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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  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 September 30, 2004 o
    
    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 000-32955    LSB Corporation     Massachusetts
    
    04-3557612(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification Number)
 30 Massachusetts Avenue, North Andover, MA
(Address of principal executive offices)
    
    01845
(Zip Code)
    (978) 725-7500
(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 report), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No o   Indicate by a check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes o No x   Indicate the number of shares outstanding of each of the registrants
classes of common stock, as of the latest practicable date. Class
    
    Outstanding as of October 31, 2004Common Stock, par value $.10 per share
    
    4,324,942 shares




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LSB CORPORATION AND SUBSIDIARY INDEX PagePART I  FINANCIAL INFORMATIONITEM 1 FINANCIAL STATEMENTS:Consolidated Balance Sheets
    
    
    3Consolidated Statements of Income
    
    
    4Consolidated Statements of Changes in Stockholders Equity
    
    
    5Consolidated Statements of Cash Flows
    
    
    6Notes to Consolidated Financial Statements
    
    
    7-9ITEM 2 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:Financial Condition:Investment Portfolio
    
    
    11Loan Portfolio
    
    
    12Allowance for Loan Losses
    
    
    12Risk Assets
    
    
    13Deposits
    
    
    13Results of Operations:Three months ended September 30, 2004 and 2003
    
    
    14Loan Interest Income
    
    
    15Deposit Interest Expense
    
    
    15Nine months ended September 30, 2004 and 2003
    
    
    17Loan Interest Income
    
    
    18Deposit Interest Expense
    
    
    18Liquidity and Capital Resources
    
    
    19ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
    
    
    20ITEM 4 CONTROLS AND PROCEDURES
    
    
    20PART II  OTHER INFORMATIONITEM 1 LEGAL PROCEEDINGS
    
    
    21ITEM 2 UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
    
    
    21ITEM 3 DEFAULTS UPON SENIOR SECURITIES
    
    
    21ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    21ITEM 5 OTHER INFORMATION
    
    
    22ITEM 6 EXHIBITS
    
    
    22SIGNATURES
    
    
    23EXHIBIT INDEX
    
    
    24EX-31.1 Section 302 CEO CertificationEX-31.2 Section 302 CFO CertificationEX-32.1 Section 906 CEO CertificationEX-32.2 Section 906 CFO Certification
  2




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PART 1   FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS 
 LSB CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(UNAUDITED) September 30,
    
    December 31,2004
    
    2003(In Thousands, Except Share Data)ASSETSAssets:Cash and due from banks
    
    $
    9,136
    
    
    $
    7,872Federal funds sold
    
    
    128
    
    
    
    889Total cash and cash equivalents
    
    
    9,264
    
    
    
    8,761Investment securities held to maturity (market value of
$200,402 in 2004 and $184,592 in 2003)
    
    
    200,608
    
    
    
    184,286Investment securities available for sale (amortized cost of
$60,418 in 2004 and $48,571 in 2003)
    
    
    60,234
    
    
    
    48,592Federal Home Loan Bank stock, at cost
    
    
    7,694
    
    
    
    6,593Loans, net of allowance for loan losses
    
    
    212,529
    
    
    
    207,283Bank premises and equipment
    
    
    3,549
    
    
    
    2,875Accrued interest receivable
    
    
    2,896
    
    
    
    2,552Deferred income tax asset
    
    
    2,756
    
    
    
    3,519Other assets
    
    
    1,459
    
    
    
    1,647Total assets
    
    $
    500,989
    
    
    $
    466,108LIABILITIES AND STOCKHOLDERS EQUITYLiabilities:Interest bearing deposits
    
    $
    281,006
    
    
    $
    258,430Non-interest bearing deposits
    
    
    20,675
    
    
    
    14,110Federal Home Loan Bank advances
    
    
    102,132
    
    
    
    78,866Other borrowed funds
    
    
    31,750
    
    
    
    52,000Securities sold under agreements to repurchase
    
    
    3,662
    
    
    
    2,486Advance payments by borrowers for taxes and insurance
    
    
    618
    
    
    
    450Other liabilities
    
    
    3,649
    
    
    
    4,764Total liabilities
    
    
    443,492
    
    
    
    411,106Stockholders equity:Preferred stock, $.10 par value per share:5,000,000 shares authorized, none issued
    
    
    
    
    
    
    Common stock, $.10 par value per share;20,000,000 shares authorized;
4,539,242 and 4,454,262 shares issued at September 30, 2004 and December 31, 2003, respectively, and 4,319,942 and 4,234,962 shares
outstanding at September 30, 2004 and December 31, 2003, respectively
    
    
    454
    
    
    
    445Additional paid-in capital
    
    
    58,793
    
    
    
    58,350Retained earnings (accumulated deficit)
    
    
    1,112
    
    
    
    (1,055
    )Treasury stock, at cost (219,300 shares)
    
    
    (2,758
    )
    
    
    (2,758
    )Accumulated other comprehensive (loss) income
    
    
    (104
    )
    
    
    20Total stockholders equity
    
    
    57,497
    
    
    
    55,002Total liabilities and stockholders equity
    
    $
    500,989
    
    
    $
    466,108
 The accompanying notes are an integral part of these unaudited Consolidated Financial Statements. 3




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LSB CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED) Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(In Thousands, Except Share Data)Interest and dividend income:Loans
    
    $
    3,242
    
    
    $
    3,381
    
    
    $
    9,797
    
    
    $
    11,069Investment securities held to maturity
    
    
    1,680
    
    
    
    1,176
    
    
    
    5,058
    
    
    
    3,353Investment securities available for sale
    
    
    489
    
    
    
    367
    
    
    
    1,375
    
    
    
    1,323Federal Home Loan Bank stock
    
    
    69
    
    
    
    45
    
    
    
    141
    
    
    
    140Other interest and dividend income
    
    
    8
    
    
    
    8
    
    
    
    20
    
    
    
    68Total interest and dividend income
    
    
    5,488
    
    
    
    4,977
    
    
    
    16,391
    
    
    
    15,953Interest expense:Deposits
    
    
    964
    
    
    
    1,013
    
    
    
    2,662
    
    
    
    3,259Federal Home Loan Bank advances
    
    
    1,025
    
    
    
    1,117
    
    
    
    3,187
    
    
    
    3,502Other borrowed funds
    
    
    103
    
    
    
    31
    
    
    
    351
    
    
    
    105Securities sold under agreements to repurchase
    
    
    4
    
    
    
    4
    
    
    
    10
    
    
    
    14Total interest expense
    
    
    2,096
    
    
    
    2,165
    
    
    
    6,210
    
    
    
    6,880Net interest income
    
    
    3,392
    
    
    
    2,812
    
    
    
    10,181
    
    
    
    9,073Provision (credit) for loan losses
    
    
    
    
    
    
    
    
    
    
    (300
    )
    
    
    Net interest income after provision (credit) for loan losses
    
    
    3,392
    
    
    
    2,812
    
    
    
    10,481
    
    
    
    9,073Non-interest income:Loan servicing fees
    
    
    19
    
    
    
    233
    
    
    
    162
    
    
    
    53Deposit account fees
    
    
    236
    
    
    
    183
    
    
    
    668
    
    
    
    526Gains (losses) on sales of mortgage loans
    
    
    (5
    )
    
    
    143
    
    
    
    64
    
    
    
    457Lawsuit judgment collected
    
    
    
    
    
    
    
    
    
    
    2,275
    
    
    
    Other income
    
    
    98
    
    
    
    99
    
    
    
    281
    
    
    
    285Total non-interest income
    
    
    348
    
    
    
    658
    
    
    
    3,450
    
    
    
    1,321Non-interest expense:Salaries and employee benefits
    
    
    1,655
    
    
    
    1,417
    
    
    
    4,904
    
    
    
    4,488Occupancy and equipment expenses
    
    
    219
    
    
    
    159
    
    
    
    658
    
    
    
    581Professional expenses
    
    
    141
    
    
    
    187
    
    
    
    472
    
    
    
    550Data processing expenses
    
    
    237
    
    
    
    186
    
    
    
    670
    
    
    
    547Other expenses
    
    
    454
    
    
    
    468
    
    
    
    1,261
    
    
    
    1,295Total non-interest expenses
    
    
    2,706
    
    
    
    2,417
    
    
    
    7,965
    
    
    
    7,461Income before income tax expense
    
    
    1,034
    
    
    
    1,053
    
    
    
    5,966
    
    
    
    2,933Income tax expense
    
    
    337
    
    
    
    399
    
    
    
    2,126
    
    
    
    1,094Net income
    
    $
    697
    
    
    $
    654
    
    
    $
    3,840
    
    
    $
    1,839Average shares outstanding
    
    
    4,312,649
    
    
    
    4,214,501
    
    
    
    4,293,362
    
    
    
    4,211,435Average diluted shares outstanding
    
    
    4,482,075
    
    
    
    4,412,909
    
    
    
    4,452,403
    
    
    
    4,378,550Basic earnings per share
    
    $
    0.16
    
    
    $
    0.16
    
    
    $
    0.89
    
    
    $
    0.44Diluted earnings per share
    
    $
    0.16
    
    
    $
    0.15
    
    
    $
    0.86
    
    
    $
    0.42
 The accompanying notes are an integral part of these unaudited Consolidated Financial Statements 4




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LSB CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003(UNAUDITED) AccumulatedAdditional
    
    
    
    
    
    
    
    
    
    Other
    
    TotalCommon
    
    Paid-In
    
    (Accumulated
    
    Treasury
    
    Comprehensive
    
    StockholdersStock
    
    Capital
    
    Deficit)
    
    Stock
    
    Income
    
    Equity(In Thousands, Except Share Data)Balance at December 31, 2002
    
    $
    439
    
    
    $
    57,845
    
    
    $
    (3,168
    )
    
    $
    (1,736
    )
    
    $
    679
    
    
    $
    54,059Net income
    
    
    
    
    
    
    
    
    
    
    1,839
    
    
    
    
    
    
    
    
    
    
    
    1,839Other comprehensive income:Unrealized loss on securities
available for sale (tax effect $318)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (617
    )
    
    $
    (617
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,222Exercise of stock options
    
    
    5
    
    
    
    270
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    275Dividends declared and paid
($0.36 per share)
    
    
    
    
    
    
    
    
    
    
    (1,515
    )
    
    
    
    
    
    
    
    
    
    
    (1,515
    )Purchase of 82,800 shares of Treasury
Stock, at cost
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,022
    )
    
    
    
    
    
    
    (1,022
    )Balance at September 30, 2003
    
    $
    444
    
    
    $
    58,115
    
    
    $
    (2,844
    )
    
    $
    (2,758
    )
    
    $
    62
    
    
    $
    53,019
 Retained
    
    
    
    
    
    AccumulatedAdditional
    
    Earnings/
    
    
    
    
    
    Other
    
    TotalCommon
    
    Paid-In
    
    (Accumulated
    
    Treasury
    
    Comprehensive
    
    StockholdersStock
    
    Capital
    
    Deficit)
    
    Stock
    
    Income (loss)
    
    Equity(In Thousands, Except Share Data)Balance at December 31, 2003
    
    $
    445
    
    
    $
    58,350
    
    
    $
    (1,055
    )
    
    $
    (2,758
    )
    
    $
    20
    
    
    $
    55,002Net income
    
    
    
    
    
    
    
    
    
    
    3,840
    
    
    
    
    
    
    
    
    
    
    
    3,840Other comprehensive income:Unrealized loss on securities
available for sale (tax effect $81)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (124
    )
    
    $
    (124
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,716Exercise of stock options
    
    
    9
    
    
    
    443
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    452Dividends declared and paid
($0.39 per share)
    
    
    
    
    
    
    
    
    
    
    (1,673
    )
    
    
    
    
    
    
    
    
    
    
    (1,673
    )Balance at September 30, 2004
    
    $
    454
    
    
    $
    58,793
    
    
    $
    1,112
    
    
    $
    (2,758
    )
    
    $
    (104
    )
    
    $
    57,497
 The accompanying notes are an integral part of these unaudited Consolidated Financial Statements. 5




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LSB CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) Nine months endedSeptember 30,2004
    
    2003(In Thousands)Cash flows from operating activities:Net income
    
    $
    3,840
    
    
    $
    1,839Adjustments to reconcile net income to net cash provided by operating activities:Credit for loan losses
    
    
    (300
    )
    
    
    Gains on sales of mortgage loans
    
    
    (64
    )
    
    
    (457
    )Net amortization of investment securities
    
    
    1,276
    
    
    
    1,688Loss on sale of investment securities available for sale
    
    
    
    
    
    
    14Depreciation of premises and equipment
    
    
    318
    
    
    
    316Loans originated for sale
    
    
    (3,596
    )
    
    
    (20,622
    )Proceeds from sales of mortgage loans
    
    
    3,998
    
    
    
    22,580Increase in accrued interest receivable
    
    
    (344
    )
    
    
    (63
    )Decrease in deferred income tax asset
    
    
    844
    
    
    
    884Decrease in other assets
    
    
    188
    
    
    
    259Increase in advance payments by borrowers
    
    
    168
    
    
    
    20Decrease in other liabilities
    
    
    (1,115
    )
    
    
    (12
    )Net cash provided by operating activities
    
    
    5,213
    
    
    
    6,446Cash flows from investing activities:Proceeds from sale of mortgage-backed securities available for sale
    
    
    
    
    
    
    5,684Proceeds from maturities of investment securities held to maturity
    
    
    14,800
    
    
    
    164,900Proceeds from maturities of investment securities available for sale
    
    
    14,585
    
    
    
    7,000Purchases of investment securities held to maturity
    
    
    (47,353
    )
    
    
    (198,338
    )Purchases of mortgage-backed securities held to maturity
    
    
    
    
    
    
    (38,118
    )Purchases of investment securities available for sale
    
    
    (30,102
    )
    
    
    (16,712
    )Purchase of mutual fund available for sale
    
    
    
    
    
    
    (1,000
    )Purchases of mortgage-backed securities available for sale
    
    
    
    
    
    
    (14,775
    )Purchases of Federal Home Loan Bank stock
    
    
    (1,101
    )
    
    
    Principal payments of securities held to maturity
    
    
    15,148
    
    
    
    39,369Principal payments of securities available for sale
    
    
    3,477
    
    
    
    13,483(Increase) decrease in loans, net
    
    
    (5,284
    )
    
    
    35,886Purchases of Bank premises and equipment
    
    
    (992
    )
    
    
    (74
    )Net cash used in investing activities
    
    
    (36,822
    )
    
    
    (2,695
    )Cash flows from financing activities:Net increase in deposits
    
    
    29,141
    
    
    
    1,066Additions to Federal Home Loan Bank advances
    
    
    38,345
    
    
    
    Payments on Federal Home Loan Bank advances
    
    
    (15,079
    )
    
    
    (11,891
    )Net increase (decrease) in agreements to repurchase securities
    
    
    1,176
    
    
    
    (1,945
    )Net decrease (increase) in other borrowed funds
    
    
    (20,250
    )
    
    
    2,529Treasury stock purchased
    
    
    
    
    
    
    (1,022
    )Dividends paid
    
    
    (1,673
    )
    
    
    (1,515
    )Proceeds from exercise of stock options
    
    
    452
    
    
    
    275Net cash provided by (used in) financing activities
    
    
    32,112
    
    
    
    (12,503
    )Net increase (decrease) in cash and cash equivalents
    
    
    503
    
    
    
    (8,752
    )Cash and cash equivalents, beginning of period
    
    
    8,761
    
    
    
    16,769Cash and cash equivalents, end of period
    
    $
    9,264
    
    
    $
    8,017Cash paid during the period for:Interest on deposits
    
    $
    2,660
    
    
    $
    3,242Interest on borrowed funds
    
    
    3,551
    
    
    
    3,678Income taxes
    
    
    3,295
    
    
    
    368Supplemental Schedule of non-cash activities:Net change in valuation of investment securities available for sale
    
    
    (205
    )
    
    
    (935
    )
 The accompanying notes are an integral part of these unaudited Consolidated Financial Statements. 6




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##### Table of Contents



LSB CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
(UNAUDITED) 1. BASIS OF PRESENTATION LSB Corporation (the Corporation or the Company) is a Massachusetts
corporation and the holding company of its wholly-owned subsidiary Lawrence
Savings Bank (the Bank) a state-chartered Massachusetts savings bank. The
Corporation was organized by the Bank on July 1, 2001 to be a bank holding
company and to acquire all of the capital stock of the Bank. The Corporation is supervised by the Board of Governors of the Federal Reserve
System (FRB), and it is also subject to the jurisdiction of the Massachusetts
Division of Banks, while the Bank is subject to the regulations of, and
periodic examination by, the Federal Deposit Insurance Corporation (FDIC) and
the Massachusetts Division of Banks. The Banks deposits are insured by the
Bank Insurance Fund of the FDIC up to $100,000 per account, as defined by the
FDIC, and the Depositors Insurance Fund (DIF) for customer deposit amounts in
excess of $100,000. The Consolidated Financial Statements include the accounts
of LSB Corporation and its wholly-owned consolidated subsidiary, Lawrence
Savings Bank, and its wholly-owned subsidiaries, Shawsheen Security
Corporation, Shawsheen Security Corporation II, Pemberton Corporation, and
Spruce Wood Realty Trust. All inter-company balances and transactions have
been eliminated in consolidation. The Company has one reportable operating
segment. Certain amounts in prior periods have been re-classified to conform
to the current presentation. The Corporations Consolidated Financial Statements have been prepared in
conformity with accounting principles generally accepted in the United States
of America. Accordingly, management is required to make estimates and
assumptions that affect amounts reported in the balance sheets and statements
of income. Actual results could differ significantly from those estimates and
judgments. Material estimates that are particularly susceptible to change
relate to the allowance for loan losses, income taxes and mortgage servicing
rights. The interim results of consolidated income are not necessarily indicative of
the results for any future interim period or for the entire year. These
interim Consolidated Financial Statements do not include all disclosures
associated with annual financial statements and, accordingly, should be read in
conjunction with the annual Consolidated Financial Statements and accompanying
notes included in the Companys Annual Report on Form 10-K as of and for the
year ended December 31, 2003 filed with the Securities and Exchange Commission. 2. STOCK OPTIONS The Corporation measures compensation cost for stock-based plans using the
intrinsic value method. The intrinsic value method measures compensation cost,
if any, as the fair market value of the Companys stock at the grant date over
the exercise price. All options granted have an exercise price equivalent to
the fair market value at the date of grant and, accordingly, no compensation
cost has been recorded. If the fair value based method of accounting for stock
options had been used, the Companys net income and earnings per share would
have been reduced to the pro forma amounts for the three months and nine months
ended September 30, presented in the table which follows: Three months ended
    
    Nine months ended9/30/04
    
    9/30/03
    
    9/30/04
    
    9/30/03(In Thousands, Except Share Data)Net income:As Reported
    
    $
    697
    
    
    $
    654
    
    
    $
    3,840
    
    
    $
    1,839Less: Pro forma stock based compensation cost (net of taxes)
    
    
    (78
    )
    
    
    (44
    )
    
    
    (286
    )
    
    
    (133
    )Pro forma
    
    $
    619
    
    
    $
    610
    
    
    $
    3,554
    
    
    $
    1,706Basic earnings per share:As Reported
    
    $
    0.16
    
    
    $
    0.16
    
    
    $
    0.89
    
    
    $
    0.44Pro forma
    
    
    0.14
    
    
    
    0.14
    
    
    
    0.83
    
    
    
    0.41Diluted earnings per share:As Reported
    
    $
    0.16
    
    
    $
    0.15
    
    
    $
    0.86
    
    
    $
    0.42Pro forma
    
    
    0.14
    
    
    
    0.14
    
    
    
    0.80
    
    
    
    0.39
 The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 2004: expected volatility of 28.9%, expected
average life of 8 years, and risk-free interest rates of 3.4% and expected
dividend yield of 3.08%. 7




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3. DEFINED BENEFIT PLAN The Company provides pension benefits for its employees through membership in
the Savings Bank Employees Retirement Association (the Plan). The Plan is a
multiple-employer, non-contributory, defined benefit plan. Bank employees
become eligible after attaining 21 years of age and completing one year of
service. Additionally, benefits become fully vested after three years of
eligible service. The Companys annual contribution to the Plan is based upon
standards established by the Employee Retirement Income Security Act. The
contribution is based on an actuarial method intended to provide not only for
benefits attributable to service date, but also for those expected to be earned
in the future. The Company expects to contribute approximately $372 thousand
during the Plan Year ending at October 31, 2004. Net pension cost components for the three months and nine months ended
September 30, follow: Three months ended
    
    Nine months ended9/30/04
    
    9/30/03
    
    9/30/04
    
    9/30/03(In Thousands)Service cost
    
    $
    104
    
    
    $
    89
    
    
    $
    311
    
    
    $
    266Interest cost
    
    
    106
    
    
    
    102
    
    
    
    317
    
    
    
    306Expected return on plan assets
    
    
    (122
    )
    
    
    (107
    )
    
    
    (364
    )
    
    
    (319
    )Net amortization and deferrals
    
    
    (1
    )
    
    
    (1
    )
    
    
    (3
    )
    
    
    (3
    )Net periodic pension cost
    
    $
    87
    
    
    $
    83
    
    
    $
    261
    
    
    $
    250
 4. CONTINGENCIES The Bank was awarded a $4.2 million judgment against a debtor in 1997. The
judgment was appealed and the Bank prevailed in this matter in Appeals Court.
On February 13, 2002, the defendant filed bankruptcy under Chapter 7
(liquidation). Post-judgment interest accrues from the date of the judgment to
February 13, 2002 and approximates $1.9 million. Bids of approximately $3.3 million for the major assets were approved by the
Bankruptcy Court on October 14, 2003. The net amount to be received by the
Bank after taxes and bankruptcy expenses is not known at this time. However,
it is not likely that the full $4.2 million judgment and post-judgment interest
of $1.9 million will be collected. On June 15, 2004 the Company reported in a press release the receipt of $2.5
million on a U.S. Bankruptcy Judges Order on the Trustees Motion for
authorization to make an interim distribution to the Bank. The $2.5 million
distribution has been received and was recorded as income by the Bank on June
15, 2004. The Bank has agreed to return any of the interim distribution as
would be necessary to pay additional taxes imposed on the bankruptcy estate in
the event reserves set aside for expenses and taxes are insufficient. The
Company first reported the Bankruptcy Trustees Motion seeking authorization
from the U.S. Bankruptcy Judge for an interim distribution to creditors in a
press release dated February 26, 2004. The diluted earnings per share impact
of the interim distribution is approximately $0.35 per share based on average
dilutive shares outstanding during the quarter ended June 30, 2004. It is managements opinion the timing and final amount to be collected in this
matter can not be determined at this time. Accordingly, no recognition beyond
the amount of the interim distribution has been recorded in the Companys
Consolidated Financial Statements at September 30, 2004. 5. RECENT ACCOUNTING DEVELOPMENTS In December 2003, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position 03-3 (SOP 03-3): Accounting for
Certain Loans or Debt Securities Acquired in a Transfer. SOP 03-3 requires
loans acquired through a transfer, such as a business combination, where there
are differences in expected cash flows and contractual cash flows due in part
to credit quality be recognized at their fair value. The excess of contractual
cash flows over expected cash flows is not to be recognized as an adjustment of
yield, loss accrual, or valuation allowance. Valuation allowances can not be
created nor carried over in the initial accounting for loans acquired in a
transfer. However, valuation allowances for non-impaired loans acquired in a
business combination can be carried over. This SOP is effective for loans
acquired after December 31, 2004, with early adoption encouraged. The Company
does not believe the adoption of SOP 03-3 will have a material impact on the
Companys financial position or results of operations. 8




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##### Table of Contents



5. RECENT ACCOUNTING DEVELOPMENTS (Continued) Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB)
No. 105  Application of Accounting Principles to Loan Commitments.In March
2004, the SEC issued SAB No. 105. SAB No. 105 summarizes the views of the SEC
regarding the application of Generally Accepted Accounting Principles (GAAP)
to loan commitments for mortgage loans that will be held for sale accounted for
as derivatives. The guidance requires that the measurement of fair value of
such loan commitments include only the difference between the guaranteed
interest rate in the loan commitment and a market interest rate; future cash
flows related to servicing the loan or the customer relationship should not be
recorded as a part of the loan commitment derivative. SAB No. 105 is effective
for sold loan commitments accounted for as derivatives entered into beginning
April 1, 2004. The Company adopted this SAB on April 1, 2004. The adoption of
SAB No. 105 did not have an impact on the Companys financial condition or
results of operations as the Company already was valuing loan commitments to be
accounted for as derivatives consistent with this guidance. Financial Accounting Standards Board (FASB) Emerging Issues Task Force
(EITF) Issue 03-1. The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments. In June 2004, the FASBs EITF issued EITF
Issue 03-1. EITF 03-1 contains new guidance on other-than-temporary impairments
of investment securities. The guidance dictates when impairment is deemed to
exist, provides guidance on determining if impairment is other than temporary,
and directs how to calculate impairment loss. Issue 03-1 also details expanded
annual disclosure rules. Implementation guidance for EITF 03-1 is currently
being debated by FASB in regards to final guidance and effective date with a
comment period that ended October 29, 2004. EITF 03-1, as issued, was
originally effective for periods beginning after June 15, 2004. The Company
does not believe the adoption of EITF 03-1 will have a material impact on the
Companys financial position or results of operations. 9




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS The Company has made forward-looking statements (within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities and
Exchange Act of 1934 as amended) in this report that are subject to risks and
uncertainties. Forward-looking statements include information concerning
possible or assumed future results of operations of the Company and projected
or anticipated benefits or events related to other future developments
involving the Company or the industry in which it operates. When verbs in the
present tense such as believes, expects, seeks, anticipates,
continues, attempts, or similar expressions are used, forward-looking
statements are being made. Stockholders should exercise caution in
interpreting and relying on forward-looking statements because they involve
known and unknown risks, uncertainties and other factors which are, in some
cases, beyond the Corporations control and could materially affect actual
results, performance or achievements. Stockholders should note that many
factors, some of which are discussed elsewhere in this report and in the
documents which we incorporate by reference in this report, could affect the
future financial results of the Company and could cause the results to differ
materially from those expressed in or incorporated by reference in this report.
Without limitation, those factors include fluctuations in interest rates,
inflation, government regulations and economic conditions and competition, as
well as, possible infrastructure disruptions due to weather, terrorist
activity, computer capacity overload or other factors in the geographic and
business areas in which the Company conducts its operations. As a result of
such risks and uncertainties, the Companys actual results may differ
materially from such forward-looking statements. The Company does not
undertake, and specifically disclaims any obligation to publicly release
revisions to any such forward-looking statements to reflect the occurrence of
anticipated or unanticipated events or circumstances after the date of such
statements. EXECUTIVE LEVEL OVERVIEW The Companys financial results are dependent on the following areas of the
income statement: net interest income, provision for loan losses, non-interest
income, non-interest expense and provision for income taxes. Net interest
income is the primary earnings of the Company and the main focus of management.
Net interest income is the difference between interest earned on loans and
investment securities and interest paid on deposits and borrowings. Deposits
and borrowings have short durations and the cost of these funds do not
necessarily rise and fall in tandem with loans and investment securities.
There are many risks involved in managing net interest income including, but
not limited to credit risk, interest rate risk and duration risk. These risks
have a direct impact on the level of net interest income. The Company manages
these risks through its internal credit and underwriting function, a credit
review by an outside firm and the Asset and Liability Management Committee
(ALCO) meetings on a regular basis. The credit review process reviews loans
for underwriting and grading of loan quality while ALCO reviews the liquidity,
interest rate risk, duration risk and allocation of capital resources. Loan
quality has a direct impact on the amount of provisions for loan losses the
Company reports. Non-interest income includes various fees. Maintenance of customers loan and
deposit accounts generate various amounts of fee income depending on the
product selected. The Company generates gains on sales of mortgage loans and
receives fee income from servicing loans sold. Non-interest income is
primarily impacted by the volume of customer transactions, which could change
in response to changes in interest rates, pricing and competition. Non-interest expenses include various expenses of the Company which generally
are directly related to business volume and are controlled by a budget process. Provisions for income taxes are directly related to earnings or implemented tax
strategies of the Company. Changes in the statutory tax rates and the earnings
of the Company, the Bank and its subsidiaries, would effect the amount of
income taxes reported. 10




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##### Table of Contents



FINANCIAL CONDITION OVERVIEW The Company has maintained risk assets below 1% of total assets for the past
several years. The Company maintains its commitment to servicing the banking
needs of the local community in the Merrimack Valley area of Massachusetts and
southern New Hampshire. The Company had total assets of $501.0 million at
September 30, 2004 compared to $466.1 million at December 31, 2003. The
increase in asset size at September 30, 2004 from December 31, 2003 is mainly
attributable to an increase of $28.0 million in investment securities, $5.2
million in loan growth and $1.1 million in Federal Home Loan Bank stock. The
funding for these assets came from an increase in deposits of $29.1 million and
borrowed funds of $4.2 million during 2004. 
 INVESTMENTS The investment securities portfolio totaled $260.8 million or 52.1% of total
assets at September 30, 2004, compared to $232.9 million, or 50.0% of total
assets at December 31, 2003, an increase of $28.0 million from year-end. The
change in mix in the investment securities portfolio was the result of
maturities of U.S. Government Agency obligations, maturities and payments on
Asset-backed securities and payments on mortgage-backed securities. Purchases
and reinvested funds were in U.S. Government Agency Obligations and
Asset-backed securities. The increase in investment securities was the result
of the utilization of funds from deposit and borrowed funds growth. The following table reflects the components and carrying values of the
investment securities portfolio at September 30, 2004 and December 31, 2003: 9/30/04
    
    12/31/03(In Thousands)Investment securities held to maturity (at amortized cost):US Government Agency obligations
    
    $
    102,231
    
    
    $
    94,798Mortgage-backed securities
    
    
    32,928
    
    
    
    39,467Asset-backed securities
    
    
    48,221
    
    
    
    32,735Corporate obligations
    
    
    15,640
    
    
    
    15,662Municipal obligations
    
    
    1,588
    
    
    
    1,624Total investment securities held to maturity
    
    $
    200,608
    
    
    $
    184,286Investment securities available for sale (at market value):US Treasury obligations
    
    $
    4,870
    
    
    $
    4,795US Government Agency obligations
    
    
    41,230
    
    
    
    21,479Mortgage-backed securities
    
    
    4,981
    
    
    
    6,862Asset-backed securities
    
    
    4,869
    
    
    
    8,091Corporate obligations
    
    
    3,148
    
    
    
    6,228Mutual Funds
    
    
    975
    
    
    
    969Equity securities
    
    
    161
    
    
    
    168Total investment securities available for sale
    
    $
    60,234
    
    
    $
    48,592Total investment securities portfolio
    
    $
    260,842
    
    
    $
    232,878
  11




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##### Table of Contents



LOANS The following table reflects the loan portfolio at September 30, 2004 and December 31, 2003: 9/30/04
    
    12/31/03(In Thousands)Residential mortgage loans
    
    $
    59,426
    
    
    $
    57,017Loans held for sale
    
    
    
    
    
    
    338Equity loans
    
    
    8,999
    
    
    
    10,236Construction loans
    
    
    11,601
    
    
    
    16,040Commercial real estate loans
    
    
    124,576
    
    
    
    112,503Commercial loans
    
    
    11,444
    
    
    
    14,805Consumer loans
    
    
    622
    
    
    
    564Total loans
    
    
    216,668
    
    
    
    211,503Allowance for loan losses
    
    
    (4,139
    )
    
    
    (4,220
    )Total loans, net
    
    $
    212,529
    
    
    $
    207,283
 Total loans increased to $216.7 million or 43.2% of total assets at September
30, 2004 from $211.5 million or 45.4% of total assets at December 31, 2003.
The residential mortgage loan balances have increased slightly compared to
year-end 2003, however, the refinancing activity of existing mortgages and
sales into the secondary market has slowed during the first nine months of
2004. Construction loans have declined $4.4 million due to the completion of
some projects which have been transferred into the commercial real estate
portfolio. Commercial real estate loans have increased $12.1 million due to
increased borrowers demand for this type of loan and the completion of $4.4
million in construction loans transferred to commercial real estate loans as
mentioned above. 
 ALLOWANCE FOR LOAN LOSSES The following table summarizes changes in the allowance for loan losses for the
three months and nine months ended September 30, 2004 and 2003: Three months ended
    
    Nine months ended9/30/04
    
    9/30/03
    
    9/30/04
    
    9/30/03(In Thousands)Beginning balance
    
    $
    4,168
    
    
    $
    4,176
    
    
    $
    4,220
    
    
    $
    4,167Provision (credit) charged to operations
    
    
    
    
    
    
    
    
    
    
    (300
    )
    
    
    Recoveries on loans previously charged-off
    
    
    2
    
    
    
    33
    
    
    
    258
    
    
    
    42Loans charged-off
    
    
    (31
    )
    
    
    
    
    
    
    (39
    )
    
    
    Ending balance
    
    $
    4,139
    
    
    $
    4,209
    
    
    $
    4,139
    
    
    $
    4,209
 In the nine months ended 2004, the Bank recognized $253 thousand of the interim
distribution from a prior year legal judgment as a recovery to the allowance
for loan losses on amounts previously charged off. In conjunction with this,
the Bank also recorded a credit provision for loan losses of $300 thousand for
the nine months ended September 30, 2004. The balance of the allowance for loan losses reflects managements assessment
of losses and is based on a review of the risk characteristics of the loan
portfolio. The Company considers many factors in determining the adequacy of
the allowance for loan losses. Collateral value on a loan by loan basis,
trends of loan delinquencies on a portfolio segment level, risk classification
identified in the Companys regular review of individual loans, and economic
conditions are primary factors in establishing allowance levels. Management
believes the allowance level is adequate to absorb estimated credit losses
associated with the loan portfolio. The allowance for loan losses reflects
information available to management at the end of each period. 12




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##### Table of Contents



RISK ASSETS Risk assets consist of non-performing loans and other real estate owned.
Non-performing loans consist of both a) loans 90 days or more past due, and b)
loans placed on non-accrual because full collection of the principal balance is
in doubt. Other real estate owned (OREO) is comprised of foreclosed properties
where the Company has formally received title or has possession of the
collateral. Properties are carried at the lower of the investment in the
related loan or the estimated fair value of the property or collateral less
selling costs. Fair value of such property or collateral is determined based
upon independent appraisals and other relevant factors. Management
periodically reviews property values and makes adjustments as required. Gains
from sales of properties, net operating expenses and any subsequent provisions
to increase the allowance for losses on real estate acquired by foreclosure are
charged to other real estate owned expenses. Losses are charged to the
allowance. Total risk assets were $247 thousand at September 30, 2004. This represents an
increase of $245 thousand from December 31, 2003. These changes were primarily
attributable to an increase in non-performing loans to $247 thousand at
September 30, 2004 from zero at December 31, 2003 and $22 thousand at September
30, 2003. The Company had no impaired loans at September 30, 2004, December
31, 2003 and September 30, 2003. The following table
summarizes the Companys risk assets at September 30, 2004,
December 31, 2003 and September 30, 2003: 9/30/04
    
    12/31/03
    
    9/30/03(Dollars in Thousands)Non-performing loans
    
    $
    247
    
    
    $
    
    
    
    $
    22Other real estate owned
    
    
    
    
    
    
    2
    
    
    
    4Total risk assets
    
    $
    247
    
    
    $
    2
    
    
    $
    26Risk assets as a percent of total assets
    
    
    0.05
    %
    
    
    0.00
    %
    
    
    0.01
    %
 The following table shows the allowance for loan losses as a percent of total
loans at September 30, 2004, December 31, 2003 and September 30, 2003: 9/30/04
    
    12/31/03
    
    9/30/03(Dollars in Thousands)Allowance for loan losses
    
    $
    4,139
    
    
    $
    4,220
    
    
    $
    4,209Allowance for loan losses as a percent of total loans
    
    
    1.91
    %
    
    
    2.00
    %
    
    
    2.05
    %
 The allowance for loan losses has remained fairly consistent at approximately
$4.1 million at the end of September 30, 2004, and $4.2 million at December 31,
2003 and September 30, 2003. However, the allowance for loan losses as a
percent of total loans has decreased to 1.91% at September 30, 2004 down from
2.00% at December 31, 2003, due to an increase in total loans outstanding at
September 30, 2004 compared to December 31, 2003. 
 DEPOSITS Total interest bearing deposits amounted to $281.0 million at September 30,
2004 compared to $258.4 million at December 31, 2003, an increase of $22.6
million. The change from December 31, 2003 is due primarily to increases in
certificates of deposit, money market investment and retirement accounts. All
other deposit categories experienced slight increases. The following table reflects
the components of interest bearing deposits at September 30, 2004 and December 31, 2003: 9/30/04
    
    12/31/03(In Thousands)NOW and Super NOW accounts
    
    $
    36,347
    
    
    $
    36,108Savings accounts
    
    
    45,330
    
    
    
    44,324Money market investment accounts
    
    
    82,106
    
    
    
    76,148Certificates of deposit
    
    
    88,013
    
    
    
    74,184Retirement accounts
    
    
    29,210
    
    
    
    27,666Total interest bearing deposits
    
    $
    281,006
    
    
    $
    258,430
 13




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##### Table of Contents



RESULTS OF OPERATIONS 
 THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 OVERVIEW The Company reported net income of $697 thousand or $0.16 diluted earnings per
share and $654 thousand or $0.15 diluted earnings per share for the three
months ended September 30, 2004 and 2003, respectively. The net income
increase of $43 thousand was due primarily to an increase in net interest
income of $580 thousand or 20.6% to $3.4 million compared to the same period in
2003. Higher average investment security balances for the three months ended
2004 compared to 2003 resulted in a rise of $385 thousand to interest income
coupled with a rise in yields on investment securities contributing $265
thousand to interest income for the same periods. This was offset by a
decrease in non-interest income of $310 thousand and non-interest expenses
increasing by $289 thousand. NET INTEREST INCOME FROM OPERATIONS Net interest income for the three months ended September 30, 2004 and 2003
increased by $580 thousand or 20.6% to $3.4 million from $2.8 million,
respectively. The net interest rate spread increased to 2.59% for the quarter
ended September 30, 2004 versus 2.34% for the same quarter of 2003. Interest
income in the third quarter of 2004 experienced an increase due to higher
average investment securities balances, higher average loan balances and higher
yields on investment securities from the third quarter of 2003 all of which
contributed in total $745 thousand to interest income. The increase was
partially offset by declining yields on loans. Interest expense decreased due
to lower rates paid on deposits and borrowed funds, by $280 thousand.
Partially offsetting this decline, higher average balances for deposit and
borrowed funds increased interest expense by $211 thousand. The following table presents the components of net interest income and net
interest rate spread for the three months ended September 30, 2004 and 2003: Income/Expense
    
    Yield/RateThree Months Ended9/30/04
    
    9/30/03
    
    9/30/04
    
    9/30/03(Dollars in Thousands)Interest income and average yield:Loans
    
    $
    3,242
    
    
    $
    3,381
    
    
    
    6.01
    %
    
    
    6.44
    %Investments, mortgage-backed securities
and other earning assets
    
    
    2,246
    
    
    
    1,596
    
    
    
    3.50
    
    
    
    3.00Total
    
    
    5,488
    
    
    
    4,977
    
    
    
    4.65
    
    
    
    4.71Interest expense and average rate paid:Deposits
    
    
    964
    
    
    
    1,013
    
    
    
    1.38
    
    
    
    1.50Federal Home Loan Bank advances
    
    
    1,025
    
    
    
    1,117
    
    
    
    4.16
    
    
    
    4.99Securities sold under agreements to
repurchase and other borrowed funds
    
    
    107
    
    
    
    35
    
    
    
    1.40
    
    
    
    1.80Total
    
    
    2,096
    
    
    
    2,165
    
    
    
    2.06
    
    
    
    2.37Net interest income
    
    $
    3,392
    
    
    $
    2,812Net interest rate spread
    
    
    
    
    
    
    
    
    
    
    2.59
    %
    
    
    2.34
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    2.87
    %
    
    
    2.66
    %
 14




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##### Table of Contents



INTEREST INCOME Interest income for the third quarter of 2004 was $5.5 million as compared to
$5.0 million for the same quarter of 2003. The increase of $511 thousand in
interest income is primarily due to an increase of $745 thousand resulting from
higher average investment security balances, higher average loan balances and
higher yields on investment securities. Partially offsetting these increases
was a decrease in loan yields resulting in a decrease to interest income of
$234 thousand. Yields on loans were 6.01% and 6.44% for the quarters ended September 30, 2004
and 2003, respectively. The impact to interest income due to lower loan yields
was a decrease of $234 thousand. Higher average loan balances of $214.5
million versus $208.2 million for the quarters ended September 30, 2004 and
2003, respectively, increased interest income by $95 thousand. The following table lists the components of loan interest income for the three
months ended September 30, 2004 and 2003: Three months ended9/30/04
    
    9/30/03(In Thousands)Residential mortgage loans
    
    $
    779
    
    
    $
    793Loans held for sale
    
    
    1
    
    
    
    23Equity loans
    
    
    117
    
    
    
    127Construction loans
    
    
    181
    
    
    
    259Commercial real estate loans
    
    
    1,952
    
    
    
    1,906Commercial loans
    
    
    201
    
    
    
    263Consumer loans
    
    
    11
    
    
    
    10Total loan interest income
    
    $
    3,242
    
    
    $
    3,381
 Yields on investment securities were 3.50% and 3.00% for the quarters ended
September 30, 2004 and 2003, respectively, increasing interest income by $265
thousand. Higher average investment securities balances of $255.0 million
during the third quarter of 2004 versus $211.3 million for the same period in
2003 increased interest income by $385 thousand. 
 INTEREST EXPENSE Interest expense for the third quarter of 2004 totaled $2.1 million, a decrease
of $69 thousand from the same quarter of 2003. This decrease is primarily due
to lower rates paid on interest bearing liabilities, which decreased interest
expense by $280 thousand. Higher average balances of interest bearing
liabilities increased interest expense by $211 thousand. Rates on deposits were 1.38% and 1.50% for the quarters ended September 30,
2004 and 2003, respectively. This decrease resulted in interest expense
decreasing by $83 thousand. Average deposit balances were $277.0 million for
the third quarter of 2004 versus $267.2 million for the same period in 2003,
which resulted in a $34 thousand increase to interest expense. The following table lists the components of deposit interest expense for the
three months ended September 30, 2004 and 2003: Three months ended9/30/04
    
    9/30/03(In Thousands)NOW and Super NOW accounts
    
    $
    11
    
    
    $
    10Savings deposit accounts
    
    
    40
    
    
    
    48Money market investment accounts
    
    
    249
    
    
    
    211Certificates of deposit
    
    
    447
    
    
    
    510Retirement accounts
    
    
    217
    
    
    
    234Total deposit interest expense
    
    $
    964
    
    
    $
    1,013
 Rates on FHLB advances were 4.16% and 4.99% for the third quarters of 2004 and
2003, respectively. The decrease in rates paid on FHLB advances decreased
interest expense by $178 thousand. The average balances of FHLB advances
increased to $98.1 million in the third quarter 2004 from $89.9 million for the
third quarter of 2003, which resulted in an increase in interest expense of $86
thousand. 15




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##### Table of Contents



Rates on repurchase agreements and other borrowed funds (which includes FHLB
advances less than 90 days) were 1.40% and 1.80% for the third quarters of 2004
and 2003, respectively. The decrease in rates paid on these interest bearing
liabilities resulted in interest expense decreasing by $19 thousand. The
average balance increased to $30.4 million in 2004 from $4.6 million in 2003
which increased interest expense by $91 thousand. PROVISION FOR LOAN LOSSES The provision for loan losses was zero for the three months ended September 30,
2004 and 2003, respectively. The absence of a provision for loan losses was
based on managements assessment of the adequacy of the allowance based on an
evaluation of the Banks loan portfolio and the level of non-performing loans.
The balance of the allowance for loan losses has remained fairly consistent at
$4.1 million and $4.2 million at September 30, 2004 and December 31, 2003,
respectively. The coverage of the allowance for loan losses has decreased
slightly to 1.91% at September 30, 2004 from 2.00% at December 31, 2003 due to
the loan growth during 2004. NON-INTEREST INCOME Non-interest income was $348 thousand and $658 thousand for the quarters ended
September 30, 2004 and 2003, respectively. The decrease was primarily
attributable to loan fee income decreasing by $214 thousand in 2004 versus
2003. The decrease in loan fees for the third quarter of 2004 can be attributed
to a decrease of $81 thousand in prepayment penalties and late charges on
commercial real estate loans and to a decrease in net fair value on mortgage
servicing rights (MSR) resulting in a $33 thousand increase to the valuation
allowance in 2004 compared to a decrease in the valuation allowance of $102
thousand in the third quarter of 2003. Deposit account fees increased $53
thousand to $236 thousand in the third quarter of 2004 due to an increase in
NOW account fees of $45 thousand attributable to a new service the Company
offered in 2004. Partially offsetting these increases was a decrease in gains
on sales of mortgage loans declining to a loss of $5 thousand from gains of
$143 thousand in the third quarter of 2004 and 2003, respectively, due to a
reduction in loan sales. NON-INTEREST EXPENSE Non-interest expense totaled $2.7 million compared to $2.4 million for the
quarters ended September 30, 2004 and 2003, respectively. Salaries and
employee benefits increased by $238 thousand in the third quarter 2004 compared
to the third quarter in 2003 mainly due to normal salary increases and the
addition to headcount for the new Salem, New Hampshire branch, which opened on
June 14, 2004. Occupancy and equipment expenses totaled $219 thousand in 2004,
an increase of $60 thousand over 2003 mainly due to higher rent expense and
depreciation expense in the third quarter of 2004. Professional expenses
decreased to $141 thousand in the third quarter 2004 compared to $187 thousand
in the same period in 2003 primarily due to a reduction in legal expenses. Data
processing expenses increased to $237 thousand in the third quarter of 2004
compared to $186 thousand in the same quarter in 2003 due to an increase in
service bureau charges associated with telecommunication improvements. INCOME TAXES The Company reported an income tax expense of $337 thousand for the quarter
ended September 30, 2004 or an effective income tax rate of 32.6%. This
compares to an income tax expense of $399 thousand for the quarter ended
September 30, 2003 or effective income tax rate of 37.9%. The decrease in the
effective income tax rate in 2004 from 2003 is due to a reduction in state
income tax expense as a result of lower earnings at the Bank due to expenses
associated with marketing the new branch and higher data processing expenses
incurred during the third quarter 2004 not incurred in 2003. 16




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RESULTS OF OPERATIONS 
 NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 OVERVIEW The Bank reported net income of $3.8 million or $0.86 diluted earnings per
share and $1.8 million or $0.42 diluted earnings per share for the nine months
ended September 30, 2004 and 2003, respectively. During the first nine months
of 2004, net interest income increased by $1.1 million or 12.2% as compared to
the same period in 2003. The company received $2.5 million on a U.S.
Bankruptcy Judges Order on the Trustees Motion for authorization to make an
interim distribution in a case in which the companys wholly-owned subsidiary,
Lawrence Savings Bank (the Bank) is a secured creditor. The Bank recognized
$253 thousand of the interim distribution as a recovery to the allowance for
loan losses on amounts previously charged-off and the remaining $2.3 million as
a lawsuit judgment collected in non-interest income. Partially offsetting
these amounts for the nine months ended 2004 were a decrease in non-interest
income of $146 thousand, an increase in non-interest expense of $504 thousand
and an increase in the provision for income taxes of approximately $1.0
million, primarily attributable to the recognition of the lawsuit judgment
collected. NET INTEREST INCOME FROM OPERATIONS Net interest income for the nine months ended September 30, 2004 increased by
$1.1 million or 12.2% to $10.2 million from $9.1 million, for the corresponding
period in 2003. The net interest rate spread increased slightly to 2.64% from
2.55%. The rates paid on interest bearing liabilities decreased more rapidly
than the yield on interest bearing assets. The following table presents the
components of net interest income and net interest spread: Income/Expense
    
    Yield/RateNine Months Ended9/30/04
    
    9/30/03
    
    9/30/04
    
    9/30/03(Dollars in Thousands)Interest income and average yield:Loans
    
    $
    9,797
    
    
    $
    11,069
    
    
    
    6.07
    %
    
    
    6.65
    %Investments, mortgage-backed securities
and other earning assets
    
    
    6,594
    
    
    
    4,884
    
    
    
    3.51
    
    
    
    3.31Total
    
    
    16,391
    
    
    
    15,953
    
    
    
    4.69
    
    
    
    5.08Interest expense and average rate paid:Deposits
    
    
    2,662
    
    
    
    3,259
    
    
    
    1.32
    
    
    
    1.64Federal Home Loan Bank advances
    
    
    3,187
    
    
    
    3,502
    
    
    
    4.56
    
    
    
    5.12Securities sold under agreements to
repurchase and other borrowed funds
    
    
    361
    
    
    
    119
    
    
    
    1.14
    
    
    
    2.81Total
    
    
    6,210
    
    
    
    6,880
    
    
    
    2.05
    
    
    
    2.53Net interest income
    
    $
    10,181
    
    
    $
    9,073Net interest rate spread
    
    
    
    
    
    
    
    
    
    
    2.64
    %
    
    
    2.55
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    2.91
    %
    
    
    2.89
    %
 
 INTEREST INCOME Interest income for the first nine months of 2004 was $16.4 million as compared
to $16.0 million for the same period of 2003. The increase in interest income
of $438 thousand is due mainly to higher average investment security balances
and higher yields on investment securities contributing $1.4 million and $310
thousand, respectively, to interest income. Partially offsetting these
increases were lower yields on loans and lower average loan balances decreasing
interest income by $1.3 million in total. Yields on loans were 6.07% and 6.65% for the nine months ended September 30,
2004 and 2003, respectively. The impact on interest income due to lower yields
was a reduction of $959 thousand. Lower average loan balances of $215.7 million
in 2004 versus $222.6 million in 2003 resulted in interest income decreasing by
$313 thousand. 17




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##### Table of Contents



The following table lists the components of loan interest income for the nine
months ended September 30, 2004 and 2003: Nine months ended9/30/04
    
    9/30/03(In Thousands)Residential mortgage loans
    
    $
    2,325
    
    
    $
    2,589Loans held for sale
    
    
    21
    
    
    
    107Equity loans
    
    
    374
    
    
    
    424Construction loans
    
    
    578
    
    
    
    894Commercial real estate loans
    
    
    5,848
    
    
    
    5,977Commercial loans
    
    
    618
    
    
    
    1,046Consumer loans
    
    
    33
    
    
    
    32Total loan interest income
    
    $
    9,797
    
    
    $
    11,069
 Yields on investment securities increased to 3.51% for the nine months ended
September 30, 2004. This compares to yields on investment securities of 3.31%
for the same period in 2003. This resulted in interest income increasing by
$310 thousand. Higher average investment securities balances of $250.9 million
in 2004 versus $197.6 million in 2003 resulted in interest income increasing by
$1.4 million. 
 INTEREST EXPENSE Interest expense for the first nine months of 2004 and 2003 was $6.2 million
and $6.9 million, respectively. The decrease of $670 thousand in interest
expense is primarily due to lower rates paid on deposits, FHLB advances, and
other interest bearing liabilities, which decreased interest expense by $1.1
million. Interest expense increased $407 thousand due to higher average
balances for deposits, FHLB advances balances, and other borrowings. Rates on deposits were 1.32% and 1.64% for the first nine months of 2004 and
2003 respectively. This decrease resulted in interest expense decreasing by
$628 thousand. Average deposit balances were $269.4 million in 2004 up from
$266.3 million in 2003, which increased interest expense by $31 thousand. The following table lists the components of deposit interest expense for the
nine months ended September 30, 2004 and 2003: Nine months ended9/30/04
    
    9/30/03(In Thousands)NOW and Super NOW accounts
    
    $
    30
    
    
    $
    30Savings deposit accounts
    
    
    122
    
    
    
    161Money market investment accounts
    
    
    725
    
    
    
    678Certificates of deposit
    
    
    1,149
    
    
    
    1,664Retirement accounts
    
    
    636
    
    
    
    726Total deposit interest expense
    
    $
    2,662
    
    
    $
    3,259
 Rates on FHLB advances were 4.56% and 5.12% resulting in interest expense
decreasing by $373 thousand in 2004 from 2003. The average balances of these
interest bearing liabilities increased to $93.4 million in 2004 from $91.7
million in 2003, resulting in an increase to interest expense of $58 thousand. Rates paid on repurchase agreements and other borrowed funds were 1.14% and
2.81% for the first nine months of 2004 and 2003, respectively. This rate
decrease resulted in a decrease of $76 thousand in interest expense. The
average balances of repurchase agreements and other borrowed funds increased to
$42.2 million in 2004 compared to $5.0 million in 2003 resulting in an increase
of $318 thousand in interest expense. 18




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##### Table of Contents



PROVISION FOR LOAN LOSSES The Company recognized a credit provision for loan losses in the amount of $300
thousand for the nine months ended September 30, 2004 due to the $253 thousand
recovery to the allowance for loan losses and the continued low level of
non-performing loans. The Company made no provision for loan losses in 2003.
The absence of a provision for loan losses in 2003 was due to the overall asset
quality of the Company and low level of delinquent loans. NON-INTEREST INCOME Excluding the previously discussed interim distribution from the lawsuit,
non-interest income decreased by $146 thousand to $1.2 million and $1.3 million
for the nine months ended September 30, 2004 and 2003, respectively, as a
result of a $393 thousand decrease in gains on loan sales for the nine months
ended 2004 compared to 2003 due to a lower level of loan sales in 2004.
Partially offsetting this decrease were increases in loan fee income of $109
thousand and an increase of $142 thousand in deposit account fees due to a new
service offered to customers in 2004. NON-INTEREST EXPENSE Non-interest expense increased $504 thousand to $8.0 million for the nine
months ended September 30, 2004, compared to $7.5 million in 2003. The increase
in non-interest expense is attributable to an increase in salaries and employee
benefits to $4.9 million in 2004 up by $416 thousand over the same period in
2003 due to normal salary increases and an increase in headcount due to the new
Salem, New Hampshire branch. Occupancy and equipment expenses have risen by $77
thousand to $658 thousand for the first nine months in 2004 from $581 thousand
in 2003 due to an increase in rent expense associated with the new branch and
other occupancy costs. Professional expenses declined to $472 thousand for the
nine months in 2004 from $550 thousand over the same period in 2003 as the
Banks legal expenses have decreased. Data processing expense increased by
$123 thousand to $670 thousand from $547 thousand resulting from an increase in
service bureau charges due to the Bank upgrading its telecommunications
network. In other expenses, marketing expense increased to $172 thousand in
2004 from $60 thousand in 2003, due to increased advertising for the new Salem,
New Hampshire branch and promotions of an expanded consumer checking account
line. INCOME TAXES The Bank reported an income tax expense of $2.1 million and $1.1 million for
the first nine months ended September 30, 2004 and 2003, respectively,
representing an effective tax rate of 35.6% and 37.3%, respectively. The
increase in the provision for income taxes of $1.0 million was primarily
attributable to the previously mentioned lawsuit recovery. The decrease in the
effective income tax rate is due to a reduction in state tax expense as a
result of higher marketing expenses and data processing expenses at the Bank. 
 LIQUIDITY AND CAPITAL RESOURCES The Companys primary source of funds is cash dividends from its wholly-owned
subsidiary, Lawrence Savings Bank (the Bank). The Bank paid dividends to the
Company in the amount of $3.6 million and $500 thousand during the first nine
months of 2004 and 2003, respectively. The Company made cash payments of
dividends to shareholders in the amount of $1.7 million and $1.5 million in the
first nine months of 2004 and 2003, respectively. The Banks primary sources of funds include collections of principal payments
and repayments on outstanding loans, increases in deposits, advances from the
Federal Home Loan Bank of Boston (FHLB) and securities sold under agreements
to repurchase. The Bank has a line of credit of $6.8 million with the FHLB.
The Bank also has a $5 million unsecured Federal funds line of credit. The FHLB requires member banks to maintain qualified collateral for its
advances. Collateral is comprised of the Banks investments in FHLB stock, its
residential mortgage portfolio and the portion of the investment portfolio
which meets FHLB qualifying collateral requirements and have been designated as
such. The Banks borrowing capacity at the FHLB at September 30, 2004 was
$192.2 million, of which $133.9 million has been borrowed. 19




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##### Table of Contents



At September 30, 2004, the Companys stockholders equity was $57.5 million as
compared to $55.0 million at December 31, 2003. The change during the first
nine months of 2004 occurred due to net income of $3.8 million and $452
thousand from the exercise of stock options. Stockholders equity was reduced
by the declaration of cash dividends to shareholders of $1.7 million and a $124
thousand decrease in the market value of investment securities available for
sale, net of taxes. The Companys leverage ratio at September 30, 2004 and
December 31, 2003 was 11.78% and 12.11%, respectively. The Companys and the
Banks total risk based capital ratios were 19.94% and 19.11% at September 30,
2004, respectively, compared with 20.50% and 20.25% at December 31, 2003,
respectively. The Company exceeds all regulatory minimum capital ratio
requirements set forth by the FRB, and the Bank exceeds all minimum capital
ratio requirements as defined by the FDIC. 
 ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The response is incorporated herein by reference to the discussion under the
sub-caption Interest Rate Sensitivity of the caption MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS on pages 19 and
20 of the LSB Corporations Annual Report for the fiscal year ended December
31, 2003. 
 ITEM 4: CONTROLS AND PROCEDURES The Companys chief executive officer and chief financial officer, after
evaluating the effectiveness of the Companys disclosure controls and
procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e)
and 15d-15(e)) as of the end of the period covered by this quarterly report
(the Evaluation Date), have concluded that as of the Evaluation Date the
Companys disclosure controls and procedures were effective and designed to
ensure that material information relating to the Company and its subsidiaries
would be made known to them by others within those entities. During the period covered by this quarterly report, there were no significant
changes in the Companys internal controls that have materially affected, or
are reasonable likely to materially affect the internal controls over financial
reporting. 20




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##### Table of Contents



PART II  OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS The Company is involved in various legal proceedings incidental to its
business. Other than the following matter, management does not believe
resolution of such litigation will have a material effect on the financial
condition and operating results of the Company. The Bank was awarded a $4.2 million judgment against a debtor in 1997. The
judgment was appealed and the Bank prevailed in this matter in Appeals Court.
On February 13, 2002, the defendant filed bankruptcy under Chapter 7
(liquidation). Post-judgment interest accrues from the date of the judgment to
February 13, 2002 and approximates $1.9 million. However, collectibility of
post-judgment interest in addition to the $4.2 million award has not yet been
determined. Bids of approximately $3.3 million for the major assets of the debtor were
approved by the Bankruptcy Court on October 14, 2003. The net amount to be
received by the Bank after taxes and bankruptcy expenses is not known at this
time. However, it is not likely that the full $4.2 million judgment and
post-judgment interest of $1.9 million will be collected. On June 15, 2004 the Company reported in a press release the receipt of $2.5
million on a U.S. Bankruptcy Judges Order on the Trustees Motion for
authorization to make an interim distribution to the Bank. The $2.5 million
distribution has been received and recorded as income by the Bank on June 15,
2004. The Bank has agreed to return any of the interim distribution as would be
necessary to pay additional taxes imposed on the bankruptcy estate in the event
reserves set aside for expenses and taxes are insufficient. The Company first
reported the Bankruptcy Trustees Motion seeking authorization from the U.S.
Bankruptcy Judge for an interim distribution to creditors in a press release
dated February 26, 2004. The diluted earnings per share impact of the interim
distribution is approximately $0.35 per share based on average dilutive shares
outstanding during the quarter ended June 30, 2004. It is managements opinion the timing and final amount to be collected can not
be determined at this time. Accordingly, no recognition beyond the interim
distribution has been recorded in the Companys Consolidated Financial
Statements at September 30, 2004. For further information, please refer to the discussion under the caption
CONTINGENCIES on page 41 of the Corporations Annual Report for the fiscal
year ended December 31, 2003, which is hereby incorporated herein by reference. 
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 21




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##### Table of Contents



ITEM 5. OTHER INFORMATION None. 
 ITEM 6. EXHIBITS a.  Exhibits. Please see the Exhibit Index attached hereto. 22




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##### Table of Contents



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. LSB CORPORATION AND SUBSIDIARYNovember 12, 2004
    /s/ Paul A. MillerPaul A. MillerPresident and
Chief Executive Officer November 12, 2004
    /s/ John E. SharlandJohn E. SharlandSenior Vice President
Chief Financial Officer 23




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LSB CORPORATION AND SUBSIDIARY Quarterly Report on Form 10-Q For Quarter Ended September 30, 2004 EXHIBIT INDEX Page31.1
    
    Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002
    
    
    2531.2
    
    Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002
    
    
    2632.1
    
    Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002
    
    
    2732.2
    
    Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002
    
    
    28
 24