<PAGE>

                    U.S. Securities and Exchange Commission
                             Washington, DC 20549

                                  Form 10-QSB

  (Mark One)

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



        For the quarterly period ended: March 31, 2001
                                        --------------


  [_]   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT
          For the transition period from  __________  to ___________


                        Commission file number 000-25179
                                               ---------


                      INNES STREET FINANCIAL CORPORATION
                      ----------------------------------
                    (Exact name of small business issuer as
                           specified in its charter)

       NORTH CAROLINA                                   56-2101799
       --------------                                   ----------
 (State or other jurisdiction                (IRS Employer Identification No.)
 of incorporation or organization)


                             401 WEST INNES STREET
                              SALISBURY, NC 28144
                              -------------------
                    (Address of principal executive office)

                                (704) 633-2341
                                --------------
                          (Issuer's telephone number)

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 for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.  Yes   [X]   No  [_]

     As of April 30, 2001, there were 1,974,325 shares of the Registrant's
common stock outstanding.

Transitional Small Business Disclosure Format (Check one):  Yes [_]  No [x]
<PAGE>

               Innes Street Financial Corporation and Subsidiary

                               Table of Contents


<TABLE>
<CAPTION>
                                                                                            Page
                                                                                            ----

<S>         <C>                                                                             <C>
Part I.     Financial Information                                                             3
-------     ---------------------

Item 1.     Financial Statements
            Consolidated Balance Sheets at March 31, 2001 (unaudited)
            and September 30, 2000                                                            4

            Consolidated Statements of Income for the Six and Three Months
            Ended March 31, 2001 and 2000 (unaudited)                                         5

            Consolidated Statements of Shareholders' Equity for the Six
            Months Ended March 31, 2001 and 2000 (unaudited)                                  6

            Consolidated Statements of Cash Flows for the Six Months
            Ended March 31, 2001 and 2000 (unaudited)                                         7

            Notes to Unaudited Consolidated Financial Statements                              8

Item 2.     Management's Discussion and Analysis of Financial
            Condition and Results of Operations                                              10

Part II.    Other Information                                                                13
--------    -----------------

Item 1.     Legal Proceedings                                                                14

Item 4.     Submission of Matters to a Vote of Security Holders                              15

Item 6.     Exhibits and Reports on Form 8-K                                                 15

            Signature Page                                                                   16
</TABLE>

                                       2
<PAGE>

               Innes Street Financial Corporation and Subsidiary

                        Part I.  Financial Information

                                       3
<PAGE>

Item 1.   Financial Statements
-------   --------------------


               Innes Street Financial Corporation and Subsidiary
                          Consolidated Balance Sheets

<TABLE>
<CAPTION>
                                                                                            March 31, 2001      September 30, 2000
                                                                                         --------------------- --------------------
                                                                                             (unaudited)
<S>                                                                                      <C>                   <C>
Assets

Cash and due from banks                                                                  $          7,928,677  $          2,987,315
Federal funds sold-overnight                                                                        4,579,000             6,686,000
                                                                                         --------------------- --------------------
Cash and cash equivalents                                                                          12,507,677             9,673,315
                                                                                         --------------------- --------------------

Mortgage-backed securities available-for-sale                                                       2,910,514             3,099,380
Mortgage-backed securities held-to-maturity (fair value of $561,839 and
  $635,344 at March 31, 2001 and September 30, 2000, respectively)                                    542,760               630,476
Loans receivable, net                                                                             188,503,109           186,915,054
Premises and equipment, net                                                                         2,263,631             2,375,478
Other                                                                                               5,513,421             5,354,619
                                                                                         --------------------- --------------------
Total assets                                                                                      212,241,112  $        208.048,322
                                                                                         ===================== ====================

Liabilities and shareholders' equity

Deposit accounts                                                                         $        168,629,064  $        166,406,701
Borrowings                                                                                         15,000,000            13,600,000
Other                                                                                               2,158,092             2,240,173
                                                                                         --------------------- --------------------
Total liabilities                                                                                 185,787,156           182,246,874
                                                                                         --------------------- --------------------

Preferred stock, no par value:
  Authorized - 5,000,000 shares; none issued and outstanding                                                -                     -

Common stock, no par value:
  Authorized  -  20,000,000 shares;  issued and outstanding: 1,974,325
  shares at March 31, 2001 and September 30, 2000                                                           -                     -
Paid in capital                                                                                    10,541,028            10,522,958
Retained earnings (substantially restricted)                                                       18,591,384            18,208,565
Unallocated ESOP stock                                                                             (2,056,258)           (2,188,339)
Unearned compensation MRP                                                                            (662,438)             (779,339)
Accumulated other comprehensive income                                                                 40,240                37,603
                                                                                         --------------------- --------------------
Total shareholders' equity                                                                         26,453,956            25,801,448
                                                                                         --------------------- --------------------
Total liabilities and shareholders' equity                                               $        212,241,112         $ 208,048,322
                                                                                         ===================== ====================
</TABLE>

See accompanying notes.

                                       4
<PAGE>

              Innes Street Financial Corporation and Subsidiaries
                       Consolidated Statements of Income
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                  Six Months Ended                    Three Months Ended
                                                           -------------------------------      -------------------------------
                                                                      March 31,                            March 31,
                                                           -------------------------------      -------------------------------
                                                                2001              2000               2001              2000
                                                           --------------     ------------      --------------     ------------
<S>                                                        <C>                <C>               <C>                <C>
Interest and fee income:
Loans receivable                                           $    7,535,761     $  6,520,948      $    3,753,711     $  3,293,233
Investments                                                             -          238,317                   -           83,894
Mortgage-backed securities                                        139,269          150,844              68,762           75,102
Other interest-earning assets                                     333,574          290,216             152,640          184,003
                                                           --------------     ------------      --------------     ------------
Total interest income                                           8,008,604        7,200,325           3,975,113        3,636,232
                                                           --------------     ------------      --------------     ------------

Interest expense:
Deposits                                                        4,610,757        3,903,299           2,263,216        1,983,772
Borrowings                                                        471,781           94,052             241,972           64,539
                                                           --------------     ------------      --------------     ------------
Total interest expense                                          5,082,538        3,997,351           2,505,188        2,048,311
                                                           --------------     ------------      --------------     ------------
Net interest income                                             2,926,066        3,202,974           1,469,925        1,587,921
Provision for loan losses                                               -                -                   -                -
                                                           --------------     ------------      --------------     ------------
Net interest income after provision for loan losses             2,926,066        3,202,974           1,469,925        1,587,921
                                                           --------------     ------------      --------------     ------------

Non-interest income:
Loan servicing fees                                                32,412           42,314              15,841           18,215
Gain on sales of loans, net                                        23,606           15,241              13,361            6,697
Other                                                             (15,181)          86,855             (53,144)          40,571
                                                           --------------     ------------      --------------     ------------
Total non-interest income                                          40,837          144,410             (23,942)          65,483
                                                           --------------     ------------      --------------     ------------

Non-interest expense:
Compensation and benefits                                       1,071,666        1,301,622             460,817          786,344
Occupancy and equipment                                           283,494          266,920             143,446          136,579
Advertising and promotion                                          54,467           76,169              23,699           40,646
Data processing                                                   115,001          109,969              58,317           53,462
Deposit insurance premium                                          16,308           32,181               8,094            8,457
Other                                                             506,194          405,526             291,806          187,361
                                                           --------------     ------------      --------------     ------------
Total non-interest expense                                      2,047,130        2,192,387             986,179        1,212,849
                                                           --------------     ------------      --------------     ------------
Income before income taxes                                        919,773        1,154,997             459,804          440,555
Provision for income taxes                                        360,936          421,295             183,834          151,058
                                                           --------------     ------------      --------------     ------------
Net income                                                 $      558,837     $    733,702      $      275,970        $ 289,497
                                                           ==============     ============      ==============     ============

Net income per common share:
Basic (Note 2)                                             $         0.33     $       0.38      $         0.16           $ 0.15
Diluted (Note 2)                                           $         0.32     $       0.38      $         0.16           $ 0.15

Average shares outstanding:
Basic (Note 2)                                                  1,701,044        1,926,848           1,710,830        1,887,224
Diluted (Note 2)                                                1,734,644        1,927,607           1,743,609        1,888,742
</TABLE>

     See accompanying notes.

                                       5
<PAGE>

               Innes Street Financial Corporation and Subsidiary
                Consolidated Statements of Shareholders' Equity
               For the Six Months Ended March 31, 2001 and 2000
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                                                                      Unearned
                                              Shares of                                               Deferred       Compenstion
                                               Common             Paid in           Retained        Compensation     Relating to
                                                Stock             Capital           Earnings           Plans          the ESOP
                                            -------------      -------------     --------------     ------------     -----------
<S>                                         <C>                <C>               <C>                <C>              <C>
Balance at September 30, 1999                   2,135,838       $ 20,106,106       $ 17,251,509                -     $ (1,708,670)

Net income                                                                              733,702

Change in unrealized appreciation
on securities available-for-sale,
net of taxes of $302


Comprehensive income*

Dividends paid ($0.10 per share)                                                       (192,674)

Shares purchased and held in
rabbi trusts                                                                                             217,680

Deferred compensation obligation                                                                        (217,680)

Commitment of ESOP shares                                             18,395                                               95,283
(9,528 shares)

Repurchase of common stock                       (189,000)        (2,585,688)

Issuamce of MRP stock                              89,930          1,169,090

Prorata vesting of MRP stock
                                              -----------     -------------        ------------    -------------       ----------
Balance at March 31, 2000                       2,036,768      $ 18,707,903        $ 17,792,537    $           -     $ (1,613,387)
                                              ===========     =============        ============    =============       ==========


Balance at September 30, 2000                   1,974,325      $ 10,522,958        $ 18,208,565    $           -     $  2,188,339

Net income                                                                              558,837

Change in unrealized appreciation on
securities available-for-sale, net of
taxes of $1,659


Comprehensive income*

Dividends paid ($0.10 a share)                                                         (176,018)

Shares purchased and held in rabbi
trusts                                                                                                   248,878

Deferred compensation obligation                                                                        (248,878)

Commitment of ESOP shares                                            18,070                                               132,081
(11,917 shares)

Prorata vesting of MRP stock
                                              -----------      ------------        ------------    -------------     -----------
Balance at March 31, 2001                       1,974,325      $ 10,541,028        $ 18,591,384    $           -     $(2,056,258)
                                              ===========      ============        ============    =============     ===========
</TABLE>

<TABLE>
<CAPTION>
                                                                   Accumulated
                                                    Unearned          Other
                                                  Compensation     Comprehensive         Total
                                                      MRP             Income            Equity
                                                  ------------     --------------   ---------------
<S> <C>
Balance at September 30, 1999                     $         -        $    32,837        $ 35,681,782

Net income                                                                                   733,702

Change in unrealized appreciation
on securities available-for-sale,
net of taxes of $302                                                         704                 704
                                                                                        ------------

Comprehensive income*                                                                        734,406

Dividends paid ($0.10 per share)                                                            (192,674)

Shares purchased and held in
rabbi trusts                                                                                 217,680

Deferred compensation obligation                                                            (217,680)

Commitment of ESOP shares                                                                    113,678
(9,268 shares)

Repurchase of common stock                                                                (2,585,688)

Issuamce of MRP stock                              (1,169,090)                                     -

Prorata vesting of MRP stock                          272,851                                272,851
                                                  ------------         ---------        ------------
Balance at March 31, 2000                          $ (896,239)       $    33,541        $ 34,024,355
                                                  ============         =========        ============

Balance at September 30, 2000                      $ (779,339)       $    37,603        $ 25,801,448

Net income                                                                                   558,837

Change in unrealized appreciation on
securities available-for-sale, net of
taxes of $1,659                                                            2,637               2,637
                                                                                          ----------

Comprehensive income*                                                                        561,474

Dividends paid ($0.10 a share)                                                              (176,018)

Shares purchased and held in rabbi trusts                                                    248,878

Deferred compensation obligation                                                            (248,878)

Commitment of ESOP shares                                                                    150,151
(11,917 shares)

Prorata vesting of MRP stock                          116,901                                116,901
                                                  -----------        -----------        ------------
Balance at March 31, 2001                         $   662,438        $    40,240        $ 26,453,956
                                                  ===========        ===========        ============
</TABLE>

*Comprehensive income for the second quarter of 2001 and 2000 was $272,952 and
294,806, respectively.

                                        6

<PAGE>

               Innes Street Financial Corporation and Subsidiary
                     Consolidated Statements of Cash Flows
                                  (Unaudited)


<TABLE>
<CAPTION>
                                                                                 Six months ended March 31,
                                                                        -------------------------------------------
                                                                              2001                      2000
                                                                        -----------------        ------------------
<S>                                                                     <C>                      <C>
Operating activities
Net income                                                              $         558,837        $          733,702
Adjustments to reconcile net income to net cash provided by
 operating activities:
  Depreciation                                                                    153,423                   139,141
  Amortization of premium (discount) on investments                                   644                    (2,510)
  Amortization of deferred loan fees                                              (75,391)                   17,885
  Commitment of ESOP shares                                                       150,151                   113,678
  Prorata vesting of MRP stock                                                    116,901                   272,851
  Deferred income taxes                                                          (116,051)                  (76,976)
  Gain on sales of loans, net                                                     (23,606)                  (15,241)
  Loss on sale of investments                                                           -                     3,441
  Other, net                                                                     (390,960)                 (517,953)
                                                                        -----------------        ------------------
Net cash provided by operating activities                                         373,948                   668,018

Investment activities
  Proceeds from maturity and sale of investment securities                              -                 9,995,750
  Principal repayment of mortgage-backed securities                               280,234                   642,465
  Net increase in loans                                                        (2,497,285)               (8,941,118)
  Purchases of loans                                                             (426,114)                        -
  Proceeds from sales of loans                                                  1,434,341                 2,079,046
  Purchase of FHLB stock                                                          (87,800)                  (21,000)
  Purchases of premises and equipment                                             (41,576)                 (436,551)
  Proceeds from sales of foreclosed real estate                                   252,006                         -
  Proceeds from sales of premises and equipment                                         -                       133
                                                                        -----------------        ------------------
Net cash (used in) provided by investing activities                            (1,086,194)                3,318,725

Financing activities
  Net increase in deposit accounts                                              2,222,363                 3,207,757
  Proceeds from borrowings                                                     17,000,000                 7,000,000
  Repayment of borrowings                                                     (15,600,000)               (7,000,000)
  Net increase in mortgage escrow funds                                           100,263                    98,094
  Repurchase of common stock                                                            -                (2,585,688)
  Dividends paid                                                                 (176,018)                 (192,674)
                                                                        -----------------        ------------------
Net cash provided by financing activities                                       3,546,608                   527,489

Net increase in cash and cash equivalents                                       2,834,362                 4,514,232
Cash and cash equivalents at beginning of period                                9,673,315                 6,789,346
                                                                        -----------------        ------------------
Cash and cash equivalents at end of period                              $      12,507,677        $       11,303,578
                                                                        =================        ==================
</TABLE>


See accompanying notes.

                                       7
<PAGE>

               Innes Street Financial Corporation and Subsidiary
             Notes to Unaudited Consolidated Financial Statements

1.  Organization

Innes Street Financial Corporation was incorporated on July 6, 1998 to serve as
the holding company for Citizens Bank, FSB (the "Bank") upon the Bank's
conversion from a federally chartered mutual savings bank to a federally
chartered stock savings bank ("Conversion"). Innes Street Financial Corporation
completed the Conversion on December 28, 1998 through the sale and issuance of
2,248,250 shares of common stock. Information set forth in this report relating
to periods prior to the Conversion, including financial statements and related
data relates to the Bank.

On January 8, 2001 the Bank converted from a federally chartered stock savings
bank to a North Carolina chartered stock savings bank. The Bank's name was
changed from Citizens Bank, FSB to Citizens Bank, Inc. (the "Bank"). The Bank's
primary regulators are now the state of North Carolina and the Federal Deposit
Insurance Corporation (the "FDIC"). Also, on January 8, 2001 Innes Street
Financial Corporation converted from a savings holding company to a bank holding
company. Innes Street Financial Corporation is now subject to the rules and
regulations of the Federal Reserve.

The accompanying unaudited consolidated financial statements of the Company
(Innes Street Financial Corporation and the Bank) have been prepared in
accordance with instructions to Form 10-QSB. Accordingly, they do not include
all of the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting solely of normal recurring adjustments) considered
necessary for a fair presentation have been included.

The results of operations for the six and three months ended March 31, 2001 are
not necessarily indicative of the results to be expected for the year ending
September 30, 2001. The consolidated financial statements and notes thereto
should be read in conjunction with the audited financial statements and notes
thereto for the year ended September 30, 2000.

2.  Earnings Per Share

The following table sets forth the computation of basic and diluted Earnings Per
Share ("EPS") for the periods indicated.


<TABLE>
<CAPTION>
                                                                        Six Months Ended               Three Months Ended
                                                                           March 31,                        March 31,
                                                                    --------------------------       ------------------------
                                                                       2001            2000              2001         2000
                                                                    ----------      ----------       ----------    ----------
<S>                                                                 <C>             <C>              <C>           <C>
BASIC
Net Income                                                          $  558,837      $  733,702       $  275,970    $  289,497

Weighted average shares outstanding                                  1,908,218       2,093,395        1,914,180     2,050,486
Less weighted average unallocated ESOP shares                         (207,174)       (166,547)        (203,350)            -
                                                                    ----------      ----------       ----------    ----------
Total weighted average shares outstanding                            1,701,044       1,926,848        1,710,830     1,887,224
                                                                    ==========      ==========       ==========    ==========

Basic earnings per share                                            $     0.33      $     0.38       $     0.16    $     0.15

DILUTED
Net Income                                                          $  558,837      $  733,702       $  275,970    $  289,497

Weighted average shares outstanding                                  1,908,218       2,093,395        1,914,180     2,050,486
Less weighted average unallocated ESOP shares                         (207,174)       (166,547)        (203,350)     (163,262)
                                                                    ----------      ----------       ----------    ----------
Total weighted average shares outstanding                            1,701,044       1,926,848        1,710,830     1,887,224
                                                                    ----------      ----------       ----------    ----------
Dilutive common stock awards at market price                                 -             656                -         1,312
Dilutive common stock options at market price                           33,600             759           32,779         1,518
                                                                    ----------      ----------       ----------    ----------
Average dilutive shares outstanding                                  1,734,644       1,927,607        1,743,609     1,888,742
                                                                    ==========      ==========       ==========    ==========

Diluted earnings per share                                          $     0.32      $     0.38       $     0.16    $     0.15
</TABLE>

                                       8
<PAGE>

3.  New Accounting Standards

In September 2000, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishment of Liabilities" (FASB 140) that replaces
FASB Statement No. 125. FASB 140 revises the standards for accounting for
securitizations and other transfers of financial assets and collateral and
requires certain additional disclosures regarding these activities. The
statement is effective for transfers and servicing of financial assets or
extinguishments of liabilities that occur after March 31, 2001. The statement is
effective for recognition and reclassification of collateral and for disclosures
relating to securitization transactions and collateral for fiscal years ending
after December 15, 2000. The Company is in the process of assessing the impact
and plans to adopt the standard in accordance with the effective dates. Adoption
is not expected to result in a material financial impact.

                                       9
<PAGE>

               Innes Street Financial Corporation and Subsidiary

Item 2.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations

Comparison of Financial Condition at March 31, 2001 and September 30, 2000

Total assets were $212.2 million at March 31, 2001 and $208.0 million at
September 30, 2000, an increase of  $4.2 million or 2.0%.

Cash and cash equivalents increased from $9.7 million at September 30, 2000 to
$12.5 million at March 31, 2001, an increase of 2.8 million or 28.9%. This
increase was a result of a $2.2 million increase in deposits and a $1.4 million
increase in Federal Home Loan Bank ("FHLB") advances, offset by an increase in
loans.

Mortgage-backed securities available-for-sale and mortgage-backed securities
held-to-maturity decreased from $3.7 million at September 30, 2000 to $3.5
million at March 31, 2001. This decrease was due to scheduled repayments.

Loans receivable, increased from $186.9 million at September 30, 2000 to $188.5
million at March 31, 2001, an increase of $1.6 million, or 0.9%. This increase
was primarily due to an increase in loan production offset by the sale of loans.
During the year, the Bank has increased its production of nonresidential, home
equity, and multi-family loans in an effort to increase loan yield.

Deposit accounts increased from $166.4 million at September 30, 2000 to $168.6
million at March 31, 2001, an increase of 1.3%. This increase was mainly in
premium money market accounts, which have increased as a result of an aggressive
marketing campaign.

Retained earnings increased by the net income earned during the six months ended
March 31, 2001 of $0.6 million. During the six months ended March 31, 2001 the
Company paid dividends totaling $0.10 a share to stockholders. This dividend
resulted in a $0.2 million decrease in retained earnings.

Unallocated ESOP stock decreased by $132,081. This decrease was a result of the
ESOP trust using dividends that it had received in the calendar year 2000 to
make an additional loan repayment of $38,788, which resulted in a release of an
additional 2,927 shares to be allocated to eligible employees. Also 8,990 shares
were allocated to eligible employees as part of the normal repayment of the ESOP
loan, which resulted in a decline of $93,293. Unallocated ESOP stock decreases
every month due to the Bank's recording of the shares earned for that month that
will be allocated in the future to eligible employees.

Unearned compensation Management Recognition Plan ("MRP") decreased by $116,901.
Each month the Company records compensation and benefits expense and reduces the
unearned compensation MRP by $19,483. This entry will continue until the
remaining MRP stock is fully vested on February 1, 2004.


Results of Operations

The earnings of the Company depend primarily on its level of net interest income
which is the difference between interest earned on the Company's interest-
earning assets and the interest paid on its interest-bearing liabilities. Net
interest income is a function of the Company's spread, which is the difference
between yield earned on interest-earning assets and the rate paid on interest-
bearing liabilities, as well as a function of the average balance of interest-
earning assets as compared to the average balance of interest-bearing
liabilities.

Comparison of Operating Results for the Six Months ended March 31, 2001 and 2001

Net Income. Net income for the six months ended March 31, 2001 was $558,837
compared to $733,702 for the six months ended March 31, 2000, a decrease of
23.8%. This decrease was primarily a result of a decrease in net interest
income.

Net Interest Income. Net interest income decreased from $3,202,974 for the six
months ended March 31, 2000 to $2,926,066 for the six months ended March 31,
2001. This decrease is a result of an increase in interest expense of

                                       10
<PAGE>

$1.1 million offset by an $0.8 million increase in interest income. Interest
income increased due to a $9.7 million increase in average interest-earning
assets and an increase in yield on interest-earning assets. The Company's
average borrowings outstanding and deposits increased from $163.2 million during
the six months ended March 31, 2000 to $180.7 million during the six months
ended March 31, 2001, an increase of $17.5 million or 10.7%. This increase in
average-costing liabilities was due to the Company's payment of a $4.00 per
share distribution to shareholders in June, 2000 as well as the share repurchase
program during calendar year 2000 and the growth of interest-earning assets.

Provision for Loan Losses. No provision for loan losses was made in either the
six months ended March 31, 2001 or the six months ended March 31, 2000. In the
opinion of management, based on its review of specific loans and historical loss
experience, the allowance for loan losses is adequate to cover probable credit
losses that were incurred as of March 31, 2001 and 2000. Accordingly, no
provision for loan losses was recorded during the six months ended March 31,
2001 and 2000.

Non-interest income. Non-interest income decreased from $144,410 for the six-
month period ended March 31, 2000 to $40,837 for the six-month period ended
March 31, 2001. The Company experienced a decrease in market value on trading
accounts associated with its Rabbi Trusts during the quarter ended March 31,
2001.

Non-interest expense. Non-interest expense decreased from $2,192,387 during the
six-month period ended March 31, 2000 to $2,047,130 for the six-month period
ended March 31, 2001. A decrease in compensation and benefits offset by an
increase in other non-interest expense during the six-month period ended March
31, 2001 account for the majority of this decrease. The decrease in compensation
and benefits was a result of a decrease in the number of employees and a
decrease in MRP expenses. The implementation of the MRP resulted in $272,851
expense during the six-month period ended March 31, 2000 as opposed to only
$116,901 for the six-month period ended March 31, 2001. Other non-interest
expense increased due to increases in charitable contributions, loan expenses,
and direct mail campaigns.

Provision for Income Taxes. The provision for income taxes decreased from
$421,295 for the six-month period ended March 31, 2000 to $360,936 for the six-
month period ended March 31, 2001 as a result of lower pre-tax income.

Comparison of Operating Results for the Three Months ended March 31, 2001 and
2001

Net Income. Net income for the three months ended March 31, 2001 was $275,970
compared to $289,497 for the three months ended March 31, 2000, a decrease of
4.7%.

Net Interest Income. Net interest income decreased from $1,587,921 for the three
months ended March 31, 2000 to $1,469,925 for the three months ended March 31,
2001. This decrease was a result of a $16.5 million increase in average
interest-costing liabilities offset by only an $11.2 million increase in average
interest-earning assets.

Provision for Loan Losses. No provision for loan losses was made in either the
three months ended March 31, 2001 or the three months ended March 31, 2000. In
the opinion of management, based on its review of specific loans and historical
loss experience, the allowance for loan losses is adequate to cover probable
credit losses that were incurred as of March 31, 2001 and 2000. Accordingly, no
provision for loan losses was recorded during the three months ended March 31,
2001 and 2000.

Non-interest income. Non-interest income decreased from $65,483 for the three-
month period ended March 31, 2000 to ($23,942) for the three-month period ended
March 31, 2001. The Company experienced a decrease in market value on trading
accounts associated with its Rabbi Trusts during the quarter ended March 31,
2001.

Non-interest expense. Non-interest expense decreased from $1,212,849 during the
three-month period ended March 31, 2000 to $986,179 for the three-month period
ended March 31, 2001. A decrease in compensation and benefits offset by an
increase in other non-interest expense account for the majority of this
decrease. The decrease in compensation and benefits was a result of a decrease
in the number of employees and a decrease in MRP expenses. The implementation of
the MRP resulted in a $272,851 expense during the quarter ended March 31, 2000
as

                                       11
<PAGE>

opposed to only $58,450 for the quarter ended March 31, 2001. Other non-interest
expense increased due to increases in charitable contributions, loan expenses,
and direct mail campaigns.

Provision for Income Taxes. The provision for income taxes increased from
$151,058 for the three-month period ended March 31, 2000 to $183,834 for the
three-month period ended March 31, 2001 as a result of a higher effective tax
rate.

Liquidity and Capital Resources. The Company's primary sources of funds are
customer deposits, proceeds from loan principal and interest payments, sales of
loans, maturing investments, and FHLB of Atlanta advances. While maturities and
scheduled amortization of loans are a predictable source of funds, deposit flows
and mortgage prepayments are influenced greatly by general interest rates, other
economic conditions, and competition.

The Bank is required by the state of North Carolina to maintain 10% of its
assets in specified liquid assets. The Bank's liquidity ratio at March 31, 2001
was 6.3%, which did not meet the requirement. As part of its conversion to a
state chartered savings bank, the Bank was given six months to meet the
liquidity requirement. It is anticipated that the Bank will meet the requirement
by quarter ended June 30, 2001. Given its ability to borrow from the FHLB of
Atlanta, the Bank believes that it will have sufficient funds available to meet
anticipated future loan commitments, unexpected deposit withdrawals, and other
cash requirements.

As of March 31, 2001, the Bank's regulatory capital was in excess of all
applicable regulatory requirements. At March 31, 2001, under applicable
regulations, the Bank's actual leverage and risk-based capital ratios were 11.6%
and 19.3%, respectively, compared to requirements of 4.0% and 8.0%,
respectively.

Due to the Company's excess capital position, the Board of Directors continues
to consider opportunities to enhance shareholder value, including stock
repurchases, special cash dividends and a return of capital. A decision by the
Board of Directors to undertake any of these activities will depend upon a
number of factors, including investment opportunities available to the Company
and the Bank, capital requirements, regulatory limitations, the Company's and
the Bank's results of operations and financial condition, tax considerations and
general economic conditions. Upon review of such considerations, the Board of
Directors may authorize such activities if it deems them appropriate and in
compliance with applicable law and regulation. However, no assurances can be
given that any of these activities will in fact be authorized by the Board of
Directors in the future.

                                       12
<PAGE>

               Innes Street Financial Corporation and Subsidiary

                          Part II.  Other Information

                                       13
<PAGE>

               Innes Street Financial Corporation and Subsidiary

Item 1.   Legal Proceedings
---- --   -----------------

From time to time the Company is a party to various legal proceedings incident
to its business. At March 31, 2001, there were no legal proceedings to which the
Company was a party, or to which any of its property was subject, which were
expected by management to result in a material loss.

Item 4.  Submission of Matters to a Vote of Security Holders
------   ---------------------------------------------------

On February 5, 2001, the Company held an annual meeting of shareholders for the
following purposes:

1.   Election of seven directors for one-year terms;

2.   Ratification of appointment of Ernst & Young LLP as independent auditors
     for the fiscal year ending September 30, 2001;

3.   To act upon such other matters as may properly come before the meeting or
     any adjournment's thereof.

The results of the voting are set forth below:

1.   Election of Directors:

            Name                                   For                 Withheld
            ------------------------------        ---------            --------
            Ronald E. Bostian                     1,625,326              1,000
            Harold C. Earnhardt                   1,624,876              1,450
            Gordon P. Hurley                      1,625,326              1,000
            James W. Duke                         1,625,326              1,000
            Bobby A. Lomax                        1,624,876              1,450
            K. V. Epting, Jr.                     1,624,876              1,450
            Malcolm B. Blankenship, Jr.           1,624,876              1,450

2.   Ratification of appointment of Ernst & Young LLP as independent auditors
     for the fiscal year ending September 30, 2001:



              For              Against      Abstain
          -----------         ---------    ---------
           1,625,326            1,000          0



3.   Other matters:
     No other matters came before the meeting.

                                       14
<PAGE>

  Item 6.  Exhibits and Reports on Form 8-K
  ---- --  --------------------------------

     a)   Exhibits

          (3)(i)    Articles of Incorporation, incorporated herein by reference
                    to Exhibit (3)(i) to the Registration Statement on Form S-1,
                    Registration No. 333-63363, dated September 14, 1998, as
                    amended by Pre-Effective Amendment No. 1, dated November 2,
                    1998, Pre-Effective Amendment No. 2, dated November 10, 1998
                    and Pre-Effective Amendment No. 3, dated November 12, 1998.

          (3)(ii)   Bylaws, incorporated herein by reference to Exhibit (3)(ii)
                    to the Registration Statement on Form S-1, Registration No.
                    333-63363, dated September 14, 1998, as amended by Pre-
                    Effective Amendment No. 1, dated November 2, 1998, Pre-
                    Effective Amendment No. 2, dated November 10, 1998 and Pre-
                    Effective Amendment No. 3, dated November 12, 1998.

          (4)       Specimen Stock Certificate, incorporated herein by reference
                    to Exhibit (4) to the Registration Statement on Form S-1,
                    Registration No. 333-63363, dated September 14, 1998, as
                    amended by Pre-Effective Amendment No. 1, dated November 2,
                    1998, Pre-Effective Amendment No. 2, dated November 10, 1998
                    and Pre-Effective Amendment No. 3, dated November 12, 1998.

          10(a)     Employment agreement between Citizen Bank, FSB and Ronald E.
                    Bostian, incorporated herein by reference to Exhibit 10(a)
                    to the Form 10-KSB dated December 20, 1999.

          10(b)     Innes Street Financial Corporation Stock Option Plan,
                    incorporated herein by reference to Exhibit 10(c) to the
                    Form 10-KSB dated December 20, 1999.

          10(c)     Citizens Bank, FSB Management Recognition Plan and Trust,
                    incorporated herein by reference to Exhibit 10(d) to the
                    Form 10-KSB dated December 20, 1999.

          10(d)     Severance Agreement, incorporated herein by reference to
                    Exhibit 10(e) to the Registration Statement on Form S-1,
                    Registration No. 333-63363, dated September 14, 1998, as
                    amended by Pre-Effective Amendment No. 1, dated November 2,
                    1998, Pre-Effective Amendment No. 2, dated November 10, 1998
                    and Pre-Effective Amendment No. 3, dated November 12, 1998.

          10(e)     Amended and Restated Nonqualified Deferred Compensation
                    Plan, incorporated herein by reference to Exhibit 10(f) to
                    the Registration Statement on Form S-1, Registration No.
                    333-63363, dated September 14, 1998, as amended by Pre-
                    Effective Amendment No. 1, dated November 2, 1998, Pre-
                    Effective Amendment No. 2, dated November 10, 1998 and Pre-
                    Effective Amendment No. 3, dated November 12, 1998.

          10(f)     Amended and Restated Directors Deferred Compensation Plan,
                    incorporated herein by reference to Exhibit 10(g) to the
                    Registration Statement on Form S-1, Registration No. 333-
                    63363, dated September 14, 1998, as amended by Pre-Effective
                    Amendment No. 1, dated November 2, 1998, Pre-Effective
                    Amendment No. 2, dated November 10, 1998 and Pre-Effective
                    Amendment No. 3, dated November 12, 1998.

          10(g)     Second Directors' Deferred Compensation Plan of Citizens
                    Bank, FSB, incorporated by reference to Exhibit 10(i) to the
                    Form 10-QSB dated May 13, 1999.

          10(h)     Second Nonqualified Deferred Compensation Plan for Key
                    Employees of Citizens Bank, FSB, incorporated by reference
                    to Exhibit 10(ii) to the Form 10-QSB dated May 13, 1999.

     b)   No reports on Form 8-K were filed during the quarter ended March 31,
          2001.

                                       15
<PAGE>

               Innes Street Financial Corporation and Subsidiary

                                  Signatures


In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on behalf by the undersigned, thereunto duly
authorized.


                                  Innes Street Financial Corporation
                                  ----------------------------------
                                         (Registrant)


     May 15, 2001                      /s/ Ronald E. Bostian
-----------------------                --------------------------------
        (Date)                          Ronald E. Bostian
                                        President and CEO
                                        (Duly Authorized Rerpresentative)



    May 15, 2001                       /s/ Dianne E. Hawkins
--------------------                   ---------------------
        (Date)                          Dianne E. Hawkins
                                        Treasurer and Controller
                                        (Principal Financial Officer)


                                      16