UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q


       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
                              EXCHANGE ACT OF 1934

                For the quarterly period ended September 30, 2004

                                     0-15786
                                     -------
                            (Commission File Number)


                              COMMUNITY BANKS, INC.
                              ---------------------
             (Exact name of registrant as specified in its charter)


     PENNSYLVANIA                                     23-2251762
     ------------                                     ----------
(State of incorporation)                (I.R.S. Employer Identification Number)

   750 East Park Dr., Harrisburg, PA                    17111
----------------------------------------            -------------
(Address of principal executive offices)             (Zip Code)

                                 (717) 920-1698
                                 --------------
              (Registrant's telephone number, including area code)


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

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


               Number of shares outstanding as of October 31, 2004

   CAPITAL STOCK-COMMON                                       12,221,503
   --------------------                                       ----------
     (Title of Class)                                    (Outstanding Shares)





<PAGE>

<TABLE>
<CAPTION>

                     COMMUNITY BANKS, INC. AND SUBSIDIARIES
                                    FORM 10-Q
                                      INDEX




          <S>                                                                                                      <C>
         PART I - Financial Information                                                                            Page

         Item 1.     Financial Statements

               Consolidated Interim Balance Sheets                                                                    3
               Consolidated Interim Statements of Income                                                              4
               Consolidated Interim Statements of Changes in Stockholders' Equity                                     5
               Consolidated Interim Statements of Cash Flows                                                          6
               Notes to Consolidated Interim Financial Statements                                                  7-11

         Item 2.     Management's Discussion and Analysis of Financial
           Condition and Results of Operations                                                                    12-21

         Item 3.     Quantitative and Qualitative Disclosures About Market Risk                                      22

         Item 4.     Controls and Procedures                                                                         23


         PART II - Other Information

         Item 1.     Legal Proceedings                                                                               24

         Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds                                     24

         Item 3.     Defaults Upon Senior Securities                                                                 24

         Item 4.     Submission of Matters to a Vote of Security Holders                                             24

         Item 5.     Other Information                                                                               24

         Item 6.     Exhibits                                                                                        25


         SIGNATURES                                                                                                  26

</TABLE>


                                       2
<PAGE>




<TABLE>
<CAPTION>

                         PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements
-----------------------------

Community Banks, Inc. and Subsidiaries
CONSOLIDATED INTERIM BALANCE SHEETS
 (Dollars in thousands except per share data)

                                                                              September 30,              December 31,
                                                                                  2004                       2003
                                                                           --------------------       --------------------
      ASSETS                                                                   (Unaudited)

<S>                                                                        <C>                        <C>
      Cash and due from banks                                              $            38,736        $            42,790
      Federal funds sold                                                                 9,566                     17,097
                                                                          --------------------       --------------------
         Cash and cash equivalents                                                      48,302                     59,887
      Interest-bearing time deposits in other banks                                      1,770                      3,301
      Investment securities, available for sale                                        643,591                    646,961
      Loans held for sale                                                                1,168                      6,067
      Loans                                                                          1,188,280                  1,078,611
         Less:  Allowance for loans losses                                             (14,436)                   (13,178)
                                                                           --------------------       --------------------
               Net loans                                                             1,173,844                  1,065,433
      Premises and equipment, net                                                       24,914                     24,153
      Goodwill and identifiable intangible assets                                        5,036                      4,773
      Accrued interest receivable and other assets                                      57,186                     50,488
                                                                           --------------------       --------------------
               Total assets                                                $         1,955,811        $         1,861,063
                                                                           ====================       ====================

      LIABILITIES

      Deposits
         Non-interest bearing                                              $           186,613        $           165,174
         Interest bearing                                                            1,133,863                  1,065,511
                                                                           --------------------       --------------------
               Total deposits                                                        1,320,476                  1,230,685
      Short-term borrowings                                                             34,699                     27,764
      Long-term debt                                                                   406,370                    411,422
      Subordinated debt                                                                 30,928                     30,928
      Accrued interest payable and other liabilities                                    13,919                     16,858
                                                                           --------------------       --------------------
               Total liabilities                                                     1,806,392                  1,717,657
                                                                           --------------------       --------------------

      STOCKHOLDERS' EQUITY

      Preferred stock, no par value; 500,000 shares
        authorized; no shares issued and outstanding                                       ---                        ---
      Common stock-$5.00 par value; 20,000,000 shares
        authorized;  12,422,000  and 11,851,000 shares issued                           62,108                     59,256
      Surplus                                                                           73,229                     57,563
      Retained Earnings                                                                 14,694                     24,297
      Accumulated other comprehensive income,
        net of tax                                                                       5,050                      6,596
      Treasury stock;  238,000  and 203,000
        shares in 2004 and 2003, at cost                                                (5,662)                    (4,306)
                                                                           --------------------       --------------------
              Total stockholders' equity                                               149,419                    143,406
                                                                           --------------------       --------------------
              Total liabilities and stockholders' equity                   $         1,955,811        $         1,861,063
                                                                           ====================       ====================
</TABLE>

The  accompanying  notes  are  an  integral  part  of the  consolidated  interim
financial statements.


                                       3
<PAGE>


Community Banks, Inc. and Subsidiaries
CONSOLIDATED INTERIM STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands except per share data)

<TABLE>
<CAPTION>

                                                                    Three Months Ended                   Nine Months Ended
                                                                       September 30,                        September 30,
                                                              -------------------------------    ---------------------------------
                                                                   2004              2003             2004               2003
                                                              -------------------------------    ---------------------------------
   INTEREST INCOME:
<S>                                                           <C>               <C>              <C>                <C>
      Loans, including fees                                   $      17,712     $     16,691     $      51,366      $     49,121
      Investment securities:
          Taxable                                                     4,816            4,297            14,469            13,869
          Tax exempt                                                  2,176            2,246             6,629             6,777
          Dividends                                                     501              531             1,564             1,489
      Other                                                              22                4                61                 7
                                                              --------------    -------------    --------------     --------------
          Total interest income                                      25,227           23,769            74,089            71,263
                                                              --------------    -------------    --------------     --------------

   INTEREST EXPENSE:
      Deposits                                                        5,669            5,663            16,802            17,555
      Short-term borrowings                                             202              365               524             1,129
      Long-term debt                                                  4,655            4,316            13,664            12,697
      Subordinated debt                                                 408              176             1,163               542
                                                              --------------    -------------    --------------     --------------
          Total interest expense                                     10,934           10,520            32,153            31,923
                                                              --------------    -------------    --------------     --------------
          Net interest income                                        14,293           13,249            41,936            39,340
   Provision for loan losses                                            750              900             2,350             1,900
                                                              --------------    -------------    --------------     --------------
          Net interest income after provision for loan losses        13,543           12,349            39,586            37,440
                                                              --------------    -------------    --------------     --------------

   NON-INTEREST INCOME:
      Investment management and trust services                          443              292             1,119               942
      Service charges on deposit accounts                             1,996            1,350             5,108             3,686
      Other service charges, commissions and fees                       888              799             2,565             2,329
      Investment security gains                                         108              302             2,284             1,849
      Insurance premium income and commissions                          708              819             2,387             2,077
      Mortgage banking activities                                       558              936             2,013             1,807
      Earnings on investment in life insurance                          433              372             1,210             1,144
      Other                                                             878              636             1,105             1,078
                                                              --------------    -------------    --------------     --------------
          Total non-interest income                                   6,012            5,506            17,791            14,912
                                                              --------------    -------------    --------------     --------------


   NON-INTEREST EXPENSES:
      Salaries and employee benefits                                  6,975            6,623            20,851            18,799
      Net occupancy                                                   1,962            1,820             5,990             5,364
      Marketing expense                                                 611              412             1,900             1,497
      Telecommunications expense                                        318              425               979               952
      Other                                                           2,664            2,298             7,655             7,144
                                                              --------------    -------------    --------------     --------------
          Total non-interest expenses                                12,530           11,578            37,375            33,756
                                                              --------------    -------------    --------------     --------------

          Income before income taxes                                  7,025            6,277            20,002            18,596
   Income taxes                                                       1,379            1,130             3,744             3,372
                                                              --------------    -------------    --------------     --------------
          Net income                                          $       5,646     $      5,147     $      16,258      $     15,224
                                                              ==============    =============    ==============     ==============

   CONSOLIDATED PER SHARE DATA:
      Basic earnings per share                                $        0.46     $       0.42     $        1.33      $       1.25
      Diluted earnings per share                              $        0.45     $       0.41     $        1.29      $       1.22
      Dividends declared                                      $        0.17     $       0.16     $        0.50      $       0.47
</TABLE>

   The accompanying notes are an integral part of the consolidated interim
financial statements.


                                       4
<PAGE>


Community Banks, Inc. and Subsidiaries
CONSOLIDATED INTERIM STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
(In thousands)

<TABLE>
<CAPTION>


                                                                                            Accumulated
                                                                                               Other
                                      Outstanding       Common                 Retained    Comprehensive  Treasury          Total
                                                                                              Income
                                        Shares           Stock      Surplus    Earnings       (Loss)        Stock           Equity
                                      -----------    ----------- ----------- ------------ ------------- ------------     -----------
<S>              <C>                      <C>        <C>         <C>         <C>          <C>           <C>              <C>
Balance, January 1, 2003                  9,151      $    47,053 $    46,418 $    35,344  $     6,538   $    (6,191)     $  129,162
Comprehensive income:
    Net income                                                                    15,224                                     15,224
    Unrealized loss on securities,
        net of reclassification
        adjustment and tax effect                                                              (2,087)                       (2,087)
                                                                                                                         -----------
    Total comprehensive income                                                                                               13,137
Cash dividends                                                                    (5,678)                                    (5,678)
5% stock dividend                           458            2,346      10,612     (12,984)                                       (26)
Stock split  paid in the form of a
    20% stock dividend                    1,975            9,878                  (9,878)                                       ---
Purchases of treasury
stock                                      (115)                                                             (3,275)         (3,275)
Exercise of common stock options
    and issuances under stock
    purchase plan                           179              (11)                   (619)                     3,661           3,031
Tax benefits from employee stock
    transactions                                                         359                                                    359
                                      -----------    ----------- ----------- ------------ ------------- ------------     -----------

Balance, September 30, 2003              11,648      $    59,266 $    57,389 $    21,409  $     4,451   $    (5,805)     $  136,710
                                      ===========    =========== =========== ============ ============= ============     ===========




Balance, January 1, 2004                 11,648      $    59,256 $    57,563 $    24,297  $     6,596   $    (4,306)     $  143,406
Comprehensive income (loss):
    Net income                                                                    16,258                                     16,258
    Unrealized loss on securities,
      net of reclassification
      adjustment and tax effect                                                                (1,546)                       (1,546)
                                                                                                                         -----------
    Total comprehensive income (loss)                                                                                        14,712
Cash dividends                                                                    (6,136)                                    (6,136)
5% stock dividend                           584            2,953      15,103     (18,085)                                       (29)
Stock split  paid in the form of a
    20% stock dividend (fractional
    shares)                                                   (4)                    (25)                                       (29)
Purchases of treasury stock                (144)                                                             (4,151)         (4,151)
Exercise of common stock options
    and issuances under stock
    purchase plan                            96              (97)                 (1,615)                     2,795           1,083
Tax benefits from employee stock
    transactions                                                         563                                                    563
                                      -----------    ----------- ----------- ------------ ------------- ------------     -----------

Balance, September 30, 2004              12,184      $    62,108 $    73,229 $    14,694  $     5,050   $    (5,662)     $  149,419
                                      ===========    =========== =========== ============ ============= ============     ===========
</TABLE>

The accompanying notes are an integral part of the consolidated interim
financial statements.




                                       5
<PAGE>



Community Banks, Inc. and Subsidiaries
CONSOLIDATED INTERIM STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
>                                                                                              Nine Months Ended
                                                                                                 September 30,
                                                                                   -------------------------------------------
                                                                                         2004                     2003
                                                                                   -------------------------------------------

    Operating Activities:
<S>                                                                                <C>                     <C>
       Net income                                                                  $          16,258       $         15,224
    Adjustments to reconcile net income to net cash
      provided by operating activities:
       Provision for loan losses                                                               2,350                  1,900
       Depreciation and amortization                                                           2,480                  2,309
       Amortization of security premiums and discounts, net                                      929                  2,109
       Investment security gains                                                              (2,284)                (1,849)
       Loans originated for sale                                                              (9,331)               (58,880)
       Proceeds from sales of loans held for sale                                             14,571                 64,866
       Gains on loan sales                                                                    (1,065)                (1,338)
       Earnings on investment in life insurance                                               (1,210)                (1,144)
       Change in other assets, net                                                             1,259                  3,989
       Change in accrued interest payable and other liabilities, net                          (2,405)                (2,554)
                                                                                   ------------------      -------------------
           Net cash provided by operating activities                                          21,552                 24,632
                                                                                   ------------------      -------------------

    Investing Activities:
       Net (increase) decrease in interest-bearing time deposits
         in other banks                                                                        1,531                   (228)
       Proceeds from sales of investment securities                                          109,450                153,233
       Proceeds from maturities of investment securities                                     100,908                126,803
       Purchases of investment securities                                                   (207,978)              (248,966)
       Net increase in total loans                                                          (115,739)              (165,852)
       Proceeds from sale of credit card portfolio                                             4,556                    ---
       Investment in life insurance                                                           (5,000)                   ---
       Net additions to premises and equipment                                                (2,895)                (2,311)
       Other                                                                                    (382)                (2,584)
                                                                                   ------------------      -------------------
           Net cash used by investing activities                                            (115,549)              (139,905)
                                                                                   ------------------      -------------------

    Financing Activities:
       Net increase in deposits                                                               89,791                 77,719
       Net increase (decrease) in short-term borrowings                                      (18,065)                23,810
       Proceeds from issuance of long-term debt                                               35,000                 30,000
       Repayment of long-term debt                                                           (15,052)                (2,451)
       Cash dividends and cash paid in lieu of fractional shares                              (6,194)                (5,704)
       Purchases of treasury stock                                                            (4,151)                (3,275)
       Proceeds from issuance of common stock                                                  1,083                  2,281
                                                                                   ------------------      -------------------
           Net cash provided by financing activities                                          82,412                122,380
                                                                                   ------------------      -------------------

           Increase (decrease) in cash and cash equivalents                                  (11,585)                 7,107

    Cash and cash equivalents at beginning of period                                          59,887                 36,137
                                                                                   ------------------      -------------------
    Cash and cash equivalents at end of period                                     $          48,302       $         43,244
                                                                                   ==================      ===================
</TABLE>

The accompanying notes are an integral part of the consolidated interim
financial statements.


                                       6
<PAGE>


Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
 (Unaudited)


1.  Summary of Significant Accounting Policies
----------------------------------------------

Basis  of  Presentation  - The  accompanying  unaudited  consolidated  financial
statements of Community  Banks,  Inc. and Subsidiaries  ("Community")  have been
prepared in accordance  with  accounting  principles  generally  accepted in the
United States for interim  financial  information and  instructions to Form 10-Q
and Article 10 of Regulation  S-X.  Accordingly,  they do not include all of the
information and footnotes required by accounting  principles  generally accepted
in the United  States  for  complete  financial  statements.  In the  opinion of
management, all adjustments, consisting of normal recurring accruals, considered
necessary for a fair presentation have been included.

Operating  results  for the  nine  months  ended  September  30,  2004,  are not
necessarily  indicative  of the results that may be expected for the year ending
December 31, 2004.

For further information, refer to the audited consolidated financial statements,
and footnotes thereto,  included in the Annual Report on Form 10-K, for the year
ended December 31, 2003.

Community is a financial holding company whose wholly-owned subsidiaries include
Community Banks,  Community Bank Investments,  Inc. (CBII),  and Community Banks
Life Insurance Co.  (CBLIC).  Community  Banks provides a wide range of services
through  its  network  of  offices  in  Adams,  Cumberland,   Dauphin,  Luzerne,
Northumberland,  Schuylkill,  Snyder,  and York  Counties  in  Pennsylvania  and
Carroll and Montgomery Counties in Maryland.

Statement  of Cash Flows - Cash and cash  equivalents  include cash and due from
banks and federal funds sold. In 2004,  $25 million of maturing  long-term  debt
was refinanced with short-term borrowings in a non-cash transaction.

Stock-Based  Compensation  - Community has a stock-based  compensation  plan and
accounts for this plan under the recognition  and measurement  principles of APB
No. 25, "Accounting for Stock Issued to Employees," and related Interpretations.
No  stock-based  compensation  cost is reflected  in net income,  as all options
granted  under this plan had an exercise  price equal to the market value of the
underlying  common stock on the date of grant.  The following table  illustrates
the effect on net income and  earnings  per share if  Community  had applied the
fair value recognition  provisions of FASB No. 123,  "Accounting for Stock-Based
Compensation," to stock-based compensation.

         (Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
                                                                      Three Months Ended              Nine Months Ended
                                                                         September 30,                  September 30,
                                                                     2004            2003            2004            2003
                                                                 ----------------------------    -----------------------------

<S>                                                              <C>             <C>             <C>             <C>
         Net income, as reported                                 $     5,646     $    5,147      $    16,258     $    15,224
         Deduct:  Total stock-based compensation
           expense determined under fair value based
           method for all awards, net of related tax effect             (322)          (187)            (967)           (560)
                                                                 ------------    ------------    ------------    -------------


         Pro forma net income                                    $     5,324     $    4,960      $    15,291     $    14,664
                                                                 ============    ============    ============    =============


         Earnings per share:
           Basic - as reported                                   $      0.46     $     0.42      $      1.33     $      1.25
           Basic - pro forma                                     $      0.44     $     0.41      $      1.25     $      1.21

           Diluted - as reported                                 $      0.45     $     0.41      $      1.29     $      1.22
           Diluted - pro forma                                   $      0.43     $     0.40      $      1.22     $      1.18
</TABLE>


                                       7
<PAGE>

Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
 (Unaudited)

Comprehensive Income (Loss):

The components of other comprehensive  income (loss) and related tax effects for
periods ended September 30 are as follows (in thousands):
<TABLE>
<CAPTION>

                                                                Three Months Ended                  Nine Months Ended
                                                                  September 30,                       September 30,
                                                         --------------------------------    --------------------------------
                                                              2004              2003              2004              2003
                                                         --------------------------------    --------------------------------

<S>                                                      <C>               <C>                <C>              <C>
              Unrealized holding gains (losses)
                   on available-for-sale securities      $     16,503      $    (13,813)     $        (94)     $     (1,362)
              Reclassification adjustments for
                    gains included in net income                 (108)             (302)           (2,284)           (1,849)
                                                         --------------    --------------    --------------    --------------
              Net unrealized gains (losses)                    16,395           (14,115)           (2,378)           (3,211)
              Tax effect                                       (5,738)            4,940               832             1,124
                                                         --------------    --------------    --------------    --------------

                                                         $     10,657      $     (9,175)     $     (1,546)     $     (2,087)
                                                         ==============    ==============    ==============    ==============
</TABLE>


The components of accumulated other comprehensive income, included in
stockholders' equity, are as follows (in thousands):
<TABLE>
<CAPTION>

                                                                              September 30,          December 31,
                                                                                 2004                  2003
                                                                         -------------------    -------------------
<S>                                                                      <C>                    <C>
               Net unrealized gain on
                    available-for-sale securities                        $        10,968        $        13,347
               Tax effect                                                         (3,839)                (4,672)
                                                                         -------------------    -------------------
                    Net-of-tax amount                                              7,129                  8,675
                                                                         -------------------    -------------------

               Unfunded pension liability                                         (3,199)                (3,199)
               Tax effect                                                          1,120                  1,120
                                                                         -------------------    -------------------
                    Net-of-tax amount                                             (2,079)                (2,079)
                                                                         -------------------    -------------------

               Accumulated other comprehensive income                    $         5,050        $         6,596
                                                                         ===================    ===================
</TABLE>


Reclassifications  -  Certain  amounts  reported  in the  prior  year  have been
reclassified to conform with the 2004 presentation.  These reclassifications did
not impact the Corporation's financial condition or results of operations.

Recent  Accounting  Developments - In March 2004, the Emerging Issues Task Force
(EITF) reached  consensus on Issue 03-01,  "The Meaning of  Other-Than-Temporary
Impairment and Its Application to Certain  Investments." EITF No. 03-01 includes
new guidance for evaluating and recording  impairment  losses on debt and equity
investments,  as well as new disclosure  requirements  for investments  that are
deemed to be temporarily impaired.  The accounting guidance of EITF No. 03-01 is
effective for fiscal years beginning  after June 15, 2004,  while the disclosure
requirements  are  effective  for fiscal years  ending after June 15, 2004.  The
Corporation  has not yet  determined  the impact that  adoption will have on its
financial  position or results of operations as the impact is heavily  dependent
on  the  interest  rate   environment  at  the  date  of  adoption  and  pending
implementation guidance from the Financial Accounting Standards Board.


                                       8
<PAGE>


Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
(Unaudited)

2.  Allowance for loan losses:
------------------------------

Changes in the allowance for loan losses are as follows (in thousands):
<TABLE>
<CAPTION>

                                                           Nine Months Ended        Year Ended         Nine Months Ended
                                                             September 30,          December 31,          September 30,
                                                                 2004                  2003                   2003

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

<S>                                                         <C>                    <C>                    <C>
          Balance, January 1                                $       13,178         $      12,343          $      12,343
          Provision for loan losses                                  2,350                 2,500                  1,900
          Loan charge-offs                                          (1,988)               (2,839)                (1,360)
          Recoveries                                                   896                 1,174                    557
                                                          -------------------    ----------------     --------------------
          Balance, end of period                            $       14,436         $      13,178          $      13,440
                                                          ===================    ================     ====================
</TABLE>


The following table summarizes period-end risk elements (in thousands):
<TABLE>
<CAPTION>

                                                            September 30,          December 31,           September 30,
                                                                2004                   2003                   2003
                                                        -------------------      ----------------      ------------------

<S>                                                       <C>                      <C>                     <C>
          Non-accrual loans                               $        5,990           $       8,151          $      11,310
          Foreclosed real estate                                   2,203                   4,865                    572
                                                        -------------------      ----------------      ------------------
               Total non-performing assets                         8,193                  13,016                 11,882
          Accruing loans 90 days past due                             16                      90                     71
                                                        -------------------      ----------------      ------------------

          Total risk elements                             $        8,209           $      13,106          $      11,953
                                                        ===================      ================      ==================
</TABLE>




                                       9
<PAGE>



Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
 (Unaudited)

3.  Earnings Per Share:
-----------------------

Basic  earnings  per share is  computed  as net income  divided by the  weighted
average  number of  shares  outstanding.  Diluted  earnings  per share  reflects
additional  common  shares  that  would  have  been  outstanding  as a result of
converting common stock equivalents, calculated using the treasury stock method.
Common stock equivalents consist solely of outstanding stock options.

Earnings per share for the three months and nine months ended September 30, 2004
and 2003 have been computed as follows (in thousands, except per share data):

<TABLE>
<CAPTION>
                                                                 Three Months Ended             Nine Months Ended
                                                                   September 30,                  September 30,
                                                             ---------------------------    --------------------------
                                                                2004            2003           2004           2003
                                                             ------------    -----------    -----------    -----------

<S>                                                          <C>             <C>            <C>            <C>
        Net income                                           $     5,646     $    5,147     $   16,258     $   15,224
                                                             ============    ===========    ===========    ===========

        Weighted average shares outstanding  (basic)              12,189         12,139         12,235         12,120
        Effect of dilutive stock options                             319            362            347            328
                                                             ------------    -----------    -----------    -----------

        Weighted average shares outstanding  (diluted)            12,508         12,501         12,582         12,448
                                                             ============    ===========    ===========    ===========

        Per share information:
            Basic earnings per share                         $      0.46     $     0.42     $     1.33     $     1.25
            Diluted earnings per share                              0.45           0.41           1.29           1.22
</TABLE>

Per share and number of share amounts reflect stock splits and dividends.


4.   Guarantees:
----------------

Community does not issue any guarantees that would require liability recognition
or  disclosure,  other than its standby  letters of credit.  Standby  letters of
credit written are conditional  commitments issued by Community to guarantee the
performance  of a customer to a third party.  Generally,  all letters of credit,
when issued have  expiration  dates within one year. The credit risk involved in
issuing  letters of credit is essentially the same as those that are involved in
extending loan facilities to customers.  Community  generally  holds  collateral
and/or personal  guarantees  supporting these commitments.  Community had issued
$35.6 million of standby letters of credit as of September 30, 2004.  Management
believes that the proceeds  obtained through a liquidation of collateral and the
enforcement of guarantees  would be sufficient to cover the potential  amount of
future payment required under the corresponding  guarantees.  The current amount
of the liability as of September 30, 2004, for guarantees  under standby letters
of credit issued is not material.



                                       10
<PAGE>



Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS, (continued)
 (Unaudited)


5.  Subordinated Debt to Unconsolidated Subsidiary Trusts
---------------------------------------------------------

In  January  2003,  the  Financial   Accounting   Standards  Board  issued  FASB
Interpretation  No.  46,   "Consolidation  of  Variable  Interest  Entities,  an
Interpretation  of ARB  No.  51"  which  was  revised  in  December  2003.  This
Interpretation  provides  guidance for the  consolidation  of variable  interest
entities (VIEs).  CMTY Capital Trust I and CMTY Capital  Statutory Trust II (the
trusts) qualify as VIEs under FIN 46. The trusts issued  mandatorily  redeemable
preferred securities (Trust Preferred  Securities) to third- party investors and
loaned the proceeds to Community. The debentures held by each trust are the sole
assets of that trust.

In the first quarter of 2004, as a result of applying the  provisions of FIN 46,
which  represents  new accounting  guidance  governing the  consolidation  of an
equity  interest,  Community was required to  deconsolidate  the trusts from its
consolidated  financial  statements.  Prior  periods  have  been  restated.  The
deconsolidation  of the net assets and results of  operations  of the trusts had
virtually no impact on Community's  financial  statements or liquidity  position
since  Community  continues to be obligated to repay the debentures  held by the
trusts and guarantees  repayment of the capital securities issued by the trusts.
Community's total debt obligation  related to the trusts did increase,  however,
from $30 million to $30.9  million  upon  deconsolidation,  with the  difference
representing  Community's common ownership interest in the trusts,  which is now
reported in "Other assets."

For regulatory reporting purposes,  the Federal Reserve Board has an outstanding
proposal under which Trust Preferred Securities will continue to qualify as Tier
1 Capital  subject to new  restrictions.  It is anticipated  that Community will
continue to meet its minimum capital requirements under the proposed rule.



                                       11
<PAGE>



COMMUNITY BANKS, INC. AND SUBSIDIARIES

Part 1 - Item 2.   Management's Discussion and Analysis of Financial Condition
-------------------------------------------------------------------------------
and Results of Operations
-------------------------

Overview

The purpose of this review is to provide  additional  information  necessary  to
fully understand the consolidated  financial condition and results of operations
of  Community.  Throughout  this review,  net  interest  income and the yield on
earning  assets  are  stated on a fully  taxable-equivalent  basis and  balances
represent average daily balances unless otherwise indicated. In addition, income
statement comparisons are based on the first nine months of 2004 compared to the
same period of 2003 unless  otherwise  indicated.  Per share and number of share
amounts reflect stock splits and dividends.

Forward-Looking Statements

Periodically,  Community has made and will continue to make  statements that may
include  forward-looking  information.  Community cautions that  forward-looking
information disseminated through financial presentations should not be construed
as guarantees of future performance. Furthermore, actual results may differ from
expectations  contained  in such  forward-looking  information  as a  result  of
factors  that  are  not  predictable.  Examples  of  factors  that  may  not  be
predictable  or may be  out of  management's  control  include:  the  effect  of
prevailing  economic  conditions;  unforeseen or dramatic changes in the general
interest rate environment; actions or changes in policies of the Federal Reserve
Board and other  government  agencies;  and business  risk  associated  with the
management of the credit extension  function and fiduciary  activities.  Each of
these factors could affect estimates,  assumptions,  uncertainties and risk used
to develop forward-looking information, and could cause actual results to differ
materially from management's expectations regarding future performance.

Critical Accounting Policies

The following is a summary of those accounting policies that Community considers
to be most important to the portrayal of its financial  condition and results of
operations as they require  management's most difficult judgments as a result of
the need to make  estimates  about the  effects of matters  that are  inherently
uncertain.

Provision  and  Allowance  for Loan  Losses - The  allowance  for loan losses is
evaluated  on a  regular  basis by  management  and is based  upon  management's
periodic  review  of the  collectibility  of the  loans in  light of  historical
experience, the nature and volume of the loan portfolio, adverse situations that
may affect the borrower's  ability to repay,  estimated  value of any underlying
collateral and prevailing  economic  conditions.  This  evaluation is inherently
subjective as it requires estimates that are susceptible to significant revision
as additional information becomes available.

Impairment is measured on a loan by loan basis for commercial  and  construction
loans over  $250,000 by either the present  value of expected  future cash flows
discounted at the loan's effective  interest rate, the loan's  obtainable market
price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for
impairment.  Accordingly,  Community  does not  separately  identify  individual
consumer and residential loans for impairment disclosures.

Loans  continue  to be  classified  as impaired  unless  they are brought  fully
current and the  collection  of scheduled  interest and  principal is considered
probable.  When an impaired loan or portion of an impaired loan is determined to
be uncollectible,  the portion deemed  uncollectible is charged to the allowance
for  loan  losses,  and  subsequent  recoveries,  if any,  are  credited  to the
allowance for loan losses.




                                       12
<PAGE>




COMMUNITY BANKS, INC. AND SUBSIDIARIES

PART I - Item 2.    Management's Discussion and Analysis of Financial Condition
--------------------------------------------------------------------------------
and Results of Operations (continued)
-------------------------------------

SUMMARY OF FINANCIAL RESULTS
----------------------------

Earnings per share for the third quarter  reached $0.45, a 10% increase over the
$0.41  recorded in the third quarter of 2003. Net income for the quarter rose to
$5.6 million  versus $5.1 million in the third  quarter of the previous  year, a
quarter-to-quarter  increase of almost 10%.  Return on average assets and return
on average  equity reached 1.15% and 15.84%,  respectively,  for the three month
period ended September 30, 2004.

For the first nine months of 2004,  earnings  grew at a slightly  less  vigorous
pace than the  quarterly  comparisons.  Earnings per share grew to $1.29 for the
first three  quarters of 2004  compared to $1.22 in the same period of 2003,  an
increase of almost 6%. Net income for the period grew to $16.3 million  compared
to $15.2 million in 2003.

Results  during the third  quarter  continued to reflect many of the trends that
have influenced  performance throughout the first half of 2004. Loan and deposit
growth patterns have remained  consistently  strong throughout the year. Average
loans for the nine  months  ended  September  30,  2004 have grown 17%, to $1.14
billion,  from a year ago, while average  deposits have grown 11% to almost $1.3
billion.  Earnings  for  the  third  quarter  included  a  nonrecurring  gain of
approximately  $725,000  from the sale of the credit  card  portfolio,  which is
included in other income. On a comparative basis with the third quarter of 2003,
the credit card gain served to offset  declines in gains from security sales and
reduced fees from mortgage brokerage and title insurance activities. Declines in
refinancing  activity have  influenced  the  reductions in related  mortgage and
title insurance income.

Financial  performance  also  continues to be favorably  impacted by the overall
quality of the loan portfolio.  Even with growth in loan balances, asset quality
measures  continue  to  improve as  evidenced  by modest  charge-offs,  improved
allowance  for loan loss  coverage,  and low  levels of problem  credits.  These
trends  have  precluded  the  need  for  substantial   increases  in  loan  loss
provisions.

The record low level of  interest  rates  continues  to  moderate  growth in net
interest income.  Performance in this area was constricted  through much of 2003
due to declining interest rates. Increases in the volume of activity during 2004
have mitigated the adverse impact of the extended low interest rate environment.
Interest  spreads  appear to have  stabilized,  resulting in steady,  but modest
improvements  in net interest  income.  Additionally,  revenues  from  fee-based
services augmented the growth in net interest income and included increased fees
from the sales of annuities, brokerage products, and deposit fees from overdraft
privilege  services.  At the same time, more recent expense trends suggested the
potential for a more moderate  growth rate for core operating  expenses.  Higher
expense  growth in the first half of 2004 had been  influenced  by  acquisitions
which occurred in 2003 and by planned increases in marketing expenditures. Third
quarter expenses in 2004 actually  declined from the second quarter of the year,
including reduced salary and marketing costs.





                                       13
<PAGE>



COMMUNITY BANKS, INC. AND SUBSIDIARIES

PART I - Item 2.     Management's Discussion and Analysis of Financial Condition
--------------------------------------------------------------------------------
 and Results of Operations (continued)
--------------------------------------

RESULTS OF OPERATIONS

Nine months ended  September 30, 2004,  compared to nine months ended  September
--------------------------------------------------------------------------------
30, 2003
--------

Overview

Net income for the nine months  ended  September  30,  2004,  was $16.3  million
compared to $15.2  million in 2003,  an increase of $1.1 million or 7%.  Diluted
earnings per share were $1.29 for 2004 and $1.22 for 2003, resulting in a return
on average  stockholders' equity of 15.10% for 2004 compared to 15.12% for 2003.
The return on average assets was 1.12% for 2004 compared to 1.15% for 2003.

Net Interest Income

The  following  table  compares  net  interest  income and net  interest  margin
components  between  the  first  nine  months  of  2004  and  2003  (dollars  in
thousands):

<TABLE>
<CAPTION>

                                              Net Interest Margin - Year to Date
      -------------------------------------------------------------------------------------------------------------------------

      (dollars in thousands)                            September 30, 2004                        September 30, 2003
      ------------------------------------    ---------------------------------------    --------------------------------------
                                                               FTE         Average                       FTE          Average
                                                             Interest        Rate                      Interest        Rate
                                                Average       Income/       Earned/        Average      Income/       Earned/
                                                Balance       Expense        Paid          Balance      Expense        Paid
      ------------------------------------    ---------------------------------------    --------------------------------------
<S>                                           <C>           <C>                 <C>      <C>         <C>                  <C>
      Federal funds sold and interest-
            bearing deposits in banks         $    8,124    $       61          1.00%    $    1,116  $        7           0.84%
      Investment securities                      678,865        26,820          5.28%       688,069      26,346           5.12%
      Loans - commercial                         405,534        17,132          5.64%       329,523      15,359           6.23%
             - commercial real estate            298,111        13,450          6.03%       265,187      13,107           6.61%
             - residential real estate            96,162         4,808          6.68%       103,721       5,872           7.57%
             - consumer (1)                      340,820        16,693          6.54%       279,042      15,309           7.34%
      ------------------------------------    ---------------------------------------    --------------------------------------
      Total earning assets                    $1,827,616    $   78,964          5.77%    $1,666,658  $   76,000           6.10%
      ------------------------------------    ---------------------------------------    --------------------------------------

      Deposits - savings and NOW accounts     $  496,532    $    3,155          0.85%    $  387,112  $    2,387           0.82%
              -  time                            621,963        13,647          2.93%       610,772      15,168           3.32%
      Short-term borrowings                       62,763           524          1.12%       115,357       1,129           1.31%
      Long-term debt                             391,387        13,664          4.66%       322,774      12,697           5.26%
      Subordinated debt                           30,928         1,163          5.02%        15,464         542           4.69%
      ------------------------------------    ---------------------------------------    --------------------------------------
      Total interest-bearing liabilities      $1,603,573    $   32,153          2.68%    $1,451,479  $   31,923           2.94%
      ------------------------------------    ---------------------------------------    --------------------------------------

      Interest income to earning assets                                         5.77%                                     6.10%
      Interest expense to paying
      liabilities                                                               2.68%                                     2.94%
      ------------------------------------    ---------------------------------------    --------------------------------------

      Interest spread                                                           3.09%                                     3.16%
      Impact of non-interest funds                                              0.33%                                     0.39%
      ------------------------------------    ---------------------------------------    --------------------------------------
      Net interest margin                                   $   46,811          3.42%                $   44,077           3.55%
      ------------------------------------    ---------------------------------------    --------------------------------------
</TABLE>

        (1) Education loans held for sale are included in consumer loan earning
assets.



                                       14
<PAGE>

COMMUNITY BANKS, INC. AND SUBSIDIARIES

PART I - Item 2.     Management's Discussion and Analysis of Financial Condition
--------------------------------------------------------------------------------
 and Results of Operations (continued)
--------------------------------------


Interest  income totaled $79.0 million in 2004, 3.9% more than the $76.0 million
recorded in 2003,  despite an earning  asset yield  decline from 6.10% to 5.77%.
The increase in earning  assets offset the effect of lower earning asset yields.
From 2003 to 2004,  earning  assets grew $161 million,  with an increase of $163
million in loans and a decrease of $9 million in investment  securities.  Growth
in loans was funded principally by an increase in deposits.

Interest  expense on deposits  and  borrowings  increased  modestly,  from $31.9
million  in  2003  to  $32.1   million  in  2004.   The  average  rate  paid  on
interest-bearing    liabilities    declined   from   2.94%   to   2.68%,   while
interest-bearing  deposits  grew by nearly  $121  million.  The  majority of the
increase in deposits occurred in savings, Power Checking and other accounts that
were responsive to customer preferences for liquidity.

As a result of rate trends and other  dynamics  specific  to its balance  sheet,
Community reported a slight decline in net interest spread from 3.16% in 2003 to
3.09% in 2004, and a decline in net interest margin from 3.55% to 3.42% over the
same  period.  The  decline in margin  was also  linked to the impact of reduced
contribution  from  non-interest  funding sources,  which declined from 0.39% to
0.33%.  As noted in the  discussion  comparing  third  quarter  2004  results of
operations  to 2003,  interest  margins  on a  quarterly  basis  appear  to have
stabilized.


Provision for Loan Losses

The  provision for loan losses  increased  from $1.9 million for the nine months
ended September 30, 2003, to $2.4 million for 2004 while the relationship of the
allowance for loan losses to loans  declined from 1.26% at September 30, 2003 to
1.21% at  September  30,  2004.  The  provision  and the level of the  allowance
reflect  Community's  response to changing  credit  quality  conditions  of both
seasoned  loans and the  incremental  risk  identified  within the growing  loan
portfolio noted above. Net charge-offs during the first nine months of 2004 were
$1.1 million,  or 0.13% of average loans annualized,  compared to $803 thousand,
or .11% of average loans in 2003.


Non-Interest Income

Non-interest  income  totaled $17.8 million for the nine months ended  September
30, 2004, increasing $2.9 million, or 19%, from $14.9 million reported for 2003.
Excluding  investment  securities  gains,  non-interest  income  increased  $2.4
million.  The growth of non-interest  income reflected important steps Community
has   undertaken  to  solidify  and  expand  its   integrated   businesses   and
complementary banking services.

A  substantial  increase  in fees  occurred  in the area of  service  charges on
deposits.  Income of $5.1 million for 2004  increased 39% over 2003 results.  In
the first quarter of 2003, Community initiated a new service known as "Overdraft
Honor," a carefully  designed  program which enabled  customers who so choose to
have access to a service that  facilitates  payment of periodic  overdraft items
while  simultaneously  avoiding  adverse credit history events.  Fees from these
services,  coupled  with  considerable  growth  in the  number  of new  checking
accounts,  were  responsible for virtually all of the increase in this category.

Other service charges totaled $2.6 million for 2004, an increase of 10% from the
same  period  in 2003.  Other  service  charges  include  interchange  fees from
Community's ATM network and debit card transactions.  Nearly all of the increase
in these sources of fee income resulted from increased usage, reflecting growing
consumer acceptance of electronic transaction mediums.



                                       15
<PAGE>


COMMUNITY BANKS, INC. AND SUBSIDIARIES

PART I - Item 2.     Management's Discussion and Analysis of Financial Condition
--------------------------------------------------------------------------------
 and Results of Operations (continued)
--------------------------------------

Investment  security gains were $2.3 million for 2004,  compared to $1.8 million
for 2003.  Improvements  in the valuation of Community's  bank equity  portfolio
produced increased realized security gains.

Insurance  premiums  and  commissions  include  agency-based   commissions  from
commercial and personal lines,  fees from credit  insurance  related to consumer
lending,  and  the  revenue  from  title  insurance  and  settlement  activities
conducted through  Community's title insurance  subsidiary.  Income reported for
2004 totaled $2.4  million,  an increase of $310  thousand over the $2.1 million
reported  for 2003.  The  increase  was  related  to  agency-based  commissions,
including activity generated over a full nine month period from the acquisitions
of  insurance  agencies  later  in  2003.  Revenues  from  title  insurance  and
settlement  activity  declined $423 thousand from 2003 to 2004, and was directly
influenced by the decrease in mortgage refinancing activity by consumers.

Mortgage  banking income  increased  $200 thousand,  or 11%, to $2.0 million for
2004. The increase is attributable to activity  generated over a full nine month
period from the  acquisition of Erie Financial  Group,  Ltd., a mortgage  broker
service,  in July,  2003.  Community  has more  than  doubled  its  capacity  to
originate  mortgages  with  the  acquisition  of  Erie  and  has  become  a more
significant and efficient competitor in its core and extended Maryland markets.

Other income  totaling  $1.1 million for 2004 included a  non-recurring  gain of
$724  thousand in the third  quarter  from the sale of  Community's  credit card
portfolio.  Community  will  continue  to provide  credit  card  services to its
customer base, but will no longer retain the credits within its loan  portfolio.
For  2003,  other  income  totaling  $1.1  million  included  $497  thousand  of
nonrecurring  income  from a  curtailment  of benefits  in  Community's  defined
benefit pension plan.


Non-Interest Expenses

Total  non-interest  expenses  reached  $37.4  million for the nine months ended
September  30,  2004,  and  reflected  an 11%  increase  from the $33.8  million
recorded  in 2003.  Comparisons  between  2004 and 2003 were  influenced  by the
acquisitions of integrated  businesses  acquired in the second half of 2003, for
which a full nine months of expenses were included in 2004.  Comparisons  to the
most recent prior quarter yielded modest declines.

Salaries and employee benefits totaling $20.9 million for 2004,  represented 56%
of operating  costs, and increased $2.1 million,  or 11%,  compared to 2003. The
increase  was  affected  by a number of  factors,  including:  the annual  merit
increase;  employees  added through the expansion of Community's  office network
and its fee-based  activities;  and the  acquisitions of Abstracting  Company of
York County in April 2003,  Erie Financial  Group,  Ltd., in July 2003, and Your
Insurance Partnership in September 2003.

Occupancy  expenses were $6.0 million for 2004,  an increase of $.5 million,  or
12%,  over 2003 and  similarly  includes  the  effect of  branch  expansion  and
the acquisitions of fee-based companies.

Marketing expenses  increased $400 thousand,  or 27%, to a total of $1.9 million
for 2004,  versus 2003. During the first half of 2003,  increased  marketing and
promotional efforts had been undertaken to increase  Community's market share in
new markets and to preserve  and extend share in its legacy  communities.  Those
increased efforts have carried over to 2004 as Community  continues to execute a
targeted  strategic  marketing campaign that includes radio,  billboard,  direct
mail, and television mediums.

Income Taxes

Income tax expense for the nine months ended  September  30, 2004,  totaled $3.7
million,  resulting  in an  effective  tax rate of 18.7%,  compared to 18.1% for
2003. The relative mix of tax exempt income  influences the effective income tax
rate and remains the primary reason for the difference between the effective tax
rate and the statutory federal tax rate for corporations.


                                       16
<PAGE>


COMMUNITY BANKS, INC. AND SUBSIDIARIES

PART I - Item 2.     Management's Discussion and Analysis of Financial Condition
--------------------------------------------------------------------------------
 and Results of Operations (continued)
--------------------------------------

RESULTS OF OPERATIONS
---------------------

Quarter ended September 30, 2004, compared to quarter ended September 30, 2003
------------------------------------------------------------------------------

Overview

Net income for the third quarter of 2004  increased  $500  thousand,  or 10%, in
comparison  to net income for the third  quarter of 2003.  Diluted  earnings per
share  increased  $.04, or 10%, to $.45 for 2004, from $.41 for 2003. Net income
of  $5.6  million  for  2004  resulted  in  an  annualized   return  on  average
stockholders' equity of 15.84% and an annualized return on assets of 1.15%.


Net Interest Income

<TABLE>
<CAPTION>

                                                Net Interest Margin - Quarter to Date
      -------------------------------------------------------------------------------------------------------------------------

      (dollars in thousands)                            September 30, 2004                        September 30, 2003
      ------------------------------------    ---------------------------------------    --------------------------------------
                                                Average         FTE        Average       Average         FTE        Average
                                                             Interest       Rate                      Interest
                                                              Income/      Earned/                     Income/    Rate Earned/
                                                Balance       Expense       Paid          Balance      Expense        Paid
      ------------------------------------    ---------------------------------------    --------------------------------------
<S>                                           <C>           <C>                 <C>      <C>         <C>                  <C>
      Federal funds sold and interest-
            bearing deposits in banks         $    6,013    $       22          1.46%    $    1,277  $        4           1.24%
      Investment securities                      663,153         8,854          5.31%       682,608       8,484           4.93%
      Loans - commercial                         420,252         6,034          5.71%       348,904       5,273           6.00%
             - commercial real estate            308,927         4,667          6.01%       273,196       4,376           6.35%
             - residential real estate            95,693         1,559          6.48%        99,469       1,853           7.39%
             - consumer (1)                      351,181         5,704          6.46%       308,824       5,409           6.95%
      ------------------------------------    ---------------------------------------    --------------------------------------
      Total earning assets                    $1,845,219    $   26,840          5.79%    $1,714,278  $   25,399           5.88%
      ------------------------------------    ---------------------------------------    --------------------------------------

      Deposits - savings and NOW accounts     $  515,917    $    1,139          0.88%    $  417,872  $      825           0.78%
              -  time                            615,023         4,530          2.93%       604,951       4,838           3.17%
      Short-term borrowings                       59,464           202          1.35%       124,568         365           1.16%
      Long-term debt                             399,085         4,655          4.64%       328,508       4,316           5.21%
      Subordinated debt                           30,928           408          5.25%        15,464         176           4.52%
      ------------------------------------    ---------------------------------------    --------------------------------------
      Total interest-bearing liabilities      $1,620,417    $   10,934          2.68%    $1,491,363  $   10,520           2.80%
      ------------------------------------    ---------------------------------------    --------------------------------------

      Interest income to earning assets                                         5.79%                                     5.88%
      Interest expense to paying
      liabilities                                                               2.68%                                     2.80%
      ------------------------------------    ---------------------------------------    --------------------------------------

      Interest spread                                                           3.11%                                     3.08%
      Impact of non-interest funds                                              0.32%                                     0.36%
      ------------------------------------    ---------------------------------------    --------------------------------------
      Net interest margin                                   $   15,906          3.43%                $   14,879           3.44%
      ------------------------------------    ---------------------------------------    --------------------------------------
</TABLE>

        (1) Education loans held for sale are included in consumer loan earning
assets.

Interest  income  increased  from the $25.3  million  recorded  in 2003 to $26.8
million in 2004,  with an increase in earning assets from $1.71 billion to $1.85
billion  offset by a decline in earning asset yields from 5.88% to 5.79%.  Loans
grew $145  million and were  principally  funded by a $108  million  increase in
deposits.

Interest   expense  on   deposits   remained   steady,   with  an   increase  in
interest-bearing liabilities offset by a decrease in rates from 2.80% to 2.68%.

                                       17
<PAGE>

COMMUNITY BANKS, INC. AND SUBSIDIARIES

PART I - Item 2.     Management's Discussion and Analysis of Financial Condition
--------------------------------------------------------------------------------
 and Results of Operations (continued)
--------------------------------------

Net interest spread increased modestly from 3.08% in 2003 to 3.11% in 2004, with
a reduced  contribution from non-interest  funding sources resulting in flat net
interest margin  performance from 3.44% in 2003 to 3.43% in 2004. On a quarterly
basis,  net interest margin appears to have stabilized and has shown only modest
improvement since the fourth quarter of 2003 and the first quarter of 2004, when
it was 3.41% and 3.40%, respectively.


Provision for Loan Losses

The provision for loan losses decreased from $900 thousand for the quarter ended
September 30, 2003, to $750  thousand for 2004 based on  management's  quarterly
review of the loan portfolio and its assessment of loan quality;  identification
of impaired  loans;  analysis of  delinquencies  and loan growth;  evaluation of
potential  charge-offs  and  recoveries;  and  assessment  of  general  economic
conditions.


Non-Interest Income

Non-interest  income increased from $5.5 million for the quarter ended September
30, 2003,  to $6.0 million for the quarter ended  September 30, 2004.  Excluding
investment  securities gains,  non-interest  income increased $700 thousand,  or
13%. Factors contributing to changes between 2003 and 2004 are substantially the
same as those discussed above in the comparison of year-to-date results.

Investment  management  and trust  services  income  totaled $443  thousand,  an
increase of $151 thousand,  or 52%, over 2003,  reflecting a general increase in
income related to the sale of retail investment products.

Income from service charges on deposit accounts increased 48%, from $1.4 million
in 2003 to $2.0 million in 2004,  reflecting  primarily  the  "Overdraft  Honor"
service started in the first quarter of 2003.

Investment security gains were $108 thousand for 2004, compared to $302 thousand
for 2003. The gains recorded in 2004 were  principally  related to sales of bank
equity holdings.

Insurance  premiums  and  commissions  income  reported  for 2004  totaled  $708
thousand,  a decrease  of $111  thousand  over 2003.  Income  from  agency-based
commissions  and credit  insurance fees increased $147 thousand,  while revenues
from  title  insurance  and  settlement   activities  decreased  $258  thousand,
reflecting  the impact from the  decrease in  mortgage  refinancing  activity by
consumers.

Mortgage  banking income  decreased $378 thousand,  or 40%, to $558 thousand for
2004 which is also  attributable  to the  decrease in mortgage  refinancings  by
consumers.

Other income for 2004  included the  aforementioned  non-recurring  gain of $724
thousand from the sale of Community's credit card portfolio.  In 2003, Community
recognized $497 thousand of  nonrecurring  income from a curtailment of benefits
in its defined benefit pension plan.

Non-Interest Expenses

Non-interest  expenses totaled $12.5 million for the quarter ended September 30,
2004,  and  reflected an 8% increase,  or $1.0  million,  from the $11.5 million
recorded in 2003.  Factors  contributing  to changes  between  2004 and 2003 are
substantially   the  same  as  those   discussed  above  in  the  comparison  of
year-to-date results,  including the influence of integrated businesses acquired
in the first nine months of 2003,  for which a full nine months of expenses  was
included in 2004.

Salaries and employee benefits  totaling $7.0 million for 2004,  represented 56%
of operating costs, and increased $352 thousand, or 5%, compared to 2003.


                                       18
<PAGE>


COMMUNITY BANKS, INC. AND SUBSIDIARIES

PART I - Item 2.     Management's Discussion and Analysis of Financial Condition
--------------------------------------------------------------------------------
 and Results of Operations (continued)
--------------------------------------

Marketing expenses increased $199 thousand, or 48%, to a total of $611 thousand
for 2004 versus 2003, for continued expansion of marketing and promotional
efforts.


Income Taxes

Income tax expense for the quarter ended September 30, 2004, totaled $1.4
million, resulting in an effective tax rate of 19.6%, compared to the effective
rate of 18.0% for 2003. The relative mix of tax exempt income influences the
effective income tax rate.


FINANCIAL CONDITION
-------------------

The average balance sheets for the nine months ended September 30, 2004 and 2003
were as follows (dollars in thousands):
<TABLE>
<CAPTION>

                                                                September 30,                            Change
                                                      -----------------------------------    --------------------------------
                                                            2004              2003               Volume             %
           ------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>               <C>                  <C>                      <C>
           Cash and due from banks                    $       36,192    $        35,804      $         388            1
           Federal funds sold and other                        8,124              1,116              7,008          628
           Investments                                       678,865            688,069             (9,204)          (1)
           Loans held for sale                                 3,006              8,048             (5,042)         (63)
           Loans                                           1,138,093            973,752            164,341           17
           Allowance for loan losses                          14,025             12,874              1,151            9
           ------------------------------------------------------------------------------------------------------------------
           Net loans                                       1,124,068            960,878            163,190           17
           Goodwill and identifiable intangibles               4,858              2,375              2,483          105
           Other assets                                       80,602             70,008             10,594           15
           ------------------------------------------------------------------------------------------------------------------

           Total assets                               $    1,935,715    $     1,766,298      $     169,417           10
           ------------------------------------------------------------------------------------------------------------------

           Noninterest-bearing deposits               $      174,611    $       167,130      $       7,481            4
           Interest-bearing deposits                       1,118,495            997,885            120,610           12
           Short-term borrowings                              62,763            115,357            (52,594)        (46)
           Long-term debt                                    391,387            322,774             68,613           21
           Subordinated debt                                  30,928             15,464             15,464          100
           Other liabilities                                  13,716             13,066                650            5
           ------------------------------------------------------------------------------------------------------------------

           Total liabilities                               1,791,900          1,631,676            160,224           10
           ------------------------------------------------------------------------------------------------------------------

           Stockholders' equity                              143,815            134,622              9,193            7
           ------------------------------------------------------------------------------------------------------------------

           Total liabilities and stockholders'
           equity                                     $    1,935,715    $     1,766,298      $     169,417           10
           ==================================================================================================================
</TABLE>


                                       19
<PAGE>


COMMUNITY BANKS, INC. AND SUBSIDIARIES

PART I - Item 2.     Management's Discussion and Analysis of Financial Condition
--------------------------------------------------------------------------------
 and Results of Operations (continued)
--------------------------------------

Average  loans  reached $1.1 billion at September  30, 2004, a 17% increase over
the $974 million of average loans  recorded at September 30, 2003. The following
presentation  of average  loans at September 30 is an indication of the relative
mix of loans included in the portfolio (dollars in thousands):
<TABLE>
<CAPTION>

                                                                                                   Change
                                                          2004              2003           Amount            %
               --------------------------------------------------------------------------------------------------
<S>                                                 <C>               <C>               <C>                 <C>
               Commercial                           $        405,534  $       329,523   $      76,011       23%
               Commercial real estate                        298,111          265,187          32,924       12%
               Residential real estate                        96,162          103,721          (7,559)     (7)%
               Consumer                                      338,286          275,321          62,965       23%
               --------------------------------------------------------------------------------------------------
                    Total                           $      1,138,093  $       973,752   $     164,341       17%
               ==================================================================================================
</TABLE>


Declining  interest  rate  trends  have  caused  many  commercial  borrowers  to
reevaluate  their existing  credit  arrangements  in search of improved  funding
terms and more responsive credit relationships.  Community has consistently made
efforts to position  itself in the  marketplace to ensure its ability to compete
with large and small competitors alike. As a result,  Community has been able to
increase both its  commercial and  commercial  real estate  portfolios by nearly
$110 million on an aggregate basis.  Much of the growth in the commercial sector
was  attributed to  Community's  ability to acquire  existing  market  share.  A
portion of this growth  also can be  attributed  to the  addition of certain key
lending  personnel  made  available  as a result of mergers  of local  financial
institutions by out-of-market acquirers.

Significant growth also occurred in consumer lending,  which grew by $63 million
between September 30, 2003, and September 30, 2004,  particularly in home equity
lending.  Community has made efforts to increase its  visibility in core markets
as a more  effective  consumer  lender,  in part  by  substantial  increases  in
marketing and advertising  efforts.  Consumer demand for credit was aided by the
high levels of consumer confidence and improved credit affordability experienced
in the current  interest rate  environment.  Expansion of the office network and
increased  sales  efforts over the last several  years have also aided growth in
this area.

Residential real estate lending, primarily loans to single-family creditors, has
experienced  a steady  decline as a result of the  increasing  accessibility  of
secondary market liquidity through mortgage banking activities.  Community-based
banks  continue to provide a convenient  avenue for consumers to access  funding
for residential  lending, but most fixed-rate credits continue to be sold in the
secondary  market.  This strategy has reduced the interest rate risk  associated
with consumer  preferences for long-term,  fixed rate lending,  and continues to
provide valuable liquidity for other forms of relationship lending.

Deposit balances remain the primary source of funding.  Growth of nearly 12% was
reported, as indicated by the following summary of average balances at September
30 (dollars in thousands):
<TABLE>
<CAPTION>

                                                                                                  Change
                                                           2004             2003           Amount          %
                    -------------------------------------------------------------------------------------------
<S>                                                   <C>              <C>              <C>                <C>
                    Demand                            $       174,611  $       167,130  $      7,481       4%
                    Savings & NOW accounts                    496,532          387,113       109,419      28%
                    Time                                      508,544          499,872         8,672       2%
                    Time $100,000 or more                     113,419          110,900         2,519       2%
                    -------------------------------------------------------------------------------------------
                                                      $     1,293,106  $     1,165,015  $    128,091      11%
                    ===========================================================================================
</TABLE>


                                       20
<PAGE>


COMMUNITY BANKS, INC. AND SUBSIDIARIES

PART I - Item 2.     Management's Discussion and Analysis of Financial Condition
--------------------------------------------------------------------------------
 and Results of Operations (continued)
--------------------------------------

Deposit growth occurred primarily in savings and NOW deposits; more specifically
Community's Power Checking  account.  This account utilizes  characteristics  of
both a money  market and  checking  account  and  balances  have grown  steadily
throughout 2003 and 2004. At the same time,  longer term time deposit growth was
relatively flat. Consumer preferences have been weighted in favor of maintaining
adequate  liquidity in  anticipation  of a rise in rates.  Downward  pressure on
rates, combined with lack of confidence in other more risky investment vehicles,
increased  consumer  preference  for the  flexibility,  liquidity and guaranteed
return provided by these accounts.

Beginning  in the latter part of 2003,  Community  extended  the  maturities  of
overnight  borrowings  through the Federal  Home Loan Bank to take  advantage of
lower long-term rates on longer borrowings.


Capital

Regulators  have  established  standards for the monitoring  and  maintenance of
appropriate  levels of capital for financial  institutions.  Regulatory  capital
guidelines are based on a risk-based supervisory approach that has been designed
to ensure effective  management of capital levels and associated  business risk.
The following table provides the risk-based  capital  positions of Community and
its banking  subsidiary,  Community  Banks, at September 30, 2004,  along with a
comparison to the various current regulatory capital requirements:
<TABLE>
<CAPTION>

                                                                      September 30,      Regulatory         "Well
                                                                          2004            Minimum        Capitalized"
                                                                    --------------------------------------------------
                   Leverage ratio
                   --------------
<S>                                                                        <C>               <C>
                       Community Banks, Inc.                               8.56%             4%              n/a
                       Community Banks                                     7.94%             4%              5%

                   Tier 1 capital ratio
                   --------------------
                       Community Banks, Inc.                              11.48%             4%              n/a
                       Community Banks                                    10.63%             4%              6%

                   Total risk-based capital ratio
                   ------------------------------
                       Community Banks, Inc.                              12.49%             8%              n/a
                       Community Banks                                    11.63%             8%              10%
</TABLE>

At September 30, 2004, total  stockholders'  equity reflected  accumulated other
comprehensive  income of $5.1  million  compared to $6.6 million at December 31,
2003.  This decrease can be attributed to the change in the net unrealized  gain
on investment securities available for sale, net of taxes.


Off-Balance-Sheet Commitments


Financial instruments with  off-balance-sheet risk at September 30, 2004, are as
follows (in thousands):
<TABLE>
<CAPTION>

                                                                                  Contract Amount
                                                                             ----------------------
<S>                                                                               <C>
                     Commitments to fund loans                                    $       111,772
                     Unused lines of credit                                       $       329,825
                     Standby letters of credit                                    $        38,222
                     Unadvanced portions of construction loans                    $        56,481
</TABLE>


                                       21
<PAGE>


COMMUNITY BANKS, INC. AND SUBSIDIARIES

PART I - Item 3.     Quantitative and Qualitative Disclosures About Market Risk
-------------------------------------------------------------------------------

Market  risk,  the  exposure  to economic  loss that arises from  changes in the
values of certain financial  instruments  pursuant to factors arising out of the
various categories of market risk, can include a number of categories, including
interest rate risk, foreign currency risk,  exchange rate risk,  commodity price
risk, etc. For domestic, community-based banks, the vast majority of market risk
is related to interest rate risk.

The following  table  provides a measure of interest rate  sensitivity  for each
category  of  interest  earning  assets  and  interest  bearing  liabilities  at
September 30, 2004.
<TABLE>
<CAPTION>

           Interest Rate Sensitivity
           -----------------------------------------------------------------------------------------------------------------
                                                    1-90          90-180         180-365         1 year or        Total
           Dollars in thousands                     days           days            days             more
           -----------------------------------------------------------------------------------------------------------------

           Assets
<S>                                             <C>            <C>            <C>             <C>            <C>
           Federal funds sold                   $       9,566  $         ---  $         ---   $         ---  $       9,566
           Interest-bearing deposits in other
           banks                                        1,770            ---            ---             ---          1,770
           Loans held for sale(1)                         ---            ---            ---             946            946
           Investment securities                      112,150         55,918         24,969         450,554        643,591
           Loans(2)                                   454,204         65,430         92,603         576,043      1,188,280
           -----------------------------------------------------------------------------------------------------------------
           Earning assets                             577,690        121,348        117,572       1,027,543      1,844,153
           Non-earning assets                             222            ---            ---         111,436        111,658
           -----------------------------------------------------------------------------------------------------------------
           Total assets                         $     577,912  $     121,348  $     117,572   $   1,138,979  $   1,955,811
           -----------------------------------------------------------------------------------------------------------------

           Liabilities
           Savings                              $     268,171  $         ---  $         ---   $     247,131  $     515,302
           Time                                        87,050         61,025         97,407         267,281        512,763
           Time in denominations of  $100,000
               or more                                 22,971         12,834         21,507          48,486        105,798
           Short-term borrowings                       34,699            ---            ---             ---         34,699
           Long-term debt                               1,803          1,803         13,606         389,158        406,370
           Subordinated debt                           23,196            ---            ---           7,732         30,928
           -----------------------------------------------------------------------------------------------------------------
           Interest bearing liabilities               437,890         75,662        132,520         959,788      1,605,860
           Other liabilities and equity                   ---            ---            ---         349,951        349,951
           -----------------------------------------------------------------------------------------------------------------
           Total liabilities and equity         $     437,890  $      75,662  $     132,520   $   1,309,739  $   1,955,811
           -----------------------------------------------------------------------------------------------------------------
</TABLE>

   (1) Only education loans held for sale are included in earning assets. (2)
   Includes non-accrual loans.

<TABLE>
<CAPTION>

        Interest Sensitivity GAP
        --------------------------------------------------------------------------------------------------
        Dollars in                                 1-90          90-180         180-365       1 year or
        thousands                                  days           days           days            more
        --------------------------------------------------------------------------------------------------

<S>                                           <C>             <C>           <C>            <C>
        Periodic                              $     140,022   $     45,686  $    (14,948)  $   (170,760)
        Cumulative                                  140,022        185,708       170,760
        Cumulative GAP as a percentage
        of total assets                               7.2%          9.50%          8.73%          0.00%
</TABLE>


The  positive   GAP  between   interest-earning   assets  and   interest-bearing
liabilities maturing or repricing within one year approximated 8.7% at September
30, 2004 and has increased from 1.7% since December 31, 2003.


                                       22
<PAGE>


COMMUNITY BANKS, INC. AND SUBSIDIARIES

PART I - Item 4.  Controls and Procedures
-----------------------------------------

Under the  supervision  and with the  participation  of Community's  management,
including its Chief Executive Officer and Chief Financial Officer, Community has
evaluated the  effectiveness  of its  disclosure  controls and  procedures as of
September 30, 2004. Based upon this evaluation,  the Chief Executive Officer and
Chief Financial Officer have concluded that Community's  disclosure controls and
procedures  are  adequate  and  effective  to ensure that  material  information
relating to Community and its consolidated subsidiaries is made known to them by
others  within  those  entities,  particularly  during  the period in which this
quarterly  report was prepared.  There have not been any changes in  Community's
internal  control  over  financial  reporting  (as such term is defined in Rules
13a-15(f)  and  15d-15(f)  under the Exchange Act) during the most recent fiscal
quarter that have materially  affected,  or are reasonably  likely to materially
affect, Community's internal control over financial reporting.



                                       23
<PAGE>



COMMUNITY BANKS, INC. AND SUBSIDIARIES

                           PART II - OTHER INFORMATION



Item 1 - Legal Proceedings
--------------------------

     The nature of Community's business generates a certain amount of litigation
involving matters arising out of the ordinary course of business. In the opinion
of management,  there are no legal proceedings that might have a material effect
on the results of operations,  liquidity, or the financial position of Community
at this time.

Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
--------------------------------------------------------------------

  The following shares were purchased during the quarter as part of Community's
Share Repurchase Program:
<TABLE>
<CAPTION>

                                                        Average Price       Shares Purchased          Capacity to
                                        Shares              Paid               as part of              Purchase
                                      Purchased           Per Share        Repurchase Program         More Shares
                                   ---------------------------------------------------------------------------------

<S>                                     <C>                <C>                   <C>                    <C>
             07/1/04-07/31/04           20,500             $26.74                20,500                 109,434
             08/1/04-08/31/04           21,500             $26.37                21,500                  87,934
             09/1/04-09/30/04              ---                ---                   ---                  87,934
</TABLE>


Item 3 - Defaults Upon Senior Securities
----------------------------------------

          Not applicable.

Item 4 - Submission of Matters to a Vote of Security Holders
------------------------------------------------------------

          Not applicable.

Item 5 - Other Information
--------------------------

          Not applicable.


                                       24
<PAGE>



COMMUNITY BANKS, INC. AND SUBSIDIARIES

PART II - Other Information (continued)
---------------------------------------



Item 6 - Exhibits
------------------

 <TABLE>
<CAPTION>


<S>        <C>
           3.1      Amended Articles of Incorporation (Incorporated by reference
                    to Exhibit 3.1, attached to Community's registration on Form
                    8-A, filed on May 13, 2002)
           3.2      Amended By-Laws (Incorporated by reference to Exhibit 3.2,
                    attached to Community's Quarterly Report on Form 10-Q for
                    the quarter ended March 31, 2003, filed with the Commission
                    on May 15, 2003)
           4        Instruments defining the rights of the holders of trust
                    capital securities sold by Community in December 2002 and in
                    December 2003 are not attached, as the amount of such
                    securities is less than 10% of the consolidated assets of
                    Community and its subsidiaries, and the securities have not
                    been registered. Community agrees to provide copies of such
                    instruments to the SEC upon request.
           10.1     Employment agreement for Eddie L. Dunklebarger
           10.2     Employment agreement for Donald F. Holt
           10.3     Employment agreement for Robert W. Lawley
           10.4     Employment agreement for Anthony N. Leo
           10.5     Employment agreement for Jeffrey M. Seibert
           31.1     Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer)
           31.2     Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer)
           32.1     Section 1350 Certification (Chief Executive Officer)
           32.2     Section 1350 Certification (Chief Financial Officer)
</TABLE>




                                       25
<PAGE>


                                   SIGNATURES

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

                              COMMUNITY BANKS, INC.
                                  (Registrant)

Date  November 9, 2004                              /s/ Eddie L. Dunklebarger
    ---------------------                          -----------------------------
                                                        Eddie L. Dunklebarger
                                                        Chairman and President
                                                       (Chief Executive Officer)

Date  November 9, 2004                             /s/ Donald F. Holt
    ---------------------                          -----------------------------
                                                       Donald F. Holt
                                                       Executive Vice President
                                                      (Chief Financial Officer)


                                       26