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MIDDLEFIELD BANC CORP - Quarter Report: 2004 September (Form 10-Q)

Middlefield Banc Corp. 10-Q
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20552

FORM 10 - Q

     
[X]
  QUARTERLY REPORT UNDER SECTION 13 OF 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

     
[   ]
  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT

For the transition period from          to

Commission File Number 000-32561


Middlefield Banc Corp.

(Exact name of registrant as specified in its charter)
     
Ohio
(State or other jurisdiction of incorporation
or organization)
  34 - 1585111
(IRS Employer Identification No.)

15985 East High Street, Middlefield, Ohio 44062-0035
(Address of principal executive offices)

(440) 632-1666
(Registrant’s telephone number, including area code)

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  [X]  No  [   ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12-b2 of the Act).  Yes  [   ]  No  [X]

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

Class: Common Stock, without par value
Outstanding at November 5, 2004: 1,289,682

 


MIDDLEFIELD BANC CORP.

INDEX

         
    Page
    Number

PART I - FINANCIAL INFORMATION
       
Item 1. Financial Statements
       
    3  
    4  
    5  
    6  
    7  
    11  
    18  
    19  
       
    20  
    20  
    20  
    20  
    21  
    21  
       
CERTIFICATIONS
       
 EX-31.1 Certification Purusant to Section 302 of the Securities Exchange Act of 1034 - Thomas G. Caldwell
 EX-31.2 Certification Purusant to Section 302 of the Securities Exchange Act of 1034 - Donald L. Stacy
 EX-32 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 EX-99.2 Independent Accountants Report

 


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MIDDLEFIELD BANC CORP.

CONSOLIDATED BALANCE SHEET
(Unaudited)
                 
    September 30   December 31
    2004
  2003
ASSETS
               
Cash and due from banks
  $ 7,324,873     $ 3,956,453  
Federal funds sold
    3,420,000       930,000  
 
   
 
     
 
 
Cash and cash equivalents
    10,744,873       4,886,453  
Interest-bearing deposits in other institutions
    612,575       539,147  
Investment securities available for sale
    55,676,770       49,966,511  
Investment securities held to maturity (estimated market value of $589,666 and $1,915,366)
    562,011       1,858,904  
Loans
    209,257,288       192,880,153  
Less allowance for loan losses
    2,626,548       2,521,270  
 
   
 
     
 
 
Net loans
    206,630,740       190,358,883  
Premises and equipment
    6,668,043       6,807,930  
Bank-owned life insurance
    5,370,355       5,202,385  
Accrued interest and other assets
    2,948,771       2,749,235  
 
   
 
     
 
 
TOTAL ASSETS
  $ 289,214,138     $ 262,369,448  
 
   
 
     
 
 
LIABILITIES
               
Deposits:
               
Noninterest-bearing demand
  $ 35,110,530     $ 29,423,027  
Interest-bearing demand
    8,877,466       7,369,754  
Money market
    14,717,901       15,708,932  
Savings
    75,110,539       69,570,895  
Time
    104,922,655       97,767,302  
 
   
 
     
 
 
Total deposits
    238,739,091       219,839,910  
Short-term borrowings
    102,881       444,819  
Other borrowings
    23,957,754       17,665,661  
Accrued interest and other liabilities
    905,016       914,744  
 
   
 
     
 
 
TOTAL LIABILITIES
    263,704,742       238,865,134  
 
   
 
     
 
 
STOCKHOLDERS’ EQUITY
               
Common stock, no par value; 5,000,000 shares authorized, 1,289,602 and 1,268,954 shares issued
    10,385,960       10,038,156  
Retained earnings
    16,715,668       15,085,868  
Accumulated other comprehensive income
    152,677       125,199  
Treasury stock, at cost (55,309 shares)
    (1,744,909 )     (1,744,909 )
 
   
 
     
 
 
TOTAL STOCKHOLDERS’ EQUITY
    25,509,396       23,504,314  
 
   
 
     
 
 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 289,214,138     $ 262,369,448  
 
   
 
     
 
 

See accompanying notes to unaudited consolidated financial statements.

 


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MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
                                 
    Three Months Ended   Nine Months Ended
    September 30,   September
    2004
  2003
  2004
  2003
INTEREST INCOME
                               
Interest and fees on loans
  $ 3,432,153     $ 3,270,175     $ 10,115,762     $ 9,609,355  
Interest-bearing deposits in other institutions
    1,538       3,850       3,539       15,670  
Federal funds sold
    10,884       20,836       28,046       40,049  
Investment securities:
                               
Taxable interest
    354,392       270,921       1,050,915       855,382  
Tax-exempt interest
    166,645       121,503       429,556       354,595  
Dividends on FHLB stock
    12,964       12,988       38,883       38,843  
 
   
 
     
 
     
 
     
 
 
Total interest income
    3,978,576       3,700,273       11,666,701       10,913,894  
 
   
 
     
 
     
 
     
 
 
INTEREST EXPENSE
                               
Deposits
    1,246,617       1,227,318       3,642,941       3,709,505  
Short-term borrowings
    304       365       1,143       3,704  
Other borrowings
    209,550       202,388       607,419       618,575  
 
   
 
     
 
     
 
     
 
 
Total interest expense
    1,456,471       1,430,071       4,251,503       4,331,784  
 
   
 
     
 
     
 
     
 
 
NET INTEREST INCOME
    2,522,105       2,270,202       7,415,198       6,582,110  
Provision for loan losses
    51,000       105,000       111,000       315,000  
 
   
 
     
 
     
 
     
 
 
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
    2,471,105       2,165,202       7,304,198       6,267,110  
 
   
 
     
 
     
 
     
 
 
NONINTEREST INCOME
                               
Service charges on deposit accounts
    371,495       269,757       1,034,095       760,318  
Investment securities gains, net
                      542  
Earnings on bank-owned life insurance
    53,114       67,019       167,970       135,305  
Other income
    59,635       38,588       164,787       113,879  
 
   
 
     
 
     
 
     
 
 
Total noninterest income
    484,244       375,364       1,366,852       1,010,044  
 
   
 
     
 
     
 
     
 
 
NONINTEREST EXPENSE
                               
Salaries and employee benefits
    941,353       829,874       2,652,971       2,287,264  
Occupancy expense
    114,691       105,248       378,011       310,292  
Equipment expense
    94,948       89,649       288,208       227,261  
Data processing costs
    125,077       93,601       339,038       281,031  
Ohio state franchise tax
    82,500       75,000       247,500       225,050  
Other expense
    444,989       399,007       1,361,755       1,185,447  
 
   
 
     
 
     
 
     
 
 
Total noninterest expense
    1,803,558       1,592,379       5,267,483       4,516,345  
 
   
 
     
 
     
 
     
 
 
Income before income taxes
    1,151,791       948,187       3,403,567       2,760,809  
Income taxes
    330,000       246,000       988,000       790,928  
 
   
 
     
 
     
 
     
 
 
NET INCOME
  $ 821,791     $ 702,187     $ 2,415,567     $ 1,969,881  
 
   
 
     
 
     
 
     
 
 
EARNINGS PER SHARE
                               
Basic
  $ 0.67     $ 0.58     $ 1.97     $ 1.62  
Diluted
    0.66       0.57       1.95       1.61  
DIVIDENDS DECLARED PER SHARE
    0.22       0.20       0.64       0.58  

See accompanying notes to unaudited consolidated financial statements.

 


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MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited)
                                                 
                    Accumulated                
                    Other           Total    
    Common   Retained   Comprehensive   Treasury   Stockholders’   Comprehensive
    Stock
  Earnings
  Income
  Stock
  Equity
  Income
Balance, December 31, 2003
  $ 10,038,156     $ 15,085,868     $ 125,199     $ (1,744,909 )   $ 23,504,314          
Net income
            2,415,567                       2,415,567     $ 2,415,567  
Other comprehensive income:
                                               
Unrealized gain on available for sale securities net of taxes of $14,155
                    27,478               27,478       27,478  
 
                                           
 
 
Comprehensive income
                                          $ 2,443,045  
 
                                           
 
 
Exercise of stock options
    14,198                               14,198          
Common stock issued
    177,341                               177,341          
Dividend reinvestment plan
    156,265                               156,265          
Cash dividends ($.64 per share)
            (785,767 )                     (785,767 )        
 
   
 
     
 
     
 
     
 
     
 
         
Balance, September 30, 2004
  $ 10,385,960     $ 16,715,668     $ 152,677     $ (1,744,909 )   $ 25,509,396          
 
   
 
     
 
     
 
     
 
     
 
         

See accompanying notes to unaudited consolidated financial statements.

 


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MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
                 
    Nine Months Ended
    September 30,
    2004
  2003
OPERATING ACTIVITIES
               
Net income
  $ 2,415,567     $ 1,969,881  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
    111,000       315,000  
Depreciation and amortization
    311,026       266,126  
Amortization of premium and discount on investment securities
    187,430       202,506  
Amortization of net deferred loan fees
    (105,386 )     (88,621 )
Investment security gains, net
          (542 )
Earnings on bank-owned life insurance
    (167,970 )     (135,305 )
Decrease (increase) in accrued interest receivable
    (331,811 )     (86,003 )
Decrease in accrued interest payable
    97,307       (50,794 )
Other, net
    50,185       (19,378 )
 
   
 
     
 
 
Net cash provided by operating activities
    2,567,348       2,372,870  
 
   
 
     
 
 
INVESTING ACTIVITIES
               
Increase in interest-bearing deposits in other institutions, net
    (73,428 )     34,351  
Investment securities available for sale:
               
Proceeds from repayments and maturities
    9,416,139       11,966,385  
Proceeds from the sale of securities
          1,991,917  
Purchases
    (15,274,302 )     (28,446,539 )
Investment securities held to maturity:
               
Proceeds from repayments and maturities
    1,299,000       3,465,000  
Increase in loans, net
    (16,277,471 )     (13,925,825 )
Purchase of Federal Home Loan Bank Stock
    (39,100 )     (39,100 )
Purchase of bank-owned life insurance
    (167,970 )     (5,135,305 )
Purchase of premises and equipment
    (171,139 )     (698,853 )
 
   
 
     
 
 
Net cash used for investing activities
    (21,288,271 )     (30,787,969 )
 
   
 
     
 
 
FINANCING ACTIVITIES
               
Net increase in deposits
    18,899,181       31,685,715  
Decrease in short-term borrowings, net
    (341,938 )     (366,361 )
Repayment of other borrowings
    (4,707,907 )     (2,847,034 )
Proceeds from other borrowings
    11,000,000       5,000,000  
Purchase of treasury stock
          (81,624 )
Exercise of stock options
    14,198       9,350  
Common stock issued
    177,341       119,598  
Proceeds from dividend reinvestment
    156,266       122,660  
Cash dividends
    (785,767 )     (705,588 )
 
   
 
     
 
 
Net cash provided by financing activities
    24,411,373       32,936,716  
 
   
 
     
 
 
Increase in cash and cash equivalents
    5,690,451       4,521,617  
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    4,886,453       2,125,324  
 
   
 
     
 
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
  $ 10,576,904     $ 6,646,941  
 
   
 
     
 
 
SUPPLEMENTAL INFORMATION
               
Cash paid during the year for:
               
Interest on deposits and borrowings
  $ 4,348,810     $ 4,382,578  
Income taxes
    930,000       845,000  

 


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MIDDLEFIELD BANC CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 — BASIS OF PRESENTATION

The consolidated financial statements of Middlefield Banc Corp. (“Middlefield”) includes its wholly owned subsidiary, The Middlefield Banking Company (the “Bank”). All significant inter-company items have been eliminated.

The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions for Form 10-Q and Article 10 of Regulation S-X. In Management’s opinion, the financial statements include all adjustments, consisting of normal recurring adjustments, that Middlefield considers necessary to fairly state Middlefield’s financial position and the results of operations and cash flows. The balance sheet at December 31, 2003, has been derived from the audited financial statements at that date but does not include all of the necessary informational disclosures and footnotes as required by accounting principles generally accepted in the United States of America. The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included with Middlefield’s Form 10-K (File No. 33-23094). The results of Middlefield’s operations for any interim period are not necessarily indicative of the results of Middlefield’s operations for any other interim period or for a full fiscal year.

NOTE 2 — EARNINGS PER SHARE

Middlefield provides dual presentation of Basic and Diluted earnings per share. Basic earnings per share utilizes net income as reported as the numerator and the actual average shares outstanding as the denominator. Diluted earnings per share includes any dilutive effects of options, warrants, and convertible securities.

There are no convertible securities that would affect the numerator in calculating basic and diluted earnings per share; therefore, net income as presented on the Consolidated Statement of Income (Unaudited) will be used as the numerator. The following tables set forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation.

                                 
    For the Three   For the Nine
    Months Ended   Months Ended
    September 30,   September 30,
    2004
  2003
  2004
  2003
Weighted average common shares outstanding
    1,287,356       1,274,994       1,283,601       1,272,388  
Average treasury stock shares
    (55,309 )     (55,309 )     (55,309 )     (54,673 )
 
   
 
     
 
     
 
     
 
 

 


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    For the Three   For the Nine
    Months Ended   Months Ended
    September 30,   September 30,
    2004
  2003
  2004
  2003
Weighted average common shares and common stock equivalents used to calculate basic earnings per share
    1,232,047       1,219,685       1,228,292       1,217,715  
 
   
 
     
 
     
 
     
 
 
Additional common stock equivalents (stock options) used to calculate diluted earnings per share
    7,790       3,565       7,303       3,071  
 
   
 
     
 
     
 
     
 
 
Weighted average common shares and common stock equivalents used to calculate diluted earnings per share
    1,239,837       1,223,250       1,235,595       1,220,786  
 
   
 
     
 
     
 
     
 
 

NOTE 3 — COMPREHENSIVE INCOME

The components of comprehensive income consist exclusively of unrealized gains and losses on available for sale securities. For the nine months ended September 30, 2004, this activity is shown under the heading Comprehensive Income as presented in the Consolidated Statement of Changes in Stockholders’ Equity (Unaudited). For the nine months ended September 30, 2003, comprehensive income totaled $1,769,180. For the three months ended September 30, 2004 and 2003, comprehensive income totaled $584,291 and $384,587 respectively.

NOTE 4 — STOCK-BASED COMPENSATION

The Company maintains a stock option plan for key officers, employees, and non-employee directors. Had compensation expense for the stock option plans been recognized in accordance with the fair vale accounting provisions of FAS No. 123, Accounting for Stock-Based Compensation, net income applicable to common stock, basic, and diluted net income per common share would have been as follows:

                                 
    Three Months Ended September 30,   Nine Months Ended September 30,
    2004
  2003
  2004
  2003
Net income, as reported:
  $ 821,791     $ 702,187     $ 2,415,567     $ 1,969,881  
Less proforma expense related to stock options
    28,519       19,871       85,557       59,613  

 


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    Three Months Ended September 30,   Nine Months Ended September 30,
    2004
  2003
  2004
  2003
 
   
 
     
 
     
 
     
 
 
Proforma net income
  $ 793,272     $ 682,316     $ 2,330,010     $ 1,910,268  
 
   
 
     
 
     
 
     
 
 
Basic net income per common share:
                               
As reported
  $ 0.67     $ .58     $ 1.97     $ 1.62  
Pro forma
    0.64       .56       1.90       1.57  
Diluted net income per common share:
                               
As reported
  $ 0.66     $ .57     $ 1.95     $ 1.61  
Pro forma
    0.64       .56       1.89       1.57  

NOTE 5 — RECENT ACCOUNTING PRONOUNCEMENTS

In March 2004, the Financial Accounting Standards Board (“FASB”) reached consensus on the guidance provided by Emerging Issues Task Force Issue 03-1 (“EITF 03-1”), The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. The guidance is applicable to debt and equity securities that are within the scope of FASB Statement of Financial Accounting Standard (“SFAS”) No. 115, Accounting for Certain Investments In Debt and Equity Securities and certain other investments. EITF 03-1 specifies that an impairment would be considered other-than-temporary unless (a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment and (b) evidence indicating the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. EITF 03-1 cost method investment and disclosure provisions were effective for reporting periods ending after June 15, 2004. The measurement and recognition provisions relating to debt and equity securities have been delayed until the FASB issues additional guidance. The Company adopted cost method investment and disclosure provisions of EITF 03-1 on June 30, 2004. The adoption did not have a material impact on the consolidated financial statements, results of operations or liquidity of the Company

In December 2003, the Financial Accounting Standards Board (“FASB”) issued a revision to Interpretation 46, Consolidation of Variable Interest Entities, which established standards for identifying a variable interest entity (“VIE”) and for determining under what circumstances a VIE should be consolidated with its primary beneficiary. The Interpretation requires consolidation of entities in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Prior to the interpretation, entities were generally consolidated by an enterprise when it had a controlling financial interest through ownership of a majority voting interest in the entity. The adoption of this Interpretation has not and is not

 


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expected to have a material effect on the Company’s financial position or results of operations.

In December 2003, the FASB revised FAS No. 132, Employers’ Disclosures about Pension and Other Postretirement Benefit. This statement retains the disclosures required by FAS No. 132, which standardized the disclosure requirements for pensions and other postretirement benefits to the extent practicable and requires additional information on changes in the benefit obligations and fair value of plan assets. Additional disclosures include information describing the types of plan assets, investment strategy, measurement date(s), plan obligations, cash flows, and components of net periodic benefit cost recognized during interim periods. This statement retains reduced disclosure requirements for nonpublic entities from FAS No. 132, and it includes reduced disclosure for certain of the new requirements. This statement is effective for financial statements with fiscal years ending after December 15, 2003. The interim disclosures required by this statement are effective for interim periods beginning after December 15, 2003. The Company has adopted the revised disclosure provisions

NOTE 6 — SUPPLEMENTAL RETIREMENT PLAN

The Bank maintains a Directors Retirement Plan to provide post-retirement payments over a ten-year period to members of the Board of Directors who have completed five or more years of service. The Plan requires payment of 25 percent of the final average annual board fees paid to a director in the three years preceding the director’s retirement.

The following table illustrates the components of the net periodic pension cost for the Supplemental Retirement Plan:

                 
    Three Months Ended
    September 30,
    2004
  2003
Service cost
  $ 6,922     $ 10,024  
Interest cost
    2,316       1,951  
Expected return on plan assets
           
Amortization of transition obligation (asset)
           
Amortization of prior service cost
           
Amortization of actuarial (gains)/losses
           
 
   
 
     
 
 
Net periodic benefit cost
  $ 9,238     $ 11,975  
 
   
 
     
 
 

 


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    Nine Months Ended
    September 30,
    2004
  2003
Service cost
  $ 20,766     $ 30,072  
Interest cost
    6,948       5,853  
Expected return on plan assets
           
Amortization of transition obligation (asset)
           
Amortization of prior service cost
           
Amortization of actuarial (gains)/losses
           
 
   
 
     
 
 
Net periodic benefit cost
  $ 27,714     $ 35,925  
 
   
 
     
 
 

Management’s Discussion and Analysis

General

The following discusses the financial condition of the Company as of September 30, 2004, as compared to December 31, 2003 and the results of operations for the three and nine months ended September 30, 2004 compared to the same period in 2003. This discussion should be read in conjunction with the interim condensed consolidated financial statements and related footnotes included herein.

Introduction

Middlefield is an Ohio corporation organized to become the holding company of The Middlefield Banking Company (“Bank”). The Bank is a state-chartered bank located in Middlefield, Ohio. Middlefield and its subsidiary bank derive substantially all of their income from banking and bank-related services, including interest earnings on residential real estate, commercial mortgage, commercial, and consumer financings as well as interest earnings on investment securities and deposit services to its customers through six locations.

Risk identification and management are essential elements for the successful management of the Company. In the normal course of business, the Company is subject to various types of risk, including interest rate, credit and liquidity risk.

Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in interest rates. Interest rate risk results from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company. The Company uses its asset/liability management policy to control and manage interest rate risk.

Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from loans with customers and purchasing of securities. The Company’s primary credit risk is in the loan portfolio. The Company manages credit risk by adhering to an

 


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established credit policy and through a disciplined evaluation of the adequacy of the allowance for loan losses. Also, the investment policy limits the amount of credit risk that may be taken in the investment portfolio.

Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors. The Company has established guidelines within its asset/liability policy to manage liquidity risk. These guidelines include contingent funding alternatives.

We face strong competition in the communities we serve from other commercial banks, savings banks, savings and loan associations and credit unions, some of which are substantially larger institutions. We also compete with issuers of money market funds, securities brokerage firms, consumer finance companies and mortgage brokers. These entities are strong competitors for virtually all types of financial services.

In recent years, the financial services industry has experienced tremendous change to competitive barriers between bank and non-bank institutions. We not only must compete with traditional financial institutions, but also with other business corporations that have begun to deliver competing financial services. Competition for banking services is based on price, nature of product, quality of service, and in the case of certain activities, convenience of location.

Forward Looking Statement

The Private Securities Litigation Reform Act of 1995 contains safe harbor provisions regarding forward-looking statements. Forward-looking statements can be identified by terminology such as “believes,” “expects,” “anticipates,” “estimates,” “intends,” “should,” “will,” “plans,” “potential” and similar words. Forward-looking statements are also statements that are not statements of historical fact. Forward-looking statements necessarily involve risks and uncertainties. They are merely predictive or statements of probabilities, involving known and unknown risks, uncertainties and other factors. If one or more of these risks of uncertainties occurs or if the underlying assumptions prove incorrect, actual results could differ materially from those expressed in or implied by the forward-looking statements.

Forward-looking statements are based upon a variety of estimates and assumptions. The estimates and assumptions involve judgments about a number of things, including future economic, competitive, and financial market conditions and future business decisions. These matters are inherently subject to significant business, economic, and competitive uncertainties, all of which are difficult to predict and many of which are beyond Middlefield’s control. Although Middlefield believes its estimates and assumptions are reasonable, actual results could vary materially from those shown. Inclusion of forward-looking information does not constitute a representation by Middlefield or any other person that the indicated results will be achieved. Investors are cautioned not to place undue reliance on forward-looking information.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents totaled $10,745,000 at September 30, 2004 compared to $4,886,000 on December 31, 2003. Non-interest-bearing cash increased $3,368,000 since year-end 2003, while interest-bearing cash increased $2,490,000 during that same period. We believe the liquidity needs of the Company, are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, and the portion of the investment and loan portfolios that mature within one year. These sources of funds will enable the Company to meet cash obligations and off-balance sheet commitments as they come due.

 


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EARNING ASSETS — LOANS

At September 30, 2004, net loans were $209,257,000 compared to $192,880,000 at year-end 2003, an increase of $16,377,000 or 8.5%. The increase in total outstanding loans was the result of an increase in the commercial, home equity and real estate portfolios. Management attributes the relatively significant increase in loans to the general economic improvement in the lending markets served.

Commercial loans comprised 26.2% of total loans at September 30, 2004 compared to 25.5% at December 31, 2003. Commercial loans have increased $5,210,000 or 10.5 since December 31, 2003. The Company has originated these types of loans to benefit from consistent economic growth inside the Company’s primary market area. The majority of these loans are secured by real estate holdings.

Real estate loans were 61.8% of total loans at September 30, 2004 and 69.5% at year-end 2003. In dollar volume real estate loans increased 5.14% since December 31, 2003. Home equity loans showed the highest percentage growth for the first three quarters of 33.3%. Management’s position is to focus on adjustable rate products as the overall rate environment reaches historical low levels with the intent these products will adjust as interest rates rise.

The allowance for loan losses represents the amount which management and the Board of Directors estimates is adequate to provide for probable losses inherent in the loan portfolio. The allowance balance and the provision charged to expense are reviewed by management and the Board of Directors quarterly using a risk evaluation model that considers borrowers’ past due experience, economic conditions and various other circumstances that are subject to change over time. Management believes the current balance of the allowance for loan losses is adequate to absorb probable incurred credit losses associated with the loan portfolio. Net charge-offs for the nine months ended September 30, 2004 were $6,000.

EARNING ASSETS — SECURITIES AND FEDERAL FUNDS SOLD

The securities portfolio is comprised of U.S. Government agency-backed securities, tax-exempt obligations of states and political subdivisions and certain other investments. The Company does not hold any collateralized mortgage-backed securities, other than those issued by U.S. government agencies, or derivative securities. The quality rating of obligations of state and political subdivisions within Ohio is no less than BBB+, with all out-of-state bonds rated at AAA. Board policy permits the purchase of certain non-rated bonds of local schools, townships and municipalities, based on their estimated levels of credit risk. Securities available for sale at September 30, 2004 increased $5.7 million, or 11.4% from year-end 2003 totals. Municipal bonds make up the majority of the security growth in 2004. Securities held to maturity at September 30, 2004, decreased $1.3 million or 69.8% compared to year-end 2003 totals. The increase in the investment portfolio for the first nine months was due to higher than anticipated deposit growth in the second quarter.

Management monitors the earnings performance and the effectiveness of the liquidity of the investment portfolio on a regular basis. Through active balance sheet management and analysis of the securities portfolio, the Company maintains sufficient liquidity to satisfy depositor requirements and various credit needs of its customers.

SOURCES OF FUNDS — DEPOSITS

The Company’s primary source of funds is core deposits from retail and business customers. These core deposits include all categories of interest-bearing and non-interest-bearing deposits, excluding certificates of deposit greater than $100,000. For the period ended September 30, 2004, total core

 


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deposits increased approximately $17,666,000 or 8.7% primarily from an increase in non-interest bearing demand deposits, savings accounts and certificates of deposits.

The Company has a strong deposit base from public agencies, including local school districts, city and township municipalities, and others that may tend to be more seasonal in nature resulting from the receipt and disbursement of state and federal grants. These entities have maintained fairly static balances with the Company due to various funding and disbursement timeframes.

Certificates of deposit greater than $100,000 are not considered part of core deposits and as such are used to balance rate sensitivity as a tool of funds management. At September 30, 2004 certificates of deposit greater than $100,000 increased $1.2 million or 7.9% from year-end 2003 totals.

SOURCES OF FUNDS — SHORT TERM AND OTHER BORROWINGS

Other interest-bearing liabilities include securities sold under agreements to repurchase, sweep accounts, federal funds purchased, Treasury, Tax & Loan notes payable and Federal Home Loan Bank (“FHLB”) advances. In the first nine months of 2004, the Company continued to utilize the FHLB programs to manage interest rate risk and liquidity positions. Total other borrowings increased $6.3 million, or 35.6% from year-end 2003 totals.

RESULTS OF OPERATIONS FOR THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003

OVERVIEW OF THE INCOME STATEMENT

The Company had net income of $822,000 and $2,416,000 for the third quarter and first nine months of 2004, respectively. Basic and diluted earnings per share for the nine months ended September 30, 2004 totaled $1.97 and $1.95, compared with $1.62 and $1.62 for the nine months ended September 30, 2003, an increase of 16%. In dollars, net income increased 22.6% for the nine months ended September 30, 2004, compared to the same period in 2003.

NET INTEREST INCOME

Net interest income, by definition, is the difference between interest income generated on interest-earning assets and the interest expense incurred on interest-bearing liabilities. Various factors contribute to changes in net interest income, including volumes, interest rates and the composition or mix of interest-earning assets in relation to interest-bearing liabilities.

Net interest income, after provision for loan losses, totaled $2,471,000 in the third quarter, an increase of $306,000 or 14.1%, over the third quarter of 2003 and totaled 7,304,000 for the nine months of 2004, an increase of $1,037,000 or 16.6% over the prior year. The Bank experienced an increase in earning assets in the past nine months, which came primarily from our continued efforts to grow our existing offices.

Interest income totaled $3,979,000 in the third quarter, an increase of $278,000 or 7.5%, over the third quarter of 2003 and totaled $11,667,000 for the nine months of 2004, an increase of $753,000 or 6.9% over the prior year. The increase can be attributed to the growth of the loan portfolio that had an average balance 13% greater during the first nine months in 2004 than during the same period in 2003. Growth in the investment portfolio of 7.8% also contributed to the growth of interest income.

Interest expense totaled $1,456,000 in the third quarter, an increase of $26,000 or 1.9%, over the third

 


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quarter of 2003 and totaled 4,252,000 for the nine months of 2004, an decrease of $80,000 or 1.8% over the prior year. The decrease YTD can be attributed to the overall lower interest rate environment that currently exists along with increases in lower rate deposit accounts. Management has been proactive in lowering deposit product interest rates and has relied less on certificates of deposits to fund asset growth. Interest cost for the 3rd quarter increased as compared to the same period in 2003 due to the higher volume of borrowing from the Federal Home Loan Bank.

PROVISION FOR LOAN LOSSES

The Company recorded a provision for loan losses in the 3rd quarter of $51,000 compared to the 3rd quarter of 2003 at $105,000 and $111,000 for the nine months of 2004 compared to $315,000 in 2003. At September 30, 2004, Middlefield’s allowance for loan losses increased to $2,627,000 from $2,521,000 at December 31, 2003, and now represents 1.3% of the gross loan portfolio as compared to 1.4% for the previous period. The allowance for loan losses is established through a provision for loan losses, which is charged to operations. The provision is based on management’s periodic evaluation of the adequacy of the allowance, taking into account the overall risk characteristics of the various portfolio segments, the bank’s loan loss experience, the impact of economic conditions on borrowers, and other relevant factors. The estimates used to determine the adequacy of the allowance for loan losses, including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to significant change in the near term. The total allowance for loan losses is a combination of a specific allowance for identified problem loans, a formula allowance, and an unallocated allowance.

NON-INTEREST INCOME

Total non-interest income is made up of bank related fees and service charges, as well as other income producing services provided, ATM income, early redemption penalties for certificates of deposit, safe deposit rental income, internet bank service fees and other miscellaneous items. Non-interest income increased $109,000 or 29% and $357,000 or 35.3% in the 3rd quarter and the first nine months of 2004, respectively, when compared to the same periods in 2003. The primary components of increase were the income from bank-owned life insurance as well as the implementation of a new overdraft privilege program in the second quarter accounting for $238,000 or 67% of the YTD upsurge. Bank Owned Life Insurance (BOLI) is an important and growing investment of choice for many banks. BOLI’s tax favored status generally results in net yields that often are higher than those of other revenue sources. BOLI income showed a 24% YTD increase over the first 9 months of 2003 totaling $33,000. We continue to evaluate means of increasing non-interest income. Our approach is to apply service charges on business transaction accounts by charging fees on transaction activity (reduced by earnings credit based on customers’ balances) to more equitably recover costs. We expect to continue this analysis for our other products.

NON-INTEREST EXPENSE

Total non-interest expense increased $211,000 or 13.3% during the 3rd quarter of 2004 and $751,000 or 16.6% in the first nine months of 2004 when compared to the same period in 2003. Employee compensation and benefit expense represented the majority of the increase in non-interest expense for both the quarter of $111,000 and YTD of $366,000. The additional costs were the result of increased staffing, higher payroll and health insurance costs. Reflected within the increased staffing costs, as well as increased occupancy and other costs, is the operation of the bank’s Orwell office, which opened in April 2003.

CAPITAL RESOURCES

We evaluate stockholders’ equity in relation to total assets and the risk associated with those assets.

 


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The greater the capital resources, the more likely a corporation is to meet its cash obligations and absorb unforeseen losses. For these reasons, capital adequacy has been, and will continue to be, of paramount importance.

Internal capital growth, through the retention of earnings, is the primary means of maintaining capital adequacy for the Company. Stockholders’ equity at September 30, 2004, totaled $25,509,000 compared to $23,504,000 at December 31, 2003, a 8.5% increase. Stockholders’ equity in relation to total assets was 8.82% at September 30, 2004 compared to 8.96% at December 31, 2003.

The Company has a Dividend Reinvestment Plan (“The Plan”) for shareholders under which the Company’s common stock will be purchased by the Plan for participants with automatically reinvested dividends. The Plan does not represent a change in the Company’s dividend policy or a guarantee of future dividends.

The Company is subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the Banks’ operations.

The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion and plans for capital restoration are required.

The minimum requirements are:

                         
    TOTAL   TIER 1   TIER 1
    CAPITAL TO   CAPITAL TO   CAPITAL TO
    RISK-WEIGHTED   RISK-WEIGHTED   AVERAGE
    ASSETS
  ASSETS
  ASSETS
Well capitalized
    10.00 %     6.00 %     5.00 %
Adequately capitalized
    8.00 %     4.00 %     4.00 %
Undercapitalized
    6.00 %     3.00 %     3.00 %

The following table illustrates the Company’s risk-weighted capital ratios at September 30, 2004:


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    SEPTEMBER 30,
(in thousands)   2004
Tier 1 capital
  $ 25,357  
Total risk-based capital
  $ 27,565  
Risk-weighted assets
  $ 177,254  
Average total assets
  $ 276,453  
Tier 1 capital to average assets
    9.17 %
Tier 1 risk-based capital ratio
    14.66 %
Total risk-based capital ratio
    15.55 %

NON-PERFORMING LOANS

The table below presents information concerning nonperforming assets including nonaccrual loans, renegotiated loans, loans 90 days or more past due, other real estate loans, and repossessed assets. A loan is classified as nonaccrual when, in the opinion of management, there are serious doubts about collectibility of interest and principal. At the time the accrual of interest is discontinued, future income is recognized only when cash is received. Renegotiated loans are those loans which terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of the deterioration of the borrower.

                 
    September 30,   December 31,
    2004
  2003
    (Dollars in thousands)
Loans on nonaccrual basis
  $ 455     $ 372  
Loans past due 90 days or more and still accruing
    773       137  
 
   
 
     
 
 
Total nonperforming loans
  $ 1,228     $ 509  
 
   
 
     
 
 
Nonperforming loans as a percent of total loans
    0.59 %     0.26 %
 
   
 
     
 
 
Nonperforming assets as a percent of total assets
    0.42 %     0.19 %
 
   
 
     
 
 

As of September 30, 2004, loans past due 90 days and still accruing increased $636,000 from year-end 2003. This increase is primarily attributable to four borrower relationships. In two of those cases, all credits are secured with real estate. The other two are to commercial customers and represent borrowings secured by the respective business assets. All loans are secured and in the process of collection, with payments having been made during the quarter. The sole exception relates to two loans to one borrower which is secured by real estate and is in the process of being re-negotiated.

 


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The company also experienced an increase in loans maintained on a non-accrual basis. This group is comprised of five loans, four of which are secured by real estate properly margined. The fifth credit is secured by business assets and involves a borrower who has filed a petition under Federal bankruptcy laws.

At September 30, 2004 and December 31, 2003, no real estate or other assets were held as foreclosed or repossessed property.

Management monitors impaired loans on a continual basis. As of September 30, 2004, impaired loans had no material effect on the Middlefield’s financial position or results of operations.

LIQUIDITY

Management’s objective in managing liquidity is maintaining the ability to continue meeting the cash flow needs of its customers, such as borrowings or deposit withdrawals, as well as its own financial commitments. The principal sources of liquidity are net income, loan payments, maturing securities and sales of securities available for sale, federal funds sold and cash and deposits with banks. Along with its liquid assets, the Company has additional sources of liquidity available to ensure that adequate funds are available as needed. These include, but are not limited to, the purchase of federal funds, the ability to borrow funds under line of credit agreements with correspondent banks and a borrowing agreement with the Federal Home Loan Bank of Cincinnati, Ohio and the adjustment of interest rates to obtain depositors. Management feels that it has the capital adequacy, profitability and reputation to meet the current and projected needs of its customers.

For the nine months ended September 30, 2004, the adjustments to reconcile net income to net cash from operating activities consisted mainly of depreciation and amortization of premises and equipment and intangibles, the provision for loan losses, net amortization of securities and net changes in other assets and liabilities. Changes in cash and cash equivalents are detailed on the consolidated statements of cash flows.

INFLATION

Substantially all of the Company’s assets and liabilities relate to banking activities and are monetary in nature. The consolidated financial statements and related financial data are presented in accordance with U.S. GAAP. GAAP currently requires the Company to measure the financial position and results of operations in terms of historical dollars, with the exception of securities available for sale, impaired loans and other real estate loans that are measured at fair value. Changes in the value of money due to rising inflation can cause purchasing power loss.

Management’s opinion is that movements in interest rates affect the financial condition and results of operations to a greater degree than changes in the rate of inflation. It should be noted that interest rates and inflation do effect each other, but do not always move in correlation with each other. The Company’s ability to match the interest sensitivity of its financial assets to the interest sensitivity of its liabilities in its asset/liability management may tend to minimize the effect of changes in interest rates on the Company’s performance.

REGULATORY MATTERS

The Company is subject to the regulatory requirements of The Federal Reserve System as a one-bank holding company. The affiliate bank is subject to regulations of the Federal Deposit Insurance Corporation (FDIC) and the State of Ohio, Division of Financial Institutions.

 


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Quantitative and Qualitative Disclosures about Market Risk

The Bank measures interest-rate risk from the perspectives of earnings at risk and value at risk. The primary purpose of both the loan and investment portfolios is the generation of income, but if credit risk is the principal focus of risk analysis in the loan portfolio, interest-rate risk is the principal focus in the investment portfolio. Because of the greater liquidity of the investment portfolio, it is the vehicle for managing interest-rate risk in the entire balance sheet. The Bank manages interest rate risk position using simulation analysis of net interest income over a one-year period. The Bank also calculates the effect of an instantaneous change in market interest rates on the economic value of equity or net portfolio value. Once these analyses are complete, management reviews the results, with an emphasis on the income-simulation results for purposes of managing interest-rate risk. The rate sensitivity position is managed to avoid wide swings in net interest margins. Measurement and identification of current and potential interest rate risk exposures is conducted quarterly, with reporting and monitoring also occurring quarterly. The Bank applies interest rate shocks to its financial instruments up and down 200 basis points.

The following table presents an analysis of the potential sensitivity of the Bank’s annual net interest income and present value of the Bank’s financial instruments to sudden and sustained increase and decrease of 200 basis point change in market interest rates:

                 
    Maximum Change    
    2004   Guidelines
One Year Net interest Income Change
               
+200 Basis Points
    8 %     (10 )%
-200 Basis Points
    (11 )%     (10 )%
Net Present Value of Equity Change
               
+200 Basis Points
    (4 )%     (20 )%
-200 Basis Points
    4 %     (20 )%

The projected volatility of net interest income in a -200 basis points change in market rates for the 3rd quarter of 2004 falls outside the Board of Directors guidelines. With rates at historic lows it is unlikely that the market can decline 200BP so the potential interest rate risk exposure is considered minimal.

Item 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. Based on their evaluation as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q, the Registrant’s principal executive officer and principal financial officer have concluded that the Registrant’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by Middlefield in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

 


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(b) Changes in internal controls. There were no significant changes in the Registrant’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 


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PART II — OTHER INFORMATION

Item 1. Legal Proceedings

None

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

      On May 12, 2004, the Company announced a program to repurchase of to 4.99% of outstanding common stock or approximately 63,760 shares. The program will expire in May 2005 and all shares will generally be effected through open market purchases or in privately negotiated transactions.

Item 3. Defaults by the Company on its senior securities

None

Item 4. Submission of matters to a vote of security holders

None

Item 4. Submission of matters to a vote of security holders

None

Item 5. Other information

None

Item 6. Exhibits and Reports on Form 8-K

(a)   The following exhibits are included in this Report or incorporated herein by reference:

  3.1   Second Amended and Restated Articles of Incorporation of Middlefield Banc Corp. *
 
  3.2   Regulations of Middlefield Banc Corp. *
 
  4   Specimen Stock Certificate *
 
  10.1   1999 Stock Option Plan of Middlefield Banc Corp. *
 
  10.2   Severance Agreement of President and Chief Executive Officer *
 
  10.3   Severance Agreement of Executive Vice President *
 
  10.4   Severance Agreement of Vice President *
 
  10.5   Federal Home Loan Bank of Cincinnati Agreement for Advances and Security Agreement dated September 14, 2000
 
  10.7   Director Retirement Agreement with Richard T. Coyne *
 
  10.8   Director Retirement Agreement with Francis H. Frank *
 
  10.9   Director Retirement Agreement with Thomas C. Halstead *

 


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  10.10   Director Retirement Agreement with George F. Hasman *
 
  10.11   Director Retirement Agreement with Donald D. Hunter *
 
  10.12   Director Retirement Agreement with Martin S. Paul *
 
  10.13   Director Retirement Agreement with Donald E. Villers *
 
  10.14   DBO Agreement with Donald L. Stacy **
 
  10.15   DBO Agreement with Jay P. Giles **
 
  10.16   DBO Agreement with Alfred S. Thompson, Jr. **
 
  10.17   DBO Agreement with Nancy C. Snow **
 
  10.18   DBO Agreement with Teresa M. Hetrick **
 
  10.19   DBO Agreement with Jack L. Lester **
 
  10.20   DBO Agreement with James R. Heslop, II **
 
  10.21   DBO Agreement with Thomas G. Caldwell **
 
  23   Consent of S.R. Snodgrass, A.C., independent auditors of Middlefield Banc Corp.**
 
  31.1   Certification Pursuant to Section 302 of the Securities Exchange Act of 1934 — Thomas G. Caldwell
 
  31.2   Certification Pursuant to Section 302 of the Securities Exchange Act of 1934 — Donald L. Stacy
 
  32   Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act 0f 2002.
 
  99.1   Form of Indemnification Agreement with directors of Middlefield Banc Corp. and executive officers of Middlefield Banc Corp. and The Middlefield Banking Company*
 
  99.2   Independent Accountants Report

*   Incorporated by reference to the identically numbered exhibit to the December 31, 2001 Form 10-K (File No. 033-23094) filed with the SEC on March 28, 2002.
 
**   Incorporated by reference to the identically numbered exhibit to the December 31, 2003 Form 10-K (File No. 000-32561) filed with the SEC on March 30, 2004.

(b)) Reports on Form 8-K.

On October 25, 2004, a Form 8-K (Item 12) was filed with the Securities and Exchange Commission to report earnings for the third quarter ended September 30, 2004.

On July 20, 2004, a Form 8-K (Item 12) was filed with the Securities and Exchange Commission to report earnings for the second quarter ended September 30, 2004.

On May 12, 2004, a Form 8-K (Item 5) was filed with the Securities and Exchange Commission to announce a plan to repurchase up to 4.99% of Middlefield Banc Corp.’s outstanding common stock.

On April 23, 2004, a Form 8-K (Item 12) was filed with the Securities and Exchange Commission to report earnings for the first quarter ended March 31, 2004.

 


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On April 12, 2004, a Form 8-K (Items 5 and 7) was filed with the Securities and Exchange Commission to notify the appointment of American Stock Transfer & Trust Company as its new stock transfer agent..

 


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SIGNATURES

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

     
  MIDDLEFIELD BANC CORP.
 
   
Date: November 10, 2004
  By: /s/Thomas G. Caldwell
 
 
  Thomas G. Caldwell
  President and Chief Executive Officer
 
   
Date November 10, 2004
  By: /s/Donald L. Stacy
 
 
  Donald L. Stacy Principal
  Financial and Accounting Officer