were effective on January 1, 2006, the Company recorded $47,000 in expense related to stock options in the first quarter of 2006 - see Note 4 to the Consolidated Financial Statements above for additional discussion. The provision for income taxes was $3,072,000 in the first quarter of 2006, an effective tax rate of 38.1%, compared to $2,984,000 in the first quarter of 2005, an effective tax rate of 38.8%. The Company expects its effective tax rate to remain at approximately 38-39% for the foreseeable future. The Consolidated Statements of Comprehensive Income reflect "Other Comprehensive Loss" of $49,000 and $857,000 during the first quarters of 2006 and 2005, respectively, related primarily to unrealized available for sale security holding losses occurring during the quarter. The unrealized security holding losses were caused by an increase in market yields for fixed income securities during each quarter. The Company's available for sale securities portfolio is predominantly comprised of fixed income securities that decline in value when market yields for fixed income securities increase. Page 21
FINANCIAL CONDITION Total assets at March 31, 2006 amounted to $1.91 billion, 13.1% higher than a year earlier. Total loans at March 31, 2006 amounted to $1.55 billion, an 11.3% increase from a year earlier, and total deposits amounted to $1.57 billion at March 31, 2006, an 8.0% increase from a year earlier. The following tables present information regarding the nature of the Company's growth since March 31, 2005. <TABLE> <CAPTION> Balance at Change in Balance at Total Internal growth, April 1, 2005 to beginning of Internal brokered end of percentage excluding change in March 31, 2006 period Growth deposits period growth brokered deposits - ------------------------------- ------------- ------------- ------------- ------------- ------------- ----------------- <S> <C> <C> <C> <C> <C> <C> ($ in thousands) Loans $ 1,395,324 158,047 -- 1,553,371 11.3% 11.3% ============= ============= ============= ============= ============= ============= Deposits - Noninterest bearing $ 175,698 37,963 -- 213,661 21.6% 21.6% Deposits - Savings, NOW, and Money Market 477,838 (4,183) -- 473,655 -0.9% -0.9% Deposits - Time>$100,000 361,567 60,538 (49,873) 372,232 2.9% 16.7% Deposits - Time<$100,000 433,589 71,903 -- 505,492 16.6% 16.6% ------------- ------------- ------------- ------------- Total deposits $ 1,448,692 166,221 (49,873) 1,565,040 8.0% 11.5% ============= ============= ============= ============= ============= ============= January 1, 2006 to March 31, 2006 - ------------------------------ Loans $ 1,482,611 70,760 -- 1,553,371 4.8% 4.8% ============= ============= ============= ============= ============= ============= Deposits - Noninterest bearing $ 194,051 19,610 -- 213,661 10.1% 10.1% Deposits - Savings, NOW, and Money Market 458,221 15,434 -- 473,655 3.4% 3.4% Deposits - Time>$100,000 356,281 15,951 -- 372,232 4.5% 4.5% Deposits - Time<$100,000 486,024 19,468 -- 505,492 4.0% 4.0% ------------- ------------- ------------- ------------- Total deposits $ 1,494,577 70,463 -- 1,565,040 4.7% 4.7% ============= ============= ============= ============= ============= ============= </TABLE> In the second and third quarters of 2005, $50 million in brokered deposits that had been gathered in 2004 matured and were paid off, without renewing. The Company experienced strong loan and deposit growth during the first quarter of 2006, with loans increasing by $71 million, or 19.5% on an annualized basis, and deposits increasing by $70 million, or 19.1% on an annualized basis. The mix of the Company's loan portfolio remains substantially the same at March 31, 2006 compared to December 31, 2005, with approximately 86% of the Company's loans being real estate loans, 9% being commercial, financial, and agricultural loans, and the remaining 5% being consumer installment loans. The majority of the Company's real estate loans are primarily various personal and commercial loans where real estate provides additional security for the loan. Page 22
Nonperforming Assets Nonperforming assets are defined as nonaccrual loans, loans past due 90 or more days and still accruing interest, restructured loans and other real estate. Nonperforming assets are summarized as follows: <TABLE> <CAPTION> March 31, December 31, March 31, ($ in thousands) 2006 2005 2005 - ---------------------------------------- ------------ ------------ ------------ <S> <C> <C> <C> Nonperforming loans: Nonaccrual loans $ 3,283 1,640 4,249 Restructured loans 12 13 15 Accruing loans > 90 days past due -- -- -- ------------ ------------ ------------ Total nonperforming loans 3,295 1,653 4,264 Other real estate 1,451 1,421 2,401 ------------ ------------ ------------ Total nonperforming assets $ 4,746 3,074 6,665 ============ ============ ============ Nonperforming loans to total loans 0.21% 0.11% 0.31% Nonperforming assets as a percentage of loans and other real estate 0.31% 0.21% 0.48% Nonperforming assets to total assets 0.25% 0.17% 0.40% Allowance for loan losses to total loans 1.07% 1.06% 1.08% </TABLE> Management has reviewed the collateral for the nonperforming assets, including nonaccrual loans, and has included this review among the factors considered in the evaluation of the allowance for loan losses discussed below. Nonperforming loans (which includes nonaccrual loans and restructured loans) as of March 31, 2006, December 31, 2005, and March 31, 2005 totaled $3,295,000, $1,653,000, and $4,264,000, respectively. Nonperforming loans as a percentage of total loans amounted to 0.21%, 0.11%, and 0.31%, at March 31, 2006, December 31, 2005, and March 31, 2005, respectively. The variances in nonperforming loans among the periods has been primarily due to changes in nonaccrual loans, as restructured loans have not changed significantly. In the fourth quarter of 2005, the collection process for several of the Company's largest nonaccrual loan relationships reached a conclusion and their principal balances were reduced to zero either as a result of cash received or the recording of a charge-off. This resulted in the amount of the Company's nonperforming loans at December 31, 2005 reaching their lowest level in over five years. In the first quarter of 2006, the Company experienced more typical activity within its nonaccrual loan category, and the amount of nonaccrual loans rebounded upwards. Although nonperforming loans increased from December 31, 2005 to March 31, 2006, the 0.21% ratio of nonperforming loans to total loans at March 31, 2006 is lower than the 0.31% ratio at March 31, 2005 and compares favorably to industry averages. The largest nonaccrual relationship at March 31, 2006 amounted to $308,000. At March 31, 2006, December 31, 2005, and March 31, 2005, the recorded investments in loans considered to be impaired were $1,205,000, $338,000, and $2,138,000, respectively, all of which were on nonaccrual status. At March 31, 2006, December 31, 2005, and March 31, 2005, the related allowances for loan losses for all impaired loans were $298,000, $100,000, and $619,000, respectively. At March 31, 2006, December 31, 2005, and March 31, 2005, there was $124,000, $0, and $1,045,000 in impaired loans for which there was no related allowance. The average recorded investments in impaired loans during the three month period ended March 31, 2006, the year ended December 31, 2005, and the three months ended March 31, 2005 were approximately $772,000, $1,474,000, and $1,858,000, respectively. For the same periods, the Company recognized no interest income on those impaired loans during the period that they were considered to be impaired. The Company's other real estate owned amounted to $1,451,000, $1,421,000, and $2,401,000 at March 31, 2006, December 31, 2005 and March 31, 2005, respectively. The decrease in other real estate owned from March 31, 2005 relates primarily to a lake-front single family residence that the Company foreclosed on in the first quarter Page 23
of 2005 with a balance of $559,000. This property was subsequently sold in April 2005 at a loss of less than $20,000 to the Company. The Company's management has reviewed recent appraisals of its other real estate and believes that their fair values, less estimated costs to sell, equal or exceed their respective carrying values at the dates presented. Summary of Loan Loss Experience The allowance for loan losses is created by direct charges to operations. Losses on loans are charged against the allowance in the period in which such loans, in management's opinion, become uncollectible. The recoveries realized during the period are credited to this allowance. The Company has no foreign loans, few agricultural loans and does not engage in significant lease financing or highly leveraged transactions. Commercial loans are diversified among a variety of industries. The majority of the Company's real estate loans are primarily various personal and commercial loans where real estate provides additional security for the loan. Collateral for virtually all of these loans is located within the Company's principal market area. The Company's provision for loan losses increased significantly in 2006 compared to 2005, amounting to $1,015,000 in the first quarter of 2006 versus $580,000 in the first quarter of 2005. The increase was primarily the result of the strong loan growth realized in 2006, as asset quality ratios remained stable. Loan growth was $71 million in the first quarter of 2006 compared to $28 million in the first quarter of 2005. The Company's ratio of annualized net charge-offs to average loans amounted to 3 basis points for the first quarter of 2006 compared to 7 basis points for the first quarter of 2005. The Company's ratio of nonperforming assets to total assets was 0.25% at March 31, 2006 compared to 0.40% at March 31, 2005. At March 31, 2006, the allowance for loan losses amounted to $16,610,000, compared to $15,716,000 at December 31, 2005 and $15,066,000 at March 31, 2004. The allowance for loan losses as a percentage of total loans was 1.07% at March 31, 2006, 1.06% at December 31, 2005, and 1.08% at March 31, 2005. Management believes the Company's reserve levels are adequate to cover probable loan losses on the loans outstanding as of each reporting date. It must be emphasized, however, that the determination of the reserve using the Company's procedures and methods rests upon various judgments and assumptions about economic conditions and other factors affecting loans. No assurance can be given that the Company will not in any particular period sustain loan losses that are sizable in relation to the amounts reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses and value of other real estate. Such agencies may require the Company to recognize adjustments to the allowance or the carrying value of other real estate based on their judgments about information available at the time of their examinations. Page 24
For the periods indicated, the following table summarizes the Company's balances of loans outstanding, average loans outstanding, changes in the allowance for loan losses arising from charge-offs and recoveries, and additions to the allowance for loan losses that have been charged to expense and additions that were recorded related to acquisitions. <TABLE> <CAPTION> Three Months Twelve Months Three Months Ended Ended Ended March 31, December 31, March 31, ($ in thousands) 2006 2005 2005 ----------- ----------- ----------- <S> <C> <C> <C> Loans outstanding at end of period $ 1,553,371 1,482,611 1,395,324 =========== =========== =========== Average amount of loans outstanding $ 1,516,456 1,422,419 1,383,216 =========== =========== =========== Allowance for loan losses, a beginning of period $ 15,716 14,717 14,717 Total charge-offs (208) (2,363) (298) Total recoveries 87 322 67 ----------- ----------- ----------- Net charge-offs (121) (2,041) (231) ----------- ----------- ----------- Additions to the allowance charged to expense 1,015 3,040 580 ----------- ----------- ----------- Allowance for loan losses, at end of period $ 16,610 15,716 15,066 =========== =========== =========== Ratios: Net charge-offs (annualized) as a percent of average loans 0.03% 0.14% 0.07% Allowance for loan losses as a percent of loans at end of period 1.07% 1.06% 1.08% </TABLE> Based on the results of the Company's loan analysis and grading program and management's evaluation of the allowance for loan losses at March 31, 2006, there have been no material changes to the allocation of the allowance for loan losses among the various categories of loans since December 31, 2005. Liquidity, Commitments, and Contingencies The Company's liquidity is determined by its ability to convert assets to cash or acquire alternative sources of funds to meet the needs of its customers who are withdrawing or borrowing funds, and to maintain required reserve levels, pay expenses and operate the Company on an ongoing basis. The Company's primary liquidity sources are net income from operations, cash and due from banks, federal funds sold and other short-term investments. The Company's securities portfolio is comprised almost entirely of readily marketable securities, which could also be sold to provide cash. In addition to internally generated liquidity sources, the Company has the ability to obtain borrowings from the following three sources - 1) an approximately $380 million line of credit with the Federal Home Loan Bank (of which $90.5 million was outstanding at March 31, 2006), 2) a $50 million overnight federal funds line of credit with a correspondent bank (none of which was outstanding at March 31, 2006), and 3) an approximately $69 million line of credit through the Federal Reserve Bank of Richmond's discount window (none of which was outstanding at March 31, 2006). The Company's liquidity remained stable during the first quarter of 2006. The Company's loan to deposit ratio was 99.3% at March 31, 2006 compared to 99.2% at December 31, 2005. The level of the Company's liquid assets (consisting of cash, due from banks, federal funds sold, presold mortgages in process of settlement and securities) as a percentage of deposits and borrowings was 15.6% at March 31, 2006 compared to 14.4% at December 31, 2005. Page 25
The Company's management believes its liquidity sources, including unused lines of credit, are at an acceptable level and remain adequate to meet its operating needs in the foreseeable future. The Company will continue to monitor its liquidity position carefully and will explore and implement strategies to increase liquidity if deemed appropriate. The amount and timing of the Company's contractual obligations and commercial commitments has not changed materially since December 31, 2005, detail of which is presented in Table 18 on page 56 of the Company's 2005 Form 10-K. See Note 10 to the Consolidated Financial Statements above for information related to a tax contingency. The Company is not involved in any legal proceedings that, in management's opinion, could have a material effect on the consolidated financial position of the Company. Off-Balance Sheet Arrangements and Derivative Financial Instruments Off-balance sheet arrangements include transactions, agreements, or other contractual arrangements in which the Company has obligations or provides guarantees on behalf of an unconsolidated entity. The Company has no off-balance sheet arrangements of this kind other than repayment guarantees associated with trust preferred securities. Derivative financial instruments include futures, forwards, interest rate swaps, options contracts, and other financial instruments with similar characteristics. The Company has not engaged in derivative activities through March 31, 2006, and has no current plans to do so. Capital Resources The Company is regulated by the Board of Governors of the Federal Reserve Board (FED) and is subject to the securities registration and public reporting regulations of the Securities and Exchange Commission. The Company's banking subsidiary is regulated by the Federal Deposit Insurance Corporation (FDIC) and the North Carolina Office of the Commissioner of Banks. The Company is not aware of any recommendations of regulatory authorities or otherwise which, if they were to be implemented, would have a material effect on its liquidity, capital resources, or operations. The Company must comply with regulatory capital requirements established by the FED and FDIC. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. These capital standards require the Company to maintain minimum ratios of "Tier 1" capital to total risk-weighted assets and total capital to risk-weighted assets of 4.00% and 8.00%, respectively. Tier 1 capital is comprised of total shareholders' equity calculated in accordance with generally accepted accounting principles, excluding accumulated other comprehensive income (loss), less intangible assets, and total capital is comprised of Tier 1 capital plus certain adjustments, the largest of which for the Company is the allowance for loan losses. Risk-weighted assets refer to the on- and off-balance sheet exposures of the Company, adjusted for their related risk levels using formulas set forth in FED and FDIC regulations. In addition to the risk-based capital requirements described above, the Company is subject to a leverage capital requirement, which calls for a minimum ratio of Tier 1 capital (as defined above) to quarterly average total assets of 3.00% to 5.00%, depending upon the institution's composite ratings as determined by its regulators. The FED has not advised the Company of any requirement specifically applicable to it. Page 26
At March 31, 2006, the Company's capital ratios exceeded the regulatory minimum ratios discussed above. The following table presents the Company's capital ratios and the regulatory minimums discussed above for the periods indicated. <TABLE> <CAPTION> March 31, December 31, March 31, 2006 2005 2005 ----------- ----------- ---------- <S> <C> <C> <C> Risk-based capital ratios: Tier I capital to Tier I risk adjusted assets 10.16% 10.52% 10.88% Minimum required Tier I capital 4.00% 4.00% 4.00% Total risk-based capital to Tier II risk-adjusted assets 11.15% 11.51% 11.90% Minimum required total risk-based capital 8.00% 8.00% 8.00% Leverage capital ratios: Tier I leverage capital to adjusted most recent quarter average assets 8.59% 8.62% 8.85% Minimum required Tier I leverage capital 4.00% 4.00% 4.00% </TABLE> The Company's capital ratios have decreased since March 31, 2005 primarily as a result of the Company's strong balance sheet growth. In April 2006, the Company issued an additional $25 million in trust preferred securities, which increased the Tier I capital ratio by approximately 80 basis points, the total risk based capital ratio by approximately 165 basis points, and the Tier I leverage ratio by approximately 70 basis points. The Company's bank subsidiary is also subject to similar capital requirements as those discussed above. The bank subsidiary's capital ratios do not vary materially from the Company's capital ratios presented above. At March 31, 2006, the Company's bank subsidiary exceeded the minimum ratios established by the FED and FDIC. SHARE REPURCHASES During the first quarter of 2006, the Company did not repurchase any of its own common stock. At March 31, 2006, the Company had approximately 315,000 shares available for repurchase under existing authority from its board of directors. The Company may repurchase these shares in open market and privately negotiated transactions, as market conditions and the Company's liquidity warrant, subject to compliance with applicable regulations. See also Part II, Item 2 "Unregistered Sales of Equity Securities and Use of Proceeds." Page 27
Item 3 - Quantitative and Qualitative Disclosures About Market Risk INTEREST RATE RISK (INCLUDING QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK) Net interest income is the Company's most significant component of earnings. Notwithstanding changes in volumes of loans and deposits, the Company's level of net interest income is continually at risk due to the effect that changes in general market interest rate trends have on interest yields earned and paid with respect to the various categories of earning assets and interest-bearing liabilities. It is the Company's policy to maintain portfolios of earning assets and interest-bearing liabilities with maturities and repricing opportunities that will afford protection, to the extent practical, against wide interest rate fluctuations. The Company's exposure to interest rate risk is analyzed on a regular basis by management using standard GAP reports, maturity reports, and an asset/liability software model that simulates future levels of interest income and expense based on current interest rates, expected future interest rates, and various intervals of "shock" interest rates. Over the years, the Company has been able to maintain a fairly consistent yield on average earning assets (net interest margin). Over the past five calendar years the Company's net interest margin has ranged from a low of 4.23% (realized in 2001) to a high of 4.58% (realized in 2002). During that five year period, the prime rate of interest has ranged from a low of 4.00% to a high of 9.50%. Using stated maturities for all instruments except mortgage-backed securities (which are allocated in the periods of their expected payback) and securities and borrowings with call features that are expected to be called (which are included in the period of their expected call), at March 31, 2006 the Company had $324.2 million more in interest-bearing liabilities that are subject to interest rate changes within one year than earning assets. This generally would indicate that net interest income would experience downward pressure in a rising interest rate environment and would benefit from a declining interest rate environment. However, this method of analyzing interest sensitivity only measures the magnitude of the timing differences and does not address earnings, market value, or management actions. Also, interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. In addition to the effects of "when" various rate-sensitive products reprice, market rate changes may not result in uniform changes in rates among all products. For example, included in interest-bearing liabilities at March 31, 2006 subject to interest rate changes within one year are deposits totaling $473.7 million comprised of NOW, savings, and certain types of money market deposits with interest rates set by management. These types of deposits historically have not repriced coincidentally with or in the same proportion as general market indicators. Thus, the Company believes that in the near term (twelve months), net interest income would not likely experience significant downward pressure from rising interest rates. Similarly, management would not expect a significant increase in near term net interest income from falling interest rates (In fact, it has been the Company's experience that the interest rate cuts that occurred in 2001-2003 negatively impacted (at least temporarily) the Company's net interest margin and that interest rate increases occurring since July 1, 2004 have positively impacted (at least temporarily) the Company's net interest margin). Generally, when rates change, the Company's interest-sensitive assets that are subject to adjustment reprice immediately at the full amount of the change, while the Company's interest-sensitive liabilities that are subject to adjustment reprice at a lag to the rate change and typically not to the full extent of the rate change. The net effect is that in the twelve month horizon, as rates change, the impact of having a higher level of interest-sensitive liabilities is substantially negated by the later and typically lower proportionate change these liabilities experience compared to interest sensitive assets. However, the rate cuts totaling 75 basis points that occurred in late 2002 and mid-2003 had a more pronounced and a longer lasting negative impact on the Company's net interest margin than previous rate cuts because of the inability of the Company to reset deposit rates by an amount (because of their already near-zero rates) that would offset the negative impact of the rate cut on the yields earned on the Company's interest earning assets. Additionally, from 2001 - 2004, the Company originated significantly more adjustable rate loans compared to fixed rate loans in an effort to protect itself from an anticipated rise in the interest rate environment. Adjustable rate loans generally Page 28
carry lower initial interest rates than fixed rate loans. For these reasons, the second quarter of 2004 marked the fifth consecutive quarter of declining net interest margins. Since the second half of 2004, the Federal Reserve increased interest rates fifteen times totaling 375 basis points, which was largely responsible for the Company's net interest margin reversing its downward trend. Over the past six quarters, the Company's net interest margin has been within a fairly tight range - from a low of 4.31% to a high of 4.37%. The immediate positive impact of increases in interest rates has been largely offset by the mix of the Company's deposit growth being more concentrated in the categories of time deposits and time deposits greater than $100,000. These are the Company's highest cost categories of deposits and adjust upwards when rates change to a greater extent than the Company's other categories of deposits. The Company has no market risk sensitive instruments held for trading purposes, nor does it maintain any foreign currency positions. See additional discussion of the Company's net interest margin in the "Components of Earnings" section above. Item 4 - Controls and Procedures As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic reports with the Securities and Exchange Commission. In addition, no change in our internal control over financial reporting has occurred during, or subsequent to, the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. FORWARD-LOOKING STATEMENTS Part I of this report contains statements that could be deemed forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act, which statements are inherently subject to risks and uncertainties. Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualifying words (and their derivatives) such as "expect," "believe," "estimate," "plan," "project," or other statements concerning opinions or judgment of the Company and its management about future events. Factors that could influence the accuracy of such forward-looking statements include, but are not limited to, the financial success or changing strategies of the Company's customers, the Company's level of success in integrating acquisitions, actions of government regulators, the level of market interest rates, and general economic conditions. Page 29
Part II. Other Information Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds <TABLE> <CAPTION> Issuer Purchases of Equity Securities - ------------------------------------------------------------------------------------------------------------------------------- Total Number of Shares Maximum Number of Purchased as Part of Shares that May Yet Be Total Number of Average Price Paid per Publicly Announced Purchased Under the Period Shares Purchased Share Plans or Programs Plans or Programs (1) --------------------- ------------------------ ----------------------- ----------------------- <S> <C> <C> <C> <C> January 1, 2006 to January 31, 2006 -- -- -- 315,015 February 1, 2006 to February 28, 2006 -- -- -- 315,015 March 1, 2006 to March 31, 2006 -- -- -- 315,015 --------------------- ------------------------ ----------------------- ----------------------- Total -- -- -- 315,015 (2) ===================== ======================== ======================= ======================= </TABLE> Footnotes to the Above Table - ---------------------------- (1) All shares available for repurchase are pursuant to publicly announced share repurchase authorizations. On July 30, 2004, the Company announced that its Board of Directors had approved the repurchase of 375,000 shares of the Company's common stock. The repurchase authorization does not have an expiration date. There are no plans or programs the issuer has determined to terminate prior to expiration, or under which the issuer does not intend to make further purchases. (2) The above table above does not include shares that were used by option holders to satisfy the exercise price of the Company's call options issued by the Company to its employees and directors pursuant to the Company's stock option plans. There were three such exercises during the three months ended March 31, 2006. In January 2006, 439 shares of the Company's common stock, with a market price of $22.50 per share, were used to satisfy an exercise of options. In February 2006, 125 shares of the Company's common stock, with a market price of $21.30 per share, were used to satisfy an exercise of options. In March 2006, 1,086 shares of the Company's common stock, with a market price of $22.70 per share, were used to satisfy an exercise of options. Item 6 - Exhibits The following exhibits are filed with this report or, as noted, are incorporated by reference. Management contracts, compensatory plans and arrangements are marked with an asterisk (*). 3.a. Copy of Articles of Incorporation of the Company and amendments thereto were filed as Exhibits 3.a.i through 3.a.v to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2002, and are incorporated herein by reference. 3.b Copy of the Amended and Restated Bylaws of the Company was filed as Exhibit 3.b to the Company's Annual Report on Form 10-K for the year ended December 31, 2003, and is incorporated herein by reference. 4 Form of Common Stock Certificate was filed as Exhibit 4 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999, and is incorporated herein by reference. Page 30
10 Material Contracts 10.a Data Processing Agreement dated October 1, 1984 by and between Bank of Montgomery (First Bank) and Montgomery Data Services, Inc. was filed as Exhibit 10(k) to the Registrant's Registration Statement Number 33-12692, and is incorporated herein by reference. 10.b First Bancorp Annual Incentive Plan was filed as Exhibit 10(a) to the Form 8-K filed on January 26, 2005 and is incorporated herein by reference. (*) 10.c Indemnification Agreement between the Company and its Directors and Officers was filed as Exhibit 10(t) to the Registrant's Registration Statement Number 33-12692, and is incorporated herein by reference. 10.d First Bancorp Senior Management Supplemental Executive Retirement Plan was filed as Exhibit 10(d) to the Company's Annual Report on Form 10-K for the year ended December 31, 2001, and is incorporated herein by reference. (*) 10.e First Bancorp 1994 Stock Option Plan was filed as Exhibit 10(f) to the Company's Annual Report on Form 10-K for the year ended December 31, 2001, and is incorporated herein by reference. (*) 10.f First Bancorp 2004 Stock Option Plan was filed as Exhibit B to the Registrant's Form Def 14A filed on March 30, 2004 and is incorporated herein by reference. (*) 10.g Employment Agreement between the Company and James H. Garner dated August 17, 1998 was filed as Exhibit 10(l) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, and is incorporated by reference (Commission File Number 000-15572). (*) 10.h Employment Agreement between the Company and Anna G. Hollers dated August 17, 1998 was filed as Exhibit 10(m) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, and is incorporated by reference (Commission File Number 000-15572). (*) 10.i Employment Agreement between the Company and Teresa C. Nixon dated August 17, 1998 was filed as Exhibit 10(n) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, and is incorporated by reference (Commission File Number 000-15572). (*) 10.j Employment Agreement between the Company and Eric P. Credle dated August 17, 1998 was filed as Exhibit 10(p) to the Company's Annual Report on Form 10-K for the year ended December 31, 1998, and is incorporated herein by reference (Commission File Number 333-71431).(*) 10.k Employment Agreement between the Company and John F. Burns dated September 14, 2000 was filed as Exhibit 10.w to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000 and is incorporated herein by reference. (*) 10.l Employment Agreement between the Company and James G. Hudson, Jr. dated May 17, 2001 was filed as Exhibit 10(p) to the Company's Annual Report on Form 10-K for the year ended December 31, 2001, and is incorporated herein by reference. (*) 10.m Amendment to the employment agreement between the Company and James G. Hudson, Jr. dated April 26, 2005 was filed as Exhibit 10.a to the Form 8-K filed on April 29, 2005 and is incorporated herein by reference. (*) Page 31
10.n Employment Agreement between the Company and R. Walton Brown dated January 15, 2003 was filed as Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 and is incorporated herein by reference. (*) 10.o Amendment to the employment agreement between the Company and R. Walton Brown dated March 8, 2005 was filed as Exhibit 10.n to the Company's Annual Report on Form 10-K for the year ended December 31, 2004 and is incorporated herein by reference. (*) 10.p Employment Agreement between the Company and Jerry L. Ocheltree was filed as Exhibit 10.1 to the Form 8-K filed on January 25, 2006, and is incorporated herein by reference. (*) 10.q First Bancorp Long Term Care Insurance Plan was filed as Exhibit 10(o) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, and is incorporated by reference. (*) 10.r Description of Director Compensation pursuant to Item 601(b)(10)(iii)(A) of Regulation S-K. 10.s Advances and Security Agreement with the Federal Home Loan Bank of Atlanta dated February 15, 2005 was attached as Exhibit 99(a) to the Form 8-K filed on February 22, 2005, and is incorporated herein by reference 10.t The 2006 base salaries for certain of the Company's executive officers, and disclosure that the Compensation Committee had recommended to the Board of Directors the 2006 earnings target for the Company's Annual Incentive Plan, was disclosed in the Company's Form 8-K filed on January 25, 2006, and is incorporated herein by reference. (*) 21 List of Subsidiaries of Registrant was filed as Exhibit 21 to the Company's Annual Report on Form 10-K for the year ended December 31, 2003, and is incorporated herein by reference. 31.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. 31.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Copies of exhibits are available upon written request to: First Bancorp, Anna G. Hollers, Executive Vice President, P.O. Box 508, Troy, NC 27371 Page 32
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. FIRST BANCORP May 9, 2006 BY: James H. Garner --------------------------- James H. Garner President (Principal Executive Officer), Treasurer and Director May 9, 2006 BY: Anna G. Hollers --------------------------- Anna G. Hollers Executive Vice President, Secretary and Chief Operating Officer May 9, 2006 BY: Eric P. Credle --------------------------- Eric P. Credle Senior Vice President and Chief Financial Officer Page 33