CITIZENS HOLDING CO /MS/ - Quarter Report: 2003 June (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2003

OR

For the transition period from              to             

Commission file number: 000-25221

CITIZENS HOLDING COMPANY

(exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: 601-656-4692

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No

Indicate by check whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    x  Yes    ¨  No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of August 7, 2003.

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CITIZENS HOLDING COMPANY

SECOND QUARTER 2003 INTERIM FINANCIAL STATEMENTS

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PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

CITIZENS HOLDING COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CONDITION

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See notes to consolidated financial statements.

CITIZENS HOLDING COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

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See notes to consolidated financial statements.

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CITIZENS HOLDING COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

See notes to consolidated financial statements.

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CITIZENS HOLDING COMPANY AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

See notes to consolidated financial statements.

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CITIZENS HOLDING COMPANY AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

For the six months ended June 30, 2003

The interim consolidated financial statements of Citizens Holding Company include the accounts of its 97.52% owned subsidiary, The Citizens Bank of Philadelphia (collectively referred to as “the Corporation”). All significant intercompany transactions have been eliminated in consolidation.

Investment Securities—The Corporation classifies all of its securities as available-for-sale and carries them at fair value with unrealized gains or losses reported as a separate component of capital, net of any applicable income taxes. Realized gains or losses on the sale of securities available-for-sale, if any, are determined on an identification basis. The Corporation does not have any securities classified as held for trading or held to maturity.

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The follow is a summary of the assets and liabilities acquired:

The Corporation has completed its evaluation of the assets and liabilities acquired and has allocated $1,846,909 of the $4,414,509 total intangible asset to core deposit intangibles and the remaining $2,567,600 to goodwill. The core deposit intangible is to be amortized at the rate of $15,391 per month until fully amortized, representing an estimated economic life of 10 years. The amount of core deposit amortization expense related to the Louisville purchase was $92,346 year to date at June 30, 2003. The operations of CB&T Capital Corporation are included in the consolidated financial statements since the acquisition date.

Total amortization expense related to the core deposit intangible assets for the period ended June 30, 2003 and 2002 was $268,751 and $176,406, respectively.

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Diluted, has been computed based on the weighted average number of shares outstanding during each period plus the dilutive effect of outstanding granted options. Basic weighted average shares have been adjusted to reflect the five-for-one stock split on the common stock effective January 1, 1999 and the three-for-two stock split that was effective January 2, 2002. Earnings per share were computed as follows:

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net income and earnings per share if the Corporation had applied the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 , “Accounting for Stock-Based Compensation,” for the three and six months ended June 30, 2003 and 2002.

In October 2002, the FASB issued Standard No. 147 related to Acquisitions of Certain Financial Institutions. The standard clarifies the requirements of Standards No. 141 and 142 as they relate to business combinations between financial institutions and makes the provisions of Standard No. 144 applicable to long-term customer relationship intangible assets. The standard is effective for transactions on or after October 1, 2002. Adopting the standard by the Corporation did not have a material effect on the Corporation’s financial statements.

In November 2002, FASB Interpretation (“FIN”) No. 45, “Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” was issued. FIN No. 45 elaborates on the disclosures to

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be made by a guarantor in its interim and annual financial statements regarding its obligations under certain guarantees that it has issued. FIN No. 45 also clarifies the requirement of the guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The initial recognition and initial measurement provisions of this interpretation were adopted by the Corporation effective January 1, 2003. The adoption of FIN No. 45 did not have any material impact on the financial statements of the Corporation.

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CITIZENS HOLDING COMPANY AND SUBSIDIARY

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis is written to provide greater insight into the results of operations and the financial condition of Citizens Holding Company and its 97.52% owned subsidiary, The Citizens Bank of Philadelphia (collectively, the “Corporation”).

LIQUIDITY

The Corporation has an asset and liability management program that assists management in maintaining net interest margins during times of both rising and falling interest rates and in maintaining sufficient liquidity. Liquidity of the Corporation at June 30, 2003 was 67.18%, at December 31, 2002 was 75.24% and at June 30, 2002 was 48.10%. Liquidity is the ratio of net deposits and short-term liabilities divided by net cash, short-term investments and marketable assets. Management believes it maintains adequate liquidity for the Corporation’s current needs.

When the Corporation has more funds than it needs for its reserve requirements or short-term liquidity needs, the Corporation increases its security investments or sells federal funds. It is management’s policy to maintain an adequate portion of its portfolio of assets and liabilities on a short-term basis to insure rate flexibility and to meet loan funding and liquidity needs. The Corporation has secured and unsecured federal funds lines with correspondent banks in the amount of $38,500,000. In addition, the Corporation has the ability to draw on its line of credit with the Federal Home Loan Bank in excess of $140,424,653 at June 30, 2003. At June 30, 2003, the Corporation had unused and available $33,600,000 of its federal funds line of credit and $106,297,188 of its line of credit with the Federal Home Loan Bank.

CAPITAL RESOURCES

The Corporation’s equity capital was $55,673,038 at June 30, 2003. The main source of capital for the Corporation has been the retention of net income.

On January 2, 2002, the Corporation issued a three-for-two (3:2) split to the shareholders of the Corporation. This split increased the number of outstanding shares to 4,963,028 and increased the authorized shares from 15,000,000 to 22,500,000. In December 2002, certain employees exercised stock options for 11,550 shares that brought the number of outstanding shares to 4,974,578. Cash dividends in the amount of $1,392,882 or $0.28 per share were paid during the period January 1, 2003 to June 30, 2003.

Quantitative measures established by regulation to ensure capital adequacy require the Corporation to maintain minimum amounts and ratios of Total and Tier 1 capital

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(primarily common stock and retained earnings, less goodwill) to risk weighted assets, and of Tier 1 capital to average assets. Management believes that as of June 30, 2003, the Corporation meets all capital adequacy requirements to which it is subject.

RESULTS OF OPERATIONS

The following table sets forth for the periods indicated, certain items in the consolidated statements of income of the Corporation and the related changes between those periods:

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Net Income Per Share—Basic is calculated using weighted average number of shares outstanding for the period. Net Income Per Share—Diluted is calculated using the weighted average number of shares outstanding for the period, plus the net dilutive effect of granted stock options determined using the treasury stock method.

Annualized return on average equity (ROE) was 12.67% and 11.86% for the three and six months ended June 30, 2003, and 13.63% and 13.21% for the three and six months ended June 30, 2002.

The book value per share increased to $11.19 at June 30, 2003 compared to $10.81 at December 31, 2002. This increase is due to earnings exceeding dividends paid during this period. Average assets for the six months ended June 30, 2003, were $537,938,397 compared to $491,832,644 for the year ended December 31, 2002, and average equity increased to $55,522,584 for the six months ended June 30, 2003, from $51,303,506 for the year ended December 31, 2002. The increase in average assets is due to the expansion of the Corporation’s business as a result of the acquisition of Citizens Bank & Trust Company in May 2002.

NET INTEREST INCOME/NET INTEREST MARGIN

One component of the Corporation’s earnings is net interest income, which is the difference between the interest and fees earned on loans and investments and the interest paid for deposits and borrowed funds. The net interest margin is net interest income expressed as a percentage of average earning assets.

The annualized net interest margin was 4.43% and 4.46% for the three and six months ended June 30, 2003, compared to an annualized net interest margin of 4.79% and 4.71% for the three and six months ended June 30, 2002. This slight decline in net interest margin can be attributed to continued declines in market interest rates and the ongoing re-pricing of investments, loans and deposits. Earning assets averaged $490,570,885 for the six months ended June 30, 2003. This represented an increase of $62,271,588, or 14.7%, over average earning assets of $425,058,413 for the six months ended June 30, 2002. The increase in average earning assets results from the May 2002 CB&T Capital Corporation acquisition and normal bank growth.

Net interest income was $5,330,519 and $10,495,694 for the three and six month periods in 2003, an increase of $136,155 and $736,456 respectively over the same periods in 2002. An increase in loan volume and investments in the first half of 2003 contributed to this increase. A lower cost of deposits and other borrowed funds during 2003 over the

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same period in 2002 also contributed to the increase in Net Interest Income. Income from investment securities increased in the first half of 2003 as a result of both an increase in the principal balance of investment securities and a shift in the mix of investments from lower yielding U. S. Treasury Securities into higher yield mortgage backed products.

Other interest income decreased in the three and six month periods ended June 30, 2003 compared to the same period in 2002 due to a decrease in the interest rates on Federal Funds Sold.

The following table shows the interest and fees and corresponding yields for loans only.

The decrease in rates in the three and six month periods ended June 30, 2003 reflects the decrease in all loan rates for both new and refinanced loans in the period.

CREDIT LOSS EXPERIENCE

As a natural corollary to the Corporation’s lending activities, some loan losses are to be expected. The risk of loss varies with the type of loan being made and the creditworthiness of the borrower over the term of the loan. The degree of perceived risk is taken into account in establishing the structure of, and interest rates and security for, specific loans and for various types of loans. The Corporation attempts to minimize its credit risk exposure by use of thorough loan application and approval procedures.

The Corporation maintains a program of systematic review of its existing loans. Loans are graded for their overall quality. Those loans which the Corporation’s management determines require further monitoring and supervision are segregated and reviewed on a periodic basis. Significant problem loans are reviewed on a monthly basis by the Corporation’s Board of Directors.

The Corporation charges off that portion of any loan which management considers to represent a loss. A loan is generally considered by management to represent a loss in whole or in part when an exposure beyond the collateral value is apparent, servicing of the unsecured portion has been discontinued or collection is not anticipated based on the borrower’s financial condition and general economic conditions in the borrower’s industry. The principal amount of any loan which is declared a loss is charged against the Corporation’s allowance for loan losses.

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The Corporation’s allowance for loan losses is designed to provide for loan losses which can be reasonably anticipated. The allowance for loan losses is established through charges to operating expenses in the form of provisions for loan losses. Actual loan losses or recoveries are charged or credited to the allowance for loan losses. The amount of the allowance is determined by management of the Corporation. Among the factors considered in determining the allowance for loan losses are the current financial condition of the Corporation’s borrowers and the value of security, if any, for their loans. Estimates of future economic conditions and their impact on various industries and individual borrowers are also taken into consideration, as are the Corporation’s historical loan loss experience and reports of banking regulatory authorities. Because these estimates, factors and evaluations are primarily judgmental, no assurance can be given as to whether or not the Corporation will sustain loan losses in excess or below its allowance or that subsequent evaluation of the loan portfolio may not require material increases or decreases in such allowance.

The following table summarizes the Corporation’s allowance for loan losses for the dates indicated:

The provision for loan losses for the three months ended June 30, 2003 was $375,000, a decrease of $60,318 or 13.9% when compared to the $435,318 for the same period in 2002. The provision for the six months ended June 30, 2003 was $750,000, an increase of $80,186 or 12.0% over the $669,814 for the six months ended June 30, 2002. The increase in the provision for the six months ended June 30, 2003 was made to bring the allowance back to the desired level after the net charge-offs for these periods and to cover the volume increases in the loan portfolio. The allowance for loan losses was increased $847,341 as a result of the acquisition of Citizens Bank & Trust Company in the second quarter of 2002. This addition to the allowance for loan losses was made to reflect estimated loan losses as of the acquisition date.

For the three months ended June 30, 2003, net loan losses charged to allowance for loan losses totaled $258,384, a decrease of $176,954 over the same period in 2002. For the six

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months ended June 30, 2003, net loan losses charged to the allowance for loan losses totaled $454,010, a decrease of $215,804 over the same period in 2002.

Management of the Corporation reviews with the Board of Directors the adequacy of the allowance for possible loan losses on a quarterly basis. The loan loss provision is adjusted when specific items reflect a need for such an adjustment. Management believes that there were no material loan losses during the last three months that have not been charged off. Management also believes that the Corporation’s allowance will be adequate to absorb probable losses inherent in the Corporation’s loan portfolio. However, in light of overall economic conditions in the Corporation’s geographic area and the nation as a whole, it is possible that additional provisions for loan loss may be required.

OTHER INCOME

Other operating income includes service charges on deposit accounts, wire transfer fees, safe deposit box rentals and other revenue not derived from interest on earning assets.

Other operating income for the three months ended June 30, 2003 increased $309,997 or 29.7% over the same period in 2002 and for the six months ended June 30, 2003, increased $408,814 or 19.9% over the same period in 2002. The increase in both periods was the result of increased overdraft, returned check income and other service charges and mortgage loan origination income. Net gains on the sale of securities during the three and six months ended June 30, 2003 totaled $200,149 compared to $22,780 during the three and six month periods ended June 30, 2002. These securities were sold as a strategy to increase the yields on the security portfolio.

OTHER EXPENSE

Other expenses include salaries and employee benefits, occupancy and equipment, and other operating expenses. Other expenses for the three and six months ended June 30, 2003 were $3,682,494 and $7,385,313 compared to the $3,364,960 and $6,407,194 for the three and six months ended June 30, 2002 for an increase of $317,534 and $978,119 respectively. Salaries and benefits increased to $1,959,324 and $3,891,152 for the three and six month periods in 2003 from $1,803,864 and $3,476,897 for the same periods in 2002, an increase of $155,460 or 8.6% and $414,255 or 11.9% respectively. Both the increase in Other Expenses as a whole, and salaries and benefits specifically, are the result of the growth of the Corporation, both from the acquisition of Citizens Bank & Trust Company in May 2002 and internal growth of the deposit base. The Corporation’s efficiency ratio for the three and six month periods ended June 30, 2003 was 53.69% and 55.57% compared to 52.86% and 53.18% for the same periods in 2002.

BALANCE SHEET ANALYSIS

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CASH AND CASH EQUIVALENTS

Cash and cash equivalents are made up of cash, balances at correspondent banks and items in process of collection. The balance as of June 30, 2003 decreased $3,003,220 or 14.2% from December 31, 2002. Improved collection of outgoing cash letters caused the due from bank balances to be lower this quarter.

INVESTMENT SECURITIES

The investment securities are made up of U. S. Treasury Notes, U. S. Agency debentures, mortgage-backed securities, obligations of states, counties and municipal governments and Federal Home Loan Bank Stock. Investments increased $14,688,975 or 9.1% as of June 30, 2003 compared to December 31, 2002.

LOANS

Loan demand in the Corporation’s service area began to strengthen as net loans increased by $29,393,721 or 9.7% during the six month period ended June 30, 2003. Residential housing loans continue to be in demand along with commercial and industrial loans. No special loan programs were initiated during this period.

DEPOSITS

The following shows the balance and percentage change in the various deposits:

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The increase is the result of normal deposit growth. Normal deposit growth was influenced by the decline in the stock market and the need for more conservative investments by our depositors. The Corporation does not have any brokered deposits. There were no special deposit programs or incentives in place during this period.

FORWARD LOOKING STATEMENTS

In addition to historical information, this report contains statements which constitute forward-looking statements and information within the meaning of the Private Securities Litigation Reform Act of 1995 which are based on management’s beliefs, plans, expectations, assumptions and on information currently available to management. The words “may,” “should,” “expect,” “anticipate,” “intend,” “plan,” “continue,” “believe,” “seek,” “estimate,” and similar expressions used in this report that do not relate to historical facts are intended to identify forward-looking statements. These statements appear in a number of places in this report, including, but not limited to, statements found in Item 1 “Notes to Consolidated Financial Statements” and in Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The Corporation notes that a variety of factors could cause the actual results or experience to differ materially from the anticipated results or other expectations described or implied by such forward-looking statements. The risks and uncertainties that may affect the operation, performance, development and results of the Corporation’s business include, but are not limited to, the following: (a) the risk of adverse changes in business conditions in the banking industry generally and in the specific markets in which the Corporation operates; (b) changes in the legislative and regulatory environment that negatively impact the Corporation through increased operating expenses; (c) increased competition from other financial institutions; (d) the impact of technological advances; (e) expectations about the movement of interest rates, including actions that may be taken by the Federal Reserve Board in response to changing economic conditions; (f) changes in asset quality and loan demand; (g) expectations about overall economic strength and the performance of the economics in the Corporation’s market area and (h) other risks detailed from time to time in the Corporation’s filings with the Securities and Exchange Commission. The Corporation does not undertake any obligation to update or revise any forward-looking statements subsequent to the date on which they are made.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES

ABOUT MARKET RISK

Overview

The definition of market risk is the possibility of loss that could result from adverse changes in market prices and rates. The Corporation has taken steps to assess the amount of risk that is associated with its asset and liability structure. The Corporation measures the potential risk on a regular basis and makes changes to its strategies to manage these risks. The Corporation does not participate in some of the financial instruments that are inherently subject to substantial market risk.

Market/Interest Rate Risk Management

The primary purpose in managing interest rate risk is to effectively invest capital and preserve the value created by the core banking business. The Corporation utilizes an investment portfolio to manage the interest rate risk naturally created through its business activities. The quarterly interest rate risk report is used to evaluate exposure to interest rate risk, project earnings and manage the composition of the balance sheet and its growth.

Static gap analysis is also used in measuring interest rate risk. An analysis of the Corporation’s repricing opportunities indicates a negative gap position over the next three- and twelve–month periods, which indicates that the Corporation would benefit somewhat from a decrease in market interest rates. Interest rates remained stable during the quarter ended June 30, 2003. The Corporation’s interest bearing deposit liabilities have been substantially repriced to reflect the current interest rate environment.

There has been no material change in the Corporation’s disclosure of quantitative and qualitative disclosures about market risk as of June 30, 2003 from that presented in the Corporation’s annual report on Form 10-K for the fiscal year ended December 31, 2002. For additional information concerning the Corporation’s quantitative and qualitative disclosures about market risk, see our annual report on Form 10-K for the fiscal year ended December 31, 2002.

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ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this quarterly report on Form 10-Q, the Corporation carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our principal executive officer and principal 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 SEC reports. There has been no change in the Corporation’s internal control over financial reporting during the fiscal quarter covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

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PART II.—OTHER INFORMATION

The Corporation held its Annual Meeting of Shareholders on April 22, 2003 at 3:30 p.m. at the Main Office of The Citizens Bank of Philadelphia, 521 Main Street, Philadelphia, Mississippi. At this meeting there were 4,053,654 shares or 81.5% of the Corporation’s issued and outstanding shares of common stock represented either in person or by proxy at the Annual Meeting.

The shareholders considered and voted upon a proposal to set the number of directors to serve on the Board of Directors at twelve members. The shareholders of the Corporation adopted this proposal by a vote of 4,030,630 for the proposal, 6,679 shares against the proposal with 16,345 abstentions or broker non-votes.

An election was held to elect four Class I directors to a three-year term expiring in 2006. The votes for each nominee were:

The shareholders considered and voted upon a proposal to ratify the Horne CPA Group as the Corporation’s independent auditors for the fiscal year ending December 31, 2003. The shareholders of the Corporation adopted this proposal by a vote of 4,048,795 affirmative votes to 4,859 votes against with no abstentions or broker non-votes.

(a) Exhibits

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The following report on form 8-K was filed by the Corporation during the quarterly period covered by this Form 10-Q:

On April 24, 2003, the Corporation furnished on Form 8-K under Item 7(a), Item 9 and Item 12 a press release announcing the financial results of the Corporation for the quarter ended March 31, 2003.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.