**United States Securities andExchange Commission**

 

**Washington, D.C. 20549**

 

**FORM 10-QSB**

 

**ý****QUARTERLY REPORT UNDERSECTION 13 OF 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Forthe quarterly period ended September 30, 2003**

 

**OR**

 

**o****TRANSITION REPORT UNDER SECTION 13OF 15 (D) OF THE SECURTIES EXCHANGE ACT**

 

**Forthe transition period from                to                .**

 

**Commission File No. 000-25231**

 

**Northern Star Financial, Inc.**

(Exact name ofregistrant as specified in its charter)

 

| **Minnesota**                                          |   | **41-1912467**       |
|--------------------------------------------------------|--------|----------------------|
| (State of  Incorporation)                              |   | (IRS Employer ID  #) |
|                                                   |   |                 |
| **1650 Madison Avenue**                                |
| **Mankato, MN  56001**                            |
| (Address of  Principal Executive Offices)              |
|                                                   |   |                 |
| **507-387-2265**                                       |
| (Issuer’s  Telephone Number, Including Area Code) |

 

Check whether the issuer(1) filed all reports required to be filed by Sections 13 or 15(d) of theExchange Act during the past 12 months (or such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes   ý   Noo.

 

State the numberof shares outstanding of each of the issuer’s classes of common equity as ofthe latest practicable date.

 

**Class:  Common Stock, par value $.01 per shareOutstanding shares at November 10,2003:  567,506**

 

Transitional SmallBusiness Disclosure Format (Check one): Yes  o  No ý.

 

 

----

 

**Northern Star Financial, Inc. andSubsidiary**

 

**Index to Form 10-QSBSeptember 30, 2003**

 
| PART  I.   | FINANCIAL INFORMATION                                                                                                    |   |
|------------|--------------------------------------------------------------------------------------------------------------------------|--------|
|       |                                                                                                                     |
| Item 1.    | Summary of Financial Data                                                                                                |   |
|       |                                                                                                                     |
|       | Consolidated  Statements of Financial Condition at September 30, 2003 (unaudited) and  June 30, 2003 (audited) |   |
|       |                                                                                                                     |
|       | Unaudited  Consolidated Statements of Operations for the three months ended September 30,  2003 and 2002            |   |
|       |                                                                                                                     |   |
|       | Unaudited  Consolidated Statement of Cash Flows for the three months ended  September 30, 2003 and 2002             |   |
|       |                                                                                                                     |   |
|       | Notes  to Condensed Consolidated Financial Statements (unaudited)                                                        |   |
|       |                                                                                                                     |   |
| Item  2.   | Management’s  Discussion and Analysis or Plan of Operation                                                          |   |
|       |                                                                                                                     |
| Item 3.    | Controls and Procedures                                                                                                  |   |
|       |                                                                                                                     |
| PART II.   | OTHER INFORMATION                                                                                                        |   |
|       |                                                                                                                     |
| Item 1.    | Legal Proceedings                                                                                                        |   |
|       |                                                                                                                     |
| Item  2.   | Changes  in Securities and Use of Proceeds                                                                               |   |
|       |                                                                                                                     |
| Item  3.   | Default  Upon Senior Securities                                                                                          |   |
|       |                                                                                                                     |
| Item  4.   | Submission  of Matters to a Vote of Security Holders                                                                     |   |
|       |                                                                                                                     |
| Item 5.    | Other Information                                                                                                        |   |
|       |                                                                                                                     |
| Item  6.   | Exhibits  and Reports on Form 8-K                                                                                        |   |
|       |
| SIGNATURES |                                                                                                                     |
|            |                                                                                                                          |        |  |

 

2

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### **ITEM 1**. SUMMARY OF FINANCIALDATA

 

Northern StarFinancial, Inc. Summary of Financial Data

 

The following tablesummarizes certain historical financial data of Northern Star Financial, Inc.and its subsidiary on a consolidated basis as of and for the three months endedSeptember 30, 2003 and 2002.  Youshould read this table in conjunction with our financial statements and relatednotes appearing elsewhere in this document.

 
|                                                                  |   | **As of and for the Three Months  Ended September 30,** |       |
|-----------------------------------------------------------------------|--------|---------------------------------------------------------|------------|
|                                                                  |   | **2003**                                                |       | **2002** |   |
| Statement of Operations:                                              |   |                                                    |       |   |   |
| Interest income                                                       |   | $                                                       | 698,594    |   | $ | 743,537 |   |
| Interest expense                                                      |   | 312,193                                                 |       | 404,486 |   |
| Net interest income                                                   |   | 386,401                                                 |       | 339,051 |   |
| Provision for loan losses                                             |   | 15,200                                                  |       | 21,000 |   |
| Other non-interest income                                             |   | 289,324                                                 |       | 153,236 |   |
| Non-interest expense                                                  |   | 594,380                                                 |       | 510,513 |   |
| Income (loss) before income tax expense                               |   | 66,145                                                  |       | (39,226 | ) |
| Income tax expense (benefit)                                          |   | —                                                  |       | — |   |
| Net income (loss)                                                     |   | $                                                       | 66,145     |   | $ | (39,226 | ) |
| Balance Sheet:                                                        |   |                                                    |       |   |   |
| Assets                                                                |   | $                                                       | 49,646,666 |   | $ | 48,803,383 |   |
| Allowance for loan losses                                             |   | $                                                       | 812,505    |   | $ | 680,786 |   |
| Deposits                                                              |   | $                                                       | 39,616,529 |   | $ | 40,002,850 |   |
| Stockholders’ equity                                             |   | $                                                       | 2,083,896  |   | $ | 1,888,584 |   |
|                                                                  |   |                                                    |       |   |   |
| Per Share Data:                                                       |   |                                                    |       |   |   |
| Net income (loss) - basic                                             |   | $                                                       | 0.13       |   | $ | (0.08 | ) |
| Net income (loss) - diluted                                           |   | $                                                       | 0.13       |   | $ | (0.08 | ) |
| Book value                                                            |   | $                                                       | 3.84       |   | $ | 3.94 |   |
|                                                                  |   |                                                    |       |   |   |
| Other Data                                                            |   |                                                    |       |   |   |
| Average shares outstanding - basic                                    |   | 520,539                                                 |       | 479,506 |   |
| Average shares outstanding - diluted                                  |   | 520,539                                                 |       | 479,506 |   |
|                                                                  |   |                                                    |       |   |   |
| Financial Ratios:                                                     |   |                                                    |       |   |   |
| Equity to assets                                                      |   | 3.96                                                    | %          | 3.91 | % |
| Return on average assets                                              |   | 0.13                                                    | %          | -0.08 | % |
| Return on average stockholders’ equity                           |   | 3.28                                                    | %          | -2.06 | % |
| Net interest margin                                                   |   | 3.36                                                    | %          | 2.97 | % |
| Tier 1 leverage ratio                                                 |   | 8.29                                                    | %          | 8.01 | % |
| Tier 1 capital to risk-weighted assets                                |   | 11.41                                                   | %          | 10.91 | % |
| Total capital to risk-weighted assets                                 |   | 12.67                                                   | %          | 12.16 | % |
|                                                                  |   |                                                    |       |   |   |
| Asset Quality Ratios:                                                 |   |                                                    |       |   |   |
| Nonperforming assets to total assets                                  |   | 3.46                                                    | %          | 4.10 | % |
| Nonperforming assets to total loans and and other  real estated owned |   | 4.63                                                    | %          | 5.69 | % |
| Allowance for loan losses to total loans                              |   | 2.19                                                    | %          | 1.94 | % |
|                                                                       |        |                                                         |            |  |  |  |  |  |  |

 

3

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**Northern Star Financial, Inc. andSubsidiary**

Consolidated Statementsof Financial Condition

 
|                                                                                                                         |   | **September 30, 2003** |       | **June 30, 2003** |       |
|------------------------------------------------------------------------------------------------------------------------------|--------|------------------------|------------|-------------------|------------|
|                                                                                                                         |   | **(Unaudited)**        |       | **(Audited)**     |       |
| **ASSETS**                                                                                                                   |   |                   | ** ** |              | ** ** |
|                                                                                                                         |   |                   | ** ** |              | ** ** |
| Cash and due from banks                                                                                                      |   | $                      | 1,952,432  |              | $          | 2,377,132 |   |
| Federal funds sold                                                                                                           |   | 3,855,000              |       | 482,000           |       |
| Securities available for sale, at fair value                                                                                 |   | 5,056,132              |       | 6,113,088         |       |
| Securities held for trading, at fair value                                                                                   |   | 113,696                |       | 115,862           |       |
| Federal Home Loan Bank and United Bankers Bank stock,  at cost                                                               |   | 367,100                |       | 367,100           |       |
| Loans held for sale                                                                                                          |   | 945,676                |       | 2,035,176         |       |
| Loans receivable, net of allowance for loan and  lease losses of $812,505 and $1,029,581                                     |   | 36,333,478             |       | 38,852,128        |       |
| Accrued interest receivable                                                                                                  |   | 250,468                |       | 282,416           |       |
| Property and equipment, net of depreciation                                                                                  |   | 493,671                |       | 503,397           |       |
| Other assets                                                                                                                 |   | 279,013                |       | 124,363           |       |
| **Total Assets**                                                                                                             |   | $                      | 49,646,666 |              | $          | 51,252,662 |   |
|                                                                                                                         |   |                   |       |              |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                               |   |                   |       |              |       |
| **Liabilities:**                                                                                                             |   |                   |       |              |       |
| Demand deposits                                                                                                              |   | $                      | 3,332,904  |              | $          | 5,090,364 |   |
| NOW and money market                                                                                                         |   | 8,594,903              |       | 8,623,932         |       |
| Savings                                                                                                                      |   | 4,201,827              |       | 4,630,763         |       |
| Time deposits                                                                                                                |   | 23,486,895             |       | 23,083,651        |       |
| Total deposits                                                                                                               |   | 39,616,529             |       | 41,428,710        |       |
| Notes payable and other borrowings                                                                                           |   | 5,975,000              |       | 5,975,000         |       |
| Convertible subordinated notes payable                                                                                       |   | 1,600,000              |       | 1,600,000         |       |
| Accrued interest payable and other                                                                                           |   | 371,241                |       | 334,818           |       |
| Total Liabilities                                                                                                            |   | 47,562,770             |       | 49,338,528        |       |
|                                                                                                                         |   |                   |       |              |       |
| **Stockholders’ Equity:**                                                                                               |   |                   |       |              |       |
| Common stock, $.01 par value, 15,000,000 shares  authorized; 542,506 and 519,506 shares issued and outstanding, respectively |   | 5,425                  |       | 5,195             |       |
| Undesignated stock, par value $.01 per share;  5,000,000 shares authorized, no shares issued                                 |   | —                 |       | —            |       |
| Additional paid in capital                                                                                                   |   | 4,504,374              |       | 4,378,104         |       |
| Accumulated deficit                                                                                                          |   | (2,447,030             | )          | (2,513,175        | )          |
| Unearned stock compensation                                                                                                  |   | (7,005                 | )          | (8,005            | )          |
| Accumulated other comprehensive income                                                                                       |   | 28,132                 |       | 52,015            |       |
| **Total Stockholders’ Equity**                                                                                          |   | 2,083,896              |       | 1,914,134         |       |
| **Total Liabilities and Stockholders’  Equity**                                                                         |   | $                      | 49,646,666 |              | $          | 51,252,662 |   |

 

See Notes toConsolidated Financial Statements

 

4

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**Northern Star Financial, Inc. andSubsidiary**

Unaudited ConsolidatedStatements of Operations

 
|                                                           |   | **For the Three Months  Ended September 30,** |    |
|----------------------------------------------------------------|--------|-----------------------------------------------|---------|
|                                                           |   | **2003**                                      |    | **2002** |   |
| **Interest income:**                                           |   |                                          |    |   |   |
| Loans receivable                                               |   | $                                             | 640,300 |   | $ | 635,156 |   |
| Securities available for sale                                  |   | 51,115                                        |    | 97,276 |   |
| Federal funds sold                                             |   | 7,179                                         |    | 11,105 |   |
| Total interest income                                          |   | 698,594                                       |    | 743,537 |   |
|                                                           |   |                                          |    |   |   |
| **Interest expense:**                                          |   |                                          |    |   |   |
| Deposits                                                       |   | 234,846                                       |    | 323,303 |   |
| Borrowed funds                                                 |   | 77,347                                        |    | 81,183 |   |
| Total interest expense                                         |   | 312,193                                       |    | 404,486 |   |
|                                                           |   |                                          |    |   |   |
| Net interest income                                            |   | 386,401                                       |    | 339,051 |   |
| Provision for loan losses                                      |   | 15,200                                        |    | 21,000 |   |
|                                                           |   |                                          |    |   |   |
| Net interest income after provision for loan loss              |   | 371,201                                       |    | 318,051 |   |
|                                                           |   |                                          |    |   |   |
| **Non-interest income:**                                       |   |                                          |    |   |   |
| Other fees and service charges                                 |   | 52,048                                        |    | 44,425 |   |
| Gain on sale of securities                                     |   | 13,760                                        |    | 3,125 |   |
| Gain on sale of loans                                          |   | 223,516                                       |    | 105,686 |   |
| Total non-interest income                                      |   | 289,324                                       |    | 153,236 |   |
|                                                           |   |                                          |    |   |   |
| **Non-interest expense:**                                      |   |                                          |    |   |   |
| Compensation and employee benefits                             |   | 276,704                                       |    | 221,705 |   |
| Board fees                                                     |   | 23,500                                        |    | 23,000 |   |
| Occupancy                                                      |   | 46,119                                        |    | 39,873 |   |
| Printing & supplies                                        |   | 19,410                                        |    | 21,502 |   |
| Property and equipment depreciation                            |   | 19,771                                        |    | 17,873 |   |
| Data processing                                                |   | 40,150                                        |    | 31,939 |   |
| Professional fees                                              |   | 75,461                                        |    | 75,558 |   |
| Other                                                          |   | 93,265                                        |    | 79,063 |   |
| Total non-interest expense                                     |   | 594,380                                       |    | 510,513 |   |
|                                                           |   |                                          |    |   |   |
| **Income (loss) before income tax  benefit**                   |   | 66,145                                        |    | (39,226 | ) |
| Income tax benefit                                             |   | —                                        |    | — |   |
|                                                           |   |                                          |    |   |   |
| **Net income (loss)**                                          |   | $                                             | 66,145  |   | $ | (39,226 | ) |
|                                                           |   |                                          |    |   |   |
| **Net income (loss) per common share**                         |   |                                          |    |   |   |
| Basic and diluted income  (loss) per share of comon stock |   | $                                             | 0.13    |   | $ | (0.08 | ) |

 

See Notes toConsolidated Financial Statements

 

5

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## **Northern Star Financial, Inc. and Subsidiary**

Unaudited ConsolidatedStatements of Cash Flows

 
|                                                                              |   | **For the Three Months  Ended September 30,** |      |
|-----------------------------------------------------------------------------------|--------|-----------------------------------------------|-----------|
|                                                                              |   | **2003**                                      |      | **2002** |   |
| Cash flows from operating activities:                                             |   |                                          |      |   |   |
| RECONCILIATION OF NET INCOME (LOSS) TO NET CASH  PROVIDED BY OPERATING ACTIVITIES |   |                                          |      |   |   |
| Net income (loss)                                                                 |   | $                                             | 66,145    |   | $ | (39,226 | ) |
| Adjustments:                                                                      |   |                                          |      |   |   |
| Depreciation                                                                      |   | 23,488                                        |      | 20,998 |   |
| Provision for loan losses                                                         |   | 15,200                                        |      | 21,000 |   |
| Accretion and (amortization) of premiums and  discounts, net                      |   | 103                                           |      | 505 |   |
| Stock compensation earned                                                         |   | 1,000                                         |      | 1,000 |   |
| Gain on sale of investments                                                       |   | (13,760                                       | )         | (3,125 | ) |
| Deferred loan fees                                                                |   | 14,135                                        |      | 21,310 |   |
| Originations of loans held for sale                                               |   | (14,671,664                                   | )         | (7,404,093 | ) |
| Proceeds from sales of loans held for sale                                        |   | 15,761,164                                    |      | 6,207,558 |   |
| Other                                                                             |   | (81,038                                       | )         | 63,895 |   |
| Net cash provided by (used in) operating activities                               |   | $                                             | 1,114,773 |   | $ | (1,110,178 | ) |
|                                                                              |   |                                          |      |   |   |
| Cash flows from investing activities:                                             |   |                                          |      |   |   |
| Purchases of available-for-sale securities                                        |   | (685,358                                      | )         | (1,000,000 | ) |
| Proceeds from maturities of available-for-sale  securities                        |   | 500,000                                       |      | 500,000 |   |
| Proceeds from sales of available-for-sale securities                              |   | 1,202,406                                     |      | 3,822,381 |   |
| Proceeds from sales/maturities of trading securities                              |   | 15,926                                        |      | — |   |
| Purchase of restricted stock                                                      |   | —                                        |      | (45,000 | ) |
| Net increase in federal funds sold                                                |   | (3,368,000                                    | )         | (2,293,000 | ) |
| Loan origination’s and principal payments on loans,  net                     |   | 2,494,996                                     |      | (712,627 | ) |
| Purchase of property and equipment                                                |   | (13,762                                       | )         | (22,956 | ) |
| Net cash provided by investing activities                                         |   | 146,208                                       |      | 248,798 |   |
|                                                                              |   |                                          |      |   |   |
| Cash flows from financing activities:                                             |   |                                          |      |   |   |
| Net increase in non-interest bearing demand and  savings deposit accounts         |   | (2,215,425                                    | )         | 514,241 |   |
| Net increase (decrease) in time deposits                                          |   | 403,244                                       |      | (101,120 | ) |
| Proceeds from other borrowings                                                    |   | —                                        |      | (200,000 | ) |
| Proceeds from sale of common stock                                                |   | 126,500                                       |      | — |   |
| Net cash provided by (used in) financing activities                               |   | (1,685,681                                    | )         | 213,121 |   |
| Net decrease in cash                                                              |   | (424,700                                      | )         | (648,259 | ) |
| Cash and cash equivalents at beginning of year                                    |   | 2,377,132                                     |      | 2,348,081 |   |
| Cash and cash equivalents at end of year                                          |   | $                                             | 1,952,432 |   | $ | 1,699,822 |   |
|                                                                              |   |                                          |      |   |   |
| Supplemental disclosure of cash flow information:                                 |   |                                          |      |   |   |
| Cash paid for interest                                                            |   | $                                             | 255,125   |   | $ | 365,126 |   |

 

See Notes toConsolidated Financial Statements

 

6

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## **NORTHERN STAR FINANCIAL, INC AND SUBSIDIARY**

## **NOTES TO CONDENSEDCONDOLIDATED FINANCIAL STATEMENTS**

**September 30, 2003 (Unaudited)**

 

Note 1:  PRINCIPLES OF CONSOLIDATION

 

The unaudited consolidated financial statements as ofand for the three-month period ended September 30, 2003 include theaccounts of Northern Star Financial, Inc. (the “Company”) and its wholly ownedsubsidiary Northern Star Bank (the “Bank”). All significant inter-company accounts and transactions have been eliminatedin consolidation.

 

Note 2:  BASIS OF PRESENTATION

 

The accompanying unaudited interim consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America for interimfinancial information.  Accordingly,they do not include all information and disclosures required by generallyaccepted accounting principles for complete financial statements.  The accompanying consolidated financialstatements do not purport to contain all the necessary financial disclosuresrequired by generally accepted accounting principles that might otherwise bynecessary in the circumstances and should be read with the fiscal 2003consolidated financial statements and notes of Northern Star Financial, Inc.and Subsidiary included in their annual report as of and for the year endedJune 30, 2003.

 

In the opinion of management, all adjustments(consisting of normal recurring accruals) considered necessary for fairpresentations have been included.  Theresults of operations for three month periods ended September 30, 2003 and2002, are not necessarily indicative of the results that may be expected forthe entire fiscal year or any other interim period.

 

Note 3:  EARNINGS PER SHARE

 

The earnings per share amounts were computed using theweighted average number of shares outstanding during the periodspresented.  For the three-month periodsending September 30, 2003 and 2002 the weighted average number of sharesoutstanding for basic and diluted earnings per share computation were 520,539and 479,506, respectively. As of September 30, 2003 and 2002 of thepotential common shares of 320,094 and 283,383 respectively, related to stockoptions, warrants, and convertible subordinated notes payable, 313,994 and 277,883,respectively, were exercisable and anti-dilutive.

 

During the quarters ended September 30, 2002 and2003, there were no options granted.

 

7

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Note 4:  COMPREHENSIVE INCOME (LOSS)

 
|                                                                    |   | **For the Three Months  Ended September 30,** |   |
|-------------------------------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                    |   | **2003**                                      |   | **2002** |   |
| Accumulated comprehensive income (loss) in composted  of the following: |   |                                          |   |   |   |
|                                                                    |   |                                          |   |   |   |
| Unrealized gains (losses) on securities                                 |   |                                          |   |   |   |
| Beginning balance                                                       |   | $                                             | 52,015 |   | $ | 52,728 |   |
| Current-period change net of tax                                        |   | (23,883                                       | )      | 3,146 |   |
| Ending balance                                                          |   | $                                             | 28,132 |   | $ | 55,874 |   |
|                                                                    |   |                                          |   |   |   |
| Comprehensive income (loss) consists of the  following:                 |   |                                          |   |   |   |
| Net income (loss)                                                       |   | $                                             | 66,145 |   | $ | (39,226 | ) |
| Other comprehensive income (loss)                                       |   | (23,883                                       | )      | 3,146 |   |
| Comprehensive income (loss)                                             |   | $                                             | 42,262 |   | $ | (36,080 | ) |

 

Note 5:  STOCK OPTION ACCOUNTING

The Company accounts forstock options under the intrinsic value method of recognition and measurementprinciples of APB Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations.  Nostock-based employee compensation cost is reflected in net income (loss), asall options granted under those plans had an exercise price equal to the marketvalue of the underlying common stock on the date of the grant.  Statement of Financial Accounting StandardsNo. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure*, iseffective for the interim period beginning after December 15, 2002 andrequires pro-forma net income (loss) and earnings (loss) per share disclosureson a quarterly basis.  The followingtable illustrates the effect on net income (loss) and earnings (loss) per shareas if the Company had applied the fair value recognition provision of FASBStatement No. 123, *Accounting for Stock Based Compensation*,to stock-based employee compensation.

 
|                                                                                                                                      |   | **Three Months  Ended September 30,** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                                                                                      |   | **2003**                              |   | **2002** |   |
| Net income (loss), as reported                                                                                                            |   | $                                     | 66,145 |   | $ | (39,226 | ) |
| Deduct:                                                                                                                                   |   |                                  |   |   |   |
| Total stock-based employee compensation expense  determined under the fair value based method for all awards, net of related  tax effects |   | 1,726                                 |   | — |   |
|                                                                                                                                      |   |                                  |   |   |   |
| Pro-forma net income (loss)                                                                                                               |   | $                                     | 64,419 |   | $ | (39,226 | ) |
|                                                                                                                                      |   |                                  |   |   |   |
| Earnings (loss) per share:                                                                                                                |   |                                  |   |   |   |
| Basic, as reported                                                                                                                        |   | $                                     | 0.13   |   | $ | (0.08 | ) |
| Basic, pro-forma                                                                                                                          |   | $                                     | 0.12   |   | $ | (0.08 | ) |
| Diluted, as reported                                                                                                                      |   | $                                     | 0.13   |   | $ | (0.08 | ) |
| Diluted, pro-forma                                                                                                                        |   | $                                     | 0.12   |   | $ | (0.08 | ) |
|                                                                                                                                      |   |                                  |   |   |   |
| Basic Shares                                                                                                                              |   | 520,539                               |   | 479,506 |   |
| Diluted Shares                                                                                                                            |   | 520,539                               |   | 479,506 |   |

 

8

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Note 6:  CONTINGENCIES

 

The Federal DepositInsurance Corporation (FDIC) conducted its annual Safety and SoundnessExamination of the Bank during the first quarter of 2004 and has issued itsreport thereon. This report specifies a variety of financial and operationalactions to be taken by the Bank, some of which the Bank does not concur withand, as a result, is exploring the possibility of appealing the results of theexamination. The ultimate resolution of these matters and their effects on thefinancial statements, if any, cannot be determined at this time. While the occurrenceof a material loss in connection with the requirements of the FDIC in thisregard is a reasonable possibility, management anticipates that it is unlikelythat such a loss will occur.

 

 

**ITEM 2:  MANAGEMENT’S DISCUSSION AND ANALYSISOR PLAN OF OPERATION**

NorthernStar Financial, Inc. is the bank holding company of Northern Star Bank (the“Bank”).  Since the principal businessof the Company is the Bank, the following discussion pertains mainly to theBank.

 

Thefollowing is management’s discussion and analysis of the major factors thatinfluenced the financial performance of the Bank for the three months endedSeptember 30, 2003.  This analysis should be read in conjunction withthe Company’s 2003 Annual Report as filed on form 10KSB and with the unauditedfinancial statements and notes as set forth in this report.

 

Certain statements contained in this Report, including,without limitation, statements containing the words “believes”, “anticipates”,“intends”, “expects”, and words of similar import, constitute “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934.  Suchforward looking statements involve known and unknown risks, uncertainties andother factors that may cause the actual results, performance or achievements ofthe Company to be materially different from any future results, performance orachievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic andbusiness conditions in those areas in which the Company operates, demographicchanges, competition, fluctuations in interest rates, changes in businessstrategy or development plans, changes in governmental regulation, credit quality,the availability of capital to fund the expansion of the Company’s business,economic, political and global changes. The Company disclaims any obligation to update any such factors or topublicly announce the results of any revisions to any of the forward-lookingstatements contained herein to reflect future events or developments.

 

This discussion should beread in conjunction with the financial statements of the Company, including thenotes thereto, appearing elsewhere in this report.

 

### **CRITICAL ACCOUNTINGPOLICIES**

 

We have adoptedaccounting principles generally accepted in the United States of America (GAAP)in the preparation of our financial statements.  The financial information contained within our financialstatements is, to a significant extent, based on approximate measures of thefinancial effects of transactionsand events that have already occurred. Our significant accounting policies are described in the notes to theconsolidated financial statements at June 30, 2003 as filed in our annualreport on Form 10-KSB. Certain accounting policies involve significantjudgments and assumptions by us and have a material impact on the carryingvalue of certain assets and liabilities. We consider these accounting policiesto be critical accounting policies. The judgments and assumptions we use arebased on the historical experience and other factors, which we believe to bereasonable under the circumstances. Because of the nature of the judgments andassumptions we make, actual results could differ from these judgments andestimates which could have a major impact on our carrying values of assets andliabilities and on our results of operations. A variety of factors could affectthe

 

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ultimate value that is obtained either when earning income, recognizingan expense, recovering an asset or relieving a liability. In certain instances,the Company uses the discount factor and prepayment assumptions to determinethe present value of assets and liabilities. A change in the discount factor orprepayment spreads could increase or decrease the values of those assets andliabilities which would result in either a beneficial or adverse impact to theCompany’s financial results.  Otherestimates that the Company used are related to the expected useful lives of theCompany’s depreciable assets. In addition GAAP itself may change from onepreviously acceptable method to another method. Although the economics of theCompany’s transactions would be the same, the timing of events that wouldimpact the Company’s transactions could change.

 

The Company accounts forits stock based awards using the intrinsic value method in accordance withAccounting Principles Board (APB) Opinion No. 25 and related interpretations.Since the Company’s stock option plans provide for the issuance of options at aprice of no less than the fair market value at the date of the grant, nocompensation expense has been recognized in the financial statements at thedate of grant.

 

We believe the allowancefor loan losses is a critical accounting policy that requires the mostsignificant judgments and estimates used in preparation of our consolidatedfinancial statements.  The allowance forprobable loan losses is an estimate of the losses that may be sustained in theCompany’s loan portfolio. The allowance is based on two basic principles ofaccounting. (1) Statement of Financial Accounting Standards (SFAS) No. 5 *Accounting for Contingencies*, whichrequires that losses be accrued when they are probable of occurring andestimable and (2) SFAS No. 114, *Accountingby Creditors for Impairment of a Loan*, which requires that losses beaccrued based on the differences between the value of collateral, present valueof future cash flows or values that are observable in the secondary market andthe loan balance.

 

**RESULTS OF OPERATIONS**

 

**Net Income**

Net income increased to$66,145 for the three months ended September 30, 2003 compared to a lossof $39,226 for the three months ended September 30, 2002, and a net lossof $232,816 for the fiscal year ended June 30, 2003.  Basic anddiluted earnings per share were $0.13 and $(0.08) for the three months endedSeptember 30, 2003 and 2002, respectively, and $(0.47) at fiscal yearending June 30, 2003.   The increase in net income fromSeptember 30, 2002 to September 30, 2003 was mainly due to theincreases in gain on sale of loans and in net interest income, which werepartially offset by increases in other operating expenses.  Net interestincome increased due to an increase in net interest margin.  Non-interest income increased due to anincrease in the amount of residential mortgage loans originated and sold intothe secondary market.  Non-interestexpenses increased during the three months ended September 30, 2003 duethe to the indirect cost incurred in connection with the increase in the amountof residential mortgage loans originated and sold.

 

Thereturn on average equity was 3.28% for the three months endedSeptember 30, 2003 compared to (2.06)% for the three months endedSeptember 30, 2002.  Return on average assets

 

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for the three months ended September 30,2003 was 0.13% compared to (0.08)% for the three months endedSeptember 30, 2002.  The return on average equity was (12.13)% forfiscal year ended June 30, 2003.  The increase in the return onaverage assets from September 30, 2002 to September 30, 2003 was dueto the increase in net income noted above, which is the result of the 13.97%growth in net interest income combined with a 88.81% increase in non-interestincome, which was partially offset by the 16.43% increase in non-interestexpense.

 

**Interest Income**

Netinterest income is a significant component of the Bank’s income fromoperations.  Net interest income is the difference between the grossinterest earned on the loan and investment portfolios and the interest paid ondeposits and other borrowings.  Net interest income depends on the volumeof and interest rate earned on interest earning assets and the volume of andinterest rate paid on interest bearing liabilities.

 

Interestincome for the three months ended September 30, 2003 decreased to$698,594, compared to $743,537 for the three months ended September 30,2002.  The decrease in interest income was due to an increase of $1.27million in the level of interest earning assets offset by a decrease in therates of interest received on interest earnings assets.  Interest earning assets include loanreceivables, securities available for sale and federal funds sold.  The decrease in interest income was morethan offset by decreases in interest expense on deposits and borrowed funds.Our net interest margin improved 39 basis points to 3.36% for the three monthsended September 30, 2003 from a margin of 2.97% for the three months endedSeptember 30, 2002 despite a decline of 44 basis points in the yield oninterest earning assets.  The yield oninterest earning assets decreased to 6.07% for the three months ended September 30,2003 compared to 6.51% for the three months ended September 30, 2002.

 

#### **InterestExpense**

Interestexpense for the three months ended September 30, 2003 decreased to$312,193 compared to $404,486 for the three months ended September 30,2002.  This decrease was due to a lower level of interest rates oninterest bearing liabilities that resulted from and was aided by an initiativeundertaken by the Company to reduce its average cost of funds.  Due to thedecline in the rates of interest paid by the Bank, the cost of depositsdeclined from 3.61% for the three months ended September 30, 2002 to 2.54%for the three months ended September 30, 2003.  Notes payable andother borrowings of $5.98 million remained unchanged from the prior period endwith a cost of 3.14% for the three months ended September 30, 2003,compared to a cost of 3.54% at the fiscal year ended June 30, 2003.  Average interest-bearing deposits decreasedto $37.04 million for the three months ended September 30, 2003 comparedto $35.87 million for the three months ended September 30, 2002.  AtSeptember 30, 2003, the interest cost on interest bearing depositsdecrease to 2.54% from 3.61%, at September 30, 2002, an improvement of 107basis points.

 

**Net Interest Income Before Provisionfor Estimated Loan Losses**

Netinterest income before provision for estimated loan losses for the three monthsended September 30, 2003 was $386,401, compared to $339,051 for the threemonths ended September 30, 2002.  Average interest earning assetswere $46.04 million for the three months ended September 30, 2003 with ayield of 6.07% compared to $45.66 million with a yield of 6.51% for

 

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the three months ended September 30, 2002.

 

**Provision for Estimated Loan Losses**

Theprovision for estimated loan losses totaled $15,200 for the three months endedSeptember 30, 2003 compared to $21,000 for the three months endedSeptember 30, 2002.  The provision for estimated loan losses totaled$373,937 for the fiscal year ended June 30, 2003.  During the fiscal year ended June 30,2003, the Bank made a $287,114 provision for loan losses associated withmanagement’s assessment of the risk of loss inherent on a commercial loan withan outstanding balance of approximately $600,000.

 

**Other Operating Income**

Otheroperating income represents non-interest types of revenue and is comprised ofnet gain on sale of loans, loan servicing fees, customer service charges andother fee income.  Other operatingincome was $289,324 for the three months ended September 30, 2003 comparedto $153,236 for the three months ended September 30, 2002.

 

TheBank’s current policy is to sell in the secondary market all residentialmortgage loans with a fixed interest rate and with a re-pricing term of morethan five years.  Mortgage loansoriginated and intended for sale are carried at the lower of cost or estimatedmarket value in the aggregate.  Gains onthe sale of loans are based on the net proceeds received and the recordedinvestment in the loan.  Net gain onsale of loans increased from $105,686 for the three months endedSeptember 30, 2002 to $223,516 for the three months endedSeptember 30, 2003.  Net gain on sale of loans for the fiscal yearended June 30, 2003 was $865,581.

 

Duringthe three months ended September 30, 2003, the Bank originated for sale$14.67 million in residential mortgage loans compared to $7.40 million duringthe three months ended September 30, 2002.  The Bank sold 100%, ofthe residential real estate loans originated during the three-month periodsended September 30, 2003 and September 30, 2002.  Based uponcurrent forecasts of interest rates, management anticipates that the Bank’svolume of residential mortgage lending is likely to fall appreciably during thesecond quarter of the current fiscal year.

 

Otherfee income and service charges increased from $44,425 for the three monthsended September 30, 2002 to $52,048 for the three months endedSeptember 30, 2003.  The increase is the result of an increase in thevolume of fees earned that are associated with current period loan fees, checkcashing and other service charges.

 

**Non-Interest Expenses**

Otheroperating expenses are non-interest types of expenses and are incurred by theCompany and the Bank in its normal course of business.  Salaries andemployee benefits, board fees, occupancy, premises and equipment, dataprocessing, professional services, and other expenses are the major categoriesof other operating expenses.  Noninterest expenses increased to $594,380for the three months ended September 30, 2003 compared to $510,513 for thethree months ended September 30, 2002.

 

The increase in other operating expenses isprimarily due to the increase in salaries and employee benefits to $276,704 forthe three months ended September 30, 2003 compared to

 

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$221,705 for the three months ended September 30,2002.  As a result of the increased loan origination, commissions andincentives paid to the Bank’s residential mortgage lenders have increased by$27,512 when comparing the quarter ended September 30, 2003 toSeptember 30, 2002.  Additionally, the number of full time equivalentemployees increased to 19 as of September 30, 2003 compared to 18 as ofSeptember 30, 2002.

 

**Provision for Income Taxes**

Theeffective income tax rate for the Company was 0% for the three months endedSeptember 30, 2003 because the tax liability of the net operating profitwas eliminated by a deferred tax asset valuation allowance in accordance withgenerally accepted accounting principles. The Company’s deferred tax assets have been reduced to $0 by a valuationaccount due to the uncertainty of the Company’s ability to make use of theunderlying net operating loss carry forwards.

 

**FINANCIAL CONDITION**

**Summary of Changes in ConsolidatedBalance Sheets**

**September 30, 2003 compared toSeptember 30, 2002 and June 30, 2003**

 

Totalassets of the Bank increased to $49.65 million as of September 30, 2003compared to $48.80 million as of September 30, 2002. Total assets of theBank decreased $1.61 million or 3.13% when compared to the $51.25 million as ofJune 30, 2003.  Management attributes the decrease in total assetsoccurring during the three-month period ended September 30, 2003 to thelower level of loans held for sale resulting from a reduction in the volume ofresidential mortgage lending activity associated with refinancing activity inits market.

 

Totaldeposits decreased to $39.62 million as of September 30, 2003 compared to$40.00 million of September 30, 2002. Total deposits decreased $1.81 million when comparing the quarter endingSeptember 30, 2003 with the previous fiscal year end June 30,2003.  Cash and cash equivalents increased to $1.95 million as ofSeptember 30, 2003 compared to $1.70 million as of September 30, 2002but declined $425 thousand when compared to the $2.38 million held as ofJune 30, 2003.

 

Stockholders’equity was $2.08 million as of September 30, 2003 compared to $1.89million as of September 30, 2002 and $1.91 million as of June 30,2003.

 

**Investments**

The Bank’s investmentportfolio consists primarily of securities issued by agencies of the UnitedStates and overnight investments in the Federal Funds market. US Governmentagency securities, mortgaged back securities, and corporate bonds totaled $5.06million as of September 30, 2003 compared to $6.28 million as ofSeptember 30, 2002 and were $6.11 million as of June 30,2003. Federal Funds sold totaled $3.86 million as of September 30,2003 compared to $3.33 million as of September 30, 2002 and were $0.48 millionas of June 30, 2003.  Totalinvestments held in the Bank’s investment portfolio was $8.91 atSeptember 30, 2003 and $6.60 million as of the fiscal year endedJune 30, 2003, not including securities held for trading.  Management attributes the fluctuations inthe investment portfolio during the periods to timing differences associatedwith securities maturing and reinvesting activities as well as to the level ofloans held

 

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for sale.

 

**Loans**

Loanbalances, net of the allowance for loan losses, increased to $36.33 million asof September 30, 2003 compared to $34.50 million as of September 30,2002.  However, loan balances, net ofthe allowance for loan losses, decreased $2.52 million as of September 30,2003 from $38.85 million as of June 30 2003. The decrease in loanbalances is attributed to the management’s effort to improve net interestmargin.

 

**Non-performing Assets.**

Nonperformingassets consist of nonperforming loans and other real estate owned (“OREO”) andother repossessed assets.  Nonperforming loans are those loans which have(i) been placed on nonaccrual status, (ii) been subject to troubled debtrestructurings, or (iii) become contractually past due 90 days or more withrespect to principal or interest and have not been restructured or placed onnonaccrual status.  AtSeptember 30, 2003, the Bank had $1.72 million in non-performing assetscompared to $2.00 million at September 30, 2002, and $1.85 million atJune 30, 2003.

 

**Nonaccrual Loans.**

Nonaccrualloans are impaired loans where the original contractual amount may not be fullycollectible.  The Bank measures its impaired loans by using the fair valueof the collateral if the loan is collateral-dependent and the present value ofthe expected future cash flows discounted at the loan’s effective interest rateif the loan is not collateral-dependent.  The Bank places loans onnonaccrual status that are delinquent 90 days or more or when a reasonabledoubt exists as to the collectibility of all payments due under the terms ofthe loan.  As of September 30, 2003and June 30, 2003, the Bank had nine loans on nonaccrual status totaling$1.85 million.  As of September 30, 2002, the Bank had seven loans onnonaccrual status totaling $1.81 million.

 

**Classified Assets.**

Fromtime to time, management has reason to believe that certain borrowers will notrepay their loans within the parameters of the present repayment terms, eventhough, in some cases, the loans are current at the time. These loans aregraded in the classified loan grades of “substandard,” “doubtful,” or “loss”and include non-performing loans.  Each classified loan is monitoredmonthly.  Classified assets (consisting of nonaccrual loans, loans gradedas substandard or lower and other repossessed assets) at September 30,2003 were $2.95 million compared to $2.03 million as of September 30, 2002and were $1.85 million at June 30, 2002.

 

**Allowance for Loan Losses.**

TheBank has established a methodology for the determination of provisions for loanlosses.  The methodology is set forth in a formal policy and takes intoconsideration the need for an overall allowance for loan losses as well asspecific allowances that are tied to individual loans.  The Bank’smethodology for assessing the appropriateness of the allowance consists ofseveral key elements, which include the formula allowance and a specificallowance for identified problem loans.

 

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Inoriginating loans, the Bank recognizes that losses will be experienced and thatthe risk of loss will vary with, among other things, the type of loan beingmade, the creditworthiness of the borrower over the term of the loan, generaleconomic conditions and, in the case of a secured loan, the quality of thecollateral securing the loan.  The allowance is increased by provisionscharged against earnings and reduced by net loan charge-offs.  Loans arecharged off when they are deemed to be uncollectable, or partially charged offwhen portions of a loan are deemed to be uncollectable.   Recoveriesare generally recorded only when cash payments are received.

 

Theallowance for loan losses is maintained to cover losses inherent in the loanportfolio.  The responsibility for the review of the Bank’s assets and thedetermination of the adequacy of the general valuation allowance lies with theDirector’s Loan Committee.  This committee assigns the loss reserve ratiofor each type of asset and reviews the adequacy of the allowance at leastquarterly based on an evaluation of the portfolio, past experience, prevailingmarket conditions, amount of government guarantees, concentration in loan typesand other relevant factors.  Specific valuation allowances are establishedto absorb losses on loans for which full collectability may not be reasonablyassured.  The amount of the specific allowance is based on the estimatedvalue of the collateral securing the impaired loans and other analysespertinent to each situation.  Estimates of identifiable losses arereviewed continually and, generally, a provision for losses is charged againstoperations on a monthly basis as necessary to maintain the allowance at anappropriate level.  Management presents an analysis of the allowance forloan losses to the Bank’s Board of Directors on a quarterly basis.

 

The Director’s LoanCommittee meets quarterly to review and monitor conditions in the portfolio andto determine the appropriate allowance for loan losses.  To the extentthat any of these conditions areevidenced by identifiable problem credit or portfolio segment as of theevaluation date, the committee’s estimate of such condition may be reflected asa specific allowance applicable to such credit or portfolio segment.  Byassessing the probable estimated losses inherent in the loan portfolio on aquarterly basis, the Bank is able to adjust specific and inherent lossestimates based upon the most recent information that has become available.

 

Asof September 30, 2003, the balance in the allowance for loans losses was$812,505 compared to $680,786 as of September 30, 2002 and $1,029,692 asof June 30, 2003. The allowance for loan losses as a percentage oftotal loans was 2.19% as of September 30, 2003 compared to 1.94% as ofSeptember 30, 2002 and 2.58% as of June 30, 2003.  Managementbelieves the allowance at September 30, 2003 is adequate based upon itsongoing analysis of the loan portfolio, historical loss trends, generaleconomic conditions and other factors.

 

**Deposits and Borrowings**

Totaldeposits decreased to $39.62 million as of September 30, 2003 compared to$40.00 million as of September 30, 2002 and $41.43 million as ofJune 30, 2003.  Interest bearing and non-interest bearing depositsincreased to $36.29 million and $3.33 million, respectively, as ofSeptember 30, 2003 compared to $35.51 million and $4.49 million,respectively, as of September 30, 2002 and $36.34 million and $5.09million, respectively, as of June 30, 2002.  The decrease in depositwas the result of management’s efforts to decrease the Bank’s cost of funds andwas accompanied by a decrease in the level of residential mortgage loansoriginated and held for sale.

 

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Otherborrowings totaled $5.98 million as of September 30, 2003 andJune 30, 2003, compared to $4.98 million as of September 30,2002.  Included in other borrowings are advances from the FHLB and otherbanks.  The Bank established a line of credit with the FHLB collateralizedby loans and securities.  Funds from the credit line were used to purchasegovernment securities and increase liquidity at the Bank.

 

Inaddition to the FHLB advances, other lines of credit are utilized to increasecapital at the Bank.  The Companyborrowed $600,000 from an unaffiliated lender and contributed the proceeds tothe equity capital of the Bank. In addition, the Company has issued $1.60million of unsecured subordinated notes payable, the proceeds of which was usedto provide equity capital to the Bank and to pay the operating expenses of theCompany.  The holders of the unsecurednotes have the right to convert at any time prior to maturity all or any partof the notes into shares of common stock of the Company at the conversionrate.  The conversion rate is adjustedif the number of shares changes.

 

**Capital**

TheCompany’s capital increased to $4.51 million as of September 30, 2003compared to $4.16 million as of September 30, 2002 and was $4.38 millionas of June 30, 2003.  The increase in capital, net of operatingresults from June 30, 2003 to September 30, 2003, was due to theissuance of 23,000 shares of common stock for $126,500.

 

InAugust 2003, the Board of Director’s authorized the sale of up to 700,000shares of stock at $6.00 per share with the proceeds to be used for operatingexpenses and additional capital.

 

Managementconsiders capital requirements as part of its strategic planning process. Based on current projections, management believes that the Bank will continueto remain well capitalized during 2003.  Future asset growth is dependentupon many factors, including the Bank’s access to capital markets, earningsgrowth, and overall economic conditions.  The ability to obtain capital isdependent upon the capital markets as well as performance of the Bank. Management regularly evaluates sources of capital and the timing required toaccomplish its strategic objectives.

 

AtSeptember 30, 2003 and September 30, 2002, all capital ratios wereabove all current Federal capital guidelines for a “well capitalized”bank.   As of September 30, 2003, the Bank’s regulatory Totalcapital to risk-weighted assets ratio was 12.67% compared to 12.16% as ofSeptember 30, 2002 and 11.60% as of June 30, 2003.  The Bank’sregulatory Tier 1 capital to risk-weighted assets ratio was 11.41% as ofSeptember 30, 2003 compared to 10.91% as of September 30, 2002 and10.33% as of June 30, 2003.  The Bank’s regulatory Tier 1 Capital toaverage assets ratio was 8.29% as of September 30, 2003 compared to 8.01%at September 30, 2003 and 8.04% at June 30, 2003.

 

**Dividends**

Whetheror not the Board of Directors will determine stock dividends or any cashdividends will be paid in the future depends upon their consideration ofvarious factors.  The Company’s and the Bank’s profitability andregulatory capital ratios in addition to other financial

 

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conditions will be key factors considered by theBoard of Directors in making such determinations regarding the payment ofdividends. There are state and federal statutory and regulatory requirementslimiting the amount of dividends that may be paid to the Company by ourBank.  Generally, a bank may pay cashdividends out of current operating earnings to the extent that the current rateof earnings retention is consistent with our Bank’s capital needs, assetquality, and overall financial condition. The governing regulatory agency has the authority to prohibit our Bankfrom engaging in business practices that the governing authority considers tobe unsafe or unsound.  It is possible,depending upon the financial condition of our Bank, that the governingregulatory agency may determine that the payment of dividends to the Company byour Bank might, under some circumstances, be such an unsafe and unsoundpractice.  Neither the Companynor the Bank has plans to pay any cash dividends to its stockholders in theforeseeable future.

 

**Liquidity and Interest Rate Risk**

TheBank utilizes electronic data processing modeling software for liquidity,asset/liability management, and budget modeling calculation and analysis.  Our use of these data processingapplications enable us to effectively identify, measure, monitor and controlour exposure to risk and help grow earnings.

 

TheBank closely monitors its liquidity so that the cash requirements for loans anddeposit withdrawals are met in an economical manner.  Management monitorsliquidity in relation to trends of loans and deposits for short term andlong-term requirements.  Liquidity sources are cash, deposits with otherbanks, overnight Federal Funds investments, un-pledged investment securities, andthe ability to sell loans. As of September 30, 2003 liquid assets asa percentage of deposits were 14.23% compared to 15.58% as ofSeptember 30, 2002. Liquidity risk represents the potential forloss as a result of limitations on the Company’s ability to adjust for futurecash flows, to meet the needs of depositors and borrowers, and to fundoperations on a timely and cost-effective basis. The Bank’s liquidity policyrequires monthly review of the Bank’s liquidity by the board of directors.

 

The Bank had a negative cumulative one yeargap of $4.33 million, or 8.72% of total assets, at September 30, 2003. Intheory, this would indicate that more liabilities than assets would re-price ifthere were a change in interest rates over the next year. If interest rateswere to increase, the negative gap would tend to result in a lower net interestmargin, conversely if interest rates were to decline, the negative gap wouldtend to result in a higher net interest margin. However, changes in the mix ofearning assets or supporting liabilities can either increase or decrease thenet interest margin without affecting interest rate sensitivity. Thischaracteristic is referred to as a basis risk and, generally, relates to there-pricing characteristics of certain short-term funding sources.

 

Interestrate changes do not affect all categories of assets and liabilities equally orat the same time. Varying interest rate environments can create unexpectedchanges in prepayment levels of assets and liabilities, which may have asignificant effect on the net interest margin and are not reflected in theinterest sensitivity analysis table. Because of these factors, an interestsensitivity gap report may not provide a complete assessment of the exposure tochanges in interest rates. To supplement traditional gap analysis, the Companyperforms simulation

 

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modeling to estimate the potential effects of changing interest rateenvironments. The process allows the Company to explore the complexrelationships within the gap over time and various interest rate environments.

 

The Company’s internalasset/liability committee and the finance and investment committee of the Boardof Directors each meet monthly tomonitor the Company’s investments, liquidity needs and to oversee itsasset/liability management. The Company evaluates the rates offered on itsdeposit products on a weekly basis.

 

**AVERAGE BALANCES, YIELDS AND RATES**

Thefollowing table sets forth, for the three month periods ended September 30,2003 and 2002, the weighted average yields or earned, the weighted averagerates paid, the interest rate spread and the net yield on earning assets andinterest-bearing liabilities, on an annualized basis.

 
|                                                                              |   | **For the Three Months Ended** |       |
|-----------------------------------------------------------------------------------|--------|--------------------------------|------------|
|                                                                              |   | **September 30, 2003**         |       | **September 30, 2002** |   |
|                                                                              |   | **Average  Balance**           |       | **Interest** |   | **Average  Yield or  Rates Paid** |   | **Average  Balance** |   | **Interest** |   | **Average  Yield or  Rates Paid** |   |
| **Assets**                                                                        |   |                           |       |   |   |   |   |   |   |   |   |   |   |
| Loans receivable                                                                  |   | $                              | 37,175,654 |   | $ | 640,300 |   | 6.89 | % | $ | 35,091,506 |   | $ | 635,156 |   | 7.24 | % |
| Investment securities                                                             |   | 5,683,303                      |       | 51,115 |   | 3.60 | % | 7,993,644 |   | 97,276 |   | 4.87 | % |
| Federal funds sold                                                                |   | 3,180,478                      |       | 7,179 |   | 0.90 | % | 2,578,245 |   | 11,105 |   | 1.72 | % |
| Total interest-earning assets                                                     |   | 46,039,435                     |       | 698,594 |   | 6.07 | % | 45,663,395 |   | 743,537 |   | 6.51 | % |
| Non-interest-earning assets                                                       |   | 4,736,500                      |       |   |   |   |   | 3,375,144 |   |   |   |   |   |
| Total assets                                                                      |   | $                              | 50,775,935 |   |   |   |   |   | $ | 49,038,539 |   |   |   |   |   |
| **Liabilities and  Stockholders’ Equity**                                    |   |                           |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing deposits                                                         |   | $                              | 37,038,738 |   | 234,846 |   | 2.54 | % | $ | 35,866,133 |   | 323,303 |   | 3.61 | % |
| Other liabilities                                                                 |   | 7,575,000                      |       | 77,347 |   | 4.08 | % | 6,732,860 |   | 81,183 |   | 4.82 | % |
| Total interest-bearing liabilities                                                |   | 44,613,738                     |       | 312,193 |   | 2.80 | % | 42,598,993 |   | 404,486 |   | 3.80 | % |
| Non-interest-bearing liabilities                                                  |   | 4,016,781                      |       |   |   |   |   | 4,540,375 |   |   |   |   |   |
| Total liabilities                                                                 |   | 48,630,519                     |       |   |   |   |   | 47,139,368 |   |   |   |   |   |
| Stockholders’ Equity                                                         |   | 2,145,416                      |       |   |   |   |   | 1,899,171 |   |   |   |   |   |
| Total liabilities and stockholders’ equity                                   |   | $                              | 50,775,935 |   |   |   |   |   | $ | 49,038,539 |   |   |   |   |   |
| Net interest spread                                                               |   |                           |       |   |   | 3.27 | % |   |   |   |   | 2.71 | % |
| Net interest income/margin                                                        |   |                           |       | $ | 386,401 |   | 3.36 | % |   |   | $ | 339,051 |   | 2.97 | % |
| Ratio of average interest-earning assets to  average interest-bearing liabilities |   | 1.03                           | x          |   |   |   |   | 1.07 | x |   |   |   |   |

 

**INVESTMENT PORTFOLIO**

AtSeptember 30, 2003, our available for sale investments securitiesportfolio represented approximately 11.12% of our interest earning assets of$45.24 million.  We also heldinvestments in stock of the Federal Home Loan Bank and United Bankers Bank inthe amount of $367,100, and securities held for trading in the amount of$113,696, which is not included in the tables below.  The securities are listed at fair value.

 

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|                                 |   | **September 30, 2003** |       | **June 30, 2003** |       |
|--------------------------------------|--------|------------------------|------------|-------------------|------------|
|                                 |   |                   | ** ** |              | ** ** |
| U.S. Agencies                        |   | $                      | 1,977,111  |              | $          | 2,266,739 | ** ** |
| Mortgage-back securities             |   | 2,551,094              |       | 3,318,430         | ** ** |
| Corporate bonds                      |   | 527,927                |       | 527,919           | ** ** |
| Total securities available  for sale |   | $                      | 5,056,132  |              | $          | 6,113,088 | ** ** |

 

Contractualmaturities and yields on the Company’s available for sale investments aresummarized in the following table. Expected maturities may differ from contractual maturities becauseissuers may have the right to call or prepay obligations with our without callor prepayment penalties.

 
|                     |   | **September  30, 2003** |   |
|--------------------------|--------|-------------------------|--------|
|                     |   | **One  Year  or Less**  |   | **Yield** |   | **After  one  year thru  five years** |   | **Yield** |   | **After  five  years thru  ten years** |   | **Yield** |   | **After  10  years** |   | **Yield** |   | **Total** |   | **Yield** |   |
|                     |   |                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Agencies            |   | $                       | — |   | 0.00 | % | $ | 989,688 |   | 3.34 | % | $ | 500,548 |   | 3.99 | % | $ | 486,875 |   | 4.02 | % | $ | 1,977,111 |   | 3.67 | % |
| Mortgage-back securities |   | —                  |   | 0.00 | % | 308,839 |   | 3.65 | % | 1,138,419 |   | 5.14 | % | 1,103,836 |   | 6.08 | % | 2,551,094 |   | 5.37 | % |
| Corporate bonds          |   | —                  |   | 0.00 | % | 527,927 |   | 6.06 | % | — |   | 0.00 | % | — |   | 0.00 | % | 527,927 |   | 6.06 | % |
|                     |   | $                       | — |   | 0.00 | % | $ | 1,826,454 |   | 4.18 | % | $ | 1,638,967 |   | 4.79 | % | $ | 1,590,711 |   | 5.45 | % | $ | 5,056,132 |   | 4.78 | % |

 

**LOAN PORTFOLIO**

Thefollowing table summarizes the composition of the loan portfolio.  Total gross loans including net of deferredloan fees and costs outstanding at September 30, 2003 and June 30,2002 were $37,145,983 and $39,881,709, respectively.  This table excludes loans held for sale as of September 30,2003 and June 30, 2003 of $945,676 and $2,035,176, respectively.  Loans held for sale are comprised of realestate mortgages.

 
|                            |   | **September  30, 2003** |       | **June  30, 2003** |   |
|---------------------------------|--------|-------------------------|------------|--------------------|--------|
|                            |   | **Amount**              |       | **%  of Total**    |   | **Amount** |   | **%  of Total** |   |
| Commercial &  agricultural  |   | $                       | 6,814,450  |               | 18.40  | % | $ | 6,979,307 |   | 17.55 | % |
| Real estate - construction      |   | 3,088,041               |       | 8.34               | %      | 4,433,072 |   | 11.15 | % |
| Real estate - mortgages         |   | 18,312,122              |       | 49.44              | %      | 18,504,208 |   | 46.52 | % |
| Consumer loans                  |   | 8,791,955               |       | 23.74              | %      | 9,821,027 |   | 24.69 | % |
| Lease financing                 |   | 34,447                  |       | 0.08               | %      | 35,673 |   | 0.09 | % |
| Total loans                     |   | $                       | 37,041,015 |               | 100.00 | % | $ | 39,773,287 |   | 100.00 | % |
| Net deferred loan  fees/(costs) |   | 104,968                 |       |               |   | 108,422 |   |   |   |
| Less: allowance for loan  loss  |   | (812,505                | )          |               |   | (1,029,581 | ) |   |   |
| Total net loans                 |   | $                       | 36,333,478 |               |   |   | $ | 38,852,128 |   |   |   |

 

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### **MATURITIESAND SENSITIVITY OF LOANS TO CHANGES IN INTEREST RATES**

Theinformation in the following table is based on the contractual maturities ofindividual loans, including loans, which may be subject to renewal at theircontractual maturity.  Renewal of suchloans is subject to review and credit approval as well as modification of termsupon maturity.  Actual repayments ofloans may differ from maturities reflected below because borrowers have theright to repay obligations with or without prepayment penalties.  The following table summarizes loanmaturities, by type at September 30, 2003 and June 30, 2003.

 
|                               |   | **As of  September 30, 2003** |       |
|------------------------------------|--------|-------------------------------|------------|
|                               |   | **One Year  or Less**         |       | **After One  but  within Five Years** |   | **After  Five Years** |   | **Total** |   |
| Commercial & agricultural      |   | $                             | 2,468,559  |   | $ | 2,668,370 |   | $ | 1,677,521 |   | $ | 6,814,450 |   |
| Real estate - construction         |   | 2,038,430                     |       | 1,049,611 |   | — |   | 3,088,041 |   |
| Real estate - mortgages            |   | 1,654,296                     |       | 11,882,544 |   | 4,775,282 |   | 18,312,122 |   |
| Consumer loans                     |   | 2,151,783                     |       | 5,657,654 |   | 982,518 |   | 8,791,955 |   |
| Lease financing                    |   | —                        |       | 34,447 |   | — |   | 34,447 |   |
| Total                              |   | $                             | 8,313,068  |   | $ | 21,292,626 |   | $ | 7,435,321 |   | $ | 37,041,015 |   |
| Loans maturing after one year with |   |                          |       |   |   |   |   |   |   |
| Fixed interest rate                |   | $                             | 27,205,514 |   |   |   |   |   |   |   |
| Floating interest rates            |   | $                             | 1,522,433  |   |   |   |   |   |   |   |

 
|                               |   | **As of  June 30, 2003** |       |
|------------------------------------|--------|--------------------------|------------|
|                               |   | **One Year  or Less**    |       | **After One  but  within Five Years** |   | **After  Five Years** |   | **Total** |   |
| Commercial & agricultural      |   | $                        | 2,613,798  |   | $ | 2,597,750 |   | $ | 1,767,759 |   | $ | 6,979,307 |   |
| Real estate - construction         |   | 3,496,939                |       | 936,133 |   | — |   | 4,433,072 |   |
| Real estate - mortgages            |   | 2,034,243                |       | 12,075,344 |   | 4,394,621 |   | 18,504,208 |   |
| Consumer loans                     |   | 2,283,747                |       | 6,678,656 |   | 858,624 |   | 9,821,027 |   |
| Lease financing                    |   | —                   |       | 35,673 |   | — |   | 35,673 |   |
| Total                              |   | $                        | 10,428,727 |   | $ | 22,323,556 |   | $ | 7,021,004 |   | $ | 39,773,287 |   |
| Loans maturing after one year with |   |                     |       |   |   |   |   |   |   |
| Fixed interest rate                |   | $                        | 27,452,321 |   |   |   |   |   |   |   |
| Floating interest rates            |   | $                        | 1,892,239  |   |   |   |   |   |   |   |

 

**PROVISIONAND ALLOWANCE FOR LOAN LOSSES**

We have developedpolicies and procedures for evaluating the overall quality of its creditportfolio and the timely identification of potential credit problems.  Additions to the allowance for loan losseswill be made periodically to maintain the allowance at an appropriate levelbased on management’s analysis of the potential risk in the loan portfolio.

 

At September 30,2003, the allowance for loan losses was $812,505, or 2.19% of $37,145,983 inloan receivables (net of loans held for sale). At June 30, 2003, the allowance for loan losses was $1,029,581, or2.58% of $39,881,709 in loan receivables (net of loans held for sale). Theprovision for loan losses was made primarily as a result of management’sassessment of impaired loans and general loan loss risk as our loan portfolioincreases.

 

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|                                                                                        |   | **Three Months Ended  September 30,2003** |      | **Year Ended  June 30, 2003** |   |
|---------------------------------------------------------------------------------------------|--------|-------------------------------------------|-----------|-------------------------------|--------|
| Balance  at beginning of period                                                             |   | $                                         | 1,029,581 |                          | $      | 661,170 |   |
| Charge-offs:                                                                                |   |                                      |      |                          |   |
| Commercial  & agricultural                                                         |   | —                                    |      | —                        |   |
| Consumer  loans                                                                             |   | (235,062                                  | )         | (14,680                       | )      |
|                                                                                        |   | (235,062                                  | )         | (14,680                       | )      |
| Recoveries:                                                                                 |   |                                      |      |                          |   |
| Commercial  & agricultural                                                              |   | 1,500                                     |      | 7,930                         |   |
| Consumer  loans                                                                             |   | 1,286                                     |      | 1,224                         |   |
|                                                                                        |   | 2,786                                     |      | 1,224                         |   |
|                                                                                        |   |                                      |      |                          |   |
| Net  charge offs                                                                            |   | (232,276                                  | )         | (5,526                        | )      |
| Provision  charged to operations                                                            |   | 15,200                                    |      | 373,937                       |   |
| Balance  at end of period                                                                   |   | $                                         | 812,505   |                          | $      | 1,029,581 |   |
|                                                                                        |   |                                      |      |                          |   |
| Ratio  of net charge-offs during the period to average loans outstanding during the  period |   | 0.59                                      | %         | 0.02                          | %      |

 

At September 30,2003 and June 30, 2003 the allowance was allocated as follows:

 
|                           |   | **September  30, 2003** |    | **June  30, 2003**                                      |   |
|--------------------------------|--------|-------------------------|---------|---------------------------------------------------------|--------|
|                           |   | **Amount**              |    | **Percent  of Loans  in Each Category  of Total Loans** |   | **Amount** |   | **Percent  of Loans  in Each Category  of Total Loans** |   |
| Commercial &  agricultural |   | $                       | 328,325 |                                                    | 18.40  | % | $ | 341,993 |   | 17.55 | % |
| Real estate - construction     |   | 17,685                  |    | 8.34                                                    | %      | 26,896 |   | 11.15 | % |
| Real estate - mortgages        |   | 153,788                 |    | 49.44                                                   | %      | 151,417 |   | 46.52 | % |
| Consumer loans                 |   | 312,449                 |    | 23.74                                                   | %      | 509,007 |   | 24.69 | % |
| Lease financing                |   | 258                     |    | 0.08                                                    | %      | 268 |   | 0.09 | % |
| Total                          |   | $                       | 812,505 |                                                    | 100.00 | % | $ | 1,029,581 |   | 100.00 | % |

 

21

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**DEPOSITS**

The following is a tableof deposits by category at September 30, 2003 and June 30, 2003.

 
|                              |   | **As of September 30, 2003** |       |
|-----------------------------------|--------|------------------------------|------------|
|                              |   | **Ending  Balance**          |       | **Percentage  of Total  Deposits** |   | **Average  Balance** |   | **Percentage  of Total  Average  Deposits** |   | **Effective  Cost** |   |
| Demand deposit                    |   | $                            | 3,332,904  |   | 8.41 | % | $ | 3,680,686 |   | 9.04 | % | 0.00 | % |
| Now and money market              |   | 8,594,903                    |       | 21.70 | % | 8,990,145 |   | 22.08 | % | 1.12 | % |
| Savings                           |   | 4,201,827                    |       | 10.61 | % | 4,222,687 |   | 10.37 | % | 1.27 | % |
| Time accounts less than $100,000  |   | 18,209,281                   |       | 45.96 | % | 18,590,187 |   | 45.65 | % | 3.33 | % |
| Time accounts of $100,000 or more |   | 5,277,614                    |       | 13.32 | % | 5,235,719 |   | 12.86 | % | 3.18 | % |
| Total deposits                    |   | $                            | 39,616,529 |   | 100.00 | % | $ | 40,719,424 |   | 100.00 | % |   |   |

 
|                              |   | **As of June 30, 2003** |
|-----------------------------------|--------|-------------------------|
|                              |   | **Ending  Balance**     |   | **Percentage  of Total  Deposits** |   | **Average  Balance** |   | **Percentage  of Total  Average  Deposits** |   | **Effective  Cost** |   |
| Demand deposit                    |   | $                       | 5,090,364 |   | 12.29 | % | $ | 4,166,918 |   | 10.40 | % | 0.00 | % |
| Now and money market              |   | 8,623,932               |   | 20.82 | % | 8,676,758 |   | 21.66 | % | 1.72 | % |
| Savings                           |   | 4,630,763               |   | 11.18 | % | 4,530,948 |   | 11.31 | % | 1.70 | % |
| Time accounts less than $100,000  |   | 18,021,479              |   | 43.50 | % | 18,096,268 |   | 45.17 | % | 3.98 | % |
| Time accounts of $100,000 or more |   | 5,062,172               |   | 12.21 | % | 4,587,528 |   | 11.46 | % | 4.02 | % |
| Total deposits                    |   | $                       | 41,428,710 |   | 100.00 | % | $ | 40,058,420 |   | 100.00 | % |   |   |

 

Maturitiesdistribution of time deposits of $100,000.00 and over and time deposits of lessthan $100,000 is as follows:

 
|                              |   | **September  30, 2003** |      |
|-----------------------------------|--------|-------------------------|-----------|
|                              |   | **3 months  or less**   |      | **Over 3 months  thru 6 months** |   | **Over 6  months  thru 12 months** |   | **Over  12 months** |   | **Total** |   |
| Time accounts  less than $100,000 |   | $                       | 5,627,371 |   | $ | 2,813,521 |   | $ | 3,953,003 |   | $ | 5,815,386 |   | $ | 18,209,281 |   |
| Time accounts of  $100,00 or more |   | 1,986,830               |      | 124,476 |   | 1,519,114 |   | 1,647,194 |   | 5,277,614 |   |
| Total                             |   | $                       | 7,614,201 |   | $ | 2,937,997 |   | $ | 5,472,117 |   | $ | 7,462,580 |   | $ | 23,486,895 |   |

 

**ITEM 3****. CONTROLS AND PROCEDUERS**

Evaluation of Disclosure Controls Procedures

As of the end of theperiod covered by this report, the Company conducted an evaluation under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Principal Financial Officer,regarding the effectiveness of the design and operation of the Company’sdisclosure controls and procedures pursuant to Rules 13a-15(b) of theSecurities Exchange Act of 1934 (the “Exchange Act”).  Based upon that evaluation, the Chief Executive Officer andPrincipal Financial Officer concluded that the Company’s disclosure controlsand procedures are effective to ensure that information that is required to bedisclosed by the Company in reports that it files under the Exchange Act is

 

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recorded, processed,summarized and reported within the time period specified in the rules of theSecurities Exchange Commission.

 

Changes in InternalControls

Therewere no changes in the Company’s internal control over financial reporting thatoccurred during the period covered by this report that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

## **PartII**

**OTHERINFORMATION**

 

### **Item 1.  LegalProceedings**

The Bank was a defendantin a complaint filed on February 23, 2002 in United States District Court,District of South Dakota Southern Division by Bridge Lenders, LLC; Jim Perry;Larry Ticknor; Doug English; Rollyn H. Samp; Courtney Anderson; Henry Carlson,Jr.; Michael M. Samp; Ernest Olson; Don Davis; Jerry Landerville; Allen Lewis;Gary Viger; Glen Jamtgaard and Steve Herman ("Plaintiffs").  The complaint arose out of a series of loansthat the Bank made to Plaintiffs in 2000. Plaintiffs used the proceeds of the loans to make an investment inBridge Lenders, LLC, and Bridge Lenders, LLC in turn used the funds to make aninvestment in Phenix Biocomposites, which has defaulted in its obligations toPlaintiffs.  The Bank was a defendant inthis action due to the fact that its former director, Frank Gazzola, was also adirector of Phenix Biocomposites.  ThePlaintiffs alleged that Mr. Gazzola failed to inform the Plaintiffs that theirinvestment in Phenix Biocomposites was not secured.  The Plaintiffs claim that the Bank had a fiduciary duty to thePlaintiffs because of Mr. Gazzola's dual role as a director of both the Bankand Phenix Biocomposites, that the Bank violated this fiduciary duty and aseparate implied covenant of good faith and fair dealing when Mr. Gazzolaallegedly provided false information to Plaintiffs, and that the false informationallegedly provided by Mr. Gazzola constituted intentional or unintentionalfraud by the Bank.  Plaintiffs seekcompensatory, general, special and punitive damages.  The Bank denied the Plaintiffs' allegations and brought a motionto dismiss all claims for lack of personal jurisdiction.  On July 22, 2003, the court dismissed thecomplaint based upon the failure of the plaintiffs to enjoin Mr. Gazzola.  On July 28, 2003, the Bank initiated legalaction in the Blue Earth county court of the State of Minnesota to compelpayment on the notes.  On July 29, 2003,the Plaintiffs filed a revised complaint in United States District Court,District of Minnesota, re-asserting their earlier allegations.  The Bank denies the Plaintiffs' allegationsand intends to vigorously defend itself in this action while seeking repaymentof its loans.

 

The Company was adefendant and third party plaintiff in a complaint originally filed on March22, 2002 in the United States District Court for the Western District ofWisconsin by Catalytic Combustion Corporation 401(k) Profit Sharing Plan andCatalytic Combustion Corporation ("Plaintiffs").  On March 31, 2003, the Company, the thirdparty defendant, and the plaintiffs entered into a confidential final andbinding mutual release of all claims and settlement agreement.

 

During 1999 and 2000, theBank made a series of loans to Frank Gazzola, then a Director of the Company,in various amounts at market rates of interest and for terms of various lengthsof time Mr. Gazzola defaulted on the loans and the Bank foreclosed on thecollateral for the loans.  Thebankruptcy court claimed that since certain of the collateral was conveyed tothe Bank within one year of Gazzola's bankruptcy filing and since he was aninsider, they were preferential transfers and must be reversed.  On June 12, 2003, in an out of courtsettlement, the court approved a settlement agreement where-in the Bank agreedto pay the bankruptcy court a settlement fee for which the Bank retained aclaim against the unsecured assets of Mr. Gazzola's bankruptcy estate and arelease by the court of all claims to the collateral held by the Bank.

 

**Item 2.  Changes in Securities and Use ofProceeds**

Duringthe first quarter of the current fiscal year, the Company issued 23,000 sharesof stock in the amount of $126,500 under a private placement offering for50,000 shares.  DuringOctober 2003, the Company issued 25,000 shares of stock in the amount of$137,500 under this private placement offering. The Company did not incur anyunderwriting or placement expenses in connection with these issuances.  The proceeds will be utilized to support ouron-going operations.

 

**Item 3.  Defaults Upon Senior Securities**

 

Noneto report.

 

23

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**Item 4.  Submission of Matters to a Vote ofSecurity Holders**

 

Nomatters were submitted to the security holders.

 

**Item 5.  Other Information**

 

Noneto report

 

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

 

a) Exhibits

 

Exhibits are numbers in accordance with Item 601 ofRegulation S-B. See “Exhibit Index” immediately following the signature page ofthis Form 10-QSB.

 

b) Reports on Form 8-K

 

A Form 8-K dated August 29, 2003 was filed toannounce and furnish results of the Company and its wholly owned subsidiaryNorthern Star Bank for the fourth quarter of the fiscal year endedJune 30, 2003.

 

A Form 8-K dated November 11, 2003 was filed toannounce and furnish results of the Company and its wholly owned subsidiaryNorthern Star Bank for the first quarter of the fiscal year ended June 30,2004.

 

**SIGNATURES**

 

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 
|                               | NORTHERN STAR  FINANCIAL, INC.                                |
|------------------------------------|---------------------------------------------------------------|
|                               |                                                          |
| Date:  November 12, 2003 | By                                                            | /s/  Thomas P. Stienessen |
|                               | Thomas P. Stienessen,  President and  Chief Executive Officer |
|                               |                                                          |
| Date:  November 12, 2003 | By                                                            | /s/  Gerald W. Eick |
|                               | Gerald W. Eick,  Treasurer                                    |

 

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**EXHIBIT INDEX**

**NORTHERN STAR FINANCIAL, INC.**

**FORM 10-QSB FOR QUARTER ENDEDSEPTEMBER 30, 2003**

 
| **EXHIBIT** |   | **DESCRIPTION**                                                                                  |
|-------------|--------|--------------------------------------------------------------------------------------------------|
|        |   |                                                                                             |
| 31.1        |   | Certification of CEO Pursuant to Section 302 of The Sarbanes-Oxley  Act of 2002             |
|        |   |                                                                                             |
| 31.2        |   | Certification of CFO Pursuant to Section 302 of The Sarbanes-Oxley  Act of 2002             |
|        |   |                                                                                             |
| 32          |   | Certification of the  CEO and CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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