<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 MARCH 31, 2002
                                       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 May 2, 2001
      -----------------------                    -----------------------
   Common stock, $5.00 par value                         6,292,578

<PAGE>

                            PALMETTO BANCSHARES, INC.

                          Quarterly Report on Form 10-Q
                      For the Quarter Ended March 31, 2002

<TABLE>
<CAPTION>

INDEX                                                                               Page No.
-----                                                                               --------
<S>                                                                                 <C>
PART I - FINANCIAL INFORMATION
------------------------------

Item 1.  Financial Statements

         Consolidated Balance Sheets at March 31, 2002 and December 31, 2001            1

         Consolidated Income Statements for the Three Months
         Ended March 31, 2002 and 2001                                                  2

         Consolidated Statements of Changes in Shareholders' Equity and
         Comprehensive Income for the Three Months Ended
         March 31, 2002 and 2001                                                        3

         Consolidated Statements of Cash Flows for the Three Months
         Ended March 31, 2002 and 2001                                                  4

         Notes to the Consolidated Interim Financial Statements                         5

Item 2.  Management's Discussion and Analysis of Financial
         Condition and Results of Operations                                            6-11

Item 3.  Quantitative and Qualitative Disclosures About Market Risk                    11-12

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

Item 1.  Legal Proceedings                                                              13

Item 2.  Changes in Securities and Use of Proceeds                                      13

Item 3.  Defaults Upon Senior Securities                                                13

Item 4.  Submission of Matters to a Vote of Security Holders                            13

Item 5.  Other Information                                                              13

Item 6.  Exhibits and Reports on Form 8-K                                               13

SIGNATURES                                                                              14
----------
</TABLE>

<PAGE>

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

<TABLE>
<CAPTION>
                                                                                     March 31, 2002           December 31, 2001
                                                                            ----------------------------------------------------
Assets                                                                                  (unaudited)
<S>                                                                         <C>                          <C>
Cash and due from banks                                                                   $  36,079                    $ 27,742
Federal funds sold                                                                           22,280                      17,949
Federal Home Loan Bank stock, at cost                                                         1,733                       1,733
Investment securities available for sale (amortized cost of $104,763
     and $94,708, in 2002 and 2001, respectively)                                           104,873                      95,095
Loans held for sale                                                                          13,363                      10,054
Loans                                                                                       555,660                     553,821
     Less allowance for loan losses                                                          (5,744)                     (5,658)
                                                                            ----------------------------------------------------
                               Loans, net                                                   549,916                     548,163

Premises and equipment, net                                                                  19,522                      19,175
Accrued interest                                                                              4,740                       4,947
Other assets                                                                                 12,014                      10,421
                                                                            ----------------------------------------------------
                               Total assets                                               $ 764,520                   $ 735,279
                                                                            ====================================================

Liabilities and Shareholders' Equity

Liabilities:
Deposits:
     Non-interest-bearing                                                                 $ 101,945                   $ 102,679
     Interest-bearing                                                                       565,695                     542,621
                                                                            ----------------------------------------------------
                               Total deposits                                               667,640                     645,300

Securities sold under agreements to repurchase                                               16,798                      15,313
Commercial paper (Master notes)                                                              13,154                      11,076
Other liabilities                                                                             6,225                       4,522
                                                                            ----------------------------------------------------
                               Total liabilities                                            703,817                     676,211
                                                                            ----------------------------------------------------

Shareholders' Equity:
Common stock-$5.00 par value.  Authorized 10,000,000 shares;
   6,291,578 issued and outstanding in 2002; and
   6,283,623 issued and outstanding in 2001                                                  31,458                      31,418
Capital surplus                                                                                  29                          26
Retained earnings                                                                            29,148                      27,386
Accumulated other comprehensive income (loss)                                                    68                         238
                                                                            ----------------------------------------------------
                               Total shareholders' equity                                    60,703                      59,068
                                                                            ----------------------------------------------------

                               Total liabilities and shareholders' equity                 $ 764,520                   $ 735,279
                                                                            ====================================================
</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 March 31, 2002 and 2001
                  (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                                       2002                   2001
                                                                                  ---------------------------------------
<S>                                                                                  <C>                      <C>
Interest income:
  Interest and fees on loans                                                           $ 10,528               $ 10,832
  Interest and dividends on investment securities available for sale:
     U.S. Treasury and U.S. Government agencies                                             311                    272
     State and municipal                                                                    635                    691
     Mortgage-backed securities                                                             131                    345
  Interest on federal funds sold                                                             58                    142
  Dividends on FHLB stock                                                                    26                     35
                                                                                  ---------------------------------------
                             Total interest income                                       11,689                 12,317
                                                                                  ---------------------------------------

Interest expense:
  Interest on deposits                                                                    3,267                  5,099
  Interest on securities sold under agreements to repurchase                                 41                    282
  Interest on federal funds purchased                                                         1                     15
  Interest on commercial paper (Master notes)                                                34                    136
                                                                                  ---------------------------------------
                             Total interest expense                                       3,343                  5,532
                                                                                  ---------------------------------------

                             Net interest income                                          8,346                  6,785
Provision for loan losses                                                                   900                    850
                                                                                  ---------------------------------------

                             Net interest income after provision for loan losses          7,446                  5,935
Non-interest income:
  Service charges on deposit accounts                                                     1,825                  1,412
  Fees for trust services                                                                   457                    499
  Gains on sales of loans                                                                   225                     58
  Investment securities gains                                                               140                      -
  Other income                                                                              724                    633
                                                                                  ---------------------------------------
                             Total non-interest income                                    3,371                  2,602

Non-interest expense:
  Salaries and other personnel                                                            3,679                  3,074
  Net occupancy                                                                             548                    551
  Furniture and equipment                                                                   635                    570
  FDIC assessment                                                                            28                     27
  Postage and supplies                                                                      382                    354
  Marketing and advertising                                                                 255                    225
  Telephone                                                                                 193                    189
  Cardholder processing expense                                                             141                    152
  Sales finance losses                                                                       24                     20
  Other expense                                                                           1,288                  1,035
                                                                                  ---------------------------------------
                             Total non-interest expense                                   7,173                  6,197
                                                                                  ---------------------------------------
                             Income before income taxes                                   3,644                  2,340
                                                                                  ---------------------------------------
Income tax provision                                                                      1,189                    670
                                                                                  ---------------------------------------

                             Net income                                                $  2,455               $  1,670
                                                                                  =======================================
                             Net income per share-basic                                $   0.39               $   0.27
                             Net income per share-dilutive                             $   0.38               $   0.26
                             Cash dividends declared per share                         $   0.11               $   0.10
</TABLE>

See accompanying notes to consolidated interim financial statements.

                                       2

<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY
           Consolidated Statements of Changes in Shareholders' Equity
                      and Comprehensive Income (Unaudited)
               For the three months ended March 31, 2002 and 2001
                 (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, 2000                                              31,279       23     21,555      (264)         52,593
Net income                                                                                     1,670                     1,670
Other comprehensive income, net of tax:
     Unrealized holding losses arising during period, net
          of tax effect of $585                                                                                            934
     Less: reclassification adjustment for gains included
          in net income, net of tax effect of $0                                                                             -
     Net unrealized losses on securities                                                                   934
                                                                                                                      ---------
Comprehensive income                                                                                                     2,604
                                                                                                                      ---------
Cash dividend declared                                                                          (626)                     (626)
Issuance of 4,000 shares in connection with stock options                     20       15                                   35
                                                                          -----------------------------------------------------
Balance at March 31, 2001                                                 31,299       38     22,599       670          54,606
                                                                          =====================================================

Balance at December 31, 2001                                              31,418       26     27,386       238          59,068
Net income                                                                                     2,455                     2,455
Other comprehensive income, net of tax:
     Unrealized holding gains arising during period, net
          of tax effect of $53                                                                                             (84)
     Less: reclassification adjustment for gains included
          in net income, net of tax effect of $54                                                                          (86)
     Net unrealized gains on securities                                                                   (170)
                                                                                                                      ---------
Comprehensive income                                                                                                     2,285
                                                                                                                      ---------
Cash dividend declared                                                                          (693)                     (693)
Issuance of 7,955 shares in connection with stock options                     40        3                                   43
                                                                          -----------------------------------------------------
Balance at March 31, 2002                                                 31,458       29     29,148        68          60,703
                                                                          =====================================================
</TABLE>

See accompanying notes to consolidated interim financial statements.

<PAGE>

                    PALMETTO BANCSHARES, INC. AND SUBSIDIARY
                Consolidated Statements of Cash Flows (Unaudited)
               For the three months ended March 31, 2002 and 2001
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                                                   2002                  2001
                                                                                              ----------------------------------
<S>                                                                                           <C>                     <C>
Cash flows from operating activities:
  Net income                                                                                    $    2,455            $    1,670
  Adjustments to reconcile net income to net cash
     provided by (used in) operating activities:
                Depreciation and amortization                                                          588                   533
                Gain on sale of investment securities                                                 (140)                    -
                Provision for loan losses                                                              900                   850
                Origination of loans held for sale                                                 (27,184)              (12,291)
                Sale of loans held for sale                                                         24,100                 8,481
                Gain on sale of loans                                                                 (225)                  (58)
                Change in accrued interest receivable                                                  207                   286
                Change in other assets                                                                (219)                 (391)
                Change in other liabilities, net                                                     1,809                   412
                                                                                              ----------------------------------

                                     Net cash provided by (used in) operating activities             2,291                  (508)

Cash flows from investing activities:
  Purchase of investment securities available for sale                                             (37,130)                    -
  Proceeds from maturities of investment securities available for sale                               4,841                 1,932
  Proceeds from sale of investment securities available for sale                                    20,779                     -
  Principal paydowns on mortgage-backed securities available for sale                                1,451                 1,568
  Net increase in loans outstanding                                                                 (4,043)              (18,173)
  Purchases of premises and equipment, net                                                            (774)               (1,108)
                                                                                              ----------------------------------

                                     Net cash used in investing activities                         (14,876)              (15,781)

Cash flows from financing activities:
  Net increase in deposit accounts                                                                  22,340                25,626
  Net increase (decrease) in securities sold under agreements to repurchase                          1,485                 1,598
  Net increase in commercial paper                                                                   2,078                (3,257)
  Proceeds from issuance of common stock                                                                43                    35
  Dividends paid                                                                                      (693)                 (626)
                                                                                              ----------------------------------

                                     Net cash provided by financing activities                      25,253                23,376
                                                                                              ----------------------------------

Net increase (decrease) in cash and cash equivalents                                                12,668                 7,087
                                                                                              ----------------------------------
Cash and cash equivalents at beginning of the period                                                45,691                38,184
                                                                                              ----------------------------------
Cash and cash equivalents at end of the period                                                  $   58,359            $   45,271
                                                                                              ==================================

Supplemental Information:
Cash paid during the period for:
     Interest expense                                                                           $    3,573            $    5,619
                                                                                              ==================================
     Income taxes                                                                                      698                   485
                                                                                              ==================================

Supplemental schedule of non-cash investing and financing transactions:
    Change in unrealized gain (loss) on investment securities available for sale,
          before tax                                                                            $     (276)           $    1,519
                                                                                              ==================================
    Loans transferred to other real estate owned                                                     1,390                   252
                                                                                              ==================================
    Loans charged -off                                                                                 868                   787
                                                                                              ==================================
</TABLE>

See accompanying notes to consolidated interim financial statements.

                                       4

<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, 2001.

     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-month period ended March 31,
2002 are not necessarily indicative of the results that may be expected for the
entire year.

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 2001 Annual Report on Form 10-K. There have
been no changes in these policies subsequent to the year ended December 31,
2001.

4.  Earnings 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 March 31, 2002 and 2001 (dollars in thousands except per
share numbers):

<TABLE>
<CAPTION>

                                                          Income         Shares      Per-Share
   2002                                                 (Numerator)   (Denominator)   Amount
   ----                                                 --------------------------------------
  <S>                                                   <C>           <C>            <C>
   Basic EPS:
   ----------
   Net income                                            $2,455         6,287,279      $0.39
   Effect of dilutive securities: stock options              --           186,537         --
                                                        --------------------------------------
   Diluted EPS:
   ------------
   Net income plus assumed exercises of stock options    $2,455         6,473,816      $0.38
                                                        ======================================

                                                          Income         Shares      Per-Share
   2001                                                 (Numerator)   (Denominator)   Amount
   ----                                                 --------------------------------------
   Basic EPS:
   ----------
   Net income                                            $1,670         6,259,023      $0.27
   Effect of dilutive securities: stock options              --           170,886         --
                                                        --------------------------------------
   Diluted EPS:
   ------------
   Net income plus assumed exercises of stock options    $1,670         6,429,909      $0.26
                                                         =====================================
</TABLE>

                                       5

<PAGE>

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

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.

DISCUSSION OF FINANCIAL CONDITION CHANGES FROM DECEMBER 31, 2001 TO MARCH 31,
2002

Assets
------
     Total assets increased $29.2 million, or 4%, for the three month period
ended March 31, 2002, primarily as a result of an increase in liquid assets.
Liquid assets, which include cash, federal funds sold, and investments available
for sale, increased by $22.4 million, or 16%, for the three-month period. This
increase was attributable to the $8.3 million increase in cash and due from
banks, the $9.8 million increase in investment securities available for sale,
and the $4.3 million increase in federal funds sold. During the first three
months of 2002, the Bank purchased $37.1 million of investment securities
(available for sale), $25.6 million of the investment portfolio matured or was
sold, and $1.4 million was paid down on mortgage backed securities held for
sale. The Bank had a $170,000 change in pre-tax unrealized gains in its
investment portfolio at March 31, 2002.
Net loans increased by $1.8 million, or less than 1%, during the three-month
period. Loan demand has remained flat during the first quarter due to the slower
economy. Also, management's strategy during the quarter has been to avoid
excessive loan growth fueled exclusively by low rate positions. The allowance
for loan losses as a percentage of total loans increased slightly to 1.03% at
March 31, 2002 from 1.02% at December 31, 2001. Management feels the allowance
is adequate at March 31, 2002 because the Bank uses an allowance model that
takes into account the risk grades of loans, delinquency trends, charge-off
ratios and loan growth. The Bank has been making efforts to improve its
underwriting standards, shift its emphasis toward higher-dollar, higher-quality
loans, and charge off significant amounts of lower-quality loans. Non-performing
loans (which consists of loans on non-accrual and loans greater than 90 days
past due and still accruing) were $3.1 million at March 31, 2002, compared to
$4.0 million at December 31, 2001.

     At March 31, 2002, the Company had $13.4 million in loans held for sale
with commitments to sell these loans in April and May 2002. Because the interest
rate environment has been favorable for mortgage loans and refinances, the Bank
has been able to originate approximately $30.4 million in mortgage loans during
the first three months of 2002, with over 75% being sold in the secondary
market.
The mortgage servicing rights related to the mortgage servicing department's
activities were $1.7 million

at March 31, 2002, which approximates their fair value. Loans serviced for the
benefit of others amounted to $204.2 million at March 31, 2002.

     Other assets increased by $1.6 million, or 15%, from December 31, 2001 to
March 31, 2002.  Because of the increased sales of mortgage loans, mortgage
servicing rights increased approximately $325,000,

                                       6

<PAGE>

while $196,000 of those rights were amortized. Other real estate increased by
$1.4 million with the addition of nine properties.

Liabilities and Shareholders' Equity
------------------------------------
     Total deposit balances increased by 3% during the three-month period, from
$645.3 million to $667.6 million. There was an increase in all interest-bearing
accounts, except IRAs. Securities sold under agreements to repurchase increased
by $1.5 million, or 10%, and commercial paper associated with the alternative
commercial sweep accounts (master note program) increased by $2.0 million, or
19%. These changes are the result of normal fluctuations in the accounts.
     Total shareholders' equity increased by $1.6 million, or 3%, for the
three-month period as a result of comprehensive income of $2.3 million, less
dividends paid of $693,000. The Company also added $43,000 to equity as the
result of stock option exercises. During the three months ended March 31, 2002,
the Company increased its dividends to stockholders to $.11 per share compared
to $.10 per share in the first three months of 2001.

Regulatory Capital
------------------
     As of March 31, 2002, 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:

--------------------------------------------------------------------------------
                                            Adequately
                                As of      Capitalized     Well-Capitalized
                                3/31/02     Requirement       Requirement
--------------------------------------------------------------------------------

Company:
-------

   Total Risk-based Capital     10.96%          8.00%             10.00%

   Tier 1 Risk-based Capital     9.94           4.00               6.00

   Tier 1 Leverage Ratio         7.61           4.00               5.00

Bank:
----

   Total Risk-based Capital     10.86           8.00              10.00

   Tier 1 Risk-based Capital     9.84           4.00               6.00

   Tier 1 Leverage Ratio         7.53           4.00               5.00

LIQUIDITY AND ASSET/LIABILITY MANAGEMENT

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 March 31, 2002, the
Company's liquidity ratio was 18.63%.

                                       7

<PAGE>

     At March 31, 2002, the Bank had unused short-term lines of credit totaling
approximately $37 million (which are withdrawable at the lender's option). At
March 31, 2002, unused borrowing capacity from the Federal Home Loan Bank
("FHLB") totaled $76 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 long-term debt outstanding and has declared and paid $0.11 per share in
dividends so far in 2002. Although there can be no guarantee that any additional
dividends will be paid in 2002, the Company plans to continue its quarterly
dividend payments. At March 31, 2002, the Bank has issued commitments to extend
credit of $96.0 million through various types of lending arrangements. All
unused loan commitments are at adjustable rates that fluctuate with the prime
rate or are at fixed rates that approximate market rates. The current amount of
these commitments approximates their fair value.
     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 10.86%. At March 31, 2002, the Bank had $4.9 million of excess retained
earnings available to pay out dividends and still be considered
"well-capitalized."

Asset/Liability Management
--------------------------
       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
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 following table is a summary of the Company's one year gap at March
31, 2002 (amounts in thousands):

                                                                 March  31, 2002
--------------------------------------------------------------------------------
Interest-earning assets maturing or repricing within one year        $ 216,414
Interest-bearing liabilities maturing or repricing within one year   $ 364,585
--------------------------------------------------------------------------------
Cumulative gap                                                       $(148,171)
================================================================================
Gap as a percentage of total assets                                     (19.38)%

                                       8

<PAGE>

       The above analysis does not take in to account any prepayments on
mortgages, consumer or other loans, and securities. All maturities are stated in
contractual terms. 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.
       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.

COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31,
2002 AND 2001

Net Income
----------
       Net income for the three months ended March 31, 2002 and 2001 was $2.5
million and $1.7 million, respectively. Net income per common share-basic for
the three months ended March 31, 2002 and 2001 was $0.39 and $0.27,
respectively. Net income per common share-dilutive for the same periods was
$0.38 and $0.26, 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 periods ended March 31, 2002 and 2001, net interest
income was $8.3 million and $6.8 million, respectively. Earning assets averaged
$685.3 million and $618.2 million during the first quarters of 2002 and 2001,
respectively. The increase in volume was primarily due to the growth of loans.
Although the volume of earning assets increased over the two comparative
quarters, the yield on earning assets decreased during the same time period,
from 8.08% to 6.92%. Average interest-bearing liabilities grew from $523.9
million at March 31, 2001 to $581.3 million at March 31, 2002. However, the cost
of these funds shrunk 195 basis points, from 4.28% to 2.33% during the same time
period. The dynamics of the yield on average earning assets and the cost of
interest bearing liabilities have resulted in a positive growth in the average
tax-equivalent net interest margin from 4.61% at March 31, 2001 to 5.07% at
March 31, 2002. The underlying factor for the changes in the yields and rates on
earning assets and costing liabilities has been the action of the Federal
Reserve Open Market Committee during the past year. From January 2001 through
the end of December 2001, the Federal Reserve cut interest rates four hundred
and seventy five basis points. Although there have been no reductions during the
first quarter of 2002, these reductions have continued to result in a much more
favorable interest environment for the operations of the Company.

Provision for Loan Losses
-------------------------
       During the current quarter, the Company's provision for loan losses
totaled $900,000, compared to $850,000 during the same period in the previous
year. The provision is adjusted each month to reflect loan

                                       9

<PAGE>

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. Annualized net charge-offs as a percentage of average total loans
were .58% during the current quarter, compared to .69% for the same period last
year.

       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 $769,000, or 30%, for the three
months ended March 31, 2002, as compared to the same period in 2001. Net NSF and
overdraft charges totaled $1.3 million, increasing $381,000 from the comparable
quarter in 2001. Net gains from the sale of mortgage loans totaled $225,000,
increasing by $167,000 from the same quarter last year. The Company sold a
portion of the investments held for sale resulting in a pre-tax gain of $140,000
during the current quarter; no investments were sold during the same quarter
last year.

Non-interest Expense
--------------------
       Total non-interest expense increased by $976,000, or 16%, during the 2002
three-month period compared to the same period in 2001. $605,000 of the increase
was a result of higher personnel costs, including salaries, related taxes and
medical insurance premiums. At March 31, 2002, the Bank had 370 full-time
equivalent employees compared to 355 full-time equivalent employees at March 31,
2001.

Income Taxes
------------
     During the first quarter of 2002 and 2001, the Company's effective tax rate
approximated 32.6% and 28.6%, respectively. The actual tax provision was $1.2
million during 2002 and $670,000 during 2001.

Accounting and Reporting Matters
--------------------------------
     In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 requires that the purchase method of accounting
be used for all business combinations initiated after June 30, 2001. SFAS 141
also specifies criteria that intangible assets acquired in a purchase method
business combination must meet to be recognized and reported apart from
goodwill, noting that any purchase price allocable to an assembled workforce may
not be accounted for separately. The Company adopted SFAS No. 141 on July 1,
2001 and does not expect the Statement to have a material impact on the
financial statements in the future as the Company has always accounted for
business combinations through the purchase method.

     SFAS No. 142 will require that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of SFAS No. 142.
SFAS No. 142 will also require that intangible assets with estimable useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of."

     Currently, it is the Company's understanding that SFAS No. 142 does not
apply to the acquisition of a commercial bank, a savings and loan association, a
mutual savings bank, a credit union, other depository institutions having assets
and liabilities of the same type as those institutions, and branches of such

                                       10

<PAGE>

enterprises. Intangible assets arising from these types of business
combinations must conform to the guidance in SFAS No. 72, "Accounting for
Certain Acquisitions of Banking or Thrift Institutions", and are thus excluded
from the scope of SFAS No. 142. At December 31, 2001, the Company had
unamortized intangible assets relating to core deposit premiums purchased of
$382,000 as well as unamortized goodwill defined in SFAS 72 as an unidentifiable
intangible asset ("Statement 72" goodwill) of $3.9 million. The Company plans to
continue amortizing these assets as directed in SFAS No. 72. It is the Company's
understanding that the FASB has undertaken a limited scope project to reconsider
part of the guidance in SFAS No. 72, particularly the provision that requires
recognition and amortization of an unidentifiable intangible asset. However, the
Company has continued amortizing the "Statement 72" goodwill until receiving
further guidance from the FASB. If it were determined that a commercial bank, a
savings and loan association, a mutual savings bank, a credit union, or other
depository institutions falls under the guidance of SFAS No. 142, the Company
has conducted an initial impairment test based on market capitalization. Based
on the results of the test, the Company believes does not have any additional
impairment during the first quarter 2002.

     In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". This SFAS supercedes prior
pronouncements associated with impairment or disposal of long-lived assets. SFAS
No. 144 establishes methodologies for assessing impairment of long-lived assets,
including assets to be disposed of by sale or other means. The Company adopted
the provisions of SFAS No. 144 on January 1, 2002 and does not expect the
provisions to have a material impact on the Company's financial position.

     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

                                       11

<PAGE>

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.

      At March 31, 2002, management believes that there have been no significant
changes in market risk as disclosed in the Company's Annual Report on Form 10-K
for the year ended December 31, 2001.

                                       12

<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. While the Bank
does not anticipate a negative result from this lawsuit, based on the apparent
claims being asserted by the plaintiff, there can be no assurance that a
negative result might not have a material adverse effect on the Company's
financial condition.

     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
        -----------------------------------------------------
None

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

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

(b) Reports on Form 8-K:
None

                                       13

<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:  May 1, 2002

                                       14