<PAGE>   1
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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB
                                  ANNUAL REPORT

     PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997       COMMISSION FILE NO. 000-21383

                          APPALACHIAN BANCSHARES, INC.
                 (Name of Small Business Issuer in Its Charter)

              GEORGIA                                 58-2242407
      (State of Incorporation)           (I.R.S. Employer Identification Number)

      315 INDUSTRIAL BOULEVARD
         ELLIJAY, GEORGIA                               30540
(Address of Principal Executive Offices)              (Zip Code)

                                 (706) 276-8000
                           --------------------------
                (Issuer's Telephone Number, Including Area Code)

         SECURITIES REGISTERED UNDER SECTION 12(B) OF THE EXCHANGE ACT:

TITLE OF EACH CLASS                       NAME OF EXCHANGE ON WHICH REGISTERED
-------------------                       ------------------------------------
      None                                                 N/A

         SECURITIES REGISTERED UNDER SECTION 12(G) OF THE EXCHANGE ACT:

                     Common Stock, $5.00 par value per share

         Check whether the issuer: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or
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 | |

         Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. | |

         The issuer's revenues for its most recent fiscal year were $9,527,799.

         There is no established trading market for the registrant's capital
stock. The aggregate market value of the stock held by non-affiliates of the
registrant at March 14, 1998 was $9,752,783, based on a per share price of
$22.50, which is the price of the last trade of which management is aware as of
such date. Although directors and executive officers of the registrant were
assumed to be "affiliates" of the registrant for purposes of this calculation,
the classification is not to be interpreted as an admission of such status.

         At March 14, 1998, there were 577,287 shares of the registrant's Common
Stock outstanding.

         Transitional Small Business Disclosure Format (check one):
                                                               Yes | |   No |X|

DOCUMENTS INCORPORATED BY REFERENCE

         Portions of the registrant's definitive Proxy Statement for the 1998
Annual Meeting of Shareholders are incorporated by reference into Part III of
this Report.


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<PAGE>   2

                          APPALACHIAN BANCSHARES, INC.
                         1997 FORM 10-KSB ANNUAL REPORT


                                TABLE OF CONTENTS
<TABLE>
<CAPTION>

 ITEM NUMBER                                                                                PAGE OR
IN FORM 10-KSB                       DESCRIPTION                                            LOCATION
--------------                       -----------                                            --------

<S>             <C>                                                                         <C>
    Item 1.     Business..............................................................            1

    Item 2.     Properties............................................................           20

    Item 3.     Legal Proceedings.....................................................           21

    Item 4.     Submission of Matters to a Vote of Security Holders...................           21

    Item 5.     Market for the Registrant's Common  Equity and Related Shareholder
                Matters...............................................................           21

    Item 6.     Management's Discussion and Analysis of Financial
                Condition and Results of Operations...................................           22

    Item 7.     Financial Statements..................................................          F-1

    Item 8.     Changes in and Disagreements with Accountants on Accounting and
                Financial Disclosure..................................................           31

    Item 9.     Directors, Executive Officers, Promoters and Control
                Persons; Compliance with Section 16(a) of the Exchange Act............           32

    Item 10.    Executive Compensation................................................           32

    Item 11.    Security Ownership of Certain Beneficial Owners
                and Management........................................................           32

    Item 12.    Certain Relationships and Related Transactions........................           32

    Item 13.    Exhibits, List and Reports on Form 8-K................................           32
</TABLE>

                                       i
<PAGE>   3
                                     PART I

             CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

         Certain of the statements made in this Report and in documents
incorporated by reference herein, including matters discussed under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," as well as oral statements made by the Company or its officers,
directors or employees, may constitute forward-looking statements within the
meaning of Section 27A of the Securities Exchange Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). Such forward-looking statements are based on
Management's beliefs, current expectations, estimates and projections about the
financial services industry, the economy and about the Company and the Bank in
general. The words "expect," "anticipate," "intend," "plan," "believe," "seek,"
"estimate" and similar expressions are intended to identify such forward-looking
statements; however, this Report also contains other forward-looking statements
in addition to historical information. Such forward-looking statements are not
guarantees of future performance and are subject to risks, uncertainties and
other factors that may cause the actual results, performance or achievements of
the Company to differ materially from historical results or from any results
expressed or implied by such forward-looking statements. Such factors include,
without limitation, (i) increased competition with other financial institutions,
(ii) lack of sustained growth in the economy in Gilmer County, primarily in the
local poultry industry, (iii) rapid fluctuations in interest rates, (iv) the
inability of the Bank to maintain regulatory capital standards, and (v) changes
in the legislative and regulatory environment. Many of such factors are beyond
the Company's ability to control or predict, and readers are cautioned not to
put undue reliance on such forward-looking statements. The Company disclaims any
obligation to update or revise any forward-looking statements contained in this
Report, whether as a result of new information, future events or otherwise.

ITEM 1.   BUSINESS

HISTORY AND BUSINESS OF THE COMPANY

         Appalachian Bancshares, Inc. (the "Company" or "Registrant") was
incorporated as a business corporation in May 1996 under the laws of the State
of Georgia for the purpose of acquiring 100% of the issued and outstanding
shares of common stock of Gilmer County Bank (the "Bank"). In July 1996, the
Company received approval from the Federal Reserve Bank of Atlanta (the "Federal
Reserve") and the Georgia Department of Banking and Finance ("DBF") to become a
bank holding company. In August 1996, the Company and the Bank entered into a
reorganization (the "Reorganization") pursuant to which the Company acquired
100% of the outstanding shares of the Bank, and the shareholders of the Bank
became the shareholders of the capital stock of the Company.

         At December 31, 1997, the assets of the Company consisted primarily of
its ownership of the capital stock of the Bank. Unless otherwise indicated, the
information presented herein relating to the Company refers to the Company and
the Bank on a consolidated basis.

         The Company's executive office is located at 315 Industrial Boulevard,
Ellijay, Georgia, and its telephone number at such location is (706) 276-8000.

BUSINESS OF THE BANK

         The Bank was organized in 1994 under the laws of the State of Georgia
to conduct a commercial banking business in Gilmer County, Georgia, with its
deposits insured by the Federal Deposit Insurance Corporation ("FDIC"). The Bank
was formed to meet the banking needs of individuals, small- to medium-sized
businesses, and farmers, especially those engaged in apple and poultry
production.

         The Bank performs banking services customary for full service banks of
similar size and character. Such services include the receipt of demand and time
deposit accounts, the extension of personal and commercial loans and


                                       1
<PAGE>   4

the furnishing of personal and commercial checking accounts. The Bank draws most
of its customer deposits and conducts most of its lending transactions from and
within a primary service area encompassing Gilmer County, southwestern Fannin
County, northern Pickens County, western Dawson County and southeastern Murray
County, Georgia.

         The principal business of the Bank is to attract and accept deposits
from the public and to make loans and other investments. The principal sources
of funds for the Bank's loans and investments are (1) demand, time, savings, and
other deposits (including negotiable order of withdrawal ("NOW") accounts), (2)
amortization and prepayment of loans granted, (3) sales to other lenders or
institutions of loans or participation in loans, (4) fees paid by other lenders
or institutions for servicing loans sold by the Bank to such lenders or
institutions and (5) borrowings. The principal sources of income for the Bank
are interest and fees collected on loans, including fees received for servicing
loans sold to other lenders or institutions and, to a lesser extent, interest
and dividends collected on other investments. The principal expenses of the Bank
are (1) interest paid on savings and other deposits (including NOW accounts),
(2) interest paid on borrowings by the Bank, (3) employee compensation, (4)
office expenses and (5) other overhead expenses.

         The Bank was organized by a group of individuals from Gilmer County and
the surrounding area and commenced business from its main office location at 315
Industrial Boulevard, Ellijay, Georgia on March 3, 1995.  The Bank operated in
development stage prior to that time.

         The Bank has a correspondent relationship with several banks, including
Georgia Bankers' Bank, SouthTrust Bank, Federal Home Loan Bank and Compass Bank.

EMPLOYEES

         Except for the officers of the Company, who are also officers of the
Bank, the Company does not have any employees. At December 31, 1997, the Bank
had a total of 35 employees, 30 of which were full-time employees. Neither the
Company nor the Bank are party to any collective bargaining agreements with
employees, and management believes that employee relations are generally good.

LENDING ACTIVITIES

         General. The Bank is authorized to make both secured and unsecured
commercial and consumer loans to individuals, partnerships, corporations and
other entities. The Bank's lending business consists principally of making
consumer loans to individuals and commercial loans to small and medium-sized
businesses and professional concerns. In addition, the Bank makes secured real
estate loans, including residential and commercial construction loans, and
primary and secondary mortgage loans for the acquisition or improvement of
personal residences. Loans to the poultry industry constituted approximately 19%
of the Bank's total loans at December 31, 1997.

         The Bank has engaged in secondary-market mortgage activities, obtaining
commitments, through intermediaries, from secondary mortgage purchasers to
purchase mortgage loans originated by the Bank. Based on these commitments, the
Bank originates mortgage loans on terms corresponding to such commitments and
generates fee income to supplement its interest income. No mortgage loans are
held by the Bank for resale nor are any loans held for mortgage servicing.

         Real Estate Loans. Loans secured by real estate are the primary
component of the Bank's loan portfolio, constituting approximately $56.1
million, or 66.3%, of the Bank's total loans at December 31, 1997. These loans
consist of commercial real estate loans, construction and development loans and
residential real estate loans but exclude home equity loans, which are
classified as consumer loans.

         Commercial Loans. The Bank makes loans for commercial purposes in
various lines of businesses. At December 31, 1997, the Bank held approximately
$16.5 million, or 19.5% of the Bank's total loans, in commercial loans,
excluding for these purposes commercial loans secured by real estate which are
included in the real estate category above.


                                       2
<PAGE>   5

         Consumer Loans. The Bank makes a variety of loans to individuals for
personal and household purposes, including secured and unsecured installment and
term loans, home equity loans and lines of credit, and revolving lines of credit
such as credit cards. At December 31, 1997, the Bank held approximately $10.8
million in consumer loans, representing 12.8% of total loans.

         Loan Approval and Review. The Bank's loan approval policies provide for
various levels of officer lending authority. When the aggregate outstanding
loans to a single borrower exceeds that individual officer's lending authority,
the loan request must be considered and approved by an officer with a higher
lending limit or the officers' loan committee. Individual officers' lending
limits range from $15,000 to $100,000, depending on seniority and type of loan.
The officers' loan committee, which consists of the president, executive vice
president and senior lending officer, has a lending limit of $150,000 for
secured loans. Loans between $150,000 and $300,000 must be approved by a
directors' loan committee, which is made up of the president, the senior lending
officer and three outside directors. Loans above $300,000 require approval by
the majority of the full Board of Directors.

         The Bank has a continuous loan review procedure involving multiple
officers of the Bank which is designed to promote early identification of credit
quality problems. All loan officers are charged with the responsibility of
rating their loans and reviewing those loans on a periodic basis, the frequency
of which increases as the quality of the loan decreases. The Bank's senior
lending officer was previously charged with the responsibility of ensuring that
all loans or lines of credit in excess of $100,000 are reviewed annually, with
random sample checks of loans less than $100,000. All loans or lines of credit
of $250,000 and over previously were reviewed by a consulting firm. Due to
increased loan demand, the Bank has employed an in house specialist to review
all loans in excess of $100,000.

DEPOSITS

         The Bank offers a variety of deposit programs to individuals and to
small to medium-sized businesses and other organizations at interest rates
generally consistent with local market conditions. The Bank is authorized to
accept and pay interest on deposits from individuals, corporations, partnerships
and any other type of legal entity, including fiduciaries (such as private
trusts). Qualified deposits are insured by the FDIC in an amount up to $100,000.

         The following table sets forth the mix of depository accounts at the
Bank as a percentage of total deposits at December 31, 1997.

                                DEPOSIT MIX
<TABLE>
<CAPTION>
                                                               DECEMBER 31, 1997
                                                               -----------------
<S>                                                            <C>
Non-interest bearing demand................................            4.0%
Interest-bearing demand....................................           25.6%
Savings....................................................           21.8%
Time Deposits..............................................           33.2%
Certificates of Deposit of $100,000 or more................           15.4%
  Total....................................................          100.0%
</TABLE>

         The Bank is a member of the Cirrus ATM network of automated teller
machines, which permits Bank customers to perform certain transactions in
numerous cities throughout Georgia and in other states. The Bank's charter
provides that the Bank has trust powers but only upon application to the DBF. To
date, the Bank has not submitted and has no plans to submit such an application.


                                       3
<PAGE>   6

COMPETITION AND MARKET AREA

         The banking business is highly competitive. The Bank competes as a
financial intermediary with other commercial banks, thrift institutions, credit
unions, and money market mutual funds operating in Ellijay, Gilmer County,
Georgia, and elsewhere. Some banks with which the Bank competes have
significantly greater resources and higher lending limits (by virtue of their
greater capitalization). Credit unions and money market mutual funds with which
the Bank competes may have competitive advantages as a result of being subject
to different, and possibly less stringent, regulatory requirements.

         The Bank serves the areas of Gilmer County, southwestern Fannin County,
northern Pickens County, western Dawson County and southeastern Murray County,
Georgia. As of December 31, 1997, three non-locally owned banks had offices in
Gilmer County. The Bank of Ellijay, which is owned by Century South Banks, Inc.,
a bank holding company headquartered in Gainesville, Georgia, operates a main
office and two branch offices in Gilmer County. RegionsBank, an Alabama bank
holding company, operates two offices in Gilmer County. United Community Bank,
headquartered in Blairsville, Georgia, maintains a branch office in Gilmer
County. In addition, many local businesses and individuals have deposits outside
Gilmer County.

         Recent legislation enacted by the Georgia General Assembly allow banks
in Georgia to establish de novo branch banks in Gilmer County, which branches,
if established, would also compete with the Bank. See "Supervision and
Regulation--Regulation and Legislative Changes."

MONETARY POLICIES

         The results of operations of the Company and the Bank are significantly
affected by the credit policies of monetary authorities, particularly the Board
of Governors of the Federal Reserve System. The instruments of monetary policy
employed by the Federal Reserve include open market operations in U.S.
government securities, changes in discount rates on member bank borrowings, and
changes in reserve requirements against bank deposits. In view of changing
conditions in the national economy and in the money markets, as well as the
effect of action by monetary and fiscal authorities, including the Federal
Reserve System, no prediction can be made as to possible future changes in
interest rates, deposit levels, loan demand, or the business and earnings of the
Bank.

                           SUPERVISION AND REGULATION

         The following information is not intended to be an exhaustive
description of the statutes and regulations applicable to the Company and the
Bank. The discussion of the regulatory provisions applicable to the Company and
the Bank is qualified in its entirety by reference to the particular statutory
or regulatory provisions.

THE COMPANY

         The Company is a bank holding company within the meaning of the federal
Bank Holding Company Act ("BHC Act") and is registered with and subject to the
regulation of the Federal Reserve under the BHC Act. As a bank holding company,
the Company is required to file with the Federal Reserve annual reports and such
other reports and information as may be required under the BHC Act. The Federal
Reserve may conduct examinations of the Company and the Bank to determine
whether such institutions are in compliance with the regulations promulgated
under the BHC Act.

         The BHC Act requires a bank holding company to obtain prior approval of
the Federal Reserve (i) before it may acquire directly or indirectly the
ownership or control of more than 5% of any class of voting stock of any bank
not already controlled by it, (ii) before it or any subsidiary (other than a
bank) may acquire all or substantially all of the assets of a bank, and (iii)
before it may merge or consolidate with any other bank holding company. The
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the
"Interstate Banking Act") facilitates branching and permits the establishment of
agency relationships across state lines and permits bank holding companies to
acquire banks in any state without regard to whether the transaction is
prohibited under the laws of such state, subject to certain


                                       4
<PAGE>   7

state provisions, including minimum age requirements of banks that are the
target of the acquisition. The minimum age of local banks subject to interstate
acquisition is limited to a maximum of five years. See "--Regulation and
Legislative Changes."

         Bank holding companies are also generally prohibited under the BHC Act
from engaging in non-banking activities or acquiring direct or indirect control
of any company engaged in non-banking activities. However, the Federal Reserve
may permit bank holding companies to engage in certain non-banking activities
found by the Federal Reserve to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto. Such activities determined
by the Federal Reserve to fall under this category include, but are not limited
to, making or servicing loans and certain leases, providing certain data
processing services, acting as a fiduciary or investment or financial advisor,
providing discount brokerage services, underwriting bank eligible securities,
and making investments designed to promote community welfare.

         The Federal Reserve Act imposes certain limitations on extensions of
credit and other transactions by and between banks that are members of the
Federal Reserve System and other affiliates (which includes any holding company
of which such bank is a subsidiary and any other non-bank subsidiary of such
holding company). Banks that are not members of the Federal Reserve System are
also subject to these limitations. Further, federal law prohibits a bank holding
company and its subsidiaries from engaging in certain tie-in arrangements in
connection with any extension of credit, lease or sale of property, or the
furnishing of services.

         Under Federal Reserve policy, a bank holding company is expected to act
as a source of financial strength to its bank subsidiaries and to commit
resources to support such subsidiaries. This support may be required at times
when, absent such policy, the bank holding company might not otherwise provide
such support. Under these provisions, a bank holding company may be required to
loan money to its subsidiary banks in the form of capital notes or other
instruments which qualify for capital under regulatory rules. Any loans by the
bank holding company to such subsidiary banks are likely to be unsecured and
subordinate to such bank's depositors and possibly to other creditors of such
bank.

         The Company is also subject to regulation as a bank holding company
under the Georgia Financial Institutions Code (the "Code"), which requires
registration and filing of periodic information with the Georgia Department of
Banking and Finance ("DBF"). Registration with the DBF includes information
relating to the financial condition, operations, management and inter-company
relationships of the Company and the Bank. The DBF may also require such other
information or make examinations as is necessary to keep itself informed as to
whether the Company is in compliance with the provisions of Georgia law and the
regulations and orders promulgated or issued thereunder.

         Under the provisions of the Code, it is unlawful without the prior
approval of the DBF (i) for any bank holding company to acquire direct or
indirect ownership or control of more than 5% of the voting shares of the Bank;
(ii) for any bank holding company or a subsidiary thereof (other than a bank) to
acquire all or substantially all of the assets of a bank; or (iii) for any bank
holding company to merge or consolidate with any other bank holding company. It
is also unlawful under the Code for any bank holding company to acquire direct
or indirect ownership or control of more than 5% of the voting shares of any
presently operating bank unless such bank has been in existence and continuously
operating or incorporated as a bank for a period of five years or more prior to
the date of application to the DBF for approval of such acquisition. In
addition, in any such acquisition by an existing bank holding company, the
initial banking subsidiary of such bank holding company must have been
incorporated for not less than two years before the holding company can acquire
another bank.

THE BANK

         The Bank operates as a banking institution incorporated under the laws
of the State of Georgia and subject to examination by the DBF. The DBF regulates
all areas of the Bank's commercial banking operations, including reserves,
loans, mergers, consolidations, reorganizations, issuance of securities, payment
of dividends, interest rates, establishment of branches, and other aspects of
its operations. The Bank must also comply with the state usury laws which limit
the rates of interest which may be charged on certain types of loans.


                                       5
<PAGE>   8


         In addition to state banking laws and regulations applicable to the
Bank as a state banking institution, the Bank is also insured and regulated by
the FDIC. The major functions of the FDIC with respect to insured banks include
paying off depositors to the extent provided by law in the event a bank is
closed without adequate provisions having been made to pay the claims of
depositors, acting as the receiver of state banks placed in receivership when
appointed receiver by state authorities, and preventing the continuance or
development of unsound and unsafe banking practices. In addition, the FDIC is
authorized to examine insured banks which are not members of the Federal Reserve
System to determine the condition of such banks for insurance purposes. (The
Bank is not a member of the Federal Reserve System.) The FDIC is also authorized
to approve mergers, consolidations and assumption of deposit liability
transactions between insured banks and non-insured banks or institutions, and to
prevent capital or surplus diminution in such transactions where the resulting,
continued, or assumed bank is an insured non-member state bank. The FDIC closely
examines non-member banks for compliance with certain federal statutes such as
the Community Reinvestment Act and the Truth-in-Lending Act.

DIVIDENDS

         The principal source of cash flow for the Company is dividends from the
Bank. Various statutory provisions require regulatory approval before the Bank
may pay dividends to the Company. Under Georgia law, the Bank must obtain
approval of the DBF before it may pay cash dividends out of retained earnings if
(1) the total classified assets at the most recent examination of such bank
exceed 80% of the equity capital, (2) the aggregate amount of dividends declared
or anticipated to be declared in the calendar year exceeds 50% of the net
profits, after taxes but before dividends, for the previous calendar year, or
(3) the ratio of equity capital to adjusted assets is less than 6%. As discussed
below, additional capital requirements imposed by the DBF may limit the Bank's
ability to pay dividends to the Company. See "--Capital Adequacy."

         The payment of dividends by the Company and the Bank may also be
affected or limited by regulatory requirements and policies, such as the
maintenance of adequate capital. If, in the opinion of the applicable regulatory
authority, a bank under its jurisdiction is engaged in or is about to engage in
an unsafe or unsound practice (which could include the payment of dividends
depending on the institution's financial condition), such authority may require,
after notice and hearing, that such bank cease and desist from such practice.
The FDIC issued a policy statement that provides that insured banks should
generally only pay dividends out of current operating earnings. The Federal
Reserve has issued a policy statement to the same effect for bank holding
companies. In addition, all insured depository institutions are subject to the
capital-based limitations required by FDICIA. See "Capital Adequacy--FDICIA."

CAPITAL ADEQUACY

         The Federal Reserve and the FDIC have implemented substantially similar
risk-based rules for assessing the capital adequacy of banks and bank holding
companies. These regulations establish minimum guidelines for the ratio of
qualifying total capital to risk-weighted assets (including certain off-balance
sheet items, such as standby letters of credit). Banks and bank holding
companies are required to have (1) a minimum level of total capital to
risk-weighted assets of 8%; (2) a minimum Tier 1 capital ratio to risk-weighted
assets of 4%; and (3) a minimum shareholder's equity to risk-weighted assets
ratio of 4%. Tier 1 capital includes common equity, retained earnings, minority
interests in equity accounts of consolidated subsidiaries, noncumulative
perpetual preferred stock and a limited amount of cumulative perpetual preferred
stock, less goodwill and most other intangibles. Tier 2 capital includes the
excess of any preferred stock not included in Tier 1 capital, mandatory
convertible securities, hybrid capital instruments, subordinated debt and
intermediate term preferred stock, and general reserve for loan and lease losses
up to 1.25% of risk-weighted assets.

         In addition, the Federal Reserve and the FDIC have established a
minimum 3% leverage ratio of Tier 1 capital to total assets for the most highly
rated bank holding companies and insured banks, respectively. All other bank
holding companies and insured banks will be required to maintain a leverage
ratio of 3% plus an additional cushion of at least 100 to 200 basis points. The
guidelines also provide that banking organizations experiencing internal growth
or making acquisitions will be expected to maintain strong capital positions
substantially above the minimum supervisory levels, without significant reliance
on intangible assets. Furthermore, the guidelines indicate that the regulatory
agencies will continue to consider a tangible Tier 1 leverage ratio and other
indicia of capital strength in evaluating


                                       6
<PAGE>   9


proposals for expansion or new activities. The tangible Tier 1 leverage ratio is
the ratio of a banking organization's Tier 1 capital, less all intangibles, to
total assets, less all intangibles. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Capital Resources."

         Failure to meet capital guidelines could subject a bank to a variety of
enforcement remedies, including the termination of deposit insurance by the
FDIC, and to certain restrictions on its business. See "--FDICIA."

         Federal banking agencies recently adopted final regulations mandating
that regulators take into consideration concentrations of interest rate and
credit risk and risks from nontraditional activities, as well as the
institution's ability to manage such risks, when determining the adequacy of an
institution's capital position. Under these rules, regulators must explicitly
include an institution's exposure to declines in the economic value of its
capital due to interest rates in evaluating an institution's capital adequacy.
The final rules do not codify a framework for assessing an institution's
exposure to interest rate risk; rather, such exposure would be considered as one
quantitative factor used in evaluating capital adequacy. Other quantitative
factors would include the institution's historical financial performance and its
earnings exposure to interest rate movements. Examiners will also consider
certain qualitative factors, including the institution's internal interest rate
risk management.

         DBF Capital Requirements. Notwithstanding the uniform risk-based
capital guidelines and leverage ratios discussed above, regulatory authorities
have the discretion to set individual minimum capital requirements for the
specific institutions at rates significantly exceeding the above minimum
guidelines and ratios. In addition to the capital standards imposed by federal
banking regulators, the DBF imposed an 8% primary capital ratio as a condition
to the approval of the Bank's charter. This standard, which exceeds the FDIC
capital standards, is calculated as the ratio of total equity to total assets,
each as adjusted for unrealized gains and losses on securities and allowance for
loan losses. This heightened requirement was imposed during the first three
years of the Bank's operation, at which time the Bank became subject to a 6%
primary capital ratio. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Capital Resources."

         FDICIA. The Federal Deposit Insurance Corporation Improvement Act of
1991 ("FDICIA") was enacted on December 19, 1991 in large measure to improve the
supervision and examination of insured depository institutions in an effort to
reduce the number of bank failures and the resulting demands on the deposit
insurance system. Among other matters, the FDICIA requires that all depository
institutions with assets in excess of $150 million, or such larger threshold as
may be established by the FDIC (currently $500 million), prepare and submit to
the FDIC and appropriate federal and state banking regulators annual financial
statements that have been audited by independent public accountants, file
reports prepared by the depository institutions containing a statement by
management of its responsibilities and by the depository institutions'
independent public accountant attesting to the accuracy of management's annual
assessment of its financial reporting, internal controls and regulatory
compliance, and establish an audit committee composed of members of the board of
directors who are independent of management. The FDIC has provided by regulation
that these provisions of the FDICIA do not apply to depository institutions with
assets less than $500 million. An enactment of the FDICIA has also resulted in
the promulgation of regulations by regulatory agencies which will tend to
restrict to some degree the real estate lending practices of financial
institutions. The FDICIA otherwise provides for additional supervision and
regulation of financial institutions.

                  (Remainder of Page Intentionally Left Blank)


                                       7
<PAGE>   10


         Under the FDICIA, regulators must take prompt corrective action against
depository institutions that do not meet minimum capital requirements. FDICIA
and the regulations thereunder establish five capital categories as shown in the
following table:

<TABLE>
<CAPTION>
                                                         TOTAL RISK-           TIER 1 RISK-             TIER 1
               CLASSIFICATION                           BASED CAPITAL          BASED CAPITAL           LEVERAGE
               --------------                           -------------          -------------           --------

         <S>                                            <C>                    <C>                     <C>
         Well Capitalized (1)                                10%                    6%                    5%
         Adequately Capitalized (1)                           8%                    4%                    4%(2)
         Undercapitalized (3)                                <8%                   <4%                   <4%
         Significantly Undercapitalized                      <6%                   <3%                   <3%
         Critically Undercapitalized                          -                     -                    <2%
</TABLE>

         -------------------------

         (1) An institution must meet all three minimums.

         (2) 3% for composite 1-rated institutions, subject to appropriate
             federal banking agency guidelines.

         (3) An institution is classified as "undercapitalized" if it is below
             the specified capital level for any of the three capital measures.

         A depository institution may be deemed to be in a capitalization
category that is lower than is indicated by its actual capital position if it
receives a less than satisfactory examination rating in any one of four
categories. As a depository institution moves downward through the
capitalization categories, the degree of regulatory scrutiny will increase and
the permitted activities of the institution will decrease. Action may be taken
by a depository institution's primary federal regulator against an institution
that falls into one of the three "undercapitalized" categories, including the
requirement of filing a capital plan with the institution's primary federal
regulator, prohibition on the payment of dividends and management fees,
restrictions on executive compensation, and increased supervisory monitoring.
Other restrictions may be imposed on the institution either by its primary
federal regulator or by the FDIC, including requirements to raise additional
capital, to sell assets, or to sell the institution.

         The foregoing capital guidelines may have an effect on the Company in a
variety of ways. Rapid growth, poor loan portfolio performance or poor earnings
performance, or a combination of these factors, could change the Company's
capital position in a short period of time, making an additional capital
infusion necessary. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Capital Resources."

SAFETY AND SOUNDNESS

         FDICIA imposes certain restrictions on transactions and required
federal banking agencies to prescribe overall safety and soundness standards
relating to internal controls, loan underwriting and documentation and asset
growth. If an insured depository institution or its holding company fails to
meet any of the regulatory standards promulgated by the regulation, then such
institution or company must submit a plan within 30 days to the FDIC describing
the steps it will take to correct the deficiency. If an institution or company
fails to submit a plan or implement the plan within the time period allowed by
the agency, the FDIC must order the institution or company to correct the
deficiency and may take such additional steps as restricting asset growth,
requiring an increase in the institution's ratio of tangible equity to assets,
restricting rates of interest that the institution may pay or take any further
corrective action the agency deems necessary.

FEDERAL DEPOSIT INSURANCE PREMIUMS AND ASSESSMENTS

         The deposits of the Bank are currently insured to a maximum of $100,000
per depositor, subject to certain aggregation rules. The FDIC establishes rates
for the payment of premiums by federally insured banks and thrifts for deposit
insurance. Separate insurance funds (the Bank Insurance Fund or "BIF" and the
Savings Association Insurance Fund or "SAIF") are maintained for commercial
banks and thrifts, with insurance premiums from the banking industry used to
offset losses from insurance payouts when banks and thrifts fail. Since 1993,
insured depository institutions like the Bank have paid for deposit insurance
under a risk-based premium system. Under this system, until mid-1995 depository
institutions paid to the BIF or the SAIF from $0.23 to $0.31 per $100 of insured


                                       8
<PAGE>   11


deposits depending on their capital levels and risk profile, as determined by
their primary federal regulator on a semi-annual basis. Once the BIF reached its
legally mandated reserve ratio in mid-1995, the FDIC lowered premiums for
well-capitalized banks to $.04 per $100. Subsequently, the FDIC revised the
range of premiums from $.00 to $.31 per $100. In 1997, the Bank paid the legally
required minimum semiannual assessment.

         On September 30, 1996, the Economic Growth and Regulatory Paperwork
Reduction Act of 1996 was enacted (the "1996 Act"). The 1996 Act's primary
accomplishment was to provide for the recapitalization of the SAIF by levying a
one-time special assessment on SAIF deposits to bring the fund to a reserve
ratio equal to $.25 per $100 of insured deposits and to provide that beginning
in 1998, BIF assessments would be used to help pay off the $780 million in
annual interest payments on the $8 billion Financing Corporation ("FICO") bonds
issued in the late 1980s as part of the government rescue of the thrift
industry. The law provides that BIF assessments for FICO bond payments must be
set at a rate equal to 20% of the SAIF rates for such assessments for 1997,
1998, and 1999. After 1999, all FDIC insured institutions will pay the same
assessment rates. For the first six months of 1998, the assessment for FICO bond
payments will be $.0132 per $100 of deposits for BIF deposits and $.0648 per
$100 of deposits for SAIF deposits.

REGULATORY AND LEGISLATIVE CHANGES

         Georgia Interstate Banking Act. The Bank is also subject to other state
and federal governmental regulations. On March 16, 1994, the Georgia General
Assembly adopted the Georgia Interstate Banking Act (the "Georgia Act"). The
Georgia Act revised the existing regional interstate banking law to expand the
scope nationwide. The Georgia Act, as amended by the 1996 Georgia Interstate
Banking Act, permits bank holding companies located in any state outside of
Georgia to acquire Georgia banks, or to acquire bank holding companies owning
Georgia banks. However, the Georgia Act retains the existing prohibition,
subject to certain limitations, on acquiring banks in operation less than five
years. Further, the board of directors of a Georgia bank or bank holding company
may adopt a resolution to exempt its bank or bank holding company from
acquisition under the Georgia Act. Finally, acquisition of the Bank must receive
prior approval from the Federal Reserve and the DBF.

         Georgia Intrastate Banking Act. The Georgia General Assembly recently
enacted legislation (the "Georgia Intrastate Banking Act") altering the public
policy of the State regarding intrastate branch banking. Essentially, the
legislation allows a bank to establish de novo branch banks on a limited basis
beginning July 1, 1996. Between July 1, 1996 and June 30, 1998, any Georgia bank
or group of affiliated banks under a single holding company may, subject to
certain restrictions, establish new or additional branch banks in any three
counties in the State of Georgia in which the bank or group of banks are not
currently operating. Beginning July 1, 1998, the number of de novo branch banks
which may be established is no longer limited by statute.

         Several federal statutes impact the ways in which the Bank conducts
business include FDICIA, the Riegle Community Development and Regulatory
Improvement Act of 1994 ("RCDRIA"), and the Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "Interstate Banking Act").

         RCDRIA. RCDRIA was enacted September 23, 1994, to promote economic
revitalization and community development to "investment areas." RCDRIA
establishes a Community Development Financial Institutions Fund to achieve these
objectives. The fund is authorized to provide financial assistance through a
variety of mechanisms, including equity investments, grants, loans, credit union
shares and deposits. The amount of assistance any community development
financial institution and its subsidiaries and affiliates may receive is
generally limited to $5 million. A qualifying institution may receive an
additional $3.75 million for the purpose of serving an investment area in
another state.

         RCDRIA provides certain regulatory relief, requiring each federal
agency to streamline and modify its regulations and policies, remove
inconsistencies and eliminate outmoded and duplicative requirements. RCDRIA
directs the federal agencies to coordinate examinations among affiliate banks,
coordinate examinations with other federal banking agencies, and work to
coordinate with state banking agencies. The federal banking agencies are also
directed to work jointly in developing a system for banks and savings
associations to file reports and statements electronically and to adopt a single
form for filing core information in reports and statements.


                                       9
<PAGE>   12


         Interstate Banking Act. The Interstate Banking Act, enacted September
29, 1994, permits, among other things, bank holding companies to merge their
multi-state bank subsidiaries into a single bank by June 1, 1997, unless state
legislators act to "opt-out" of this provision, to acquire banks in any state
one year after the effective date of the Interstate Banking Act, and permit
banks to establish de novo branches across state lines if the individual states
into which a potential de novo entrant proposes to branch specifically pass
legislation to "opt-in."

         Under the Interstate Banking Act, a bank could merge, beginning on June
1, 1997, with a bank in another state if the transaction did not involve a bank
in a home state which had enacted a law after the date of enactment of the
interstate banking act and before June 1, 1997, that applied equally to all out
of state banks and expressly prohibited such interstate merger transactions.
Such a law would have no effect on merger transactions approved before the
effective date of such state law. States were also allowed to permit merger
transactions before June 1, 1997. Georgia elected to allow such mergers
beginning June 1, 1997. The Interstate Banking Act authorizes interstate mergers
involving the acquisition of a branch of a bank without the acquisition of the
bank only as state law permits an out of state bank to acquire a branch without
acquiring the bank; Georgia has not authorized such transactions. State minimum
age laws for banks to be acquired will be preserved unless state law provides
for a minimum age period of more than five years. After consummation of any
interstate merger transaction, a resulting bank may establish or operate
additional branches at any location where any bank involved in the transaction
could have established or operated a branch under applicable federal or state
law.

         Beginning September 29, 1995, the Board of Governors of the Federal
Reserve System was authorized to approve the acquisition by a well capitalized
and adequately managed bank holding company of a bank that is located in another
state without regard to whether the acquisition is prohibited under the laws of
any state. Again, state minimum age laws for banks to be acquired will be
preserved unless the state law provides for a minimum age period of more than
five years. The Federal Reserve may not approve an interstate acquisition which
would result in the acquirer's controlling more than 10% of the total amount of
deposits of insured depository institutions in the United States with 30% or
more of the deposits in the home state of the target bank. A state may waive the
30% limit based on criteria that does not discriminate against out of state
institutions. The limitations do not apply to the initial entry into a state by
a bank holding company unless the state has a deposit concentration cap that
applies on a nondiscriminatory basis to in state or out of state bank holding
companies making an initial acquisition. Notwithstanding the foregoing,
anti-trust laws are not affected by the Interstate Banking Act.

         The Interstate Banking Act now provides that banks may establish
branches across state lines upon approval of the appropriate federal regulator
if the state "opts-in" by enacting legislation that expressly permits de novo
interstate branching. The establishment of the initial branch in a host state
which permits de novo interstate branching is subject to the same requirements
which apply to the initial acquisition of a bank in a host state, other than the
deposit concentration limits, since the bank would not control any deposits in
the host state at the time of entry. Once a branch has been established by de
novo branching, the bank may establish and acquire additional branches at any
location in the host state in the same manner as any bank in the host state
could have established or acquired additional branches under applicable federal
or state law.

         Other Regulatory Initiatives. On April 19, 1995, the four federal bank
regulatory agencies adopted revisions to the regulations promulgated pursuant to
the Community Reinvestment Act (the "CRA") which are intended to set distinct
assessment standards for financial institutions. The revised regulations contain
three evaluation tests: (i) a lending test which will compare the institution's
market share of loans in low and moderate income areas to its market share of
loans in its entire service area and the percentage of a bank's outstanding
loans to low and moderate income areas or individuals, (ii) a services test
which will evaluate the provisions of services that promote the availability of
credit to low and moderate income areas, and (iii) an investment test, which
will evaluate an institution's record of investments in organizations designed
to foster community development, small and minority-owned businesses and
affordable housing lending, including state and local government housing or
revenue bonds. The regulations are designed to reduce some paperwork
requirements of the current regulations and provide regulators, institutions and
community groups with a more objective and predictable manner with which to
evaluate the CRA performance of financial institutions. The rule became
effective on January 1, 1996, at which time evaluation under streamlined
procedures began for institutions with assets of less than $250 million that are
owned by a holding company with total


                                       10
<PAGE>   13


assets of less than $1 billion. The Bank was examined for CRA compliance on May
6, 1996 and received a CRA rating of 1.

         Congress and various federal agencies (including, in addition to the
bank regulatory agencies, HUD, the Federal Trade Commission and the Department
of Justice) (collectively the "Federal Agencies") responsible for implementing
the nation's fair lending laws have been increasingly concerned that prospective
home buyers and other borrowers are experiencing discrimination in their efforts
to obtain loans. In recent years, the Department of Justice has filed suit
against financial institutions, which it determined had discriminated, seeking
fines and restitution for borrowers who allegedly suffered from discriminatory
practices. Most, if not all, of these suits have been settled (some for
substantial sums) without a full adjudication on the merits.

         On March 8, 1994, the Federal Agencies, in an effort to clarify what
constitutes lending discrimination and specify the factors the agencies will
consider in determining if lending discrimination exists, announced a joint
policy statement detailing specific discriminatory practices prohibited under
the Equal Opportunity Act and the Fair Housing Act. In the policy statement,
three methods of proving lending discrimination were identified: (1) overt
evidence of discrimination, when a lender blatantly discriminates on a
prohibited basis, (2) evidence of disparate treatment, when a lender treats
applicants differently based on a prohibited factor even where this is no
showing that the treatment was motivated by prejudice or a conscious intention
to discriminate against a person, and (3) evidence of disparate impact, when a
lender applies a practice uniformly to all applicants, but the practice has a
discriminatory effect, where such practices are neutral on their face and are
applied equally, unless the practice can be justified on the basis of business
necessity.

               On July 3, 1997, President Clinton signed legislation to clarify
that branches of state-chartered banks operating in host states are covered by
the laws of their home chartering state. The Riegle-Neal Amendment Act of 1997
is intended to preserve the dual banking system by subjecting state banks only
to the rules of their chartering states.

         Proposals to change the laws and regulations governing the banking
industry are regularly introduced on the state and federal level. It cannot be
predicted whether or in what form any proposed legislation will be adopted or
the extent to which such legislation may affect the business of the Company or
the Bank.

                        SELECTED STATISTICAL INFORMATION

         The following tables set forth certain statistical information and
should be read in conjunction with Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in this Report and the
Company's consolidated financial statements and notes thereto beginning at page
F-1 of this Report. The average statistical data presented in this report are
generally based on daily average balances.







                  (Remainder of Page Intentionally Left Blank)


                                       11
<PAGE>   14


DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND
INTEREST DIFFERENTIAL

         The table below shows, for the periods indicated, the daily average
balances outstanding for the major categories of interest-bearing assets and
interest-bearing liabilities, and the average interest rate earned or paid
thereon. Such yields are calculated by dividing income or expense by the average
balance of the corresponding assets or liabilities.

           AVERAGE BALANCES, INTEREST INCOME/EXPENSE AND YIELDS/RATES
                            Taxable Equivalent Basis

<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31, 1997       YEAR ENDED DECEMBER 31, 1996
                                                        --------------------------------  ------------------------------
                                                         AVERAGE      INCOME/     YIELD/   AVERAGE     INCOME/    YIELD/
                                                         BALANCE      EXPENSE      RATE    BALANCE     EXPENSE     RATE
                                                        ---------    ---------   -------  --------    --------    ------

                                                                            (AMOUNTS IN THOUSANDS)
<S>                                                     <C>          <C>         <C>      <C>         <C>         <C>
ASSETS

 Earning assets:
   Loans, net of unearned income (1)...........         $  74,753    $7,675      10.27%   $ 51,008    $5,219      10.23%
     Investment securities:
     Taxable ..................................            17,498     1,160       6.63      15,277       979       6.41
     Tax-exempt ...............................             3,257       258       7.92         445        36       8.09
                                                        ---------    ------               --------    ------
   Total investment securities ................            20,755     1,418       6.83      15,722     1,015       6.45
   Federal funds sold .........................             2,895       160       5.53       2,025       104       5.14
                                                        ---------    ------               --------    ------
     Total interest-earning assets ............            98,403     9,253       9.40      68,755     6,338       9.22

 Non interest-earning assets:
   Cash and due from banks ....................             2,170                            1,522
   Premises and equipment .....................             1,644                            1,658
   Accrued interest and other assets ..........             1,818                              911
   Allowance for loan losses ..................              (774)                            (500)
                                                        ---------                         --------
Total assets ..................................         $ 103,261                         $ 72,346
                                                        =========                         ========

LIABILITIES AND SHAREHOLDERS' EQUITY

 Interest-bearing liabilities:
   Demand deposits ............................         $  22,681     1,116       4.92    $ 14,849       737       4.96
   Savings deposits ...........................            17,984       933       5.19      10,829       572       5.28
   Time deposits ..............................            45,616     2,862       6.27      33,365     2,127       6.37
                                                        ---------    ------      -----    --------    ------      -----
                                                           86,281     4,911       5.69      59,043     3,436       5.82
 Other short-term borrowings ..................             4,471       201       4.50       4,777       219       4.58
 Long-term debt ...............................             2,090       150       7.18          62         5       8.06
                                                        ---------    ------      -----    --------    ------      -----
       Total interest-bearing liabilities......            92,842     5,262       5.67      63,882     3,660       5.73
                                                        ---------    ------      -----    --------    ------      -----
 Noninterest-bearing other liabilities:........
     Demand deposits ..........................             3,527                            2,617
     Accrued interest and other liabilities....               500                              344
     Shareholders' equity .....................             6,392                            5,503
                                                        ---------                         --------
Total liabilities and shareholders' equity              $ 103,261                         $ 72,346
                                                        =========                         ========

Net interest income/net interest spread .......                       3,991       3.73%                2,678       3.49%
                                                                                 =====                            =====
Net yield on earning assets ...................                                   4.06%                            3.90%
                                                                                 =====                            =====
Taxable equivalent adjustment:
   Loans ......................................                          22                               14
   Investment securities ......................                          88                               13
                                                                     ------                           ------
     Total taxable equivalent adjustment ......                         110                               27
                                                                     ------                           ------
Net interest income ...........................                      $3,881                           $2,651
                                                                     ======                           ======
</TABLE>

---------------------------


(1) Average loans include nonaccrual loans. All loans and deposits are domestic.




                                       12
<PAGE>   15


         The following table sets forth, for the years ended December 31, 1997
and 1996, a summary of the changes in interest income and interest expense
resulting from changes in interest rates and in changes in the volume of earning
assets and interest-bearing liabilities, segregated by category. The change due
to volume is calculated by multiplying the change in volume by the prior year's
rate. The change due to rate is calculated by multiplying the change in rate by
the prior year's volume. The change attributable to both volume and rate is
calculated by multiplying the change in volume by the change in rate. Figures
are presented on a taxable equivalent basis.

                          RATE/VOLUME VARIANCE ANALYSIS
<TABLE>
<CAPTION>
                                                         CHANGE                           INTEREST                   VARIANCE (1)
                                    AVERAGE VOLUME     IN  VOLUME     AVERAGE RATE     INCOME/EXPENSE  VARIANCE      ATTRIBUTED TO
                                  ----------------     ----------     ------------     --------------  --------   ------------------
                                   1997       1996      1997-96      1997     1996       1997    1996   1997-96   VOLUME      RATE
                                  ------      ----     ----------    ----     ----       ----    ----   -------   ------     -------
                                                                     (AMOUNTS IN THOUSANDS)
<S>                               <C>       <C>         <C>         <C>      <C>       <C>      <C>      <C>      <C>        <C>
EARNING ASSETS:
Loans, net of unearned
  income .....................    $74,753   $51,008     $23,745     10.27%   10.23%    $7,675   $5,219   $2,456   $2,436     $  20
Investment securities:
  Taxable ....................     17,498    15,277       2,221      6.63     6.41      1,160      979      181      146        35
  Tax Exempt .................      3,257       445       2,812      7.92     8.09        258       36      222      223        (1)
                                  -------   -------     -------                        ------   ------   ------
    Total investment
     securities ..............     20,755    15,722       5,033      6.83     6.45      1,418    1,015      403      369        34
Federal funds sold ...........      2,895     2,025         870      5.53     5.14        160      104       56       48         8
                                  -------   -------     -------                        ------   ------   ------
Total earning assets .........    $98,403   $68,755     $29,648      9.40     9.22     $9,253   $6,338   $2,915    2,842        73
                                  =======   =======     =======                        ======   ======   ======

INTEREST-BEARING LIABILITIES:
Deposits:
  Demand .....................    $22,681   $14,849     $ 7,832      4.92     4.96     $1,116   $  737   $  379      385        (6)
  Savings ....................     17,984    10,829       7,155      5.19     5.28        933      572      361      371       (10)
  Time .......................     45,616    33,365      12,251      6.27     6.37      2,862    2,127      735      768       (33)
                                  -------    ------     -------                        ------   ------   ------
    Total interest-bearing
     deposits ................     86,281    59,043      27,238      5.69     5.82      4,911    3,436    1,475    1,524       (49)

Other short-term borrowings         4,471     4,777        (306)     4.50     4.58        201      219      (18)     (14)       (4)
Long-term debt ...............      2,090        62       2,028      7.18     8.06        150        5      145      146        (1)
                                  -------    ------     -------                        ------   ------   ------
    Total interest-bearing
     liabilities .............    $92,842   $63,882     $28,960      5.67     5.73      5,262    3,660    1,602    1,656       (54)
                                  =======   =======     =======                        ------   ------   ------   ------      ----

Net interest income/net
  interest spread ............                                       3.73%    3.49%    $3,991   $2,678   $1,313   $1,186      $127
                                                                 ========     ====     ======   ======   ======   ======      ====
Net yield on earning assets...                                       4.06%    3.90%
                                                                 ========     ====
Net cost of funds ............                                       5.34%    5.32%
                                                                 ========     ====
</TABLE>

---------------------------


(1)  The change in interest due to both rate and volume has been allocated to
     volume and rate changes in proportion to the relationship of the absolute
     dollar amounts of the change in each.

                  (Remainder of Page Intentionally Left Blank)


                                       13
<PAGE>   16


INVESTMENT PORTFOLIO

         The carrying amount of investment securities at the end of each of the
years presented is set forth in the following table:

                              INVESTMENT PORTFOLIO

<TABLE>
<CAPTION>
                                                                                DECEMBER 31,
                                                                       ----------------------------
                                                                           1997            1996
                                                                       ------------    ------------

                                                                          (AMOUNTS IN THOUSANDS)
<S>                                                                    <C>             <C>
SECURITIES AVAILABLE FOR SALE:
     U.S. Treasury and U.S. Government agencies.................       $     13,980    $     17,769
     Mortgage-backed securities.................................              1,165           2,217
     State and municipal securities.............................                  0             145
                                                                       ------------    ------------
         Total..................................................       $     15,145    $     20,131
                                                                       ============    ============

SECURITIES HELD TO MATURITY:
     State and municipal securities.............................       $      4,181    $      2,247
                                                                       ============    ============
</TABLE>

         Average taxable securities were 84.3 percent of the portfolio in 1997
compared to the prior year level of 97.0 percent. The increase of tax exempt
securities in 1997 reflects the Bank's intent to reduce the effect of federal
income taxation.

         The maturities and weighted average yields of the investments in the
1997 portfolio of investment securities are presented below. The average
maturity of the investment portfolio is 4.8 years with an average yield of 6.8
percent. Taxable equivalent adjustments (using a 34 percent tax rate) have been
made in calculating yields on tax-exempt obligations.

                    INVESTMENT PORTFOLIO MATURITY SCHEDULE

<TABLE>
<CAPTION>
                                                                                    MATURING
                                                 -------------------------------------------------------------------------------
                                                      WITHIN            AFTER ONE BUT       AFTER FIVE BUT           AFTER
                                                     ONE YEAR         WITHIN FIVE YEARS    WITHIN TEN YEARS        TEN YEARS
                                                     --------         -----------------    ----------------        ---------
                                                 AMOUNT      YIELD    AMOUNT      YIELD    AMOUNT     YIELD    AMOUNT     YIELD
                                                 ------      -----    ------      -----    ------     -----    ------     -----

                                                                                (AMOUNTS IN THOUSANDS)
<S>                                              <C>         <C>      <C>         <C>      <C>        <C>      <C>        <C>
SECURITIES AVAILABLE FOR SALE:

  U.S. Treasury ...............................  $  -0-       -0-%    $  -0-        -0-%   $   -0-      -0-%   $  -0-       -0-%
  U.S. Government agencies ....................     796      6.07      7,194       6.41      5,990     6.60       -0-       -0-
  Mortgage-backed .............................     763      5.72        402       6.03        -0-      -0-       -0-       -0-
  State and municipal .........................     -0-       -0-        -0-        -0-        -0-      -0-       -0-       -0-
                                                 ------               ------               -------             ------
                                                 $1,559      5.90     $7,596       6.39    $ 5,990     6.60    $  -0-       -0-
                                                 ======               ======               =======             ======

SECURITIES HELD TO MATURITY:

  State and municipal .........................  $  -0-       -0-%    $  512       6.30%   $   430     7.78%   $3,239      8.05%
                                                 ======               ======               =======             ======
</TABLE>

         There were no securities held by the Bank of which the aggregate value
on December 31, 1997 exceeded ten percent of shareholders' equity at that date.
(Securities which are payable from and secured by the same source of revenue or
taxing authority are considered to be securities of a single issuer. Securities
of the U.S. Government and U.S. Government agencies and corporations are not
included.)


                                       14
<PAGE>   17


LOAN PORTFOLIO

         The following table shows the classification of loans by major category
at December 31, 1997 and 1996.

                                TYPES OF LOANS
<TABLE>
<CAPTION>

                                                                           DECEMBER 31,
                                              ----------------------------------------------------------------------
                                                           1997                                   1996
                                              ------------------------------         -------------------------------
                                                                  PERCENT                                 PERCENT
                                                 AMOUNT           OF TOTAL               AMOUNT           OF TOTAL
                                              -------------     ------------         -------------     -------------

                                                                     (AMOUNTS IN THOUSANDS)

<S>                                           <C>                <C>                  <C>              <C>
Commercial, financial and agricultural.....   $     16,536             19.5%          $     13,911              21.4%
Real estate - construction.................          5,119              6.1                  4,811               7.4
Real estate - other (1)....................         50,928             60.2                 35,289              54.3
Consumer...................................         10,835             12.8                  8,628              13.3
Other loans................................          1,166              1.4                  2,323               3.6
                                              ------------          -------           ------------           -------
                                                    84,584            100.0%                64,962             100.0%
                                                                    =======                                  =======
Less:
Allowance for loan losses..................            930                                     656
                                              ------------                            ------------

Net loans..................................   $     83,654                            $     64,306
                                              ============                            ============
</TABLE>

---------------------

(1)  The "real estate - other" category includes multi-family residential, home
     equity, commercial real estate and undeveloped agricultural real estate
     loans.

         The following table shows the maturity distribution of selected loan
classifications at December 31, 1997 and an analysis of these loans maturing in
over one year.

             SELECTED LOAN MATURITY AND INTEREST RATE SENSITIVITY

<TABLE>
<CAPTION>

                                                                                         RATE STRUCTURE FOR LOANS
                                                    MATURITY                              MATURING OVER ONE YEAR
                              ------------------------------------------------------   -----------------------------
                                              OVER ONE
                                 ONE            YEAR          OVER                     PREDETERMINED     FLOATING OR
                               YEAR OR        THROUGH         FIVE                       INTEREST         ADJUSTABLE
                                 LESS        FIVE YEARS       YEARS        TOTAL           RATE             RATE
                              --------       ----------       -----       -------      -------------     -----------

                                                             (AMOUNTS IN THOUSANDS)
<S>                           <C>            <C>              <C>         <C>          <C>               <C>
Commercial, financial
   and agricultural.........  $ 11,244       $    5,275       $  17       $16,536      $       3,567     $     1,725
Real estate - construction..     5,119              -0-         -0-         5,119                -0-             -0-
                              --------        ---------       -----       -------      -------------     -----------
     Total..................  $ 16,363       $    5,275       $  17       $21,655      $       3,567     $     1,725
                              ========       ==========       =====       =======      =============     ===========
</TABLE>



                                       15
<PAGE>   18

         The following table presents information concerning outstanding
balances of nonperforming assets at December 31, 1997 and 1996.

                              NONPERFORMING ASSETS

<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                         ---------------------------
                                                          1997                 1996
                                                         ------               ------

                                                             (AMOUNTS IN THOUSANDS)

<S>                                                      <C>                  <C>
Nonaccruing loans .....................................  $   15                $  57
Loans past due 90 days or more.........................      13                    9
Restructured loans.....................................     -0-                  -0-
                                                         ------                -----
Total nonperforming loans..............................      28                   66
Nonaccruing securities.................................     -0-                  -0-
Other real estate......................................     -0-                  -0-
                                                         ------                -----

Total nonperforming assets.............................  $   28                $  66
                                                         ======                =====

RATIOS:

  Loan loss allowance to total nonperforming assets....   33.21                 9.94
                                                         ======                =====
  Total nonperforming loans to total loans
     (net of unearned interest)......................... 0.0003                0.001
                                                         ======                =====

  Total nonperforming assets to total assets............ 0.0002                0.001
                                                         ======                =====
</TABLE>

         It is the general policy of the Bank to stop accruing interest income
and place the recognition of interest on a cash basis when any commercial,
industrial or real estate loan is past due as to principal or interest and the
ultimate collection of either is in doubt. Accrual of interest income on
consumer installment loans is suspended when any payment of principal or
interest, or both, is more than ninety days delinquent. When a loan is placed on
a nonaccrual basis, any interest previously accrued but not collected is
reversed against current income unless the collateral for the loan is sufficient
to cover the accrued interest or a guarantor assures payment of interest.

         There has been no significant impact on the Company's financial
statements as a result of the provisions of Statement of Financial Accounting
Standards No. 114, Accounting by Creditors for Impairment of a Loan, or
Statement of Accounting Standards No. 118, Accounting by Creditors for
Impairment of a Loan--Income Recognition and Disclosures.

SUMMARY OF LOAN LOSS EXPERIENCE

         The provision for loan losses, which is charged to operating results,
is based on the growth of the loan portfolio, the amount of net loan losses
incurred and management's estimation of potential future losses based on an
evaluation of the risk in the loan portfolio. Management believes that the
$929,590 in the allowance for loan losses at December 31, 1997 (1.1% of total
net outstanding loans at that date) was adequate to absorb known risks in the
portfolio based upon the Bank's historical experience. No assurance can be
given, however, that increased loan volume, adverse economic conditions or other
circumstances will not result in increased losses in the Bank's loan portfolio.


                                       16
<PAGE>   19


         The following table sets forth certain information with respect to the
Company's loans, net of unearned income, and the allowance for loan losses for
each of the last three fiscal years:

                        ANALYSIS OF LOAN LOSS EXPERIENCE

<TABLE>
<CAPTION>
                                                              1997         1996          1995
                                                            -------       -------       -------

                                                                   (AMOUNTS IN THOUSANDS)

<S>                                                         <C>           <C>           <C>
Allowance for loan losses at beginning of year............  $   655       $   325           -0-

Loans charged off:
       Commercial, financial, and agricultural............       95           -0-           -0-
       Real estate-construction...........................       45           -0-           -0-
       Real estate-other..................................        2             6           -0-
       Consumer...........................................       85            32             5
         Total loans charged off..........................      227            38             5
                                                            -------       -------       -------
Recoveries on loans previously charged off:
       Commercial, financial, and agricultural............        2           -0-           -0-
       Real estate-construction...........................        8           -0-           -0-
       Real estate-other..................................        1           -0-           -0-
       Consumer...........................................       11           -0-           -0-
                                                            -------       -------       -------
         Total recoveries.................................       22           -0-           -0-
                                                            -------       -------       -------

Net loans charged off.....................................      205            38             5
                                                            -------       -------       -------
Provisions for loan losses................................      480           368           330
                                                            -------       -------       -------
Allowance for loan losses at end of period................  $   930       $   655       $   325
                                                            =======       =======       =======
Loans, net of unearned income, at end of period...........  $84,584       $64,962       $32,169
                                                            =======       =======       =======
Average loans, net of unearned income,
   outstanding for the period.............................  $74,753       $51,008       $14,831
                                                            =======       =======       =======

RATIOS:

Allowance at end of period to loans, net of
   unearned income........................................     1.10%         1.01%         1.01%
Allowance at end of period to average loans,
   net of unearned income.................................     1.24          1.28          2.19
Net charge-offs to average loans, net of
   unearned income........................................      .27           .07           .03
Net charge-offs to allowance at end of period.............    22.04          5.80          1.50
Recoveries to prior year charge-offs......................    57.89           -0-           -0-
</TABLE>


         In assessing adequacy, management relies predominantly on its ongoing
review of the loan portfolio, which is undertaken both to ascertain whether
there are probable losses which must be charged off and to assess the risk
characteristics of the portfolio in the aggregate. This review takes into
consideration the judgments of the responsible lending officers and senior
management, and also those of bank regulatory agencies that review the loan
portfolio as part of the regular bank examination process. In evaluating the
allowance, management also considers the loan loss experience of the Bank, the
amount of past due and nonperforming loans, current and anticipated economic
conditions, lender requirements and other appropriate information.


                                       17
<PAGE>   20


         Management allocated the reserve for loan losses to specific loan
classes as follows:

                     ALLOCATION OF ALLOWANCE FOR LOAN LOSSES

<TABLE>
<CAPTION>
                                                                       DECEMBER 31,
                                                   ----------------------------------------------------
                                                           1997                            1996
                                                   ---------------------            -------------------
                                                                PERCENT                        PERCENT
                                                   AMOUNT       OF TOTAL            AMOUNT     OF TOTAL
                                                   ------       --------            ------     --------

                                                                    (AMOUNTS IN THOUSANDS)

<S>                                                <C>          <C>                 <C>        <C>
DOMESTIC LOANS (1)
     Commercial, financial and agricultural        $  186             20%           $  144           22%
     Real estate - construction ...........            55              6                52            8
     Real estate - other ..................           567             61               354           54
     Consumer .............................           122             13               105           16
                                                   ------       --------            ------     --------

        Total .............................        $  930            100%           $  655         100%
                                                   ======       ========            ======     ========
</TABLE>

------------------

(1)  The Bank had no foreign loans.

DEPOSITS

         The average amounts of and the average rate paid on each of the
following categories of deposits for the years ended December 31, 1997 and 1996
are as follows:

<TABLE>
<CAPTION>
                                                         YEARS ENDED DECEMBER 31,
                                                 ----------------------------------------
                                                        1997                   1996
                                                 -----------------       -----------------
                                                 AMOUNT      RATE        AMOUNT       RATE
                                                 -------     -----       -------      ----

                                                           (AMOUNTS IN THOUSANDS)

<S>                                              <C>          <C>        <C>          <C>
Noninterest-bearing demand deposits                3,527       -0-%        2,617       -0-%

     Demand ..................................    22,681      4.92        14,849      4.96
     Savings .................................    17,984      5.19        10,829      5.28
     Time deposits ...........................    45,616      6.27        33,365      6.37
                                                 -------                 -------
         Total interest-bearing deposits .....    86,281      5.69        59,043      5.82
                                                 -------                 -------

            Total average deposits ...........   $89,808      5.47%      $61,660      5.57%
                                                 =======                 =======
</TABLE>





                  (Remainder of Page Intentionally Left Blank)


                                       18
<PAGE>   21


         The two categories of lowest cost deposits comprised the following
percentages of average total deposits during 1997: average noninterest-bearing
demand deposits, 3.9 percent; and average interest-bearing demand deposits, 25.3
percent. Of average time deposits, approximately 29.7 percent were large
denomination certificates of deposit. The maturities of the time certificates of
deposit of $100,000 or more issued by the Bank at December 31, 1997 are
summarized in the table below.

                        MATURITIES OF LARGE TIME DEPOSITS
<TABLE>
<CAPTION>
                                                                   TIME
                                                               CERTIFICATES
                                                                OF DEPOSIT
                                                               ------------

                                                          (AMOUNTS IN THOUSANDS)

           <S>                                                 <C>
           Three months or less...........................     $      4,041
           Over three through six months..................            2,313
           Over six through twelve months.................            4,627
           Over twelve months.............................            3,755
                                                               ------------

                Total.....................................     $     14,736
                                                               ============
</TABLE>


RETURN ON EQUITY AND ASSETS

         The following table summarizes certain financial ratios for the Company
for the years ended December 31, 1997 and 1996.

                           RETURN ON EQUITY AND ASSETS

<TABLE>
<CAPTION>
                                                       YEARS ENDED DECEMBER 31,
                                                       ------------------------
                                                       1997                1996
                                                       ----                ----

           <S>                                         <C>                 <C>
           Return on average assets..................   .98%                .71%

           Return on average equity..................  15.9                9.40

           Dividend payout ratio.....................   -0-                 -0-

           Average equity to average assets ratio....  6.19                7.60
</TABLE>






                  (Remainder of Page Intentionally Left Blank)


                                       19
<PAGE>   22


                      SELECTED CONSOLIDATED FINANCIAL DATA

         The following table sets forth selected consolidated financial data of
the Company for the years ended December 31, 1997, 1996 and 1995. All averages
are daily averages.

<TABLE>
<CAPTION>

                                                                               YEARS ENDED DECEMBER 31,
                                                                   ----------------------------------------------
                                                                       1997              1996              1995
                                                                   ------------      ------------      ----------

                                                                     (AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
<S>                                                                   <C>              <C>             <C>

CONSOLIDATED STATEMENT OF OPERATIONS DATA
     Interest income .......................................          $  9,143         $ 6,311         $  2,328
     Interest expense ......................................             5,262           3,660            1,278
     Net interest income ...................................             3,881           2,651            1,050
     Provision for loan losses .............................               480             368              330
     Non-interest income ...................................               385             253              111
     Non-interest expense ..................................             2,385           1,715            1,204
     Net income (loss) .....................................             1,018             517             (247)

PER SHARE DATA
     Net income (loss) - basic..............................              1.76             .91             (.43)
     Net income (loss) - diluted............................              1.75             .91             (.43)
     Cash dividends ........................................               -0-             -0-              -0-
     Shareholders' equity (book value) at period end........             14.58           10.22             9.44

CONSOLIDATED BALANCE SHEET DATA
     Loans .................................................            84,584          64,962           32,169
     Deposits ..............................................            95,348          81,148           42,128
     Average equity ........................................             6,392           5,503            5,321
     Average assets ........................................           103,261          72,346           27,265
         Total assets ......................................          $112,181         $93,154         $ 51,949

RATIOS
    Return on average assets ...............................               .98%            .71%            (.91)%
    Return on average equity ...............................              15.9            9.40            (4.64)
    Dividend payout ratio ..................................               -0-             -0-              -0-
    Average equity to average assets .......................              6.19            7.61            19.52
    Total risk-based capital ...............................              9.72           10.85            14.18
    Leverage ratio .........................................              6.22            6.96            10.32
</TABLE>


ITEM 2.  PROPERTIES

         The Company's and the Bank's main office is located at 315 Industrial
Boulevard, Ellijay, Georgia, between the business districts of Ellijay and East
Ellijay. The office building, which contains 9,780 square feet, and the land on
which it is located, which is approximately 1.22 acres, are owned by the Bank.
The building houses offices, operations, storage, and a lobby. The Bank has five
indoor teller stations, a vault with safe deposit boxes and three drive-up
teller lanes, two with pneumatic tubes. The Bank has two drive-up automatic
teller machines ("ATM") which are on-line and part of the Cirrus ATM network.
The first ATM island unit is located adjacent to the drive-up windows and
pneumatic tubes. The second unit, installed in March, 1998, is located in a
well-lighted, high traffic shopping plaza. The Bank has just completed a new
expansion project for the Bank's mortgage department adding three new office
spaces. The Bank is also constructing a second vault with safe deposit boxes to
meet customer demand. The vault expansion should be completed and available for
use by April 1, 1998. A new community room is currently under construction
adjacent to the Bank's offices and should be available for use by April 1, 1998.

         Management believes that the physical facilities maintained by the Bank
are suitable for its current operations.


                                       20
<PAGE>   23


ITEM 3.  LEGAL PROCEEDINGS

         The Company is not aware of any material pending legal proceedings to
which the Company or the Bank is a party or to which any of their property is
subject, other than ordinary routine legal proceedings incidental to the
business of the Bank.

ITEM 4.  SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS

         No matters were submitted to a vote of shareholders of the Company
during the fourth quarter of the fiscal year covered by this Report.



                                     PART II

ITEM 5.  MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
         MATTERS

MARKET INFORMATION

         There is no established trading market for the Company's Common Stock,
$5.00 par value (the "Common Stock"), which has been traded inactively in
private transactions. Therefore, no reliable information is available as to
trades of the Common Stock or as to the prices at which Common Stock has traded.
Management has reviewed the limited information available as to the ranges at
which the Common Stock has been sold. The following table sets forth the
estimated price range for sales of Bank Common Stock (prior to the
Reorganization) or Company Common Stock (after the Reorganization) for each
quarter of the last two fiscal years. The following data regarding the Common
Stock is provided for information purposes only and should not be viewed as
indicative of the actual or market value of the Common Stock.

<TABLE>
<CAPTION>

                                                                                    ESTIMATED PRICE RANGE
                                                                                          PER SHARE
                                                                                   ----------------------
                                                                                    HIGH             LOW
                                                                                   ------          ------
         <S>                                                                       <C>             <C>
         1997:
         First Quarter.......................................................      $16.00          $16.00
         Second Quarter......................................................       18.50           18.00
         Third Quarter.......................................................       22.00           16.00
         Fourth Quarter......................................................       21.00           18.50

         1996:
         First Quarter.......................................................      $15.00          $14.00
         Second Quarter......................................................       13.50           10.00
         Third Quarter.......................................................       14.00            8.00
         Fourth Quarter......................................................       15.00           10.00
</TABLE>


         At March 14, 1998, the Common Stock of the Company was held by
approximately 707 shareholders of record. At such time, approximately 11 persons
had not yet surrendered their certificates representing Gilmer County Bank
common stock, which was automatically converted into Company Common Stock
pursuant to the Reorganization.

DIVIDENDS

         The Bank is subject to restrictions on the payment of dividends under
Georgia law and the regulations of the DBF. The Company is also subject to
limits on payment of dividends by the rules, regulations and policies of federal
banking authorities. See "Supervision and Regulation--Dividends." In addition to
regulatory restrictions



                                       21
<PAGE>   24


on the Company's ability to pay dividends, the agreement relating to the
Company's $1.5 million line of credit with Hardwick Bank & Trust Company (the
"Credit Agreement") contains financial and other covenants, including covenants
that restrict the payment of dividends by the Company. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Capital Resources" for information concerning restrictions in the
Credit Agreement. No assurance can be given that any dividends will be declared
by the Company in the future, or if declared, what the amount would be or
whether such dividends would continue. Future dividend policy will depend on the
Bank's earnings, capital position, financial condition and other factors. The
Company has not paid any dividends to date.

ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

         The purpose of the following discussion is to address information
relating to the financial condition and results of operations of the Company
that may not be readily apparent from a review of the consolidated financial
statements and notes thereto, which begin on page F-1 of this Report. This
discussion should be read in conjunction with information provided in the
Company's consolidated financial statements and accompanying footnotes, and with
the statistical information appearing elsewhere in this Report under the caption
"Selected Statistical Information." Unless otherwise noted, the discussion of
net interest income in this financial review is presented on a taxable
equivalent basis to facilitate performance comparisons among various taxable and
tax-exempt assets.

EARNINGS SUMMARY

         The Company's net income of $1,017,766 for the 1997 fiscal year
represents an increase of $501,030 over the Company's net income in 1996 of
$516,736. The increase in net income relates to the growth in the Bank's deposit
and loan base as well as an increase in the Bank's net interest margin and
interest rate spread.

         Earnings per share increased to $1.76 ($1.75 on a fully diluted basis)
in 1997 compared to a $0.91 per share net income in 1996. Return on average
assets, which reflects the Bank's ability to utilize its assets, was .98% in
1997 compared with .71% in 1996. Return on average shareholders' equity
increased from 9.4% in 1996 to 15.9% in 1997.

RESULTS OF OPERATIONS

         NET INTEREST INCOME

         Net interest income is the principal source of the Bank's earnings
stream and represents the difference or spread between interest and fee income
generated from earning assets and the interest expense paid on deposits and
borrowed funds. Fluctuations in interest rates as well as volume and mix changes
in earning assets and interest-bearing liabilities materially impact net
interest income. Net interest income was $3,880,715 in 1997, as compared to
$2,651,070 in 1996, representing an increase of $1,229,645, or 46.4%. This
increase was caused by the growth of the Bank's deposit base and loan portfolio
as well as an increase in the Bank's interest rate spread and net interest
margin.

         Interest earned on fees and loans increased from $5,205,131 in 1996 to
$7,652,481 in 1997, an increase of $2,447,350 or approximately 47%. This
increase was caused by the increase in the average loan portfolio balance from
approximately $51,008,000 in 1996 to approximately $74,753,000 in 1997.

         Interest earned on taxable investment securities increased $182,580
(18.7%) from $977,917 in 1996 to $1,160,497 in 1997 while interest earned on
nontaxable investment securities increased from $24,228 in 1996 to $170,274 in
1997. The increase in interest earned on nontaxable securities in 1997 is a
result of an increase of approximately $2,812,000 (632%) in the average
investment portfolio for such securities from 1996.

         The trend in net interest income is also evaluated in terms of average
rates using the net interest margin and the interest rate spread. The net
interest margin, or the net yield on earning assets, is computed by dividing
fully



                                       22
<PAGE>   25


taxable equivalent net interest income by average earning assets. This ratio
represents the difference between the average yield returned on average earning
assets and the average rate paid for funds used to support those earning assets,
including both interest-bearing and noninterest-bearing sources. The net
interest margin for 1997 was 4.06%, compared with a net interest rate margin of
3.90% in 1996. This increase was due primarily to the growth of the Bank related
specifically to an increase in interest-bearing assets as a percentage of
interest-earning liabilities.

         The interest rate spread measures the difference between the average
yield on earning assets and the average rate paid on interest-bearing sources of
funds. The interest rate spread calculation provides a more direct perspective
on the effect of market interest rate movements. The net interest spread for
1997 was 3.73% from earning assets as compared to a net interest spread of 3.49%
in 1996.

         The following tabulation presents certain net interest income data
without modification for assumed tax equivalency:

<TABLE>
<CAPTION>


                                                                           YEARS ENDED DECEMBER 31,
                                                                     ------------------------------------
                                                                        1997          1996         1995
                                                                     ----------    ----------    --------
<S>                                                                  <C>           <C>           <C>
Rate earned on earning assets......................................     9.40%         9.22%        9.47%
Rate paid on borrowed funds........................................     5.67%         5.73%        6.16%
Interest rate spread...............................................     3.73%         3.49%        3.31%
Net yield on earning assets........................................     4.06%         3.90%        4.27%
</TABLE>

         During 1997, interest on federal funds sold increased $55,695 (53.5%)
from 1996. The increase in income from federal funds sold is the result of an
increase in the average amount of federal funds sold from approximately
$2,025,000 in 1996 to approximately $2,895,000 in 1997 and an increase in the
average yield for such funds from 5.14% in 1996 to 5.53% in 1997.

         INTEREST EXPENSE

         Total interest expense increased $1,602,026 (43.8%), from $3,660,227 in
1996 to $5,262,253 in 1997. This increase was the combined effect of an increase
in the average balance of interest-bearing deposits from approximately
$59,043,000 in 1996 to approximately $86,281,000 in 1997 and a decrease in the
average rate paid on deposits from 5.82% in 1996 to 5.69% in 1997. The effect of
these changes increased the interest expense on interest-bearing deposits from
$3,436,060 in 1996 to $4,911,266 in 1997.

         NONINTEREST INCOME

         Noninterest income for 1997 and 1996 totaled $384,831 and $252,946,
respectively. These amounts are primarily from service charges on deposit
accounts, insurance commissions and fees on services to customers. Noninterest
income increased primarily due to the continued growth in the Bank's deposit
base. Other noninterest income increased from $85,055 in 1996 to $161,086 in
1997, primarily due to an increase of approximately $39,562 in credit card fees
earned by the Bank in 1997.

         NONINTEREST EXPENSES

         Noninterest expenses totaled $2,385,193 in 1997 and $1,715,372 in 1996.
Salaries and benefits increased $261,464 (29.3%) to $1,154,456, which reflects
the Bank's increased staffing to accommodate the growth in the Bank's loans and
deposits. Furniture and equipment expenses increased $23,919 (18.9%) due to
depreciation on equipment of $98,296 in 1997 ($8,070 over 1996) and repair and
maintenance costs of $51,671 ($15,459 over 1996). Other operating expenses
increased $377,501 (62.9%). Directors' fees increased $100,422 due to payments




                                       23
<PAGE>   26

made by the Company in the first full year the Company paid directors' fees. The
$73,411 increase in professional fees was primarily attributable to compliance
with reporting requirements under the federal securities laws.

         The table below sets forth the Company's noninterest expenses for the
periods indicated.

<TABLE>
<CAPTION>

                                                                                  YEARS ENDED DECEMBER 31,
                                                                        -----------------------------------------
                                                                           1997           1996              1995
                                                                        ----------     ----------        ---------

                                                                                 (AMOUNTS IN THOUSANDS)

<S>                                                                     <C>            <C>               <C>
Salaries and employee benefits.....................................     $    1,154     $      893        $    658
Occupancy expense..................................................             96             96              62
Furniture and equipment expense....................................            150            126              65
Director and committee fees........................................            119             19             -0-
Advertising........................................................            122             93              78
Checking account expense...........................................             33             29              22
Data processing....................................................             87             47              31
Insurance..........................................................             56             27              31
Postage............................................................             70             52              26
Professional and regulatory fees...................................            195            121              63
Supplies...........................................................            117            106              89
Correspondent bank charges.........................................             35              0               0
Investment security losses.........................................              6              0               0
Taxes and licenses.................................................             26             22              15
Other..............................................................            119             84              64
                                                                        ----------     ----------        --------
     Total.........................................................     $    2,385     $    1,715        $  1,204
                                                                        ==========     ==========        ========
</TABLE>

         INCOME TAXES

         The Company attempts to maximize its net income through active tax
planning.  This planning resulted in a provision for income taxes of $382,587
(27.3%) for 1997 on pre-tax income of $1,400,353.  The tax for 1996 was $303,908
(37%) on income of $820,644 and for 1995 was a benefit of ($126,952) (34%) on a
loss of $373,644.  The 1997 tax amount and rate is lower than the statutory
federal tax rate of 34 percent primarily due to investment in loans and
securities earning interest income that is exempt from Federal taxation.  In
1997 the effective tax rate was 80.3 percent of the statutory federal tax rate
compared to 108.8 percent in 1996.  A more detailed explanation of income tax
expense is included in the accompanying Notes to Consolidated Financial
Statements.

FINANCIAL CONDITION

         EARNING ASSETS

         The Bank's earning assets, which include deposits in other banks,
federal funds sold, investment securities and loans, averaged $98,403,802 in
1997 or 95.3% of average total assets compared to $68,755,141 or 95% of average
total assets in 1996. The mix of average earning assets comprised the following
percentages:

<TABLE>
<CAPTION>

                                                                            1997           1996
                                                                           ------         ------

<S>                                                                        <C>            <C>
Deposits in other banks............................................          -0-%           -0-%
Federal funds sold.................................................         2.94%          2.95%
Investment securities..............................................        21.10%         22.87%
Loans..............................................................        75.96%         74.18%
</TABLE>

         The mix of average earning assets reflects management's attempt to
maximize interest income while maintaining acceptable levels of risk.

         The Bank has intentionally avoided the growing national market in loans
to finance leveraged buy-outs, participating in no nationally syndicated
leveraged buy-out loans. Concurrently, it has avoided exposure to lesser
developed country ("LDC") debt, having no LDC loans in its portfolio.

                                       24
<PAGE>   27


         LOANS

         Loans made up the largest component of the Bank's earning assets. At
December 31, 1997, the Bank's total loans were $84,583,853 compared to
$64,961,742 at the end of 1996. In 1997, average net loans represented 75.96% of
average earning assets and 72.39% of average total assets, compared to 74.18% of
average earning assets and 70.5% of average total assets in 1996. This was the
result of an increase in loan demand in the Bank's market area, combined with an
increase in the Bank's market share of loans in such area. As a result of the
increase in loan growth, the ratio of total loans to total deposits increased
from 80.1% in 1996 to 88.7% in 1997.

         INVESTMENT SECURITIES AND FEDERAL FUNDS SOLD

         The Bank has classified its investment securities as either available
for sale or held to maturity, depending on whether the Bank has the intent and
ability to hold such securities to maturity. At December 31, 1997, $15,144,585
of the Bank's investment securities were classified as available for sale,
compared to $20,131,443 at year-end 1996. Securities classified as held to
maturity were $4,181,021 at year-end 1997, as compared to $2,247,479 at year-end
1996.

          The composition of the Bank's investment securities portfolio reflects
the Bank's investment strategy of maximizing portfolio yields subject to risk
and liquidity considerations. The primary objectives of the Bank's investment
strategy are to maintain an appropriate level of liquidity and to provide a tool
to assist in controlling the Bank's interest rate position while at the same
time producing adequate levels of interest income. For securities classified as
investment securities, it is the Bank's intention to hold such securities for
the foreseeable future. Management of the maturity of the portfolio is necessary
to provide liquidity and to control interest rate risk. During 1997, gross
investment securities sales were $10.0 million and maturities were $8.5 million,
representing 48.2% and 41.0%, respectively, of the average portfolio for the
year. Net losses associated with sales and maturities totaled $78. Gross
unrealized gains in the portfolio amounted to $171,823 at year end 1997 and
unrealized losses amounted to $29,090. In 1996, gross investment securities
sales were $4.5 million and maturities were $4.53 million, representing 28.6%
and 28.8%, respectively, of the average portfolio for the year. Gains associated
with sales and maturities totaled $8,894 in 1996. Gross unrealized gains in the
portfolio amounted to $66,391 at year end 1996 and unrealized losses amounted to
$85,941.

         Mortgage-backed securities have varying degrees of risk of impairment
of principal, as opposed to U.S. Treasury and U.S. government agency
obligations, which are considered to contain virtually no default or prepayment
risk. Impairment risk is primarily associated with accelerated prepayments,
particularly with respect to longer maturities purchased at a premium and
interest-only strip securities. The Bank's purchase of mortgage-backed
securities during 1997 did not include securities with these characteristics.
The recoverability of the Bank's investment in mortgage-backed securities is
reviewed periodically, and if necessary, appropriate adjustments would be made
to income for impaired values.

         Management maintains federal funds sold as a tool in managing its daily
cash needs. Federal funds sold increased from $1,150,000 for 1996 to $1,828,000
for 1997. Average federal funds sold at December 31, 1997 was $2,895,106 or 2.9%
of average earning assets, compared with approximately $2,025,246 or 2.9% of
average earning assets for 1996. The increase of 43% in average federal funds
sold from 1996 reflects an emphasis by management on profitability while
maintaining an acceptable level of liquidity.

         There has been no significant impact on the Company's financial
statements as a result of the provisions of Statement of Financial Accounting
Standards No. 119, Disclosure about Derivative Financial Instruments and Fair
Value of Financial Instruments.

         DEPOSITS AND REPURCHASES

         The Bank's primary source of funds is derived from deposits of Bank
customers. Average deposits increased 46.1% from approximately $59,043,000 in
1996 to approximately $86,281,215 in 1997. At December 31, 1997, total deposits
were $95,347,946, of which $91,547,035 (96%) were interest-bearing and
$3,800,911 (4.0%)


                                       25
<PAGE>   28



were noninterest-bearing. At year-end 1996, total deposits were $81,147,881, of
which $77,683,071 (95.7%) were interest-bearing and $3,464,810 (4.3%) were
noninterest-bearing. Continued enhancement of existing products and emphasis
upon better customer service fuels the growth in the deposit base. Emphasis has
been placed upon attracting consumer deposits. It is the Bank's intent to expand
its consumer base in order to continue to fund asset growth.

         Securities sold under agreements to repurchase amounted to $4,228,129
at December 31, 1997. The weighted average maturity of the agreements was 90
days. The weighted average rate was 4.35 percent. Securities sold under
agreements to repurchase averaged $4,471,499 during 1997. The maximum amount
outstanding at any month end during 1997 was $4,693,265. The total of securities
sold under agreements to repurchase are associated with the cash flow needs of
our corporate customers that participate in repurchase agreements.

         SHAREHOLDERS' EQUITY

         Shareholders' equity increased $1,175,117 from December 31, 1996 to
December 31, 1997, due in part to net earnings of $1,017,766 and the decrease in
unrealized losses on securities available for sale totaling $9,773, net of
deferred tax liability. The increase was also a result of the issuance of 24,287
shares of the Company's common stock to the Company's 401(k) plan at a price of
$16.00 per share (total purchase price $388,592) in May 1997. The decrease in
Shareholder's equity resulting from the purchase of Company stock by the Company
on June 30, 1997 from a shareholder of the Company for a total purchase price of
$252,000 (14,000 shares at $18.00 per share) was also a significant component of
the change. On September 22, 1997 the Company repurchased 1,000 shares of its
common stock from two shareholders of the Company (500 shares from each
shareholder) at a purchase price of $22.00 per share.

         On February 26, 1998 the Company repurchased 7,000 shares of its common
stock from one of the Company's directors at a price of $22.00 per share (total
purchase price $154,000). On March 16, 1998, the Company issued 4,323 shares of
the its common stock to the Company's 401(k) plan at a price of $22.50 per share
(total purchase price of $97,267.50).

LIQUIDITY AND CAPITAL RESOURCES

         YEAR 2000

         The Bank utilizes and is dependent upon data processing systems and
software to conduct its business. Management has initiated a Year 2000 project
to prepare the Company's computer systems and applications for the Year 2000.
The approach of the Year 2000 presents a problem in that many computer programs
have been written using two digits rather than four to define the applicable
year. Any of the Company's programs that have time-sensitive software may
recognize a date using "00" as the year 1900 rather than the Year 2000. This
could result in internal system failure or miscalculation, and also creates risk
for the Company from third parties with whom the Company deals on financial
transactions. The Company is conducting a comprehensive review of its computer
systems to identify the systems that could be affected by the Year 2000, and has
developed an implementation plan to resolve the issue. The Company believes
that, since a majority of our equipment is less than three years old, the Year
2000 problem will not pose significant operational problems. The Company is not
purchasing any new software products or engaging in any new contracts unless the
products and counterparties are Year 2000 compliant. Maintenance, testing, and
modification costs will be expensed as incurred, while the costs of new software
or hardware will be capitalized and amortized over their useful lives. The
Company does not expect the amounts required to be expensed to resolve Year 2000
issues to have a material effect on its financial position or results of
operations. However, there can be no assurance that the systems of third parties
upon which the Bank's business relies will be Year 2000 compliant on a timely
basis. The failure of the Bank's computer system or applications or those
operated by third parties could have a material adverse effect on the Company's
results of operations and financial condition.


                                       26
<PAGE>   29


         LIQUIDITY MANAGEMENT

         Liquidity is defined as the ability of a company to convert assets into
cash or cash equivalents without significant loss. Liquidity management involves
maintaining the Bank's ability to meet the day-to-day cash flow requirements of
its customers, whether they are depositors wishing to withdraw funds or
borrowers requiring funds to meet their credit needs. Without proper liquidity
management, the Bank would not be able to perform the primary function of a
financial intermediary and would, therefore, not be able to meet the production
and growth needs of the communities it serves.

         The primary function of assets and liabilities management is not only
to assure adequate liquidity in order for the Bank to meet the needs of its
customer base, but to maintain an appropriate balance between interest-sensitive
assets and interest-sensitive liabilities so that the Bank can also meet the
investment requirements of its shareholders. Daily monitoring of the sources and
uses of funds is necessary to maintain an acceptable cash position that meets
both requirements. In the banking environment, both assets and liabilities are
considered sources of liquidity funding and both are, therefore, monitored on a
daily basis.

         The asset portion of the balance sheet provides liquidity primarily
through loan principal repayments or sales of investment and trading account
securities. Real estate construction and commercial, financial and agricultural
loans that mature in one year or less equaled approximately $16.4 million or
19.3% of the total loan portfolio at December 31, 1997 and investment securities
maturing in one year or less equaled $1.56 million or 8.1% of the portfolio.
Other sources of liquidity include short-term investments such as federal funds
sold and maturing interest-bearing deposits with other banks.

         The liability portion of the balance sheet provides liquidity through
various customers' interest-bearing and noninterest-bearing deposit accounts. At
the end of fiscal 1997, funds were also available through the purchase of
federal funds from correspondent commercial banks from available lines of up to
an aggregate of $2,000,000. This amount has subsequently been decreased to
$1,000,000 due to the expiration of a federal funds purchase agreement with
SouthTrust Bank. Liquidity management involves the daily monitoring of the
sources and uses of funds to maintain an acceptable cash position.

         In an effort to maintain and improve the liquidity position of the
Bank, management made application for membership with the Federal Home Loan Bank
of Atlanta in 1997. (As a member of the Federal Home Loan Bank, the Bank is able
to improve its ability to manage liquidity and reduce interest rate risk by
having a funding source to match longer term loans.) The application was
approved on April 17, 1997, and the Bank received a credit line of up to
$8,000,000. The Bank has made four $1,000,000 draws from the available credit
with the Federal Home Loan Bank. During 1997, draws were made on June 24,
September 18, October 6 and December 19. A principal reduction payment of
$50,000 was made on January 15, 1998. See Note 8 to the Notes to Consolidated
Financial Statements herein.

         CAPITAL RESOURCES

         A strong capital position is vital to the continued profitability of
the Company because it promotes depositor and investor confidence and provides a
solid foundation for future growth of the organization. A majority of the
Company's and Bank's capital requirements has been provided from the proceeds
from the Bank's initial stock offering in 1994, through draws by the Company on
a line of credit with Hardwick Bank and Trust Company (described below), through
the retention of earnings and the sale of Company stock to the Company's 401(k)
plan.

         Line of Credit. In November 1996, the Company obtained a $1 million
unsecured line of credit ("the Credit Agreement") with Hardwick Bank & Trust
Company ("Hardwick"). At December 31, 1996 the balance on the line of credit was
$700,000. The Company subsequently drew down the remaining amount in January
1997. On May 22, 1997 the Company used a portion of the proceeds from the sale
of Company stock to the Company's 401(k) plan to make a $300,000 principal
payment on the line of credit. Subsequently, on May 30, 1997 the Company made a
$300,000 draw from the line of credit to fund the repurchase of Company stock
from a shareholder of the Company and for working capital needs. The Company
made a draw of $300,000 on June 30,


                                       27
<PAGE>   30

1997. On October 29, 1997 the Company and Hardwick agreed to a modification of
the Credit Agreement increasing the amount of credit available to the Company to
$1.5 million. All other terms and conditions of the original agreement remain in
full force and effect. Subsequently, the Company made an additional draw on the
line of credit in the amount of $320,000. At December 31, 1997, the balance on
the line of credit was $1,320,000. Interest on the outstanding amounts under the
line of credit is payable on a quarterly basis at the prime rate (as defined in
the Credit Agreement with Hardwick) less 3/4 of a percentage point. The Company
began making interest payments on April 1, 1997. Principal is due in five equal
annual installments beginning January 1, 1999 with the last payment due January
1, 2003. The Credit Agreement contains certain restrictive covenants, including
but not limited to certain restrictions on (i) additional indebtedness; (ii)
creating or allowing liens on the capital stock of the Bank; (iii) guaranteeing
certain obligations of other persons; (iv) merging, consolidating or exchanging
shares with, or acquiring the stock or assets of, any Person (as defined in the
Credit Agreement); (v) payment of dividends; and (vi) disposing of the stock of
the Bank. The Company also covenanted to cause its depository institution
subsidiaries (presently only the Bank ) at all times to be classified as "well
capitalized" under FDICIA capital ratios, maintain nonperforming assets below a
specified level, and maintain a minimum ratio of consolidated loan loss reserves
to total loans. The Credit Agreement also contains certain customary affirmative
covenants.

         Federal Capital Standards. Bank regulatory authorities are placing
increased emphasis on the maintenance of adequate capital. In 1990, new
risk-based capital requirements became effective under FDICIA. The guidelines
take into consideration risk factors, as defined by regulators, associated with
various categories of assets, both on and off the balance sheet. Under the
guidelines, capital strength is measured in two tiers which are used in
conjunction with risk-adjusted assets to determine the risk-based capital
ratios. The Bank's Tier 1 capital, which consists of common equity, paid-in
capital and retained earnings (less intangible assets), amounted to $8.2 million
at December 31, 1997. Tier 2 capital components include supplemental capital
components such as qualifying allowance for loan losses and qualifying
subordinated debt. Tier 1 capital plus the Tier 2 capital components is referred
to as Total Risk-based capital and was $8.9 million at year-end 1997. The
percentage ratios as calculated under FDICIA guidelines were 9.72 percent and
10.86 percent for Tier 1 and Total Risk-based capital, respectively, at year-end
1997. Both levels exceeded the minimum ratios of four percent and eight percent,
respectively.

         Other important indicators of capital adequacy in the banking industry
are the leverage ratio and the tangible leverage ratio. The leverage ratio is
defined as the ratio the Bank's shareholders' equity, minus goodwill, bears to
total assets minus goodwill. The tangible leverage ratio is defined as the
Bank's shareholders' equity, minus all intangibles, divided by total assets
minus all intangibles. At December 31, 1997, the Bank's leverage and intangible
leverage ratios were 7.32% and 7.29%, respectively, exceeding the regulatory
minimum requirements which are generally 3% plus an additional cushion of at
least 100-200 basis points depending on risk profiles and other factors. Under
federal capital guidelines, the Company's Tier 1 capital, Total capital and
Leverage ratios were 8.23%, 9.37% and 6.22%, respectively.

         The Bank started several expansion projects in the fourth quarter of
fiscal 1997, as discussed in "Item 2. Properties" herein. These expansion
projects are being funded through current operations cash flow.




                  (Remainder of Page Intentionally Left Blank)


                                       28
<PAGE>   31



         The table below illustrates the Bank's regulatory capital ratios under
federal guidelines at December 31, 1997 and 1996:

                             CAPITAL ADEQUACY RATIOS

<TABLE>
<CAPTION>

                                                                                      YEARS ENDED DECEMBER 31,
                                                                STATUTORY          -----------------------------
                                                                 MINIMUM              1997               1996
                                                              -------------        ---------          ----------

                                                                                       (AMOUNTS IN THOUSANDS)

<S>                                                                                <C>                <C>
Tier 1 Capital..........................................                           $   8,173          $   6,467
Tier 2 Capital..........................................                                 960                655
                                                                                   ---------          ----------
Total Qualifying Capital................................                           $   9,133          $   7,122
                                                                                   =========          ==========
Risk Adjusted Total Assets (including
   off-balance-sheet exposures).........................                           $  84,074          $   65,667
                                                                                   =========          ==========
Tier 1 Risk-Based Capital Ratio.........................             4.0%               9.72%               9.36%
Total Risk-Based Capital Ratio..........................             8.0%              10.86%              10.31%
Leverage Ratio..........................................             4.0%               7.32%               6.96%
Tangible Leverage Ratio.................................             3.0%               7.29%               6.89%
</TABLE>


         DBF Capital Requirement. In addition to the capital standards imposed
by federal banking regulators, the DBF imposed an 8% primary capital ratio as a
condition to the approval of the Bank's charter. This standard, which exceeds
the FDIC capital standards, is calculated as the ratio of total equity to total
assets, each as adjusted for unrealized gains and losses on securities and
allowance for loan losses. This heightened requirement was imposed during the
first three years of the Bank's operation. Accordingly, on March 3, 1997 the
Bank became subject to a 6% primary capital ratio. At December 31, 1997, the
capital ratio as calculated under the DBF standard was 8.07%. The Bank's capital
ratio as calculated by the DBF was in compliance for the months ending January
31, 1998 and February 28, 1998.

INTEREST RATE SENSITIVITY MANAGEMENT

         Interest rate sensitivity is a function of the repricing
characteristics of the Bank's portfolio of assets and liabilities. These
repricing characteristics are the time frames within which the interest-bearing
assets and liabilities are subject to change in interest rates either at
replacement or maturity during the life of the instruments. Sensitivity is
measured as the difference between the volume of assets and liabilities in the
Bank's current portfolio that are subject to repricing in future time periods.
The differences are known as interest sensitivity gaps and are usually
calculated separately for segments of time ranging from zero to thirty days,
thirty-one to ninety days, ninety-one days to one year, one to five years, over
five years and on a cumulative basis.

                  (Remainder of Page Intentionally Left Blank)


                                       29
<PAGE>   32


         The following tables show interest sensitivity gaps for these different
intervals as of December 31, 1997.

                       INTEREST RATE SENSITIVITY ANALYSIS

<TABLE>
<CAPTION>


                                                0-30       31-90       91-365        1-5        OVER 5
                                                DAYS        DAYS        DAYS        YEARS        YEARS       TOTAL
                                             --------    ---------   ----------   ---------    ---------  ----------
                                                                     (AMOUNTS IN THOUSANDS)

<S>                                          <C>         <C>         <C>          <C>          <C>        <C>
Interest-earning assets (1)
  Loans...................................   $   9,762   $  19,788   $   28,625   $   26,345   $      64  $   84,584
  Investment Securities:
    Taxable...............................         -0-         -0-        1,559        7,596       5,990      15,145
    Tax-exempt............................         -0-         -0-          -0-          -0-       4,309       4,309
    Federal funds sold....................       1,828         -0-          -0-          -0-         -0-       1,828
                                             ---------   ---------   ----------    ---------   ---------  ----------
                                                11,590      19,788       30,184       33,941      10,363     105,866
                                             ---------   ---------   ----------    ---------   ---------  ----------
Interest-bearing liabilities (2)
  Demand deposits (3).....................       8,144       8,144        8,144          -0-         -0-      24,432
  Savings deposits (3)....................       6,915       6,915        6,914          -0-         -0-      20,744
  Time deposits...........................       5,131      10,263       19,896       11,081         -0-      46,371
  Other short-term borrowings (3).........       1,410       1,409        1,409          -0-         -0-       4,228
  Long-term debt..........................         -0-         -0-          -0-        2,056       3,264       5,320
                                             ---------   ---------   ----------    ---------   ---------  ----------
                                                21,600      26,731       36,363       13,137       3,264     101,095
                                             ---------   ---------   ----------    ---------   ---------  ----------

Interest sensitivity gap..................   $ (10,010)  $  (6,943)  $   (6,179)   $  20,804   $   7,099  $    4,771
                                             =========   =========   ==========    =========   =========  ==========

Cumulative interest sensitivity gap.......   $ (10,010)  $ (16,953)  $  (23,132)   $  (2,328)  $   4,771
                                             =========   ========    ==========    =========   =========
Ratio of interest-earning assets to
  interest-bearing liabilities............         .54         .74          .83         2.58        3.17
                                             =========   =========   ==========    =========   =========

Cumulative ratio..........................         .54         .65          .73          .98        1.05
                                             =========   =========   ==========    =========   =========
Ratio of cumulative gap to total interest-
  bearing assets..........................       (0.09)      (0.16)       (0.22)       (0.02)      0.05
                                             ==========  =========   ==========    =========   =========
</TABLE>

---------------------------

(1)  Excludes nonaccrual loans and securities.
(2)  Excludes matured certificates which have not been redeemed by the
     customer and on which no interest is accruing.
(3)  Demand and savings deposits and other short term borrowings are assumed
     to be subject to movement into other deposit instruments in equal
     amounts during the 0-30 day period, the 31-90 day period, and the
     91-365 day period.

         The above table indicates that in a rising interest rate environment,
the Bank's earnings may be adversely affected in the 0-365 day periods where
liabilities will reprice faster than assets. As seen in the preceding table, for
the first 30 days of repricing opportunity there is an excess of
interest-bearing liabilities over earning assets of $10 million. For the first
365 days, interest-bearing liabilities exceed earning assets by $23.1 million.
During this one year time frame, 84% of all interest-bearing liabilities will
reprice compared to 58% of all interest-earning assets. Changes in the mix of
earning assets or supporting liabilities can either increase or decrease the net
interest margin without affecting interest rate sensitivity. In addition, the
interest rate spread between an asset and its supporting liability can vary
significantly while the timing of repricing for both the asset and the liability
remain the same, thus impacting net interest income. Due to management's
continued emphasis on profitability, many of the higher yielding securities
presented in the table above have call features, which will result in such
securities having a shorter effective life. This in turn may reduce the interest
rate sensitivity gap presented above. It should be noted, therefore, that a
matched interest-sensitive position by itself will not ensure maximum net
interest income.


                                       30
<PAGE>   33


         Management continually evaluates the condition of the economy, the
pattern of market interest rates and other economic data to determine the types
of investments that should be made and at what maturities. Using this analysis,
management from time to time assumes calculated interest sensitivity gap
positions to maximize net interest income based upon anticipated movements in
the general level of interest rates.

IMPACT OF INFLATION AND CHANGING PRICES

         A bank's asset and liability structure is substantially different from
that of an industrial company in that virtually all assets and liabilities of a
bank are monetary in nature. Management believes the impact of inflation on
financial results depends upon the Bank's ability to react to changes in
interest rates and by such reaction to reduce the inflationary impact on
performance. Interest rates do not necessarily move in the same direction, or at
the same magnitude, as the prices of other goods and services. As discussed
previously, management seeks to manage the relationship between
interest-sensitive assets and liabilities in order to protect against wide
interest rate fluctuations, including those resulting from inflation.

         Various information shown elsewhere in this Report will assist in the
understanding of how well the Bank is positioned to react to changing interest
rates and inflationary trends. In particular, the summary of net interest
income, the maturity distributions, the composition of the loan and security
portfolios and the data on the interest sensitivity of loans and deposits should
be considered.

CONCLUSION

         The Bank has experienced continued growth since its opening in 1995. It
has enjoyed continued increases in its customer base, as shown by the rapid
increase in deposits and loans for the 1996 and 1997 fiscal years. While
management remains optimistic about the prospects for continued growth and
profitability, management does not anticipate that such growth will be at the
level experienced during the Bank's initial three years of operation. No
assurance can be given that the Bank will continue to grow and be profitable.

         The foregoing is a forward-looking statement which reflects significant
assumptions and subjective judgments believed by management to be reasonable as
of the date of this Report. It does not constitute a forecast or prediction of
actual results, and actual performance and financial results may differ
materially from those anticipated due to a variety of factors, including but not
limited to those discussed in the section entitled "Cautionary Notice Regarding
Forward-Looking Information" appearing at the beginning of this Report.

ITEM 7.  FINANCIAL STATEMENTS

         The consolidated financial statements of the Company, including notes
thereto, and the report of independent auditors are included in this Report
beginning at page F-1 and are incorporated herein by reference.

ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

         During the Company's two most recent fiscal years, there has been no
change in the Company's independent accountants or any disagreement with its
accountants on any matter of accounting principles or practices or financial
statement disclosure.


                                       31
<PAGE>   34


                                    PART III

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
         COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

         The information appearing under the heading "Election of Directors" and
the subheadings "Executive Officers" and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Proxy Statement (the "1998 Proxy Statement")
relating to the annual meeting of shareholders of the Company, scheduled to be
held on May 11, 1998, is incorporated herein by reference.

ITEM 10. EXECUTIVE COMPENSATION

         The information appearing under the heading "Compensation of Executive
Officers and Directors" in the 1998 Proxy Statement is incorporated herein by
reference.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The information appearing under the heading "Outstanding Voting
Securities of the Company and Principal Holders Thereof" in the 1998 Proxy
Statement is incorporated herein by reference.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information appearing under the caption "Certain Relationships and
Transactions" in the 1998 Proxy Statement is incorporated herein by reference.



                                     PART IV

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

         (a) The following exhibits are filed with this Report:

<TABLE>
<CAPTION>


         EXHIBIT NUMBER                 DESCRIPTION OF EXHIBIT
         --------------                 ----------------------

              <S>          <C>
               3.1         Articles of Incorporation of the Company (included as
                           Exhibit 3.1 to the Company's Registration Statement
                           on Form 8-A, dated September 16, 1996, previously
                           filed with the Commission and incorporated herein by
                           reference).

               3.2         Bylaws of the Company (included as Exhibit 3.2 to the
                           Company's Registration Statement on Form 8-A, dated
                           September 16, 1996, previously filed with the
                           Commission and incorporated herein by reference).

              10.1         1997 Directors' Non-Qualified Stock Option Plan
                           (included as Exhibit 10.1 to the Company's Annual
                           Report on Form 10-KSB for the fiscal year ended
                           December 31, 1996 (File No. 000-21383) and
                           incorporated herein by reference).*

              10.2         1997 Employee Incentive Stock Incentive Plan
                           (included as Exhibit 10.2 to the Company's Annual
                           Report on Form 10-KSB for the fiscal year ended
                           December 31, 1996 (File No. 000-21383) and
                           incorporated herein by reference).*
</TABLE>

                                       32
<PAGE>   35

<TABLE>

                  <S>      <C>
                  10.3     Credit Agreement, dated as of November 25, 1996,
                           between the Company and Hardwick Bank & Trust Company
                           (included as Exhibit 10.3 to the Company's Annual
                           Report on Form 10-KSB for the fiscal year ended
                           December 31, 1996 (File No. 000-21383) and
                           incorporated herein by reference).*

                  10.4     Adoption Agreement for the Appalachian Bancshares,
                           Inc. Section 401(k) Profit Sharing Plan(filed as
                           Exhibit 4.3(a) to the Company's Registration
                           Statement on Form S-8 (No. 333-27127) and
                           incorporated herein by reference).

                  10.5     Georgia Bankers Association Master 401(k) Profit
                           Sharing Plan (filed as Exhibit 4.3(b) to the
                           Company's Registration Statement on Form S-8 (No.
                           333-27127) and incorporated herein by reference).

                  10.6     First Amendment to the Georgia Bankers Association
                           Master Section 401(k) Profit Sharing Plan (filed as
                           Exhibit 4.3(c) to the Company's Registration
                           Statement on Form S-8 (No. 333-27127) and
                           incorporated herein by reference).

                  10.7     Form of Deferred Fee Agreement between Gilmer County
                           Bank and certain directors and executive officers,
                           with addendum (filed as Exhibit 10.6 to the Company's
                           Quarterly Report on Form 10-QSB for the period ended
                           June 30, 1997 (File No. 000-21383) and incorporated
                           herein by reference).

                  10.8     First Modification of Credit Agreement, dated October
                           29, 1997, between the Company and Hardwick Bank &
                           Trust Company (included as Exhibit 10 to the
                           Company's Quarterly Report on Form 10-QSB for the
                           period ended September 30, 1997 (File No. 000-21383)
                           and incorporated herein by reference).

                  11       Statement re: Computation of Per Share Earnings

                  21       Subsidiaries of the Registrant

                  23       Consent of Independent Auditors

                  27       Financial Data Schedule

                  99       Information required by Form 11-K with respect to the
                           Appalachian Bancshares, Inc. Section 401(k) profit
                           Sharing Plan will be filed as an amendment to this
                           Form 10-KSB within 180 days after the end of the
                           fiscal year of the plan as permitted by Rule 15d-21
                           under the Securities Exchange Act of 1934.
</TABLE>

                  * The referenced exhibit is a compensatory contract, plan or
                    arrangement.

         (b) No reports on Form 8-K were filed by the Company during the period
covered by this Report.


                                       33
<PAGE>   36
===============================================================================

                    MANAGEMENT'S STATEMENT OF RESPONSIBILITY
                           FOR FINANCIAL INFORMATION

                  Appalachian Bancshares, Inc. and Subsidiary

The management of Appalachian Bancshares, Inc. and Subsidiary is responsible
for the preparation, integrity, and objectivity of the financial statements,
related financial data, and other information in this annual report. The
financial statements are prepared in accordance with generally accepted
accounting principles and include amounts based on management's best estimates
and judgment where appropriate. Financial information appearing throughout this
annual report is consistent with the financial statements.

In meeting its responsibility both for the integrity and fairness of these
statements and information, management depends on the accounting systems and
related internal accounting controls that are designed to provide reasonable
assurances that (i) transactions are authorized and recorded in accordance with
established procedures, (ii) assets are safeguarded, and (iii) proper and
reliable records are maintained.

The concept of reasonable assurance is based on the recognition that the cost
of internal control systems should not exceed the related benefits. As an
integral part of internal control systems, the Company maintains a professional
staff of internal auditors who monitor compliance and assess the effectiveness
of internal control systems and coordinate audit coverage with independent
certified public accountants.

The responsibility of the Company's independent certified public accountants is
limited to an expression of their opinion as to the fairness of the financial
statements presented. Their opinion is based on an audit conducted in
accordance with generally accepted auditing standards as described in their
report.

The Board of Directors is responsible for insuring that both management and the
independent certified public accountants fulfill their respective
responsibilities with regard to the financial statements. The Audit Committee
meets periodically with both management and the independent certified public
accountants to assure that each is carrying out its responsibilities. The
independent certified public accountants have full and free access to the Audit
Committee and Board of Directors and may meet with them, with and without
management being present, to discuss auditing and financial reporting matters.

===============================================================================

                                      F-1
<PAGE>   37


                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY

                       CONSOLIDATED FINANCIAL STATEMENTS



                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>

                                                                                              Page(s)
                                                                                              -------
<S>                                                                                           <C>
Independent Auditors' Report.................................................................     F-3

Consolidated Statements of Financial Condition as of December 31, 1997 and 1996..............     F-4

Consolidated Statements of Income for the years ended
  December 31, 1997, 1996 and 1995...........................................................     F-5

Consolidated Statements of Shareholders' Equity for the years ended
  December 31, 1997, 1996 and 1995...........................................................     F-6

Consolidated Statements of Cash Flows for the years ended
  December 31, 1997, 1996 and 1995...........................................................     F-7

Notes to Consolidated Financial Statements...................................................     F-9
</TABLE>


                                      F-2
<PAGE>   38

                          INDEPENDENT AUDITOR'S REPORT


To the Board of Directors and Shareholders
of Appalachian Bancshares, Inc. and Subsidiary

We have audited the accompanying consolidated statements of financial condition
of Appalachian Bancshares, Inc. and Subsidiary as of December 31, 1997 and
1996, and the related consolidated statements of income, shareholders' equity
and cash flows for each of the three years in the period ended December 31,
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Appalachian Bancshares, Inc. and Subsidiary as of December 31, 1997 and 1996,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.




                                        /s/SCHAUER, TAYLOR, COX & EDWARDS, P.C.


Birmingham, Alabama
January 23, 1998



                                      F-3
<PAGE>   39


                 CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY

<TABLE>
<CAPTION>
                                                                              DECEMBER 31,
                                                                       1997                  1996
                                                                   -------------         ------------
ASSETS
<S>                                                                <C>                   <C>
     Cash ....................................................     $   1,040,359         $    866,211
     Due from banks ..........................................         2,343,174            1,658,182
     Federal funds sold ......................................         1,828,000            1,150,000

     Securities available for sale ...........................        15,544,585           20,131,443
     Securities held to maturity, estimated fair value
     of $4,308,947 and $2,277,884, respectively ..............         4,181,021            2,247,479

     Loans ...................................................        84,583,853           64,961,742
     Allowance for loan losses ...............................          (929,590)            (655,296)
                                                                   -------------         ------------
NET LOANS ....................................................        83,654,263           64,306,446

     Premises and equipment, net .............................         1,653,043            1,673,203
     Accrued interest ........................................           971,550              806,811
     Cash surrender value on life insurance ..................           585,615                  -0-
     Other assets ............................................           379,180              314,116
                                                                   -------------         ------------
TOTAL ASSETS .................................................     $ 112,180,790         $ 93,153,891
                                                                   =============         ============

LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
     Deposits:
       Noninterest-bearing ...................................     $   3,800,911         $  3,464,810
       Interest-bearing ......................................        91,547,035           77,683,071
                                                                   -------------         ------------
TOTAL DEPOSITS ...............................................        95,347,946           81,147,881
     Securities sold under agreements to repurchase ..........         4,228,129            5,283,972
     Accrued interest ........................................           188,230              154,461
     Long-term debt ..........................................         5,320,000              700,000
     Other liabilities .......................................           116,432               62,641
                                                                   -------------         ------------
TOTAL LIABILITIES ............................................       105,200,737           87,348,955
                                                                   -------------         ------------
SHAREHOLDERS' EQUITY
     Common stock, par value $5 per share,
     20,000,000 shares authorized, 592,287 and 568,000
     shares issued and outstanding, respectively .............         2,961,435            2,840,000
     Treasury stock, 15,000 shares at cost ...................          (274,000)                 -0-
     Capital surplus .........................................         3,096,486            2,829,314
     Accumulated earnings ....................................         1,186,359              168,593
     Unrealized gains (losses) on investment securities
     available for sale, net of deferred tax or tax benefit ..             9,773              (32,971)
                                                                   -------------         ------------

TOTAL SHAREHOLDERS' EQUITY ...................................         6,980,053            5,804,936
                                                                   -------------         ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ...................     $ 112,180,790         $ 93,153,891
                                                                   =============         ============

</TABLE>

                 See notes to consolidated financial statements

                                      F-4
<PAGE>   40


                       CONSOLIDATED STATEMENTS OF INCOME

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY
<TABLE>
<CAPTION>

                                                                                FOR THE YEARS ENDED
                                                                                -------------------
                                                                    DEC 31, 1997     Dec 31, 1996      Dec 31,1995
                                                                    ------------     ------------      -----------
REVENUE FROM EARNING ASSETS
<S>                                                                 <C>              <C>               <C>
    Interest and fees on loans ...............................       $ 7,652,481      $ 5,205,131      $ 1,654,502
    Interest on investment securities:
       Taxable securities ....................................         1,160,497          977,917          493,281
       Nontaxable securities .................................           170,274           24,228              -0-
    Interest on federal funds sold ...........................           159,716          104,021          180,420
                                                                     -----------      -----------      -----------
TOTAL REVENUE FROM EARNING ASSETS ............................         9,142,968        6,311,297        2,328,203
                                                                     -----------      -----------      -----------
INTEREST EXPENSE
    Interest on deposits .....................................         4,911,266        3,436,060        1,225,610
    Interest on federal funds purchased and
    securities sold under agreements to repurchase ...........           201,407          219,500           52,565
    Interest on notes payable ................................           149,580            4,667              -0-
                                                                     -----------      -----------      -----------
TOTAL INTEREST EXPENSE .......................................         5,262,253        3,660,227        1,278,175
                                                                     -----------      -----------      -----------

NET INTEREST INCOME ..........................................         3,880,715        2,651,070        1,050,028
    Provision for loan losses ................................           480,000          368,000          330,000
                                                                     -----------      -----------      -----------
NET INTEREST INCOME
    AFTER PROVISION FOR LOAN LOSSES ..........................         3,400,715        2,283,070          720,028

NONINTEREST INCOME
    Service charges on deposits ..............................           197,333          134,642           54,592
    Insurance commissions ....................................            20,655           24,355           19,410
    Other operating income ...................................           161,086           85,055           25,107
    Investment securities gains ..............................             5,757            8,894           11,417
                                                                     -----------      -----------      -----------
TOTAL NONINTEREST INCOME .....................................           384,831          252,946          110,526
                                                                     -----------      -----------      -----------
NONINTEREST EXPENSES
    Salaries and employee benefits ...........................         1,154,456          892,992          658,239
    Occupancy expense ........................................            97,267           96,165           61,578
    Furniture and equipment expense ..........................           150,358          126,439           64,820
    Other operating expenses .................................           977,277          599,776          419,581
    Investment securities losses .............................             5,835              -0-              -0-
                                                                     -----------      -----------      -----------
TOTAL NONINTEREST EXPENSES ...................................         2,385,193        1,715,372        1,204,218
                                                                     -----------      -----------      -----------

    Income (loss) before income taxes ........................         1,400,353          820,644         (373,664)
    Income tax (provision) benefit ...........................          (382,587)        (303,908)         126,952
                                                                     -----------      -----------      -----------

NET INCOME (LOSS) ............................................       $ 1,017,766      $   516,736      $  (246,712)
                                                                     ===========      ===========      ===========

EARNINGS (LOSS) PER COMMON SHARE - BASIC AND DILUTIVE
   NET INCOME (LOSS) PER COMMON SHARE
       Basic earnings per share ..............................       $      1.76      $       .91      $      (.43)
       Basic weighted average shares outstanding .............           577,495          568,000          568,000
       Diluted earnings per share.............................       $      1.75      $       .91      $      (.43)
       Diluted weighted average shares outstanding ...........           581,103          568,000          568,000

</TABLE>
                 See notes to consolidated financial statements


                                      F-5
<PAGE>   41

                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY

             For the Years Ending December 31, 1997, 1996 and 1995

<TABLE>
<CAPTION>

                                                                                               UNREALIZED
                                       COMMON        TREASURY         CAPITAL     ACCUMULATED  GAINS (LOSSES)
                                       STOCK          STOCK          SURPLUS        DEFICIT    ON SECURITIES     TOTAL
                                  --------------  ------------    -------------   -----------    --------    -----------
<S>                               <C>             <C>             <C>             <C>         <C>            <C>
Balance at January 1, 1995 .....  $   2,840,000   $        -0-    $   2,829,314   $  (101,431)   $ (5,995)   $ 5,561,888

Net Loss 1995 ..................            -0-            -0-              -0-      (246,712)        -0-       (246,712)

Net Change in Unrealized Gains
(Losses) on Securities .........            -0-            -0-              -0-           -0-      48,154         48,154
                                  -------------   ------------    -------------   -----------    --------    -----------

Balance at December 31, 1995 ...      2,840,000            -0-        2,829,314      (348,143)     42,159      5,363,330

Net Income 1996 ................            -0-            -0-              -0-       516,736         -0-        516,736

Net Change in Unrealized Gains
(Losses) on Securities .........            -0-            -0-              -0-           -0-     (75,130)       (75,130)
                                  -------------   ------------    -------------   -----------    --------    -----------

Balance at December 31, 1996 ...      2,840,000            -0-        2,829,314       168,593     (32,971)     5,804,936

Proceeds from sale of common
stock to 401(k) plan ...........        121,435            -0-          267,172           -0-         -0-        388,607

Purchase of Treasury Stock .....            -0-       (274,000)             -0-           -0-         -0-       (274,000)

Net Income 1997 ................            -0-            -0-              -0-     1,017,766         -0-      1,017,766

Net  Change in Unrealized Gains
(Losses) on Securities .........            -0-            -0-              -0-           -0-      42,744         42,744
                                  -------------   ------------    -------------   -----------    --------    -----------

Balance at December 31, 1997 ...  $   2,961,435   $   (274,000)   $   3,096,486   $ 1,186,359    $  9,773    $ 6,980,053
                                  =============   ============    =============   ===========    ========    ===========
</TABLE>


                 See notes to consolidated financial statements


                                      F-6
<PAGE>   42



                     CONSOLIDATED STATEMENTS OF CASH FLOWS

                  APPALACHIAN, BANCSHARES, INC. AND SUBSIDIARY

<TABLE>
<CAPTION>


                                                                               FOR THE YEARS ENDED
                                                                               -------------------
                                                                   DEC 31, 1997    Dec 31, 1996    Dec 31, 1995
                                                                   ------------    ------------    ------------
OPERATING ACTIVITIES:
<S>                                                                <C>             <C>             <C>
    Net income (loss) ........................................     $  1,017,766    $    516,736    $   (246,712)
    Adjustments to reconcile net loss to net
       cash used in operating activities:
    Provision for depreciation and amortization ..............          158,380         133,986          86,268
    Amortization of investment security premiums
       and accretion of discounts ............................            6,862          (6,366)        (31,214)
    Provision for loan losses ................................          480,000         368,000         330,000
    Deferred tax (benefit) ...................................          (73,426)         (8,622)       (126,952)
    Realized investment security (gains) losses net ..........               78          (8,894)        (11,417)
    Losses on disposition of foreclosed real estate ..........            3,927             -0-             -0-
    Increase in cash surrender value on life insurance .......          (17,215)            -0-             -0-
    Increase in accrued interest receivable ..................         (164,739)       (414,018)       (366,131)
    Increase in accrued interest payable .....................           33,769          59,109          95,352
    Other ....................................................           19,186         (28,100)        (11,660)
                                                                   ------------    ------------    ------------
       NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES         $  1,464,588    $    611,831    $   (282,466)
                                                                   ------------    ------------    ------------
INVESTING ACTIVITIES:
    Proceeds from sales of securities available for sale .....        9,982,814       4,497,500       2,708,282
    Proceeds from maturity of securities available for sale...        8,513,974       4,531,902       3,400,000
    Proceeds from maturity of securities held to maturity ....          145,000             -0-             -0-
    Purchase of securities available for sale ................      (13,591,323)    (15,208,797)     (6,643,363)
    Purchase of securities held to maturity ..................       (1,939,327)     (2,247,479)     (9,474,574)
    Net increase in loans to customers .......................      (19,827,817)    (32,830,349)    (32,174,097)
    Capital expenditures .....................................         (121,199)       (118,918)       (864,569)
    Purchase of life insurance plan ..........................         (568,400)            -0-             -0-
    Purchase of Federal Home Loan Bank common stock ..........         (400,000)            -0-             -0-
                                                                   ------------    ------------    ------------
       NET CASH USED IN INVESTING ACTIVITIES .................      (17,806,278)    (41,376,141)    (43,048,321)
                                                                   ------------    ------------    ------------

FINANCING ACTIVITIES:
    Net increase in demand deposits, NOW accounts,
       and savings accounts ..................................       11,384,300      16,452,274      21,127,653
    Net increase in certificates of deposit ..................        2,815,766      22,554,275      21,001,178
    Net increase (decrease) in securities sold
       under agreement to repurchase .........................       (1,055,843)        972,056       4,311,916
    Net increase in notes payable ............................        4,620,000         700,000             -0-
    Issuance of common stock .................................          388,607             -0-             -0-
    Purchase of treasury stock ...............................         (274,000)            -0-             -0-
                                                                   ------------    ------------    ------------
       NET CASH PROVIDED BY FINANCING ACTIVITIES .............       17,878,830      40,678,605      46,440,747
                                                                   ------------    ------------    ------------

Net increase in cash and cash equivalents ....................        1,537,140         (85,705)      3,109,960

Cash and cash equivalents at beginning of year ...............        3,674,393       3,760,098         650,138
                                                                   ------------    ------------    ------------

CASH AND CASH EQUIVALENTS AT END OF YEAR .....................     $  5,211,533    $  3,674,393    $  3,760,098
                                                                   ============    ============    ============
</TABLE>


                 See notes to consolidated financial statements


                                      F-7
<PAGE>   43

<TABLE>
<CAPTION>

                                                                     FOR THE YEARS ENDED
                                                                     --------------------
                                                           DEC 31, 1997   Dec 31, 1996   Dec 31, 1995
                                                           ------------   ------------   ------------

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
<S>                                                        <C>            <C>            <C>
  Cash Paid during the year for:
   Interest .............................................   $5,228,484     $ 3,601,118    $1,182,823
   Income taxes .........................................      435,511         301,983           -0-

  Loans transferred to foreclosed real estate ...........      109,209          59,275           -0-

  Net increase (decrease) in unrealized gains and losses
   on securities available for sale .....................       64,762        (114,114)       72,960

  Proceeds from sales of foreclosed real estate financed
   through loans ........................................      105,282          54,170           -0-
</TABLE>









                 See notes to consolidated financial statements

                                      F-8
<PAGE>   44

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation: The consolidated financial statements include the
accounts of Appalachian Bancshares, Inc. (the "Company") and its wholly-owned
subsidiary, Gilmer County Bank (the "Bank"). Prior to August 1996, Gilmer
County Bank operated as an independent bank. The Company was formed in May 1996
for the purpose of acquiring all the outstanding stock of Gilmer County Bank,
and operating as a bank holding company. On August 8, 1996 Gilmer County Bank
became a wholly-owned subsidiary of the Company. The acquisition was accounted
for as a pooling of interests. Net income of the subsidiary has been included
for all prior periods. Unless otherwise indicated herein, the financial results
of the Company refer to the Company and the Bank on a consolidated basis.
References to the Company relating to the period prior to the consolidation on
August 8, 1996, relate to Gilmer County Bank as an independent entity.

Business: On May 25, 1994, Gilmer County Bank's charter was approved by the
Georgia Department of Banking and Finance. On May 26, 1994, the Bank was
incorporated under the laws of the State of Georgia. The Bank opened for
business on March 3, 1995. The Bank provides a full range of banking services
to individual and corporate customers in Gilmer County and surrounding areas.

Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of foreclosed real estate. In connection with the determination of
the estimated losses on loans and foreclosed real estate, management obtains
independent appraisals for significant properties.

The Bank's loans are generally secured by specific items of collateral
including real property, consumer assets, and business assets. Although the
Bank has a diversified loan portfolio, a substantial portion of its debtors'
ability to honor their contracts is dependent on local economic conditions in
the agricultural industry.

While management uses available information to recognize losses on loans,
further reductions in the carrying amounts of loans may be necessary based on
changes in local economic conditions. In addition, regulatory agencies, as an
integral part of their examination process, periodically review the estimated
losses on loans. Such agencies may require the Bank to recognize additional
losses based on their judgments about information available to them at the time
of their examination. Because of these factors, it is reasonable possible that
the estimated losses on loans and foreclosed real estate may change materially
in the near term. However, the amount of the change that is reasonably possible
cannot be estimated.

Investment Securities: Debt securities are classified as held-to maturity when
the Company has the positive intent and ability to hold the securities to
maturity. Securities held-to maturity are carried at amortized cost. The
amortization of premiums and accretion of discounts are recognized in interest
income using methods approximating the interest method over the period to
maturity.

Debt securities not classified as held-to maturity are classified as
available-for sale. Securities available-for-sale are carried at fair value
with unrealized gains and losses reported separately net of tax, through a
separate component of stockholders' equity. Gains and losses on sales of
securities are determined on the specific-identification method.

Declines in the fair value of individual held-to maturity and
available-for-sale securities below their cost that are other than temporary
result in write-downs of the individual securities to their fair value. The
related write-downs are included in earnings as realized losses.

Loans: Loans are stated at unpaid principal balances, less the allowance for
loan losses and net deferred loan fees and unearned discounts.


                                      F-9
<PAGE>   45


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

Unearned discounts on installment loans are recognized as income over the term
of the loans using a method that approximates the interest method.

Loan origination and commitment fees, as well as certain origination costs,
when material, are deferred and amortized as a yield adjustment over the lives
of the related loans using the interest method. Amortization of deferred loan
fees is discontinued when a loan is placed on nonaccrual status.

Interest income generally is not recognized on specific impaired loans unless
the likelihood of further loss is remote. Interest payments received on such
loans are applied as a reduction of the loan principal balance. Interest income
on other impaired loans is recognized only to the extent of interest payments
received.

Allowance for Loan Losses: The allowance for loan losses is maintained at a
level which, in management's judgment, is adequate to absorb credit losses
inherent in the loan portfolio. The amount of the allowance is based on
management's evaluation of the collectibility of the loan portfolio, including
the nature of the portfolio, credit concentrations, trends in historical loss
experience, specific impaired loans, economic conditions, and other risks
inherent in the portfolio. Allowances for impaired loans are generally
determined based on collateral values or the present value of estimated cash
flows. Although management uses available information to recognize losses on
loans, because of uncertainties associated with local economic conditions,
collateral values, and future cash flows on impaired loans, it is reasonably
possible that a material change could occur in the allowance for loan losses in
the near term. However, the amount of the change that is reasonably possible
cannot be estimated. The allowance is increased by a provision for loan losses,
which is charged to expense and reduced by charge-offs, net of recoveries.
Changes in the allowance relating to impaired loans are charged or credited to
the provision for loan losses.

Premises and Equipment: Land is carried at cost. Other premises and equipment
are carried at cost net of accumulated depreciation. Depreciation is computed
using the straight-line and the declining balance methods based principally on
the estimated useful lives of the assets. Maintenance and repairs are expended
as incurred while major additions and improvements are capitalized. Gains and
losses on dispositions are included in current operations.

Other Real Estate Owned: Real estate properties acquired through or in lieu of
loan foreclosure are initially recorded at the lower of the Bank's carrying
amount or fair value less estimated selling cost at the date of foreclosure.
Any write-downs based on the asset's fair value at the date of acquisition are
charged to the allowance for loan losses. After foreclosure, these assets are
carried at the lower of their new cost basis or fair value less cost to sell.
Costs of significant property improvements are capitalized, whereas costs
relating to holding property are expensed. The portion of interest costs
relating to development of real estate is capitalized. Valuations are
periodically performed by management, and any subsequent write-downs are
recorded as a charge to operations, if necessary, to reduce the carrying value
of a property to the lower of its cost or fair value less cost to sell.

Income Taxes: Income taxes are provided for the tax effects of the transactions
reported in the financial statements and consist of taxes currently due plus
deferred taxes related primarily to differences between the basis of the
allowance for loan losses and accumulated depreciation. The deferred tax assets
and liabilities represent the future tax return consequences of those
differences, which will either be taxable or deductible when the assets and
liabilities are recovered or settled. Deferred tax assets and liabilities are
reflected at income tax rates applicable to the period in which the deferred
tax assets or liabilities are expected to be realized or settled. As changes in
tax laws or rates are enacted, deferred tax assets and liabilities are adjusted
through the provision for income taxes. The Company files consolidated income
tax returns with its subsidiary.


                                     F-10
<PAGE>   46


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

Earnings per Common Share: Basic earnings per common share are computed by
dividing earnings available to stockholders by the weighted average number of
common shares outstanding during the period. Diluted earnings per share reflect
per share amounts that would have resulted if dilutive potential common stock
had been converted to common stock, as prescribed by SFAS No. 128, Earnings per
Share. The following reconciles the weighted average number of shares
outstanding:

<TABLE>
<CAPTION>

                                                                                      1997      1996     1995
                                                                                    -------   -------   -------
<S>                                                                                 <C>       <C>       <C>
Weighted average of common shares outstanding ............................          577,495   568,000   568,000
Effect of dilutive options ...............................................            3,608       -0-       -0-
                                                                                    -------   -------   -------
Weighted average of common shares outstanding effected for dilution ......          581,103   568,000   568,000
                                                                                    =======   =======   =======
</TABLE>

Employee Benefit Plan: The Company has a 401(k) profit-sharing plan covering
substantially all of its employees. Eligible participating employees may elect
to contribute tax deferred contributions. Company contributions to the plan are
determined by the Board of Directors.

Intangibles: Intangibles consist primarily of legal, consulting and regulatory
fees charged to organizational costs. Organizational costs are generally
amortized over 5 years using the straight-line method.

Off Balance Sheet Financial Instruments: In the ordinary course of business the
Company has entered into off-balance-sheet financial instruments consisting of
commitments to extend credit, commitments under credit card arrangements,
commercial letters of credit and standby letters of credit. Such financial
instruments are recorded in the financial statements when they become payable.

The Company also has available as a source of short-term financing the purchase
of federal funds from other commercial banks from an available line of up to $1
million.

Cash Flow Information: For purposes of the statements of cash flows, the
company considers cash, due from banks and federal funds sold as cash and cash
equivalents.

Reclassifications: Certain amounts in 1996 and 1995 have been reclassifed to
conform with the 1997 presentation.

Fair Values of Financial Instruments: Statement of Financial Accounting
Standard No. 197, Disclosures about Fair Value of Financial Instruments,
requires disclosures of fair value information about financial instruments,
whether or not recognized in the statement of financial condition. In cases
where quoted market prices are not available, fair values are based on
estimates using present values or other valuation techniques. Those techniques
are significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows. In that regard, the derived fair value
estimates cannot be substantiated by comparison to independent markets and, in
many cases, could not be realized in immediate settlement of the instruments.
Statement No. 107 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Bank.

The following methods and assumptions were used by the Bank in estimating its
fair value disclosures for financial instruments:

Cash and cash equivalent: The carrying amounts reported in the statements of
financial condition for cash and cash equivalents approximate those assets'
fair values.

Investment securities (including trading account securities): Fair values for
investment securities are based on quoted market prices, where available. If a
quoted market price is not available, fair values are based on quoted market
prices of comparable instruments.


                                     F-11
<PAGE>   47


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

Loans: For variable-rate loans that reprice frequently and with no significant
change in credit-risk, fair values are based on carrying amounts. The fair
values of other loans (for example, fixed rate commercial real estate and
rental property mortgage loans and commercial and industrial loans) are
estimated using discounted cash flow analysis, based on interest rates
currently being offered for loans with similar terms to borrowers of similar
credit quality. Loan fair value estimates include judgments regarding future
expected loss experience and risk characteristics. Fair values for impaired
loans are estimated using discounted cash flow analysis or underlying
collateral values, where applicable.

Accrued interest receivable: The carrying amount of accrued interest receivable
approximates its fair value.

Deposits: The fair values disclosed for demand deposits are, by definition,
equal to the amount payable on demand at the reporting date (that is, their
carrying amounts). The carrying amounts of variable rate, fixed-term money
market accounts and certificates of deposit approximate their fair values. Fair
values for fixed-rate certificates of deposit are estimated using a discounted
cash flow calculation that applies interest rates currently offered on
certificates to a schedule of aggregated expected monthly maturities on time
deposits.

Accrued interest payable: The carrying amount of accrued interest payable
approximates its fair value.

Short-term borrowings and notes payable: The carrying amounts of short-term
borrowings and notes payable approximates their fair values.

Long Term Debt: For long-term debt, which bears interest at a current rate, the
carrying amount is a reasonable estimate of fair value.

Loan commitments: Commitments to extend credit were evaluated and fair value
was estimated using the fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
present creditworthiness of the counterparties. For fixed-rate loan
commitments, fair value also considers difference between current levels of
interest rates and the committed rates.

Recently Issued Accounting Standards: In March 1995, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of." This statement establishes accounting standards for
the impairment of long-lived assets, certain identifiable intangibles, and
goodwill related to those assets to be held and used and for long-lived assets
and certain identifiable intangibles to be disposed of. SFAS No. 121 requires
that long-lived assets and certain identifiable intangibles be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of the assets
described above is measured by a comparison of the carrying amount of the asset
to future undiscounted cash flows expected to be generated by the asset. If such
assets are considered impaired, the amount of impairment to be recognized it
measured by the amount by which the carrying amount of the assets exceeds the
fair value less costs to sell. Adoption of SFAS No. 121 did not have a material
impact on the Company's consolidated financial statements.

In May 1995, the FASB also issued SFAS No. 122 "Accounting for Mortgage
Servicing Rights." This statement amends certain provisions of SFAS No. 65 to
substantially eliminate the accounting distinction between rights to service
mortgage loans for others that are acquired through loan origination activities
and those acquired through purchase transactions. The statement requires an
allocation of the total cost of mortgage loans held for sale to mortgage
servicing rights and mortgage loans held for sale (without mortgage servicing
rights) based on their relative fair values. The adoption of SFAS No. 122 did
not have a material impact on the Company's consolidated financial statements.

In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation;" which defines a fair value based method of accounting for an
employee stock option plan. This statement establishes financial accounting and
reporting standards for stock-based employee compensation plans and stock-based
nonemployee compensation. These transactions must be accounted for based on the
fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measured. Under the fair value
based method, compensation is


                                     F-12
<PAGE>   48


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY


NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED

measured at the grant date based on the value of the award and is recognized
over the service period, which is usually the vesting period. However, SFAS No.
123 allows an entity to continue to measure compensation costs for those plans
using the intrinsic value based method of accounting prescribed by APB Opinion
No, 25, "Accounting for Stock Issued to Employees." The adoption of this
statement did not have a material effect on the Company's consolidated
financial statements.

In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities". SFAS No. 125
was amended by SFAS No. 127, which defers the effective date of certain
provisions of SFAS No. 125 until January 1, 1998. SFAS No. 125 is to be applied
prospectively to transfers and servicing of financial assets and
extinguishments of liabilities after December 31, 1996. This statement utilizes
the financial components approach that focuses on control. Under that approach,
after a transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and the liabilities it has incurred, derecognizes
financial assets when control has been surrendered, and derecognizes
liabilities when extinguished. Management does not believe that adoption of
SFAS No. 125 will have a material impact on the Company's consolidated
financial statements.

Effective for fiscal years ending after December 15, 1996, SFAS No. 126
"Exemption from Certain Required Disclosures about Financial Instruments for
Certain Nonpublic Entities" was issued by the FASB which amends FASB No. 107
"Disclosures about Fair Value of Financial Instruments." This statement allows
an entity to be exempt from the SFAS No. 107 disclosures if the following
criteria are met: the entity is a nonpublic entity, the entity's total assets
are less than $100 million on the date of the financial statements, and the
entity has not held or issued any derivative financial instruments, as defined
in FASB No. 119, "Disclosure about Derivative Financial Instruments and Fair
Value of Financial Instruments," other than loan commitments, during the
reporting period. This statement did not impact the Company's consolidated
financial statements.

In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share" which
simplifies previous standards for reporting earnings per share. Under FAS 128,
earnings per share is stated on the income statement based on two separate
measurements: basic and diluted. Basic earnings per share excludes dilution and
is computed by dividing income available to common stockholders by the weighted
average number of common shares outstanding for the period. Diluted earnings
per share reflects the potential dilution that could occur if securities or
other contracts to issue common stock were exercised or converted into common
stock or resulted in the issuance of common stock that shared in the earnings
of the entity. The adoption of this statement did not have a material effect on
the Company's consolidated financial statements.

Effective for years beginning after December 15, 1997, SFAS No. 130, "Reporting
Comprehensive Income" was issued by FASB which establishes standards for the
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements. The Statement requires that an
enterprise classify items of other comprehensive income by their nature in the
financial statement and display the accumulated balance of other comprehensive
income separately from retained earnings and additional paid in capital in the
equity section of a statement of financial position. Comprehensive income is
generally defined as the change in equity of a business enterprise during a
period from transactions and other events and circumstances from nonowner
sources. It includes all changes in equity during a period except those
resulting from investments by owners and distributions to owners. Management
does not believe that the adoption of SFAS 130 will have a material impact on
the Company's consolidated financial statements.

Effective for years beginning after December 15, 1997, SFAS No. 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits" was
issued by FASB which standardizes the disclosure requirements for pensions and
other postretirement benefits to the extent practicable, requires additional
information on changes in the benefit obligations and fair values of plan
assets that will facilitate financial analysis, and eliminates certain other
disclosures previously required. Management does not believe that the adoption
of SFAS 132 will have a material impact on the Company's consolidated financial
statements.


                                     F-13
<PAGE>   49


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY


NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANK ACCOUNTS

The Company is required to maintain average reserve balances either in vault
cash or on deposit with the Federal Reserve Bank. At December 31, 1997 and
1996, the average amount of the required reserves was $635,000 and $466,000,
respectively.

NOTE 3 - INVESTMENT SECURITIES

The carrying amounts of investment securities as shown in the statement of
financial condition of the Bank and their approximate fair values at December
31, 1997 and 1996 are presented below.

<TABLE>
<CAPTION>

                                                                      Gross          Gross        Estimated
                                                      Amortized     Unrealized     Unrealized        Fair
AS OF DECEMBER 31, 1997:                                Cost          Gains          Losses         Value
-----------------------                              -----------   -----------     ----------    -----------
SECURITIES AVAILABLE FOR SALE
<S>                                                  <C>           <C>             <C>           <C>
     U.S. GOVERNMENT AND AGENCY SECURITIES .......   $13,960,630   $    43,613     $    24,892   $13,979,351
     MORTGAGE BACKED SECURITIES ..................     1,169,148           -0-           3,914     1,165,234
     EQUITY SECURITIES ...........................       400,000           -0-             -0-       400,000
                                                     -----------   -----------     -----------   -----------
                                                     $15,529,778   $    43,613     $    28,806   $15,544,585
                                                     ===========   ===========     ===========   ===========
 SECURITIES HELD TO MATURITY
     STATE AND MUNICIPAL SECURITIES...............   $ 4,181,021   $   128,210     $       284   $ 4,308,947
                                                     ===========   ===========     ===========   ===========
</TABLE>


<TABLE>
<CAPTION>

                                                                      Gross          Gross        Estimated
                                                      Amortized     Unrealized     Unrealized        Fair
AS OF DECEMBER 31, 1996:                                Cost          Gains          Losses         Value
-----------------------                              -----------   -----------     ----------    ----------
Securities Available for Sale
<S>                                                  <C>           <C>             <C>           <C>
      U.S. government and agency securities.......   $17,812,497   $    26,849   $    70,167   $17,769,179
      Mortgage backed securities .................     2,223,901         4,681        11,318     2,217,264
      State and municipal securities .............       145,000           -0-           -0-       145,000
                                                     -----------   -----------   -----------   -----------
                                                     $20,181,398   $    31,530   $    81,485   $20,131,443
                                                     ===========   ===========   ===========   ===========
Securities Held to Maturity
      State and municipal securities .............   $ 2,247,479   $    34,861   $     4,456   $ 2,277,884
                                                     ===========   ===========   ===========   ===========
   </TABLE>


At December 31, 1997, the Company's available-for-sale securities reflected net
unrealized gains of $14,807 which resulted in an increase in stockholders'
equity of $9,773, net of the deferred tax asset. At December 31, 1996, the
Company's available-for-sale securities reflected net unrealized losses of
$49,995, which resulted in a decrease in stockholders' equity of $32,971, net
of deferred tax asset.


                                     F-14
<PAGE>   50


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY

NOTE 3 - INVESTMENT SECURITIES - CONTINUED

The contractual maturities of investment securities at December 31, 1997 are
shown below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.

<TABLE>
<CAPTION>


                                                  Amortized     Estimated
                                                     Cost       Fair Value
                                                  -----------   ----------
AS OF DECEMBER 31, 1997:
-----------------------

<S>                                               <C>           <C>
SECURITIES AVAILABLE FOR SALE:
    DUE IN ONE YEAR OR LESS ...................   $ 1,560,332   $ 1,559,447
    DUE AFTER ONE YEAR THROUGH FIVE YEARS .....     7,571,275     7,595,453
    DUE AFTER FIVE YEARS THROUGH TEN YEARS ....     5,998,172     5,989,687
                                                  -----------   -----------
                                                  $15,129,779   $15,144,587
                                                  ===========   ===========

SECURITIES HELD TO MATURITY:
    DUE AFTER ONE YEAR THROUGH FIVE YEARS .....   $   511,621   $   512,750
    DUE AFTER FIVE THROUGH TEN YEARS ..........       429,761       446,886
    DUE AFTER TEN YEARS .......................     3,239,639     3,349,311
                                                  -----------   -----------
                                                  $ 4,181,021   $ 4,308,947
                                                  ===========   ===========
</TABLE>


Gross realized gains and losses on the sale of investments in debt securities
available for sale for each of the three years in the period ended December 31,
1997 were as follows:

<TABLE>
<CAPTION>

                                                      1997           1996          1995
                                                  -----------    ----------     ----------
<S>                                               <C>            <C>            <C>
Gross realized gains..........................    $     5,757    $    5,626     $   11,417
Gross realized losses.........................          5,835           825            -0-
</TABLE>


Net gains on the maturities of investment securities totalled $4,093 for 1996.

The carrying value of investment securities pledged to secure public funds on
deposit, securities sold under agreements to repurchase, and for other purposes
as required by law amounted to approximately $6,606,000 and $7,197,000 at
December 31, 1997 and 1996.

NOTE 4 - LOANS

The Company grants loans to customers primarily in the North Georgia area. The
major classifications of loans as of December 31 were as follows:

<TABLE>
<CAPTION>

                                                1997                1996
                                            ------------       ------------
<S>                                         <C>                <C>
Commercial, financial and agricultural...   $ 16,535,602       $ 13,911,050
Real estate - construction ..............      5,118,961          4,811,413
Real estate - mortgage ..................     50,928,334         35,288,824
Consumer ................................     10,835,331          8,627,652
Other loans .............................      1,165,625          2,322,803
                                            ------------       ------------
                                              84,583,853         64,961,742
Allowance for loan losses ...............       (929,590)          (655,296)
                                            ------------       ------------

Net loans ...............................   $ 83,654,263       $ 64,306,446
                                            ============       ============
</TABLE>


                                     F-15
<PAGE>   51


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY


NOTE 4 - LOANS - CONTINUED

As of December 31, 1997, there were no loans which the Company had specifically
classified as impaired. Other nonaccrual loans at December 31, 1997 and 1996,
amounted to approximately $15,000 and $57,000. For the year ended December 31,
1997 and 1996, the difference between gross interest income that would have
been recorded in such period if nonaccruing loans had been current in
accordance with their original terms and the amount of interest income on those
loans that was included in such period's net income was negligible.

The Company has no commitments to loan additional funds to the borrowers of
nonaccrual loans

NOTE 5 - ALLOWANCE FOR LOAN LOSSES

Changes in the allowance for loan losses for each of the two years ended
December 31 were as follows:

<TABLE>
<CAPTION>

                                               1997          1996
                                             --------      ---------
<S>                                          <C>           <C>
Balance at beginning of year .............   $655,296      $324,599

Charge-offs ..............................    228,087        38,225
Recoveries ...............................     22,381           922
                                             --------      --------
Net charge-offs ..........................    205,706        37,303

Provision for loan losses ................    480,000       368,000
                                             --------      --------

Balance at end of year ...................   $929,590      $655,296
                                             ========      ========
</TABLE>

NOTE 6 - PREMISES AND EQUIPMENT

Premises and equipment were as follows:

<TABLE>
<CAPTION>


                                        1997            1996
                                     ----------      ----------
<S>                                  <C>             <C>
Land ..............................  $  329,900      $  329,900
Construction in progress ..........      55,668             -0-
Buildings and improvements ........     908,730         883,084
Furniture .........................     623,169         602,434
Vehicles ..........................      48,134          48,134
                                     ----------      ----------
                                      1,965,601       1,863,552
Less allowance for depreciation ...     312,558         190,349
                                     ----------      ----------
                                     $1,653,043      $1,673,203
                                     ==========      ==========
</TABLE>

The provisions for depreciation charged to occupancy and furniture and
equipment expense for the years ended December 31, 1997, 1996 and 1995, were
$137,432, $118,219, and $72,129, respectively.

NOTE 7 - DEPOSITS

The major classifications of deposits as of December 31, were as follows:

<TABLE>
<CAPTION>

                                                    1997              1996
                                                 -----------      -----------
<S>                                              <C>              <C>
Noninterest-bearing demand ..................    $ 3,800,911      $ 3,464,810
Interest-bearing demand .....................     24,431,854       19,691,248
Savings .....................................     20,743,964       14,436,370
Time ........................................     31,635,604       31,462,158
Certificates of deposit of $100,000 or more .     14,735,613       12,093,295
                                                 -----------      -----------
                                                 $95,347,946      $81,147,881
                                                 ===========      ===========
</TABLE>


                                     F-16
<PAGE>   52


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY

NOTE 7 - DEPOSITS - CONTINUED

The maturities of time certificates of deposit and other time deposits of
$100,000 or more issued by the Company at December 31, 1997 are as follows:

<TABLE>
<CAPTION>

                                           TIME
                                        CERTIFICATES
                                         OF DEPOSIT
                                        ------------
<S>                                     <C>
Three months or less .................  $  4,040,826
Over three through six months ........     2,313,291
Over six through twelve months .......     4,626,651
Over twelve months ...................     3,754,845
                                        ------------
                                        $ 14,735,613
                                        ============
</TABLE>


NOTE 8 - LONG-TERM DEBT

At December 31, 1997 and 1996, the Company had notes payable totalling
$5,320,000 and $700,000, respectively.

Long-term debt consists of the following at December 31:
<TABLE>
<CAPTION>


                                                                                          1997           1996
                                                                                       ----------      --------
<S>                                                                                    <C>             <C>
Note payable to another financial institution, interest, at prime, less 3/4 of
a percentage point; principal is due in five equal annual installments
beginning January 1, 1999, unsecured.............................................      $1,320,000      $700,000

Note payable on $8 million line of credit at FHLB, with varying maturities; $1
million due December, 2004, $2 million due June and September, 2007,
interest rate varies from 6.18% to 6.77%, secured by stock in FHLB...............       4,000,000           -0-
                                                                                       ----------      --------
                                                                                       $5,320,000      $700,000
                                                                                       ==========      ========
</TABLE>

Maturities of long-term debt following December 31, 1997 are as follows:

<TABLE>
<CAPTION>


          <S>                                                         <C>
          1998......................................                  $      -0-
          1999......................................                     264,000
          2000......................................                     264,000
          2001......................................                     264,000
          2002......................................                   1,264,000
          Thereafter................................                   3,264,000
                                                                      ----------
                                                                      $5,320,000
                                                                      ==========
</TABLE>


                                     F-17
<PAGE>   53

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY

NOTE 9 - SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE

Securities sold under agreements to repurchase amounted to $4,228,129 and
$5,283,972 as of December 31, 1997 and 1996 respectively.

Information concerning securities sold under agreements to repurchase is
summarized as follows:

<TABLE>
<CAPTION>

                                                     1997             1996
                                                  ----------       ----------
<S>                                               <C>              <C>
Average balance during the year ..............    $4,471,499       $4,487,562
Average interest rate during the year ........          4.50%            4.50%
Maximum month-end balance during the year ....    $4,693,265       $5,283,972
<CAPTION>


U.S. Government and agency securities underlying the agreements at year end


                                                     1997             1996
                                                  ----------       ----------
<S>                                               <C>              <C>
Carrying Value ............................       $4,200,765       $5,996,053
Estimated Fair Value ......................        4,185,437        5,938,749
Accrued interest ..........................              -0-           61,761
</TABLE>

NOTE 10 - OTHER OPERATING EXPENSES

Other operating expenses consist of the following:

<TABLE>
<CAPTION>

                                                          1997            1996           1995
                                                      ----------       ----------     ----------
<S>                                                   <C>              <C>            <C>
Advertising ......................................    $  122,358       $   93,020     $   78,660
Checking account expense .........................        32,830           29,751         21,980
Correspondent bank charges .......................        34,648           27,953         11,794
Data processing ..................................        87,095           46,843         30,676
Director and committee fees ......................       119,322           18,900            -0-
Insurance ........................................        55,524           26,468         30,764
Other ............................................       119,036           56,048         52,024
Postage ..........................................        69,806           51,511         26,221
Professional fees ................................       194,513          121,102         62,657
Stationery and supplies ..........................       116,537          105,949         89,501
Taxes and licenses ...............................        25,608           22,231         15,304
                                                      ----------       ----------     ----------

    Total other operating expenses ...............    $  977,277       $  599,776     $  419,581
                                                      ==========       ==========     ==========
</TABLE>


NOTE 11 - INCOME TAXES

Federal and state income taxes payable as of December 31, 1997 and 1996
included in other liabilities were as follows:

<TABLE>
<CAPTION>

                              1997         1996
                           ----------   ----------
Current
<S>                        <C>          <C>
Federal .................  $   25,049   $    9,547
State ...................       3,000          -0-
                           ----------   ----------
                           $   28,049   $    9,547
                           ==========   ==========
</TABLE>



                                     F-18
<PAGE>   54




                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY


NOTE 11 - INCOME TAXES - CONTINUED

The components of the net deferred income tax asset included in other assets
are as follows:

<TABLE>
<CAPTION>

                                                                                 1997            1996
                                                                               ---------       ---------
<S>                                                                            <C>             <C>
Deferred tax asset:
  Federal ...............................................................      $ 266,289       $ 198,341

Deferred tax liability:
  Federal ...............................................................        (62,323)        (45,782)
                                                                               ---------       ---------
Net deferred income tax asset ...........................................      $ 203,966       $ 152,559
                                                                               =========       =========
</TABLE>


The tax effects of each type of income and expense item that gave rise to
deferred taxes are:

<TABLE>
<CAPTION>

                                                                                  1997           1996
                                                                               ---------       ---------
<S>                                                                            <C>             <C>
Net unrealized (gains) losses on securities available for sale ..........      $  (5,034)      $  16,985
Depreciation ............................................................        (57,289)        (45,782)
Provision for loan losses ...............................................        253,064         159,138
Other ...................................................................         13,225          22,218
                                                                               ---------       ---------
                                                                               $ 203,966       $ 152,559
                                                                               =========       =========
</TABLE>

The principal sources of temporary differences resulting in deferred income
taxes included in the accompanying consolidated Statements of income and the
tax effect of each are as follows:

<TABLE>
<CAPTION>

                                                                                      1997            1996            1995
                                                                                    ---------       --------        ---------

<S>                                                                                 <C>             <C>             <C>
Net operating loss carryover .................................................      $     -0-       $  71,542       $ (71,542)
Depreciation .................................................................          9,670          31,133          14,649
Provision for loan losses ....................................................        (93,260)       (100,756)        (72,902)
Other ........................................................................         10,164         (10,541)           2843
                                                                                    ---------       ---------       ---------
                                                                                    $ (73,426)      $  (8,622)      $(126,952)
                                                                                    =========       =========       =========
</TABLE>

Tax effects of securities transactions resulted in an increase (decrease) in
income taxes for 1997, 1996, 1995 of ($27), $3,024 and $3,882 respectively.

The components of income tax expense for the years 1997, 1996, and 1995 are as
follows:

<TABLE>
<CAPTION>

                                               1997            1996             1995
                                          -------------   -------------    -------------
<S>                                                 <C>             <C>              <C>
Current Federal .......................   $     456,013   $     312,530    $         -0-
Deferred Federal ......................         (73,426)         (8,622)        (126,952)
                                          -------------   -------------    -------------
Income Tax Provision ..................   $     382,587   $     303,908    $    (126,952)
                                          =============   =============    =============
</TABLE>


                                     F-19
<PAGE>   55



                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY


NOTE 11 - INCOME TAXES - CONTINUED

The principal reasons for the difference in the effective tax rate and the
federal statutory rate are as follows for the years ended December 31, 1997,
1996 and 1995.

<TABLE>
<CAPTION>

                                            1997       1996       1995
                                          -------    -------     -------
<S>                                       <C>        <C>        <C>
Statutory federal income tax rate .....      34.0%       34.0%     34.0%

Effect on rate of:
     Tax-exempt securities ............      (4.1)       (1.0)      -0-
     Tax-exempt loans .................      (1.0)       (1.1)      -0-
     Interest expense disallowance ....       1.0          .4       -0-
     Other ............................      (2.6)        4.7       -0-
                                          -------    --------   -------

Effective income tax rate .............      27.3%       37.0%     34.0%
                                          =======    ========   =======
</TABLE>

NOTE 12 - COMMITMENTS AND CONTINGENCIES

In the normal course of business, the Company offers a variety of financial
products to its customers to aid them in meeting their requirements for
liquidity, credit enhancement, and interest rate protection. Generally accepted
accounting principles recognize these transactions as contingent liabilities
and, accordingly, they are not reflected in the accompanying financial
statements. Commitments to extend credit, credit card arrangements, commercial
letters of credit, and standby letters of credit all include exposure to some
credit loss in the event of nonperformance of the customer. The Company's
credit policies and procedures for credit commitments and financial guarantees
are the same as those for extension of credit that are recorded on the
statement of financial condition. Because these instruments have fixed maturity
dates, and because many of them expire without being drawn upon, they do not
generally present any significant liquidity risk to the Company. The Company
has not been required to perform on any financial guarantees nor has it
incurred any losses on its commitments in 1997 or 1996.

Following is a discussion of these commitments:

Standby Letters of Credit: These agreements are used by the Company's customers
as a means of improving their credit standings in their dealings with others.
Under these agreements, the Company agrees to honor certain financial
commitments in the event that its customers are unable to do so. As of December
31, 1997 and 1996, the Company has issued standby letters of credit of
approximately $385,000 and $56,000.

Management conducts regular reviews of these instruments on an individual
customer basis, and the results are considered in assessing the adequacy of the
Company's allowance for loan losses. Management does not anticipate any
material losses as a result of these letters of credit.

Loan Commitments: As of December 31, 1997 and 1996, the Company had commitments
outstanding to extend credit totaling approximately $11,049,000 and $6,410,000
respectively. These commitments generally require the customers to maintain
certain credit standards. Management does not anticipate any material losses as
a result of these commitments.

Litigation: The Company is party to litigation and claims arising in the normal
course of business. Management, after consultation with legal counsel, believes
that the liabilities, if any, arising from such litigation and claims are not
material to the financial statements.


                                     F-20
<PAGE>   56


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY


NOTE 13 - CONCENTRATIONS OF CREDIT

All of the Company's loans, commitments and standby letters of credit have been
granted to customers in the Company's market area. Substantially all such
customers are depositors of the Company. The concentrations of credit by type
of loan are set forth in Note 4. Additionally, there exists a substantial
concentration of loans in the poultry industry. At December 31, 1997 there
existed approximately $15.6 million of such loans outstanding. The commitments
to extend credit relate primarily to unused real estate draw lines.

The Company maintains its cash accounts at various commercial banks in Georgia.
The total cash balances are insured by the FDIC up to $100,000. Total uninsured
balances held at other commercial banks amounts to $929,000 and $332,000 at
December 31, 1997 and 1996, respectively.

NOTE 14 - STOCK OPTION PLAN

On June 1, 1997 the Company issued a total of 143,000 options to purchase its
common shares to its directors and executive officers. Each director received
11,000 shares, the Chief Financial Officer received 22,000 shares and the
President recieved 33,000 shares. Each of the stock option agreements contained
an option price of $16.00 per share, the market value of the shares at the time
of issuance. The options vest on an equal incremental basis over a period of
five years beginning June 1, 1998. No options were exercisable at December 31,
1997.

The following sets forth certain information regarding stock options for the
year ended December 31, 1997.

<TABLE>
<CAPTION>


                                                                          1997
                                                            --------------------------------
FIXED OPTIONS                                                                    WEIGHTED
-------------                                                                     AVERAGE
                                                              SHARES          EXERCISE PRICE
                                                            -------------     --------------
<S>                                                         <C>               <C>
Outstanding at beginning of year .......................              -0-                -0-
Granted ................................................          143,000     $           16
Exercised ..............................................              -0-                -0-
Forfieted ..............................................              -0-                -0-
                                                            -------------     --------------
Outstanding at end of year .............................          143,000     $           16
                                                            =============     ==============
</TABLE>

<TABLE>
<CAPTION>

                                                               EXPIRATION       OPTIONS
                                                 NUMBER           DATE        EXERCISABLE
                                               ------------   -------------  --------------
<S>                                            <C>            <C>            <C>
Options with Exercise Price of $16.00........  $    143,000        06-01-08             -0-
</TABLE>


In October 1995, the FASB issued Fiancial Accounting Standards No. 123,
Accounting and Disclosure of Stock-Based Compensation ("SFAS 123"), SFAS 123 is
effective for years beginning after December 15, 1995, and allows for the
option of continuing to follow Accounting Principles Board Opinion No. 25,
Accounting for Stocks Issued to Employees, and the related Interpretations or
selecting the minimum value method of expense recognition as described in SFAS
123. The Company has elected to apply APB Opinion No. 25 in accounting for its
incentive stock options, accordingly, no compensation cost has been recognized
by the Company. The Company's net income and earnings per share would have been
reduced to the pro forma amounts indicated below had compensation cost for the
Company's stock option plan been determined based on the fair value ("minimum
value method") at the grant date for options under the plan.


                                     F-21
<PAGE>   57


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY

NOTE 14 - STOCK OPTION PLAN - CONTINUED

<TABLE>
<CAPTION>


                                           1997
                                       -------------
Net Income
<S>                                    <C>
   As reported ....................    $   1,017,766
   Pro forma ......................          679,930

Basic Earnings Per Share
   As reported ....................    $        1.76
   Pro forma ......................             1.18

Diluted Earnings Per Share
   As reported ....................    $        1.75
   Pro forma ......................             1.17
</TABLE>


These options are assumed to be exercised in the calculation of diluted average
common shares outstanding, causing the equivalent number of shares outstanding
on a diluted basis to be 3,608 greater than that used to calculate basic
earnings per share for 1997. The dilutative effect on earnings per share for
the year ended December 31, 1997 was $.01.

The Company's options outstanding have a weighted average contractual life of
eight years. The weighted average fair value of options granted was $7.85 in
1997. The fair value of each grant is estimated using the minimum value method
with the following assumptions used for grants in 1997: expected option life of
10 years; no expected volatility; and a risk free interest rate of 7.00%.

The effects of applying SFAS No. 123 for providing proforma disclosures are not
likely to be representative of the effects on reported earnings for future
years, nor are the dividend estimates representative of commitments on the part
of the Company's Board.

NOTE 15 - SHAREHOLDERS' EQUITY

The Company raised $5,680,000 in capital as part of its initial offering in
1994, of which $2,840,000 was allocated to common stock and $2,840,000 was
allocated to capital surplus. Legal, printing and other costs of issuance of
stock amounting to $10,686, were applied against capital surplus.

The Board of Directors of any state-chartered bank in Georgia may declare and
pay cash dividends on its outstanding capital stock without any request for
approval of the Company's regulatory agency if the following conditions are
met:

1. Total classified assets at the most recent examination of the Company do not
exceed 80% of equity capital.

2. The aggregate amount of dividends declared in the calendar year does not
exceed 50% of the prior year's net income.

3. The ratio of equity capital to adjusted assets shall not be less than 6%.

As of December 31, 1997, the Company could declare dividends of approximately
$508,000 without regulatory consent, subject to the Bank's compliance with
regulatory capital restrictions. It is anticipated that any such dividend will
be used for the payment of long term debt service.


                                     F-22
<PAGE>   58


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY


NOTE 15 - SHAREHOLDERS' EQUITY - CONTINUED

In 1997, the Company sold 24,287 shares of stock to its 401(k) plan for
$388,607. Of this amount, $121,435 was allocated to common stock and $267,172
to capital surplus. The Company also purchased 15,000 shares of common stock
for $274,000, which is reflected as treasury stock, at cost, in shareholder's
equity.

The Company is also required to maintain minimum amounts of capital to total
"risk weighted" assets, as defined by the banking regulators. The Company's
ratios as of December 31, 1997 and December 31, 1996 exceeded the required
amounts.

NOTE 16 - REGULATORY MATTERS

The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory - and possibly additional discretionary - actions by
regulators that, if undertaken, could have a direct material effect on the Bank
and the consolidated financial statements. Under capital adequacy guidelines
and the regulatory framework from prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier 1 capital (as defined in the regulations) to risk
weighted assets (as defined), and of Tier I capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1997, that the
Bank meets all capital adequacy requirements to which it is subject.

As of September 30, 1997, the most recent notification from the Federal Deposit
Insurance Corporation, the Bank was categorized well capitalized under the
regulatory framework for prompt corrective action. To remain well capitalized
the Bank will have to maintain minimum total risk-based, Tier I risk-based, and
Tier I leverage ratios as set forth in the table below. There are no conditions
or events since that notification or events since the most recent notification
that management believes have changed the Bank's prompt corrective action
category.

The Company's actual capital amounts and ratios are also presented in the
table.

<TABLE>
<CAPTION>

                                                                                          To Be Well
                                                                                       Capitalized Under
                                                             For Capital               Prompt Corrective
                                       Actual             Adequacy Purposes:           Action Provisions:
                                       ------             ------------------           ------------------
                                 Amount      Ratio        Amount       Ratio          Amount         Ratio
                                 ------      -----        ------       -----          ------         -----
AS OF DECEMBER 31, 1997:                           (AMOUNTS IN THOUSANDS)
-----------------------
<S>                              <C>         <C>          <C>          <C>            <C>            <C>
TOTAL CAPITAL
     (TO RISK-WEIGHTED ASSETS)   $9,133       10.9%      >$6,726        >8.0%        > $8,407        > 10.0%
TIER I CAPITAL
     (TO RISK-WEIGHTED ASSETS)    8,173        9.7%      > 3,363        >4.0%        >  5,044        >  6.0
TIER I CAPITAL
     (TO AVERAGE ASSETS)          8,173        7.6%      > 4,324        >4.0%        >  5,405        >  5.0

As of December 31, 1996:
-----------------------
Total Capital
     (to Risk-Weighted Assets)   $7,122       10.3%      >$5,447        >8.0%        > $6,909       >  10.0%
Tier I Capital
     (to Risk-Weighted Assets)    6,467        9.4%      > 2,723        >4.0%        >  4,085       >   6.0%
Tier I Capital
     (to Average Assets)          6,467        5.9%      > 2,894        >4.0%        >  3,283       >   5.0%
</TABLE>


                                     F-23
<PAGE>   59



                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY

NOTE 16 - REGULATORY MATTERS - CONTINUED

The Georgia Department of Banking and Finance also imposes capital requirements
on the Bank. As a condition to its charter approval in 1994, the Bank undertook
to maintain an 8% ratio of total capital to total assets. As of December 31,
1997, this ratio (as calculated by the DBF) was 8.07%.

NOTE 17 - EMPLOYEE BENEFIT PLAN

The Company adopted a defined contribution plan covering substantially all
employees; the plan is qualified under Section 401(k) of the Internal Revenue
Code. Under the provisions of the plan, eligible participating employees may
elect to contribute up to the maximum amount of tax deferred contribution
allowed by the Internal Revenue Code. The Company's contribution to the plan is
determined by the Board of Directors . In 1996, the plan was amended to allow
employer and employee contributions to be made in the form of cash or Company
stock. The Company made a discretionary cash contribution of approximately
$102,000 to the plan in 1997 and $28,000 in 1996. No contributions were made by
the Company in 1995.

NOTE 18 - RELATED PARTY TRANSACTIONS

Loans: Certain directors, executive officers and principal shareholders,
including their immediate families and associates were loan customers of the
Company during 1997 and 1996. Such loans are made in the ordinary course of
business at normal credit terms, including interest rates and collateral and do
not represent more than a normal risk of collection.

<TABLE>
<CAPTION>

                             1997           1996
                         ------------   ------------
<S>                      <C>            <C>
Beginning of year ...... $  4,802,580   $  4,385,960
New Loans ..............    1,197,734        537,949
Less: Payments .........    1,867,012        121,329
                         ------------   ------------
End of Year ............ $  4,133,302   $  4,802,580
                         ============   ============
</TABLE>

Deposits: Deposits held from related parties were $918,848 and $569,006 at
December 31, 1997 and 1996, respectively.

Other: The Company utilized the services of an accounting firm, of which a
director is a partner, for internal review and various other accounting and tax
services. Amounts paid were at a rate comparable to that which could have been
obtained from unrelated parties.

NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate
that value:

Cash and Short-Term Investments: For those short-term instruments, the carrying
amount is a reasonable estimate of fair value.

Investment Securities: For securities and marketable equity securities held for
investment purposes, fair values are based on quoted market prices or dealer
quotes. For other securities held as investments, fair value equals quoted
market price, if available. If a quoted market price is not available, fair
value is estimated using quoted market prices for similar securities.

Loan Receivables: For certain homogeneous categories of loans, such as some
residential mortgages, credit card receivables, and other consumer loans, fair
value is estimated using the quoted market prices for securities backed by
similar loans, adjusted for differences in loan characteristics. The fair value
of other types of loans is estimated by discounting the future cash flows using
the current rates at which similar loans would be made to borrowers with
similar credit ratings and for the same remaining maturities.


                                     F-24
<PAGE>   60


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY

NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED

Deposit Liabilities: The fair value of demand deposits, savings accounts, and
certain money market deposits is the amount payable on demand at the reporting
date. The fair value of fixed-maturity certificates of deposit is estimated
using the rates currently offered for deposit of similar remaining maturities.

Short-term Borrowings: The fair value of short-term borrowings, including
securities sold under agreements to repurchase, is estimated to be
approximately the same as the carrying amount.

Long-Term Debt: Rates currently available to the Company for debt with similar
terms and remaining maturities are used to estimate fair value of existing
debt.

Commitments to Extend Credit, Standby Letters of Credit, and Financial
Guarantees Written: The fair value of commitments and letters of credit is
estimated to be approximately the same as the notional amount of the related
commitment.

The estimated fair values of the Company's financial instruments as of December
31 are as follows:

<TABLE>
<CAPTION>

                                                               1997                  1996
                                                               ----                  ----
                                                       CARRYING     FAIR     CARRYING    FAIR
                                                        AMOUNT      VALUE     AMOUNT     VALUE
                                                        ------      -----     ------     -----
                                                          (in thousands)         (in thousands)
FINANCIAL ASSETS:
<S>                                                    <C>         <C>        <C>       <C>
Cash and short-term investments .................       $  5,211   $  5,211   $  3,674  $  3,674
Investment securities ...........................         19,726     19,854     22,379    22,409
Loans ...........................................         84,584     84,683     64,962    65,108
Accrued interest receivable .....................            972        972        807       807
                                                        --------   --------   --------  --------
  TOTAL FINANCIAL ASSETS ........................       $110,493   $110,720   $ 91,822  $ 91,998
                                                        ========   ========   ========  ========
FINANCIAL LIABILITIES:
Deposits ........................................       $ 95,348   $ 95,479   $ 81,148  $ 81,263
Securities sold under agreements to repurchase...          4,228      4,228      5,284     5,284
Accrued interest payable ........................            188        188        154       154
Long-term debt ..................................          5,320      5,376        700       700
                                                        --------   --------   --------  --------
  TOTAL FINANCIAL LIABILITIES ...................       $105,084   $105,271   $ 87,286  $ 87,401
                                                        ========   ========   ========  ========
UNRECOGNIZED FINANCIAL INSTRUMENTS:
Commitments to extend credit ....................       $ 11,049   $ 11,049   $  6,410  $  6,410
Standby letters of credit .......................            385        385         56        56
                                                        --------   --------   --------  --------
  TOTAL UNRECOGNIZED FINANCIAL
    INSTRUMENTS .................................       $ 11,434   $ 11,434   $  6,466  $  6,466
                                                        ========   ========   ========  ========
</TABLE>



                                     F-25
<PAGE>   61


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY

NOTE 20 - CONDENSED PARENT INFORMATION

STATEMENT OF FINANCIAL CONDITION

<TABLE>
<CAPTION>


                                                                                         DECEMBER 31,    DECEMBER 31,
                                                                                             1997            1996
                                                                                         -------------   -------------
Assets
<S>                                                                                      <C>             <C>
     Cash and due from banks ..................................................          $      63,487   $         844
     Investment in subsidiary (equity method) eliminated upon consolidation....              8,215,672       6,479,620
     Intangibles, net .........................................................                 20,894          26,726
     Other assets .............................................................                      0           2,413
                                                                                         -------------   -------------
          Total Assets ........................................................          $   8,300,053   $   6,509,603
                                                                                         =============   =============
Liabilities and Shareholders' Equity
     Note payable .............................................................          $   1,320,000   $     700,000
     Other liabilities ........................................................                      0           4,667
                                                                                         -------------   -------------
          Total Liabilities ...................................................              1,320,000         704,667

          Total Shareholders' Equity ..........................................              6,980,053       5,804,936
                                                                                         -------------   -------------

          Total Liabilities and Shareholders' Equity ..........................          $   8,300,053   $   6,509,603
                                                                                         =============   =============
</TABLE>

STATEMENT OF INCOME

<TABLE>
<CAPTION>


                                                                                            YEARS ENDED DECEMBER 31,
                                                                                         -------------------------------
                                                                                             1997               1996
                                                                                         -------------     -------------
Income
<S>                                                                                      <C>               <C>
     Dividends from subsidiary - eliminated upon consolidation .................         $         -0-     $      30,000

Expenses
     Interest ..................................................................                78,517             4,667
     Other expenses ............................................................                15,525             2,430
                                                                                         -------------     -------------
                                                                                                94,042             7,097
                                                                                         -------------     -------------

Income before income taxes and equity in undistributed earnings of subsidiary...               (94,042)           22,903
Income tax benefits ............................................................               (30,913)           (2,413)
                                                                                         -------------     -------------

Income before equity in undistributed earnings of subsidiary ...................               (63,129)           25,316

Equity in undistributed earnings of subsidiary .................................             1,080,895           491,420
                                                                                         -------------     -------------

          Net Income ...........................................................         $   1,017,766     $     516,736
                                                                                         =============     =============
</TABLE>



                                     F-26
<PAGE>   62


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                  APPALACHIAN BANCSHARES, INC. AND SUBSIDIARY

NOTE 20 - CONDENSED PARENT INFORMATION - CONTINUED

STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>

                                                                                               YEARS ENDED DECEMBER 31,
                                                                                                1997              1996
                                                                                           -------------     -------------
Cash flows from operating activities:
<S>                                                                                        <C>               <C>
     Net Income ........................................................................   $   1,017,766     $     516,736
     Adjustments to reconcile net income to net cash provided by operating activities
     Equity in undistributed income of subsidiary ......................................      (1,080,895)         (491,420)
     Provision for amortization ........................................................           5,832             2,430
     Increase in other assets ..........................................................             -0-           (31,569)
     Increase in other liabilities .....................................................          (4,667)            4,667
                                                                                           -------------     -------------
     Net cash provided by (used in) operating activities ...............................         (61,964)              844
                                                                                           -------------     -------------

Cash flows from financing activities:
     Proceeds from notes payable .......................................................         620,000           700,000
     Increase to investment in subsidiary ..............................................        (610,000)         (700,000)
     Proceeds from sale of common stock to 401(k) plan .................................         388,607               -0-
     Purchases of treasury stock .......................................................        (274,000)              -0-
                                                                                           -------------     -------------
     Net cash provided by financing activities .........................................         124,607               -0-
                                                                                           -------------     -------------

Net increase in cash and cash equivalents ..............................................          62,643               844
                                                                                           -------------     -------------

Cash and cash equivalents at beginning of year .........................................             844               -0-
                                                                                           -------------     -------------

Cash and cash equivalents at end of year ...............................................   $      63,847     $         844
                                                                                           =============     =============

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash paid (received) during the year for:
     Interest ..........................................................................   $      83,184     $         -0-
     Income Taxes ......................................................................             -0-               -0-
</TABLE>

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCIAL ACTIVITIES:

None

                                     F-27

<PAGE>   63
                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) 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.

                                            APPALACHIAN BANCSHARES, INC.


                                            By:/s/ Tracy R. Newton
                                               --------------------------------
                                               Tracy R. Newton, President


Date:          March 30, 1998

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.


 /s/  Tracy R. Newton                                   Date: March 30, 1998
-----------------------------------------
Tracy R. Newton, President, Chief
 Executive Officer and Director
[Principal Executive Officer]


/s/  Kent W. Sanford                                    Date: March 30, 1998
-----------------------------------------
Kent W. Sanford, Executive Vice President,
 Chief Financial Officer and Chief Operating
 Officer
[Principal Financial and Accounting Officer]


/s/  Alan S. Dover                                      Date: March 30, 1998
-----------------------------------------
Alan S. Dover, Director


/s/  Charles A. Edmondson                               Date: March 30, 1998
-----------------------------------------
Charles A. Edmondson, Director


/s/  Roger E. Futch                                     Date: March 30, 1998
-----------------------------------------
Roger E. Futch, Director


/s/  Joseph C. Hensley                                  Date: March 30, 1998
-----------------------------------------
Joseph C. Hensley, Director


/s/  Frank E. Jones                                     Date: March 30, 1998
-----------------------------------------
Frank E. Jones, Director


/s/  J. Ronald Knight                                   Date: March 30, 1998
-----------------------------------------
J. Ronald Knight, Director


/s/  P. Joe Sisson                                      Date: March 30, 1998
-----------------------------------------
P. Joe Sisson, Director


/s/  Kenneth D. Warren                                  Date: March 30, 1998
-----------------------------------------
Kenneth D. Warren, Director


<PAGE>   64


<TABLE>
<CAPTION>

                                 EXHIBIT INDEX



    EXHIBIT NUMBER                    DESCRIPTION OF EXHIBIT
    --------------                    ----------------------
    <S>               <C>
           3.1        Articles of Incorporation of the Company (included as
                      Exhibit 3.1 to the Company's Registration Statement on
                      Form 8-A, dated September 16, 1996, previously filed with
                      the Commission and incorporated herein by reference).

           3.2        Bylaws of the Company (included as Exhibit 3.2 to the
                      Company's Registration Statement on Form 8-A, dated
                      September 16, 1996, previously filed with the Commission
                      and incorporated herein by reference).

           10.1       1997 Directors' Non-Qualified Stock Option Plan (included
                      as Exhibit 10.1 to the Company's Annual Report on Form
                      10-KSB for the fiscal year ended December 31, 1996 (File
                      No. 000-21383) and incorporated herein by reference).*

           10.2       1997 Employee Incentive Stock Incentive Plan (included as
                      Exhibit 10.2 to the Company's Annual Report on Form
                      10-KSB for the fiscal year ended December 31, 1996 (File
                      No. 000-21383) and incorporated herein by reference).*

           10.3       Credit Agreement, dated as of November 25, 1996, between
                      the Company and Hardwick Bank & Trust Company (included
                      as Exhibit 10.3 to the Company's Annual Report on Form
                      10-KSB for the fiscal year ended December 31, 1996 (File
                      No. 000-21383) and incorporated herein by reference).

           10.4       Adoption Agreement for the Appalachian Bancshares, Inc.
                      Section 401(k) Profit Sharing Plan (filed as Exhibit
                      4.3(a) to the Company's Registration Statement on Form
                      S-8 (No. 333-27127) and incorporated herein by
                      reference).

           10.5       Georgia Bankers Association Master 401(k) Profit Sharing
                      Plan (filed as Exhibit 4.3(b) to the Company's
                      Registration Statement on Form S-8 (No. 333-27127) and
                      incorporated herein by reference).

           10.6       First Amendment to the Georgia Bankers Association Master
                      Section 401(k) Profit Sharing Plan (filed as Exhibit
                      4.3(c) to the Company's Registration Statement on Form
                      S-8 (No. 333-27127) and incorporated herein by
                      reference).

           10.7       Form of Deferred Fee Agreement between Gilmer County Bank
                      and certain directors and executive officers, with
                      addendum (filed as Exhibit 10.6 to the Company's
                      Quarterly Report on Form 10-QSB for the period ended June
                      30, 1997 (File No. 000-21383) and incorporated herein by
                      reference).

           10.8       First Modification of Credit Agreement, dated October 29,
                      1997, between the Company and Hardwick Bank & Trust
                      Company (included as Exhibit 10 to the Company's
                      Quarterly Report on Form 10-QSB for the period ended
                      September 30, 1997 (File No. 000-21383) and incorporated
                      herein by reference).

           11         Statement re: Computation of Per Share Earnings

           21         Subsidiaries of the Registrant

</TABLE>
<PAGE>   65


           23         Consent of Independent Auditors

           27         Financial Data Schedule (for SEC use only)

           99         Information required by Form 11-K with respect to the
                      Appalachian Bancshares, Inc. Section 401(k) Profit
                      Sharing Plan will be filed as an amendment to this Form
                      10-KSB within 180 days after the end of the fiscal year
                      of the plan as permitted by Rule 15d-21 under the
                      Securities Exchange Act of 1934.

           * The referenced exhibit is a compensatory contract, plan
             or arrangement.