<PAGE>

                                 UNITED STATES

                      SECURITIES AND EXCHANGE COMMISSION

                            Washington, D.C. 20549

                                   FORM 10-Q

    __X__QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001
                                      OR
    ____TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM                TO

    Commission File Number 0-26016

                           PALMETTO BANCSHARES, INC.
            ------------------------------------------------------
            (Exact name of registrant as specified in its charter)

      South Carolina                                            74-2235055
---------------------------                                 -----------------
(State or other jurisdiction                                 (I.R.S. Employer
of incorporation or organization)                           Identification No.)

                              301 Hillcrest Drive
                            Laurens, South Carolina
                                     29360
                 --------------------------------------------
                   (Address of principal executive offices)
                                  (Zip Code)

                                (864) 984-4551
              --------------------------------------------------
             ( Registrant's telephone number, including area code)


  Indicate by check mark whether the registrant (1) has filed all reports
  required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
  1934 during the preceding 12 months (or for such shorter period that the
  registrant was required to file such reports), and (2) has been subject to
  such filing requirements for the past 90 days. Yes X   No____
                                                    ----

  Indicate the number of shares outstanding of each of the issuer's classes of
  common stock, as of the latest practicable date.


           Class                               Outstanding at August 2, 2001
  -----------------------                          ----------------------
Common stock, $5.00 par value                             6,262,734
<PAGE>

                           PALMETTO BANCSHARES, INC.

                         Quarterly Report on Form 10-Q
                      For the Quarter Ended June 30, 2001


<TABLE>
<CAPTION>

INDEX                                                                                                 Page No.
-----                                                                                                 --------


PART I - FINANCIAL INFORMATION
------------------------------

Item 1.  Financial Statements
<S>                                                                                                   <C>
         Consolidated Balance Sheets at June 30, 2001 and December 31, 2000                                  1

         Consolidated Income Statements for the Three Months
         Ended June 30, 2001 and 2000                                                                        2

         Consolidated Income Statements for the Six Months
         Ended June 30, 2001 and 2000                                                                        3

         Consolidated Statements of Changes in Shareholders' Equity and
         Comprehensive Income for the Six Months Ended
         June 30, 2001 and 2000                                                                              4

         Consolidated Statements of Cash Flows for the Six Months
         Ended June 30, 2001 and 2000                                                                        5

         Notes to the Consolidated Interim Financial Statements                                              6

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations               7-14

Item 3.  Quantitative and Qualitative Disclosures About Market Risk                                          14-15


PART II - OTHER INFORMATION
---------------------------

Item 1.  Legal Proceedings                                                                                   16

Item 2.  Changes in Securities and Use of Proceeds                                                           16

Item 3.  Defaults Upon Senior Securities                                                                     16

Item 4.  Submission of Matters to a Vote of Security Holders                                                 16

Item 5.  Other Information                                                                                   17

Item 6.  Exhibits and Reports on Form 8-K                                                                    17

SIGNATURES                                                                                                   18
----------
</TABLE>
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY
                          Consolidated Balance Sheets
                 (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                      June 30, 2001     December 31, 2000
                                                                      -----------------------------------
Assets                                                                  (unaudited)
<S>                                                                   <C>               <C>
Cash and due from banks                                                   $  32,783        $  36,305
Federal funds sold                                                            2,426            1,879
Federal Home Loan Bank stock, at cost                                         1,733            1,733
Investment securities available for sale (amortized cost of $87,498
     and $99,030, in 2001 and 2000, respectively)                            88,202           98,601
Loans held for sale                                                          11,202              611
Loans                                                                       543,392          498,242
     Less allowance for loan losses                                          (5,760)          (5,446)
                                                                          --------------------------
                 Loans, net                                                 537,632          492,796

Premises and equipment, net                                                  17,422           16,481
Accrued interest                                                              5,074            5,229
Other assets                                                                 10,272            9,755
                                                                          --------------------------
                 Total assets                                             $ 706,746        $ 663,390
                                                                          ==========================

Liabilities and Shareholders' Equity

Liabilities:
Deposits:
     Non-interest-bearing                                                   105,490           96,097
     Interest-bearing                                                       512,299          476,569
                                                                          --------------------------
                 Total deposits                                             617,789          572,666

Securities sold under agreements to repurchase                               13,578           19,923
Commercial paper (Master note)                                               11,857           15,359
Other liabilities                                                             7,720            2,849
                                                                          --------------------------
                 Total liabilities                                          650,944          610,797
                                                                          --------------------------

Shareholders' Equity:
Common stock-$5.00 par value.  Authorized 10,000,000 shares;
   6,262,734 issued and outstanding in 2001; and
   6,255,734 issued and outstanding in 2000                                  31,314           31,279
Capital surplus                                                                  40               23
Retained earnings                                                            24,063           21,555
Accumulated other comprehensive income (loss)                                   385             (264)
                                                                          --------------------------
                 Total shareholders' equity                                  55,802           52,593
                                                                          --------------------------

                 Total liabilities and shareholders' equity               $ 706,746        $ 663,390
                                                                          ==========================
</TABLE>

See accompanying notes to consolidated interim financial statements.

                                       1
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY
                  Consolidated Income Statements (Unaudited)
         For the three months ended June 30, 2001 and 2000
                 (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                                       2001          2000
                                                                                  -------------------------
<S>                                                                               <C>               <C>
Interest income:
  Interest and fees on loans                                                        $ 11,177        $ 9,888
  Interest and dividends on investment securities available for sale:
     U.S. Treasury and U.S. Government agencies                                          151            386
     State and municipal                                                                 674            793
     Mortgage-backed securities                                                          310            420
  Interest on federal funds sold                                                          75             55
  Dividends on FHLB stock                                                                 32             35
                                                                                  -------------------------
              Total interest income                                                   12,419         11,577
                                                                                  -------------------------

Interest expense:
  Interest on deposits                                                                 4,833          4,184
  Interest on securities sold under agreements to repurchase                             138            227
  Interest on federal funds purchased                                                     28            178
  Interest on commercial paper (Master note)                                              98            202
                                                                                  -------------------------
              Total interest expense                                                   5,097          4,791
                                                                                  -------------------------

              Net interest income                                                      7,322          6,786
Provision for loan losses                                                              1,388          1,610
                                                                                  -------------------------

                 Net interest income after provision for loan losses                   5,934          5,176
Non-interest income:
  Service charges on deposit accounts                                                  2,099          1,132
  Fees for trust services                                                                446            577
  Gains on sales of loans                                                                141             10
  Investment securities gains                                                              -              -
  Other income                                                                           791            688
                                                                                  -------------------------
              Total non-interest income                                                3,477          2,407

Non-interest expense:
  Salaries and other personnel                                                         3,161          2,666
  Net occupancy                                                                          478            479
  Furniture and equipment                                                                584            534
  FDIC assessment                                                                         27             28
  Postage and supplies                                                                   339            272
  Marketing and advertising                                                              288            220
  Telephone                                                                              182            183
  Cardholder processing expense                                                          123            120
  Sales finance losses                                                                    (6)             -
  Other expense                                                                        1,229            935
                                                                                  -------------------------
              Total non-interest expense                                               6,405          5,437
                                                                                  -------------------------
              Income before income taxes                                               3,006          2,146
                                                                                  -------------------------
Income tax provision                                                                     916            605
                                                                                  -------------------------

              Net income                                                             $ 2,090        $ 1,541
                                                                                  =========================
              Net income per share-basic                                             $  0.33        $  0.25
              Net income per share-dilutive                                          $  0.32        $  0.24
              Cash dividends declared per share                                      $  0.10        $  0.09
</TABLE>

See accompanying notes to consolidated interim financial statements.
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY
                  Consolidated Income Statements (Unaudited)
               For the six months ended June 30, 2001 and 2000
                 (Dollars in thousands, except per share data)


<TABLE>
<CAPTION>
                                                                                       2001             2000
                                                                                    ---------------------------
<S>                                                                                 <C>               <C>
Interest income:
  Interest and fees on loans                                                        $  22,009         $  19,385
  Interest and dividends on investment securities available for sale:
     U.S. Treasury and U.S. Government agencies                                           423               610
     State and municipal                                                                1,365             1,603
     Mortgage-backed securities                                                           655               857
  Interest on federal funds sold                                                          217               134
  Dividends on FHLB stock                                                                  67                69
                                                                                    ---------------------------
           Total interest income                                                       24,736            22,658
                                                                                    ---------------------------

Interest expense:
  Interest on deposits                                                                  9,932             8,371
  Interest on securities sold under agreements to repurchase                              420               458
  Interest on federal funds purchased                                                      43               214
  Interest on commercial paper (Master note)                                              234               349
                                                                                    ---------------------------
           Total interest expense                                                      10,629             9,392
                                                                                    ---------------------------
           Net interest income                                                         14,107            13,266
Provision for loan losses                                                               2,238             2,135
                                                                                    ---------------------------
           Net interest income after provision for loan losses                         11,869            11,131
Non-interest income:
  Service charges on deposit accounts                                                   3,511             2,148
  Fees for trust services                                                                 945             1,109
  Gains on sales of loans                                                                 199                20
  Other income                                                                          1,424             1,307
                                                                                    ---------------------------
           Total non-interest income                                                    6,079             4,584

Non-interest expense:
  Salaries and other personnel                                                          6,235             5,329
  Net occupancy                                                                         1,029               967
  Furniture and equipment                                                               1,154             1,114
  FDIC assessment                                                                          54                56
  Postage and supplies                                                                    693               594
  Marketing and advertising                                                               513               406
  Telephone                                                                               371               383
  Cardholder processing expense                                                           275               258
  Sales finance losses                                                                     14                 -
  Other expense                                                                         2,264             1,824
                                                                                    ---------------------------
           Total non-interest expense                                                  12,602            10,931
                                                                                    ---------------------------
           Income before income taxes                                                   5,346             4,784
                                                                                    ---------------------------
Income tax provision                                                                    1,586             1,348
                                                                                    ---------------------------

           Net income                                                               $   3,760         $   3,436
                                                                                    ===========================
           Net income per share-basic                                               $    0.60         $    0.55
           Net income per share-dilutive                                            $    0.58         $    0.54
           Cash dividends declared per share                                        $    0.20         $    0.18
</TABLE>

See accompanying notes to consolidated interim financial statements.

                                       3
<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY
 Consolidated Statements of Changes in Shareholders' Equity and Comprehensive
                              Income (Unaudited)
               For the six months ended June 30, 2001 and 2000
                (Dollars in thousands except number of shares)

<TABLE>
<CAPTION>
                                                                                                        Accumulated
                                                                                Capital                    Other
                                                                     Common     Surplus     Retained    Comprehensive
                                                                     Stock    (Deficit)    Earnings      Loss, Net        Total
                                                                     -----     ---------    --------      ---------        -----
<S>                                                                 <C>        <C>          <C>         <C>               <C>
Balance at December 31, 1999                                         31,134            -      16,890          (2,397)      45,627
Net income                                                                                     3,436                        3,436
Other comprehensive income, net of tax:
     Unrealized holding gains arising during period, net
      of tax effect of $14                                                                                        23           23
                                                                                                                          -------
Comprehensive income                                                                                                        3,459
                                                                                                                          -------
Cash dividend declared                                                                        (1,123)                      (1,123)
Issuance of 17,200 shares in connection with stock options               86           22                                      108
                                                                    -------------------------------------------------------------
Balance at June 30, 2000                                             31,220           22      19,203          (2,374)      48,071
                                                                    =============================================================

Balance at December 31, 2000                                         31,279           23      21,555            (264)      52,593
Net income                                                                                     3,760                        3,760
Other comprehensive income, net of tax:
     Unrealized holding gains arising during period, net
      of tax effect of $406                                                                                      649          649
                                                                                                                          -------
Comprehensive income                                                                                                        4,409
                                                                                                                          -------
Cash dividend declared                                                                        (1,252)                      (1,252)
Issuance of 7,000 shares in connection with stock options                35           17                                       52
                                                                    -------------------------------------------------------------
Balance at June 30, 2001                                             31,314           40      24,063             385       55,802
                                                                    =============================================================
</TABLE>

See accompanying notes to consolidated interim financial statements.
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY
               Consolidated Statements of Cash Flows (Unaudited)
                For the six months ended June 30, 2001 and 2000
                            (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                                              2001                2000
                                                                                          --------------------------------
<S>                                                                                       <C>               <C>
Cash flows from operating activities:
  Net income                                                                                $   3,760         $    3,436
  Adjustments to reconcile net income to net cash
      provided by operating activities:
              Depreciation and amortization                                                     1,298              1,087
              Gain on sale of investment securities                                                 -                  -
              Provision for loan losses                                                         2,238              2,135
              Origination of loans held for sale                                              (41,366)            (3,440)
              Sale of loans held for sale                                                      30,974              3,136
              Gain on sale of loans                                                              (199)               (20)
              Change in accrued interest receivable                                               155               (197)
              Change in other assets                                                             (641)              (603)
              Change in other liabilities, net                                                  4,465               (538)
                                                                                            -----------------------------

                                  Net cash provided by operating activities                       684              4,996

Cash flows from investing activities:
  Purchase of investment securities available for sale                                         (5,031)           (10,000)
  Proceeds from maturities of investment securities available for sale                         12,537              1,579
  Proceeds from sale of investment securities available for sale                                    -                  -
  Principal paydowns on mortgage-backed securities available for sale                           3,925              2,457
  Purchase of Federal Home Loan Bank stock                                                          -                  -
  Net increase in loans outstanding                                                           (47,450)           (25,822)
  Purchases of premises and equipment, net                                                     (1,716)            (1,217)
                                                                                            -----------------------------
                                  Net cash used in investing activities                       (37,735)           (33,003)

Cash flows from financing activities:
  Net increase in deposit accounts                                                             45,123              7,055
  Acquisition of deposits, net                                                                      -                  -
  Net decrease in securities sold under agreements to repurchase                               (6,345)            (2,967)
  Net increase in commercial paper                                                             (3,502)             1,716
  Net increase in federal funds purchased                                                           -             13,000
  Proceeds from issuance of common stock                                                           52                108
  Dividends paid                                                                               (1,252)            (1,123)
                                                                                            -----------------------------
                                  Net cash provided by financing activities                    34,076             17,789
                                                                                            -----------------------------
Net decrease in cash and cash equivalents                                                      (2,975)           (10,218)
                                                                                            -----------------------------
Cash and cash equivalents at beginning of the period                                           38,184             43,817
                                                                                            -----------------------------
Cash and cash equivalents at end of the period                                              $  35,209         $   33,599
                                                                                            =============================
Supplemental Information:
Cash paid during the period for:
     Interest expense                                                                       $  10,772         $    9,411
                                                                                            =============================
     Income taxes                                                                               1,644              1,304
                                                                                            =============================

Supplemental schedule of non-cash investing and financing transactions:
    Change in unrealized gain (loss) on investment securities available for sale,
          before tax                                                                            1,055                 37
                                                                                            =============================
    Loans transferred to other real estate owned                                                  376                  -
                                                                                            =============================
    Loans charged -off                                                                          2,044              1,656
                                                                                            =============================
</TABLE>


See accompanying notes to consolidated interim financial statements.

                                                                 5
<PAGE>

                   PALMETTO BANCSHARES, INC. AND SUBSIDIARY
              Notes To Consolidated Interim Financial Statements

1.  Basis of Presentation
    ---------------------

     The accompanying unaudited consolidated interim financial statements have
been prepared pursuant to the rules and regulations for reporting on Form 10-Q.
Accordingly, certain information and footnotes required by generally accepted
accounting principles for complete financial statements are not included herein.
The interim statements should be read in conjunction with the financial
statements and notes thereto included in Palmetto Bancshares, Inc.'s (the
"Company's") Annual Report on Form 10-K for the year ended December 31, 2000.

     In the Company's opinion, all adjustments necessary for a fair presentation
of these interim statements have been included and are of a normal and recurring
nature. The results of operations for the three and six month periods ended June
30, 2001 are not necessarily indicative of the results that may be expected for
the entire year.

     Certain amounts from 2000 have been reclassified to conform to the 2001
presentation.  These reclassifications have no effect on shareholders' equity or
on net income as previously reported.

2.  Principles of Consolidation
    ---------------------------

     The consolidated financial statements include the accounts of the Company,
its wholly owned subsidiary, The Palmetto Bank (the "Bank"), and Palmetto
Capital, Inc., the Bank's wholly owned subsidiary. The Bank provides a full
range of banking services, including taking deposits and making loans. Palmetto
Capital, Inc. offers the brokerage of stocks, bonds, mutual funds and unit
investment trusts. Palmetto Capital, Inc. also offers advisory services and
variable rate annuities. In consolidation, all significant intercompany accounts
and transactions have been eliminated.

3.  Summary of Significant Accounting Policies
    ------------------------------------------

     The significant accounting policies used by the Company are described in
Note 1 to the Company's December 2000 Annual Report on Form 10-K. There have
been no changes in these policies subsequent to the year ended December 31,
2000.

                                       6
<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

DISCUSSION OF FINANCIAL CONDITION CHANGES FROM DECEMBER 31, 2000 TO
JUNE 30, 2001

Forward-Looking Statements
--------------------------

     This document may contain certain "forward-looking statements," within the
meaning of Section 27A of the Securities Exchange Act of 1934, as amended, that
represent the Company's expectations or beliefs concerning future events. Such
forward-looking statements are about matters that are inherently subject to
certain risks, uncertainties, and assumptions.  Factors that could influence the
matters discussed in certain forward-looking statements include the relative
levels of market interest rates, loan prepayments and rates of change in deposit
balances, the timing and amount of revenues that may be recognized by the
Company, continuation of current revenue, expense and charge-off trends, legal
and regulatory changes, and general changes in the economy.  Should one or more
of these risks or uncertainties materialize, or should underlying assumptions
prove incorrect, actual results may vary materially from those expected or
projected.  These forward-looking statements speak only as of the date of this
document.  The Company assumes no obligation to update any forward-looking
statements. Because of the risks and uncertainties inherent in forward-looking
statements, readers are cautioned not to place undue reliance on them.

Assets
------

     Total assets increased $43.4 million, or 7%, for the six month period ended
June 30, 2001, primarily as a result of an increase in loans receivable.  Liquid
assets, which include cash, federal funds sold, and investments available for
sale, decreased by $13.4 million, or 10%, for the six-month period. The decrease
in liquid assets was attributable to the $3.5 million decrease in cash and due
from banks and the $10.4 million decrease in investment securities available for
sale, offset by a $.5 million increase in federal funds sold. During the first
six months of 2001, the Bank purchased $5.0 million of investment securities
(available for sale), $12.5 million of the investment portfolio matured, and
$4.0 million was paid down on mortgage backed securities held for sale.  The
Bank had a $1.1 million change in pre-tax unrealized gains in its investment
portfolio at June 30, 2001.

     Loans, net, increased by $44.8 million, or 9%, during the six-month period
as a result of growth sparked by a favorable interest rate environment and
increased efforts by lenders. The allowance for loan losses as a percentage of
total loans decreased slightly to 1.06% from 1.09% at June 30, 2001 and 2000,
respectively. Management feels the allowance is adequate at June 30, 2001
because the Bank uses an allowance model that takes into account the risk grades
of loans, delinquency trends, charge-off ratios and loan growth. Over the last
12 to 18 months the Bank has been improving its underwriting standards, shifting
its emphasis toward higher-dollar, higher-quality loans, and charging off
significant amounts of lower-quality loans.

     At June 30, 2001, the Company had $11.2 million in loans held for sale with
commitments to sell these loans in July and August 2001. Because the interest
rate environment has been favorable for mortgage loans and refinances, the Bank
has been able to make approximately $48.5 million in mortgage loans during the
first six months of 2001, with over 65% being sold in the secondary market. The
mortgage servicing rights related to the mortgage servicing department's
activities were $1.2 million at June 30, 2001, which approximates their fair
value. Loans serviced for the benefit of others amounted to $147.6 million at
June 30, 2001.

                                       7
<PAGE>

     Other assets increased by $517,000, or 5%, from December 31, 2000 to June
30, 2001. Because of the increased sales of mortgage loans, mortgage servicing
rights increased approximately $409,000, while $281,000 of those rights were
amortized. Other real estate increased by $376,000, prepaid expenses increased
$379,000, while repossessed assets were reduced by $300,000. During the first
six months of 2001, the investment portfolio accumulated unrealized gains, thus
eliminating the deferred tax benefit that was recorded at December 31, 2000. At
June 30, 2001, there was a deferred tax liability of $241,000 related to those
unrealized gains.

Liabilities and Shareholders' Equity
------------------------------------

     Deposit balances increased by 8% during the six-month period, from $572.7
million to $617.8 million.  The Bank offered a special rate CD during the first
six months of 2001 that accounted for $19.5 million of the increase.  A new
deposit product, the Palmetto Index Account, also contributed another $25.0
million to the increase in deposits. This account is similar to a premier
checking account, but features a competitive tiered interest rate based on a
minimum deposit balance.

     Securities sold under agreements to repurchase decreased by $6.3 million,
or 32%, and commercial paper associated with the alternative commercial sweep
accounts (master note program) decreased by $3.5 million, or 23%. These changes
are the result of normal fluctuations in the accounts.

     Total shareholders' equity increased by $3.2 million, or 6%, for the six-
month period as a result of comprehensive income of $4.4 million, less dividends
paid of $1.2 million. The Company also added $52,000 to equity as the result of
stock option exercises.

COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2001
AND 2000

Net Income
----------

     Net income for the three months ended June 30, 2001 and 2000 was $2.1
million and $1.5 million, respectively. Net income per common share-basic for
the three months ended June 30, 2001 and 2000 was $0.33 and $0.25, respectively.
Net income per common share-dilutive for the same periods was $0.32 and $0.24,
respectively.

Net Interest Income
-------------------

     The largest component of the Company's net income is the Bank's net
interest income, defined as the difference between gross interest and fees on
earning assets, primarily loans and investment securities, and interest paid on
deposits and borrowed funds. Net interest income is affected by the interest
rates earned or paid and by volume changes in loans, securities, deposits and
borrowed funds.

     For the three-month period ended June 30, 2001 and 2000, net interest
income was $7.3 million and $6.8 million, respectively. This increase in net
interest income was the result of a $54.1 million increase in average earning
assets. Earning assets averaged $634.3 million and $580.2 million during the
second quarters of 2001 and 2000, respectively. The increases in volume were
primarily due to the growth of loans. The average tax-equivalent net interest
margin for the 2001 period was 4.79%, compared to 4.88% for the same period in
2000.

     Interest and fees on loans increased 13%, from $9.9 million to $11.2
million, for the 2000 three-month period compared to the corresponding period in
2001. This increase is due to increased loan

                                       8
<PAGE>

volume, offset by a decrease in the average loan yield from 8.59% to 8.33% for
the three-month period ended June 30, 2000 and 2001, respectively. Interest on
investment securities decreased $464,000 for the 2001 three-month period
compared to the corresponding period in 2000 due to a lower balance in the
investment portfolio during the period ended June 30, 2001. Interest income on
federal funds sold increased $20,000 due to an increase in average volume of
federal funds sold for the quarter compared to the same period last year. The
yield on average earning assets, which includes loans, federal funds sold and
investment securities, decreased from 8.02% to 7.85% for the three months ended
June 30, 2000 and 2001, respectively.

     Total interest expense increased by 6%, from $4.8 million to $5.1 million.
Comparing the quarter ended June 30, 2001 to the same period in the prior year,
total interest-bearing liabilities increased 7% from $490.6 million to $525.8
million.  The total cost of average interest-bearing liabilities for the quarter
ended June 30, 2001 was 3.89%, compared to 3.93% for the same quarter last year.

Provision for Loan Losses
-------------------------

     The provision for loan losses decreased to $1.4 million from $1.6 million
for the three months ended June 30, 2001 and 2000, respectively. The provision
is adjusted each month to reflect loan volume growth and allow for loan charge-
offs, recoveries and other factors which impact management's assessment of the
adequacy of the allowance for loan losses. Management's objective is to maintain
the allowance for loan losses at an adequate level to cover probable losses in
the portfolio. Additions to the allowance for loan losses are based on
management's evaluation of the loan portfolio under current economic conditions,
past loan loss experience, and such other factors, which in management's
judgment deserve recognition in estimating loan losses.

     Loans are charged off when, in the opinion of management, they are deemed
to be uncollectible. Recognized losses are charged against the allowance, and
subsequent recoveries are added to the allowance. Loans over 90 days delinquent
and on non-accrual amounted to approximately $2.8 million at June 30, 2001 and
2000. The annualized net charge-off ratio has decreased from .79% for the
quarter ended June 30, 2000 to .39% for the quarter ended June 30, 2001. During
1999, the Bank began redirecting its emphasis on indirect lending in the sales
finance area to purchasing higher-quality indirect loans and reducing the number
of lower-quality loans in the portfolio. Activities associated with this
process, as management expected, contributed to the increase of charge-offs as
these lower-quality loans were eliminated. Management believes it has taken
these lower quality loans into consideration in estimating the level of the
allowance for loan losses, nevertheless, charge-offs are expected to remain
higher than normal until this process is complete. In the sales finance
portfolio, past due loans over 30 days were 7.2% at June 30, 2001 compared to
14.6% at December 31, 2000.

     While management uses the best information available to make evaluations,
future adjustments to the allowance in the form of provisions through the income
statement may be necessary if economic conditions differ substantially from the
assumptions used in making the evaluation.  The allowance for loan losses is
subject to periodic evaluation by various regulatory authorities and may be
subject to adjustment, based upon information that is available to them at the
time of their examination.

Non-interest Income
-------------------

     Total non-interest income increased by $1.1 million, or 44%, for the three
months ended June 30, 2001, as compared to the same period in 2000.  The largest
portion of this increase, $967,000, or 85%, can be attributed to service charges
on customer deposit accounts.  The increases are primarily related to a new
automatic overdraft privilege offered to deposit customers and the increased
collection of insufficient

                                       9
<PAGE>

funds charges associated with debit card transactions during the 2001 period
compared to the same period in 2000.

Non-interest Expense
--------------------

     Total non-interest expense increased by $968,000, or 18%, during the 2001
three-month period compared to the same period in 2000.  The largest contributor
to this increase was salaries and other personnel expense, which increased
$495,000, or 19%, due to normal raises, new employees related to growth, and
increased medical insurance premiums paid on behalf of employees. At June 30,
2001, the Bank had 362 full-time equivalent employees compared to 333 full-time
equivalent employees at June 30, 2000.

Income Taxes
------------

     The Company incurred income tax expense of $916,000 for the 2001 three-
month period compared to $605,000 for the same period in 2000 due to an increase
in taxable income. This expense is based on an expected annual effective tax
rate of approximately 29.5%. The effective tax rate for the same period in 2000
was 28.1% and the effective tax rate for the year ended December 31, 2000 was
27.4%.

Net Income Per Share
--------------------

     The following table illustrates a reconciliation of the numerators and
denominators of the basic and diluted per-share computations for net income for
the three months ended June 30, 2001 and 2000 (dollars in thousands except per
share numbers):

<TABLE>
<CAPTION>
                                                        Income        Shares      Per-Share
2001                                                  (Numerator)  (Denominator)   Amount
----                                                  -------------------------------------
<S>                                                   <C>          <C>            <C>
Basic EPS:
---------
Net income                                              $2,089       6,261,811       $0.33
Effect of dilutive securities: stock options                --         175,634          --
                                                        ----------------------------------
Diluted EPS:
-----------
Net income plus assumed exercises of stock options      $2,089       6,437,445       $0.32
                                                        ==================================

<CAPTION>
                                                        Income        Shares      Per-Share
2000                                                  (Numerator)  (Denominator)   Amount
----                                                  ----------   ------------   ---------
<S>                                                   <C>          <C>            <C>
Basic EPS:
---------
Net income                                              $1,541       6,240,550       $0.25
Effect of dilutive securities: stock options                --         185,040          --
                                                        ----------------------------------
Diluted EPS:
----------
Net income plus assumed exercises of stock options      $1,541       6,425,590       $0.24
                                                        ==================================
</TABLE>

COMPARISON OF THE RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2001
AND 2000

Net Income
----------

     Net income for the six months ended June 30, 2001 and 2000 was $3.8 million
and $3.4 million, respectively.  Net income per common share-basic for the six
months ended June 30, 2001 and 2000 was $0.60 and $0.55, respectively. Net
income per common share-dilutive for the same periods was $0.58 and $0.54,
respectively.

                                      10
<PAGE>

Net Interest Income
-------------------

  For the six-month period ended June 30, 2001 and 2000, net interest income was
$14.1 million and $13.3 million, respectively. This increase in net interest
income was the result of a $56.2 million increase in average earning assets.
Earning assets averaged $626.3 million and $570.1 million during the first six
months of 2001 and 2000, respectively. The increases in volume were primarily
due to the growth of loans. The average tax-equivalent net interest margin for
the six months ended June 30, 2001 was 4.70%, compared to 4.88% for the same
period in 2000.

  Interest and fees on loans increased 14%, from $19.4 million to $22.0 million,
for the 2000 six-month period compared to the corresponding period in 2001.
This increase is due to increased loan volume, offset by a decrease in the
average loan yield from 8.56% to 8.47% for the six-month period ended June 30,
2000 and 2001, respectively.  Interest on investment securities decreased
$627,000 for the 2001 six-month period compared to the corresponding period in
2000 due to a lower balance in the investment portfolio during the period ended
June 30, 2001.  Interest income on federal funds sold increased $83,000 due to
an increase in average volume of federal funds during the six months ending June
30, 2001 compared to the same period last year. The yield on average earning
assets, which includes loans, federal funds sold and investment securities,
decreased from 7.99% to 7.96% for the six months ended June 30, 2000 and 2001,
respectively.

  Total interest expense increased by 13.0%, from $9.4 million to $10.6 million.
For the six months ended June 30, 2001, total interest-bearing liabilities were
$527.4 million compared to $486.1 million at June 30, 2000. The total cost of
average interest-bearing liabilities for the six months ended June 30, 2001 was
4.06%, compared to 3.89% for the same period last year.

Provision for Loan Losses
-------------------------

   The provision for loan losses increased to $2.2 million from $2.1 million for
the six months ended June 30, 2001 and 2000, respectively.  The provision is
adjusted each month to reflect loan volume growth and allow for loan charge-
offs, recoveries and other factors which impact management's assessment of the
adequacy of the allowance for loan losses.  Management's objective is to
maintain the allowance for loan losses at an adequate level to cover probable
losses in the portfolio.  Additions to the allowance for loan losses are based
on management's evaluation of the loan portfolio under current economic
conditions, past loan loss experience, and such other factors, which in
management's judgment deserve recognition in estimating loan losses.

   Loans are charged off when, in the opinion of management, they are deemed to
be uncollectible. Recognized losses are charged against the allowance, and
subsequent recoveries are added to the allowance.   The annualized net charge-
off ratio has decreased from 1.12% for the six months ended June 30, 2000 to
 .74% for the six months ended June 30, 2001. During 1999, the Bank began
redirecting its emphasis on indirect lending in the sales finance area to
purchasing higher-quality indirect loans and reducing the number of lower-
quality loans in the portfolio.  Activities associated with this process, as
management expected, contributed to the increase of charge-offs as these lower-
quality loans were eliminated.  Management believes it has taken these lower
quality loans into consideration in estimating the level of the allowance for
loan losses, nevertheless, charge-offs are expected to remain higher than normal
until this process is complete. In the sales finance portfolio, past due loans
over 30 days were 7.2% at June 30, 2001 compared to 14.6% at December 31, 2000.

                                      11
<PAGE>

Non-interest Income
-------------------

   Total non-interest income increased by $1.5 million, or 33%, for the six
months ended June 30, 2001, as compared to the same period in 2000. The largest
portion of this increase, $1.4 million, can be attributed to service charges on
customer deposit accounts. The increases are primarily related to a new
automatic overdraft privilege offered to deposit customers and the increased
collection of insufficient funds charges associated with debit card transactions
during the 2001 period compared to the same period in 2000.

Non-interest Expense
--------------------

   Total non-interest expense increased by $1.7 million, or 15%, during the 2001
six-month period compared to the same period in 2000. The largest contributor to
this increase was salaries and other personnel expense, which increased
$906,000, or 17%, due to normal raises, new employees related to growth, and
increased medical insurance premiums paid on behalf of employees. At June 30,
2001, the Bank had 362 full-time equivalent employees compared to 333 full-time
equivalent employees at June 30, 2000. Knowledgeable

Income Taxes
------------

   The Company incurred income tax expense of  $1.6 million for the 2001 six-
month period compared to $1.3 million for the same period in 2000 due to an
increase in taxable income.  This expense is based on an expected annual
effective tax rate of approximately 29.5%.  The effective tax rate for the same
period in 2000 was 28.1% and the effective tax rate for the year ended December
31, 2000 was 27.4%.

Net Income Per Share
--------------------

    The following table illustrates a reconciliation of the numerators and
denominators of the basic and diluted per-share computations for net income for
the six-months ended June 30, 2001 and 2000 (dollars in thousands except per
share numbers):

<TABLE>
<CAPTION>
                                                         Income        Shares      Per-Share
 2001                                                  (Numerator)  (Denominator)   Amount
 ----                                                  -------------------------------------
<S>                                                    <C>          <C>            <C>
 Basic EPS:
 ----------
 Net income                                                $3,760      6,260,425       $0.60
 Effect of dilutive securities: stock options                  --        172,967          --
                                                           ---------------------------------
 Diluted EPS:
 -----------
 Net income plus assumed exercises of stock options        $3,760      6,433,392       $0.58
                                                           =================================

                                                         Income        Shares       Per-Share
 2000                                                  (Numerator)  (Denominator)    Amount
 ----                                                  --------------------------------------
 Basic EPS:
 ----------
 Net income                                                $3,436      6,236,785       $0.55
 Effect of dilutive securities: stock options                  --        181,100          --
                                                           ---------------------------------
 Diluted EPS:
 ------------
 Net income plus assumed exercises of stock options        $3,436     6,417,885,       $0.54
                                                           =================================
</TABLE>

Liquidity
---------

  The liquidity ratio is an indication of a company's ability to meet its short-
term funding obligations.  The Company's policy is to maintain a liquidity ratio
between 10% and 25%.  At June 30, 2001, the Company's liquidity ratio was
13.91%.

                                      12
<PAGE>

  At June 30, 2001, the Bank had unused short-term lines of credit totaling
approximately $42 million (which are withdrawable at the lender's option).  At
June 30, 2001, unused borrowing capacity from the Federal Home Loan Bank
("FHLB") totaled $48 million.  The Bank has pledged assets to be used as
collateral if the Bank takes advantage of the FHLB line of credit.  Management
believes that these sources are adequate to meet its liquidity needs and to
maintain the liquidity ratio within policy guidelines.

  The Company has certain cash needs, including general operating expenses and
the payment of dividends and interest on borrowings.  The Company currently has
no debt outstanding and has declared and paid $0.20 per share in dividends so
far in 2001.  There can be no guarantee that any additional dividends will be
paid in 2001.  Liquidity is provided from the Company's subsidiary, the Bank.
The Company and the Bank are subject to certain regulatory restrictions on the
amount of dividends they are permitted to pay. The Bank's current total risk-
based capital ratio is 10.29%. At June 30, 2001, the Bank had $1.6 million of
excess retained earnings available to pay out dividends and still be considered
"well-capitalized."  The Bank plans to continue its quarterly dividend payments.

  The Bank has begun construction of its 29th branch office located in Travelers
Rest, South Carolina.  The estimated cost of construction under contract is
approximately $613,000.  The Bank has also received regulatory approval to open
a branch office in Seneca, South Carolina.  This will be the Bank's first
location in Oconee County.

Capital Resources
-----------------

  As of June 30, 2001, the Company and the Bank were in compliance with each of
the applicable regulatory capital requirements and met or exceeded the "well-
capitalized" regulatory guidelines.  The table below sets forth various capital
ratios for the Company and the Bank:

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------
                                                 Adequately
                                    As of       Capitalized      Well-Capitalized
                                   6/30/01      Requirement         Requirement
--------------------------------------------------------------------------------------------
<S>                                <C>          <C>              <C>
Company:
--------

   Total Risk-based Capital        10.37%         8.00%               10.00%

   Tier 1 Risk-based Capital        9.31          4.00                 6.00

   Tier 1 Leverage Ratio            7.46          4.00                 5.00


Bank:
-----

   Total Risk-based Capital        10.29          8.00                10.00

   Tier 1 Risk-based Capital        9.24          4.00                 6.00

   Tier 1 Leverage Ratio            7.39          4.00                 5.00
</TABLE>

                                      13
<PAGE>

Accounting and Reporting Matters
--------------------------------

  In September 2000, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standard ("SFAS") No. 140  "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities - a replacement of FASB Statement No. 125".  This statement became
effective for transfers occurring after March 31, 2001 and for disclosures
relating to securitizations and collateral for fiscal years ending after
December 15, 2000.  In addition to replacing SFAS No. 125, this statement
rescinded SFAS No. 127 "Deferral of the Effective Date of Certain Provisions of
FASB Statement No. 125".  SFAS No. 140 revises the standards for accounting for
securitizations and other transfers of financial assets and collateral and
requires certain disclosures, but carries over most of the provisions of
Statement 125 without reconsideration. Adoption of the standard did not have a
material effect on the Company.

  In July 2001, the FASB issued Statement No. 141 (SFAS 141), "Business
Combinations" and Statement No. 142 (SFAS 142), "Goodwill and Other Intangible
Assets".  These standards will be adopted in 2002.  The Company is currently
evaluating the impact that these standards will have on its financial
statements.

  Other accounting standards that have been issued or proposed by the Financial
Accounting Standards Board that do not require adoption until a further date are
not expected to have a material impact on the consolidated financial statements
upon adoption.

  On July 2, 2001, The Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 102 "Selected Loan Loss Allowance Methodology
and Documentation Issues". SAB 102 expresses the SEC's views on the development,
documentation and application of a systematic methodology for determining the
allowance for loan and lease losses in accordance with Generally Accepted
Accounting Principles.  The Company believes that it is currently in compliance
with the requirements of SAB 102.


ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

  Market risk is the risk of loss from adverse changes in market prices and
rates.  The Company's market risk arises principally from interest rate risk
inherent in its lending, deposit, borrowing and investing activities.
Management actively monitors and manages its inherent rate risk exposure.
Although the Company manages other risks, such as credit quality and liquidity
risk, in the normal course of business, management considers interest rate risk
to be its most significant market risk. This risk could potentially have the
largest material effect on the Company's financial condition and results of
operations.  Other types of market risks, such as foreign currency exchange rate
risk and commodity price risk, do not arise in the normal course of the
Company's business activities.

  The Company's profitability is affected by fluctuations in interest rates.
Management's goal is to maintain a reasonable balance between exposure to
interest rate fluctuations and earnings.  A sudden and substantial increase or
decrease in interest rates may adversely impact the Company's earnings to the
extent that the interest rates on interest-earning assets and interest-bearing
liabilities do not change at the same speed, to the same extent or on the same
basis.  The Company monitors the impact of changes in interest rates on its net
interest income using several tools.

   The Bank's goal is to minimize interest rate risk between interest bearing
assets and liabilities at various maturities through its Asset-Liability
Management ("ALM").  ALM involves managing the mix and pricing of assets and
liabilities in the face of uncertain interest rates and an uncertain economic

                                      14
<PAGE>

outlook. It seeks to achieve steady growth of net interest income with an
acceptable amount of interest rate risk and sufficient liquidity. The process
provides a framework for determining, in conjunction with the profit planning
process, which elements of the Company's profitability factors can be controlled
by management. Understanding the current position and implications of past
decisions is necessary in providing direction for the future financial
management of the Company. The Company uses an asset-liability model to
determine the appropriate strategy for current conditions.

   Interest sensitivity management is part of the asset-liability management
process.  Interest sensitivity gap ("GAP") is the difference between total rate
sensitive assets and rate sensitive liabilities in a given time period.  The
Company's rate sensitive assets are those repricing within one year and those
maturing within one year.  Rate sensitive liabilities include insured money
market accounts, savings accounts, interest-bearing transaction accounts, time
deposits and borrowings.  The profitability of the Company is influenced
significantly by management's ability to manage the relationship between rate
sensitive assets and liabilities.

   The Company's current GAP analysis reflects that in periods of increasing or
decreasing interest rates, rate sensitive assets will reprice slower than rate
sensitive liabilities. The Company's GAP analysis also shows that at the
interest repricing of one year, the Company's net interest margin would be
adversely impacted by an increase in market interest rates. This analysis,
however, does not take into account the dynamics of the marketplace.  GAP is a
static measurement that assumes that if the prime rate increases by 100 basis
points, all assets and liabilities that are due to reprice will increase by 100
basis points at the next opportunity.  During the first six months of 2001,
market interest rates have steadily declined. Because the Bank's rate sensitive
assets have been repricing slower than its rate sensitive liabilities during
this period, the Bank has been able to maintain a strong net interest margin of
4.54%.

   Because the Company's management feels that GAP analysis is a static
measurement, it manages its interest income through its asset/liability
strategies which focus on a net interest income model based on management's
projections. The Company has a targeted net interest income range of plus or
minus twenty percent based on a 300 basis point change over twelve months. The
asset/liability committee meets weekly to address interest pricing issues, and
this model is reviewed monthly. Management will continue to monitor its
liability sensitive position in times of increasing interest rates, which might
adversely affect its net interest margin. The Company does not feel that the
market risk to the Company has changed significantly since December 31, 2000.

                                      15
<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY

                          PART II - OTHER INFORMATION
Item 1. Legal Proceedings
        -----------------

   On January 19, 2001, M. Snyder's, Inc., an automobile dealership that has
sold and assigned sales finance contracts to the Bank, filed suit against the
Bank and Richard O. Lollis, a former employee of the Bank who was the manager of
the sales finance department. The suit was filed in the Court of Common Pleas
for Greenville County, South Carolina. M. Snyder's claims arise from the sales
finance contracts and its business relationship with the Bank, including causes
of action for alleged breach of contract, breach of fiduciary duty, fraud,
negligent representation, breach of contract accompanied by fraudulent acts,
unfair trade practices, negligence and negligent supervision; M. Snyder's seeks
actual and consequential damages. The Bank has filed counterclaims against M.
Snyder's based on, among other things, alleged breach of contract with
fraudulent intent, fraud, misrepresentations, unfair trade practices, bad faith,
procurement of breach of contracts by customers and conversion of assets
properly belonging to the Bank. The Bank does not believe that M. Snyder's
claims are well-founded and is vigorously pursuing its counterclaims and its
defenses against the claims. In connection with the above lawsuit, the Bank has
also filed a third party complaint against an employee of M. Snyder's, Inc.
arising from his actions in dealing with sales finance contracts, including
causes of action for fraud, misrepresentation and conversion.

   The Company is not currently engaged in legal proceedings.  In addition to
the matter described above, from time to time the Bank is involved in legal
proceedings incidental to its normal course of business as a bank. Management
believes that none of these proceedings is likely to have a materially adverse
effect on the business of the Company or the Bank.

Item 2.  Changes in Securities and Use of Proceeds
         -----------------------------------------
None

Item 3.  Defaults Upon Senior Securities
         -------------------------------
None

Item 4. Submission of Matters to a Vote of Securities Holders
        -----------------------------------------------------
   The annual shareholders' meeting of Palmetto Bancshares, Inc. was held on
April 17, 2001. At the meeting the following directors were elected for the
terms specified:

<TABLE>
<CAPTION>
                                                    Number of Votes                       Number of Votes
                                                          FOR                                 WITHHELD
                                                --------------------------------------------------------------
Term to expire in 2004
----------------------
<S>                                                 <C>                                   <C>
W. Fred Davis, Jr.                                     5,101,632                                12,771
David P. George, Jr.                                   5,097,632                                16,771
Michael D. Glenn                                       5,101,632                                12,771
Ann B. Smith                                           4,834,306                               280,097
Term to expire in 2003
----------------------
Sam B. Phillips, Jr.                                   5,101,632                                12,771
</TABLE>

John T. Gramling, II, William S. Moore, L. Leon Patterson, James M. Shoemaker,
Jr., E. Keith Snead, III, Paul W. Stringer, and J. David Wasson continued in
their present terms as directors.

                                      16
<PAGE>

Item 5.  Other Information
         -----------------
None

Item 6.  Exhibits and Reports on Form 8-K
         --------------------------------
(a) Exhibits:
None

(b) Reports on Form 8-K:
     The Company filed a Form 8-K dated April 24, 2001 to report a change in
independent accountants.

                                      17
<PAGE>

                                   SIGNATURES



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



PALMETTO BANCSHARES, INC.



By:

/s/ L. Leon Patterson
---------------------------------------
L. Leon Patterson
Chairman and Chief Executive Officer


/s/ Paul W. Stringer
---------------------------------------
Paul W. Stringer
President and Chief Operating Officer
(Chief Accounting Officer)

Date:   August 1, 2001

                                      18