U.S. Securities and Exchange Commission

Form 10-Q

For the quarterly period ended March 31, 2005

For the transition period ended                     

Commission File Number 000-33227

Southern Community Financial Corporation

Registrant’s telephone number, including area code (336) 768-8500

Securities Registered Pursuant to Section 12(g) of the Exchange Act:
Common Stock, No Par Value

7.95% Cumulative Trust Preferred Securities
7.95% Junior Subordinated Debentures
Guarantee with respect to 7.95% Cumulative Trust Preferred Securities

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o

As of April 29, 2005, (the most recent practicable date), the registrant had outstanding 17,941,028 shares of Common Stock, no par value.

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Part I. FINANCIAL INFORMATION

SOUTHERN COMMUNITY FINANCIAL CORPORATION

* Derived from audited consolidated financial statements

See accompanying notes.

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SOUTHERN COMMUNITY FINANCIAL CORPORATION

See accompanying notes.

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SOUTHERN COMMUNITY FINANCIAL CORPORATION

See accompanying notes.

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SOUTHERN COMMUNITY FINANCIAL CORPORATION

See accompanying notes.

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Southern Community Financial Corporation
Notes to Consolidated Financial Statements

SOUTHERN COMMUNITY FINANCIAL CORPORATION

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Southern Community Financial Corporation

Note 1 — Basis of Presentation

The consolidated financial statements include the accounts of Southern Community Financial Corporation (the “Company”), and its wholly-owned subsidiary, Southern Community Bank and Trust (the “Bank”), and its wholly-owned subsidiary, VCS Management, L.L.C., the managing general partner for Salem Capital Partners L.P., a Small Business Investment Company. All intercompany transactions and balances have been eliminated in consolidation. In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three- month periods ended March 31, 2005 and 2004, in conformity with accounting principles generally accepted in the United States of America.

The preparation of the consolidated financial statements and accompanying notes requires management of the Company to make a number of estimates and assumptions relating to reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ significantly from these estimates and assumptions. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses. To a lesser extent, significant estimates are also associated with the determination of securities, intangibles, valuation of derivative instruments, stock based compensation, income tax assets or liabilities, and accounting for acquisitions. Operating results for the three-month period ended March 31, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2005.

The organization and business of Southern Community Financial Corporation, accounting policies followed by the Company and other relevant information are contained in the notes to the consolidated financial statements filed as part of the Company’s 2004 annual report on Form 10-K. This quarterly report should be read in conjunction with such annual report.

Recently issued accounting pronouncements — In April 2005, the US Securities and Exchange Commission adopted an amendment to Regulation S-X that delayed the effective date of Statement of Financial Accounting Standards No. 123(revised 2004) Share-Based Payment to the first fiscal period of fiscal years beginning after June 15, 2005. The Company intends to adopt the provisions of SFAS No. 123(R) in the first quarter of 2006. As is described in Note 4, the Company accelerated the vesting of all outstanding, unvested options in the first quarter of 2005. Accordingly, the effect of adopting the provisions of SFAS No. 123(R) in the first quarter of 2006 are not expected to have a material effect on the Company’s financial position or results of operations.

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Southern Community Financial Corporation
Notes to Consolidated Financial Statements

Note 2 — Net Income Per Share

Basic and diluted net income per share are computed based on the weighted average number of shares outstanding during each period. Diluted net income per share reflects the potential dilution that could occur if stock options were exercised or convertible trust-preferred securities were converted, resulting in the issuance of common stock that then shared in the net income of the Company. The convertible trust preferred securities were converted or redeemed during the quarter ended March 31, 2004.

Basic and diluted net income per share have been computed based upon the weighted average number of common shares outstanding or assumed to be outstanding as summarized below:

For the three months ended March 31, 2005 net income for determining diluted earnings per share was $1,600 thousand. For the three months ended March 31, 2004 net income for determining diluted earnings per share was $1,686 thousand, with no adjustment for the after tax effect of the expense associated with the dilutive convertible preferred securities which were converted or redeemed during the quarter. Due to the conversion, the after tax effect of the expense associated with the dilutive convertible preferred securities adjustment was nominal, as less than one thousand dollars in interest expense was paid on redeemed shares. For the three months ended March 31, 2005 and 2004, there were 464,165 and 5,850 stock options, respectively, that were antidilutive since the exercise price exceeded the average market price for the period. For the three months ended March 31, 2004 there were 818,861 of dilutive shares related to the convertible trust preferred securities. These dilutive common stock equivalents were included in the calculation of diluted earnings per share.

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Southern Community Financial Corporation
Notes to Consolidated Financial Statements

Note 3 — Business Combinations

On July 30, 2003, the Company entered into an “Agreement and Plan of Reorganization and Merger” with The Community Bank of Pilot Mountain, North Carolina. The acquisition was approved at a special shareholders’ meeting on December 11, 2003 and the transaction occurred effective at 12:01 am on January 12, 2004. The Community Bank shareholders could elect to receive cash, Company stock, or a combination of cash and stock with an overall consideration mix of approximately 85% stock and 15% cash. As a result of the acquisition, the Company paid approximately $15.3 million for shares exchanged for cash and issued 6,426,532 shares of common stock. The acquisition was accounted for using the purchase method of accounting. The pro forma impact of The Community Bank acquisition is not material to the quarter ended March 31, 2004 since it occurred near the beginning of the quarter.

In August 2004, the company acquired certain assets of two residential mortgage offices from J.R. Davidson Inc., dba Davidson Mortgage in Cornelius, North Carolina in exchange for cash. Davidson Mortgage, formed in 1997, is a mortgage banking company with two offices located in Cornelius, North Carolina and Lexington, South Carolina. Davidson’s primary focus is on conventional conforming and jumbo loan products. The results of Davidson Mortgage’s operations are reflected in the company’s consolidated financial statements from the date of acquisition. The pro forma impact of the Davidson Mortgage acquisition is not material.

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Southern Community Financial Corporation
Notes to Consolidated Financial Statements

Note 4 — Stock Compensation Plans

The Company accounts for stock option awards under the intrinsic value method prescribed in Accounting Principles Board (APB) No. 25, “Accounting for Stock Issued to Employees” which generally results in the recognition of no compensation expense because the exercise price of the stock options equals or exceeds the fair market value of the underlying stock on the grant date. The pro forma impact of accounting for those awards at fair value is disclosed below.

During the first quarter 2005, the Company vested all unvested stock options. As a result of this decision 623,725 non-vested options were accelerated from their established vesting over a 5 year period from date of grant to being fully vested. At the date the decision was made to accelerate the vesting, some of the options had exercise prices below market value. In accordance with the provisions of APB No. 25, compensation expense of $70,000 ($45,000 net of tax effect) has been recognized in the three months ended March 31, 2005 to reflect the effects of the accelerated vesting. The Company applied certain assumptions in the determination of the expense recognized during the period which were based on historical employee attrition rates.

The decision to accelerate the vesting of these options, which we believe to be in the best interest of our stockholders, was made primarily to reduce non-cash compensation expenses that would have been recorded in future periods following our application of SFAS No. 123(R). Because we accelerated these options, we expect to reduce our non-cash compensation expense related to these options by approximately $1.6 million (pre-tax) between the first quarter of 2006 and 2009, based on estimated value calculations using the Black-Scholes methodology.

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Southern Community Financial Corporation
Notes to Consolidated Financial Statements

Note 5 — Loans

Following is a summary of loans at each of the balance sheet dates presented: