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 June 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 July 31, 2004

    CAPITAL STOCK-COMMON                                   12,193,000
    ---------------------                             --------------------
       (Title of Class)                                (Outstanding Shares)



<PAGE>


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


<TABLE>
<CAPTION>


<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.     Changes in Securities, Use of Proceeds and Issuer Purchases                                     24
            of Equity Securities

         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 and Reports on Form 8-K                                                                25


         SIGNATURES                                                                                                  26

</TABLE>


                                       2
<PAGE>




                         PART I - FINANCIAL INFORMATION

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

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

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

<S>                                                                        <C>                        <C>
      Cash and due from banks                                              $            41,434        $            42,790
      Federal funds sold                                                                   ---                     17,097
                                                                           -------------------        -------------------
         Cash and cash equivalents                                                      41,434                     59,887
      Interest-bearing time deposits in other banks                                      2,803                      3,301
      Investment securities, available for sale                                        678,856                    646,961
      Loans held for sale                                                                  648                      6,067
      Loans:                                                                         1,161,368                  1,078,611
         Less:  Allowance for loans losses                                             (14,294)                   (13,178)
                                                                           -------------------        -------------------
              Net loans                                                              1,147,074                  1,065,433
      Premises and equipment, net                                                       25,002                     24,153
      Goodwill and identifiable intangible assets                                        4,976                      4,773
      Accrued interest receivable and other assets                                      60,268                     50,488
                                                                           -------------------        -------------------
              Total assets                                                 $         1,961,061        $         1,861,063
                                                                           ===================        ===================

      LIABILITIES

      Deposits
         Non-interest bearing                                              $           184,114        $           165,174
         Interest bearing                                                            1,113,256                  1,065,511
                                                                           -------------------        -------------------
              Total deposits                                                         1,297,370                  1,230,685
      Short-term borrowings                                                            110,475                     27,764
      Long-term debt                                                                   373,066                    411,422
      Subordinated debt                                                                 30,928                     30,928
      Accrued interest payable and other liabilities                                    13,087                     16,858
                                                                           -------------------        -------------------
              Total liabilities                                                      1,824,926                  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                                                                           73,224                     57,563
      Retained Earnings                                                                 11,302                     24,297
      Accumulated other comprehensive income (loss),
         net of tax                                                                     (5,607)                     6,596
      Treasury stock; 210,000 and 203,000
         shares in 2004 and 2003, at cost                                               (4,892)                    (4,306)
                                                                           -------------------        -------------------
              Total stockholders' equity                                               136,135                    143,406
                                                                           -------------------        -------------------
              Total liabilities and stockholders' equity                   $         1,961,061        $         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                  Six Months Ended
                                                                          June 30,                           June 30,
                                                              -------------------------------    --------------------------------
                                                                   2004              2003             2004              2003
                                                              --------------    -------------    --------------    --------------
   INTEREST INCOME:
<S>                                                           <C>               <C>              <C>               <C>
      Loans, including fees                                   $      16,996     $     16,364     $      33,654     $     32,430
      Investment securities:
          Taxable                                                     5,091            4,595             9,653            9,572
          Tax exempt                                                  2,258            2,251             4,453            4,531
          Dividends                                                     511              512             1,063              958
      Other                                                              26                1                39                3
                                                              --------------    -------------    --------------    --------------
          Total interest income                                      24,882           23,723            48,862           47,494
                                                              --------------    -------------    --------------    --------------

   INTEREST EXPENSE:
      Deposits                                                        5,675            5,874            11,133           11,892
      Short-term borrowings                                             198              430               322              764
      Long-term debt                                                  4,428            4,214             9,009            8,381
      Subordinated debt                                                 377              181               755              365
                                                              --------------    -------------    --------------    --------------
          Total interest expense                                     10,678           10,699            21,219           21,402
                                                              --------------    -------------    --------------    --------------
          Net interest income                                        14,204           13,024            27,643           26,092
   Provision for loan losses                                            750              600             1,600            1,000
                                                              --------------    -------------    --------------    --------------
          Net interest income after provision for loan
          losses                                                     13,454           12,424            26,043           25,092
                                                              --------------    -------------    --------------    --------------

   NON-INTEREST INCOME:
      Investment management and trust services                          409              333               676              650
      Service charges on deposit accounts                             1,707            1,295             3,112            2,336
      Other service charges, commissions and fees                       775              776             1,677            1,530
      Investment security gains                                         844              500             2,176            1,547
      Insurance premium income and commissions                        1,025              848             1,679            1,258
      Mortgage banking activities                                       828              445             1,455              871
      Earnings on investment in life insurance                          412              443               777              772
      Other                                                             156              371               227              441
                                                              --------------    -------------    --------------    --------------
          Total non-interest income                                   6,156            5,011            11,779            9,405
                                                              --------------    -------------    --------------    --------------

   NON-INTEREST EXPENSES:
      Salaries and employee benefits                                  7,041            6,276            13,876           12,176
      Net occupancy                                                   1,995            1,778             4,028            3,544
      Marketing expense                                                 869              571             1,289            1,085
      Telecommunications expense                                        344              327               661              527
      Other                                                           2,713            2,437             4,991            4,846
                                                              --------------    -------------    --------------    --------------
          Total non-interest expenses                                12,962           11,389            24,845           22,178
                                                              --------------    -------------    --------------    --------------

          Income before income taxes                                  6,648            6,046            12,977           12,319
   Income taxes                                                       1,211            1,070             2,365            2,242
                                                              --------------    -------------    --------------    --------------
          Net income                                          $       5,437     $      4,976     $      10,612     $     10,077
                                                              ==============    =============    ==============    ==============

   CONSOLIDATED PER SHARE DATA:
      Basic earnings per share                                $         .45     $        .41     $         .87     $        .83
      Diluted earnings per share                              $         .43     $        .40     $         .84     $        .81
      Dividends declared                                      $         .17     $        .16     $         .33     $        .31
</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
                                                                                             Comprehensive
                                        Outstanding      Common                 Retained        Income      Treasury      Total
                                          Shares         Stock       Surplus    Earnings        (Loss)        Stock       Equity
                                        -----------   --------------------------------------------------------------   -----------
<S>                                         <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                                                                     10,077                                   10,077
    Unrealized gain on securities,
      net of reclassification
      adjustment and tax effect                                                                     7,088                    7,088
                                                                                                                       -----------
    Total comprehensive income                                                                                              17,165
Cash dividends                                                                     (3,750)                                  (3,750)
5% stock dividend                             458          2,346       10,612     (12,984)                                     (26)
Purchases of treasury
stock                                        (100)                                                            (2,822)       (2,822)
Exercise of common stock options
    and issuances under stock
    purchase plan                             107            (11)                    (590)                     2,646         2,045
Tax benefits from employee stock
    transactions                                                          288                                                  288
                                        -----------   --------------------------------------------------------------   -----------

Balance, June 30, 2003                      9,616     $   49,388   $   57,318   $  28,097   $      13,626   $ (6,367)  $   142,062
                                        ===========   ==============================================================   ===========




Balance, January 1, 2004                   11,648     $   59,256   $   57,563   $  24,297   $       6,596   $ (4,306)  $   143,406
Comprehensive income (loss):
    Net income                                                                     10,612                                   10,612
    Unrealized loss on securities,
      net of reclassification
      adjustment and tax effect                                                                  (12,203)                  (12,203)
                                                                                                                       -----------
    Total comprehensive income (loss)                                                                                       (1,591)
Cash dividends                                                                     (4,065)                                  (4,065)
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                  (102)                                                            (3,036)       (3,036)
Exercise of common stock options
    and issuances under stock
    purchase plan                              82            (97)                  (1,432)                     2,450           921
Tax benefits from employee stock
    transactions                                                          558                                                  558
                                        -----------   --------------------------------------------------------------   -----------

Balance, June 30, 2004                     12,212     $   62,108   $   73,224   $  11,302   $      (5,607)  $ (4,892)  $   136,135
                                        ===========   ==============================================================   ===========
</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>
                                                                                               Six Months Ended
                                                                                                    June 30,
                                                                                   ----------------------------------------
                                                                                         2004                    2003
                                                                                   ----------------------------------------

    Operating Activities:
<S>                                                                                <C>                     <C>
       Net income                                                                  $          10,612       $         10,077
    Adjustments to reconcile net income to net cash
      provided by operating activities:
       Provision for loan losses                                                               1,600                  1,000
       Depreciation and amortization                                                           1,641                  1,532
       Amortization of security premiums and discounts, net                                      607                  1,436
       Investment security gains                                                              (2,176)                (1,547)
       Loans originated for sale                                                              (6,601)               (39,711)
       Proceeds from sales of loans                                                           12,297                 45,284
       Gains on loan sales                                                                      (277)                  (871)
       Earnings on investment in life insurance                                                 (777)                  (772)
       Change in other assets, net                                                             3,058                  4,219
       Change in accrued interest payable and other liabilities, net                          (3,175)                (3,946)
                                                                                   -----------------       ----------------
            Net cash provided by operating activities                                         16,809                 16,701
                                                                                   -----------------       ----------------

    Investing Activities:
       Net (increase) decrease in interest-bearing time deposits
         in other banks                                                                          498                    (89)
       Proceeds from sales of investment securities                                           69,049                110,442
       Proceeds from maturities of investment securities                                      83,196                 73,013
       Purchases of investment securities                                                   (201,484)              (218,154)
       Net increase in total loans                                                           (83,780)              (100,170)
       Investment in life insurance                                                           (5,000)                   ---
       Net additions to premises and equipment                                                (2,261)                (1,448)
       Other                                                                                    (282)                  (322)
                                                                                   -----------------       ----------------
           Net cash used by investing activities                                            (140,064)              (136,728)
                                                                                   -----------------       ----------------

    Financing Activities:
       Net increase in deposits                                                               66,685                 61,312
       Net increase in short-term borrowings                                                  57,711                 86,890
       Repayment of long-term debt                                                           (13,356)                (1,421)
       Cash dividends and cash paid in lieu of fractional shares                              (4,123)                (3,750)
       Purchases of treasury stock                                                            (3,036)                (2,822)
       Proceeds from issuance of common stock                                                    921                  2,045
                                                                                   -----------------       ----------------
           Net cash provided by financing activities                                         104,802                142,254
                                                                                   -----------------       ----------------

           Increase (decrease) in cash and cash equivalents                                  (18,453)                22,227

    Cash and cash equivalents at beginning of period                                          59,887                 36,137
                                                                                   -----------------       ----------------
    Cash and cash equivalents at end of period                                     $          41,434       $         58,364
                                                                                   =================       ================
</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 six months ended June 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.

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                Six Months Ended
                                                                           June 30,                        June 30,
                                                                     2004            2003            2004            2003
                                                                 ---------------------------     ----------------------------

<S>                                                              <C>             <C>             <C>             <C>
         Net income, as reported                                 $     5,437     $    4,976      $    10,612     $    10,077
         Deduct:  Total stock-based compensation
           expense determined under fair value based
           method for all awards, net of related tax effect              322            187              644             373
                                                                 ------------    -----------     ------------    -------------
                                                                 ------------    -----------     ------------    -------------

         Pro forma net income                                    $     5,115     $    4,789      $     9,968     $     9,704
                                                                 ============    ===========     ============    =============
                                                                 ============    ===========     ============    =============

         Earnings per share:
           Basic - as reported                                   $       .45     $      .41      $       .87     $       .83
           Basic - pro forma                                     $       .41     $      .39      $       .81     $       .80

           Diluted - as reported                                 $       .43     $      .40      $       .84     $       .81
           Diluted - pro forma                                   $       .41     $      .38      $       .79     $       .78
</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 June 30 are as follows (in thousands):
<TABLE>
<CAPTION>

                                                                Three Months Ended                   Six Months Ended
                                                                     June 30,                            June 30,
                                                         --------------------------------    --------------------------------
                                                              2004              2003              2004              2003
                                                         --------------------------------    --------------------------------

<S>                                                      <C>               <C>               <C>               <C>
              Unrealized holding gains (losses)
                   on available-for-sale securities      $    (24,096)     $     12,275      $    (16,598)     $     12,451
              Reclassification adjustments for
                   gains included in net income                  (844)             (500)           (2,176)           (1,547)
                                                         --------------    --------------    --------------    --------------
              Net unrealized gains (losses)                   (24,940)           11,775           (18,774)           10,904
              Tax effect                                        8,729            (4,121)            6,571            (3,816)
                                                         --------------    --------------    --------------    --------------

                                                         $    (16,211)     $      7,654      $    (12,203)     $      7,088
                                                         ==============    ==============    ==============    ==============
</TABLE>

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

<TABLE>
<CAPTION>

                                                                             June 30,           December 31,
                                                                               2004                2003
                                                                         ----------------    ----------------
<S>                                                                      <C>
               Net unrealized gain (loss) on
                    available-for-sale securities                        $        (5,428)    $        13,347
               Tax effect                                                          1,900              (4,672)
                                                                         ----------------    ----------------
                    Net-of-tax amount                                             (3,528)              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 (loss)             $        (5,607)    $         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.




                                       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>

                                                         Six Months Ended          Year Ended          Six Months Ended
                                                             June 30,              December 31,             June 30,
                                                               2004                   2003                   2003
                                                         ----------------        ----------------      ----------------

<S>                                                      <C>                     <C>                   <C>
          Balance, January 1                             $        13,178         $        12,343       $        12,343
          Provision for loan losses                                1,600                   2,500                 1,000
          Loan charge-offs                                        (1,202)                 (2,839)                 (796)
          Recoveries                                                 718                   1,174                   375
                                                         ----------------        ----------------      ----------------
          Balance, end of period                         $        14,294         $        13,178       $        12,922
                                                         ================        ================      ================
</TABLE>



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

                                                             June 30,              December 31,            June 30,
                                                               2004                    2003                  2003
                                                         ----------------        ----------------      ----------------

<S>                                                      <C>                     <C>                   <C>
          Non-accrual loans                              $         6,244         $         8,151       $        11,281
          Foreclosed real estate                                   1,788                   4,865                   359
                                                         ----------------        ----------------      ----------------
               Total non-performing assets                         8,032                  13,016                11,640
          Accruing loans 90 days past due                             32                      90                    61
                                                         ----------------        ----------------      ----------------

          Total risk elements                            $         8,064         $        13,106       $        11,701
                                                         ================        ================      ================
</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 six months ended June 30, 2004 and
2003 have been computed as follows (in thousands, except per share data):

<TABLE>
<CAPTION>
                                                                 Three Months Ended              Six Months Ended
                                                                      June 30,                       June 30,
                                                             ---------------------------    ---------------------------
                                                                 2004            2003           2004            2003
                                                             ------------    -----------    ------------    -----------

<S>                                                          <C>             <C>            <C>             <C>
        Net income                                           $     5,437     $    4,976     $    10,612     $   10,077
                                                             ============    ===========    ============    ===========

        Weighted average shares outstanding  (basic)              12,244         12,127          12,258         12,111
        Effect of dilutive stock options                             343            306             361            290
                                                             ------------    -----------    ------------    -----------

        Weighted average shares outstanding  (diluted)            12,587         12,433          12,619         12,401
                                                             ============    ===========    ============    ===========

        Per share information:
            Basic earnings per share                         $      0.45     $     0.41     $      0.87     $     0.83
            Diluted earnings per share                              0.43           0.40            0.84           0.81
</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
$36.0  million of  standby  letters  of credit as of June 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 June 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 six 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 for the second quarter of 2004 rose to $0.43 per share,  an 8% increase
over $0.40  recorded in the second  quarter of 2003.  Net income for the quarter
rose to $5.4 million  versus $5.0 in the second  quarter of the previous year, a
quarter-to-quarter  increase  of 9%.  Return on  average  assets  and  return on
average equity reached 1.11% and 15.37%, respectively, for the quarter.

For the first six months of 2004,  earnings  grew at a slightly less robust pace
than the quarterly  comparisons.  Earnings per share grew to $0.84 for the first
half of 2004  compared to $0.81 in the same period of 2003,  an increase of just
under 4%.  Net income for the period  grew to $10.6  million  compared  to $10.1
million in 2003.

In spite of an uncertain economic and political  climate,  operating results for
the periods ended June 30, 2004 reflected meaningful  improvement in a number of
key performance areas.  Growth in average balances between the second quarter of
2003 and 2004  resulted  in an  increase  in loans and  deposits of 16% and 13%,
respectively.  Balances at the end of June for loans and  deposits  reached $1.2
billion  and  $1.3  billion,   respectively.   Additionally,   critical  metrics
associated  with asset quality  within the loan  portfolio  continued to reflect
improving trends, including reduced levels of nonperforming assets and declining
net charge offs. At the same time,  the  allowance for loan losses  continues to
provide adequate coverage over credit risk inherent in the portfolio.

For the first time in several quarters  Community  recorded a slight improvement
in net interest  margin,  or the difference  between the yield on earning assets
and the cost of funding  sources.  More recent  changes in interest rate indices
have the potential for financial institutions such as CommunityBanks to increase
the spread between asset yields and funding sources.









                                       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

Six months ended June 30, 2004, compared to six months ended June 30, 2003
--------------------------------------------------------------------------

Overview

Net income for the six months ended June 30, 2004, was $10.6 million compared to
$10.1  million in 2003, an increase of $.5 million or 5%.  Diluted  earnings per
share  were $.84 for 2004 and $.81 for 2003,  resulting  in a return on  average
assets  of  1.11%  for 2004  versus  1.17%  for  2003.  The  return  on  average
stockholders'  equity was 14.74% for 2004 compared to 15.21% for 2003, while the
return on average realized equity was 15.26% for 2004 and 16.18% for 2003.


Net Interest Income

The  following  table  compares  net  interest  income and net  interest  margin
components between the first six months of 2004 and 2003 (dollars in thousands):
<TABLE>
<CAPTION>

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

      (dollars in thousands)                              June 30, 2004                              June 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-        $    9,179    $       39          0.85%    $    1,036    $        3           0.58%
            bearing deposits in banks
      Investment securities                      686,825        17,966          5.26%       690,800        17,862           5.21%
      Loans - commercial                         398,176        11,098          5.61%       319,833        10,086           6.36%
             - commercial real estate            292,703         8,783          6.03%       261,183         8,731           6.74%
             - residential real estate            96,397         3,249          6.78%       105,847         4,019           7.66%
             - consumer (1)                      335,639        10,989          6.58%       264,149         9,900           7.56%
      ------------------------------------    ---------------------------------------    ----------------------------------------
      Total earning assets                    $1,818,919    $   52,124          5.76%    $1,642,848    $   50,601           6.21%
      ------------------------------------    ---------------------------------------    ----------------------------------------

      Deposits - savings and NOW accounts     $  486,839    $    2,016          0.83%    $  371,733    $    1,562           0.85%
              -  time                            625,433         9,117          2.93%       613,683        10,330           3.39%
      Short-term borrowings                       67,677           322          0.96%       110,751           764           1.39%
      Long-term debt                             388,952         9,009          4.66%       319,906         8,381           5.28%
      Subordinated debt                           30,928           755          4.91%        15,464           365           4.76%
      ------------------------------------    ---------------------------------------    ----------------------------------------
      Total interest-bearing liabilities      $1,599,829    $   21,219          2.67%    $1,431,537    $   21,402           3.01%
      ------------------------------------    ---------------------------------------    ----------------------------------------

      Interest income to earning assets                                         5.76%                                       6.21%
      Interest expense to paying
      liabilities                                                               2.67%                                       3.01%
      ------------------------------------    ---------------------------------------    ----------- ----------------------------
      Interest spread                                                           3.09%                                       3.20%
      Impact of non-interest funds                                              0.33%                                       0.39%
      ------------------------------------    ---------------------------------------    ----------------------------------------
      Net interest margin                                   $   30,905          3.42%                  $   29,199           3.59%
      ------------------------------------    ---------------------------------------    ----------------------------------------
</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 /Earning Assets

Interest  income  totaled  $52.1  million in 2004,  slightly  ahead of the $50.6
million  recorded in 2003,  despite an earning asset yield decline from 6.21% to
5.76%.  Earning assets  increased from $1.64 billion to $1.82 billion and helped
to offset the effect of lower earning asset yields.  From 2003 to 2004,  earning
assets  grew $176  million,  with an  increase  of $172  million  in loans and a
decrease  of $4 million  in  investment  securities.  Growth in loans was funded
principally by an increase in deposits.

Interest Expense / Funding Sources

Interest  expense on  deposits  declined,  contributing  to the  increase in net
interest  income.  The rate  environment  that generated  modest  improvement in
interest income also enabled  Community to marginally reduce its overall funding
costs from $21.4 million in 2003 to $21.2 million in 2004 while interest-bearing
deposits grew by nearly $127 million.  The majority of this increase occurred in
savings,  Power  Checking and other  accounts  that were  responsive to customer
preferences for liquidity.

At various times during 2003,  Community  increased  its  long-term  borrowings,
which are composed  principally  of term funding  available  through the Federal
Home Loan Bank  program.  Community  experienced  a 25%  increase  in  long-term
funding, which included the $15 million in trust preferred instruments issued at
the end of 2003.

Interest Spread and Net Interest Margin

As a result of rate trends and other  dynamics  specific  to its balance  sheet,
Community  reported a decline in net interest spread from 3.20% in 2003 to 3.09%
in 2004, and a decline in net interest  margin from 3.59% 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%.


Provision for Loan Losses

The  provision  for loan losses  increased  from $1.0 million for the six months
ended June 30,  2003,  to $1.6  million for 2004 while the  relationship  of the
allowance for loan losses to loans declined from 1.29% at June 30, 2003 to 1.23%
at June 30, 2004. The provision and the level of the allowance  were  responsive
to the  changing  credit  quality  conditions  of both  seasoned  loans  and the
incremental  risk identified  within a growing loan  portfolio.  Net charge-offs
during the first six months of 2004 were $.5 million,  or 0.09% of average loans
annualized.


Non-Interest Income

Non-interest  income  totaled  $11.8  million for the six months  ended June 30,
2004, an increase of $2.4 million,  or 25%, from $9.4 million reported for 2003.
Excluding  investment  securities  gains,  non-interest  income  increased  $1.7
million,  or 22%. The growth of non-interest  income  reflected  important steps
undertaken in 2003 to solidify and expand Community's  integrated businesses and
complementary banking services.

A  substantial  increase  in fees  occurred  in the area of  service  charges on
deposits.  Income  was $3.1  million  for  2004,  an  increase  of 33% over 2003
results.  In the first quarter of 2003,  Community initiated a new service known
as "Overdraft  Honor." Under this carefully  designed program,  customers who so
choose  now have  access to a  service  that  facilitates  payment  of  periodic
overdraft  items while  simultaneously  avoiding  adverse credit history events.
Fees from these  services,  which were not provided prior to 2003,  coupled with
considerable growth in the number of new checking accounts, were responsible for
virtually all of the increase in this category.


                                       15
<PAGE>

COMMUNITY BANKS, INC. AND SUBSIDIARIES

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

Other service charges totaled $1.7 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 and  growing
consumer  acceptance  of  electronic  mediums as a substitute  for cash or paper
check-based transactions.

Investment  security gains were $2.2 million for 2004,  compared to $1.5 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  reinsurance  activities 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 $1.7  million,  an increase of $400  thousand over the
$1.3 million  reported for 2003. The increase was related to an overall increase
in  mortgage  loan  originations,  the  addition  of the ABCO  franchise  at the
beginning  of the second  quarter of 2003 and to the  acquisitions  of insurance
agencies later in 2003.

Mortgage  banking income  increased  $600 thousand,  or 67%, to $1.5 million for
2004. The increase is attributable to activity generated 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.

Non-Interest Expenses

Total non-interest  expenses reached $24.9 million for the six months ended June
30, 2004, and reflected a 12% increase,  or $2.7 million, from the $22.2 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 six months of expenses  were included in 2004.  Comparisons  to the
most recent prior quarter yielded only modest increases.

Salaries and employee benefits totaling $13.9 million for 2004,  represented 56%
of operating  costs, and increased $1.7 million,  or 14%,  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 $4.0 million for 2004,  an increase of $.5 million,  or
14%,  over 2003 and  similarly  includes  the  effect of  branch  expansion  and
corporate acquisitions.

Marketing expenses  increased $204 thousand,  or 19%, to a total of $1.3 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.

Telecommunications  expenses increased $134 thousand, or 25%, from 2003 to 2004,
for costs  associated with upgrades of existing  systems and increased costs for
the growing office network.

Income Taxes

Income tax expense for the six months ended June 30, 2004, totaled $2.4 million,
resulting in an effective tax rate of 18.2%,  which was the same  effective rate
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 June 30, 2004, compared to quarter ended June 30, 2003
--------------------------------------------------------------------

Overview

Net  income  for the  second  quarter  of 2004  increased  $461,000,  or 9%,  in
comparison to net income for the second  quarter of 2003.  Diluted  earnings per
share increased $.03, or 8%, to $.43 for 2004, from $.40 for 2003. Net income of
$5.4  million for 2004  resulted in an  annualized  return on average  assets of
1.11% and an annualized return on average stockholders' equity of 15.37%.


Net Interest Income

<TABLE>
<CAPTION>

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

      (dollars in thousands)                              June 30, 2004                              June 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-        $   11,960    $       26          0.87%    $      914    $       1          0.44%
         bearing deposits in banks
      Investment securities                      701,904         9,268          5.31%       695,395        8,763          5.05%
      Loans - commercial                         402,566         5,516          5.51%       334,026        5,137          6.17%
            - commercial real estate             302,104         4,574          6.09%       271,094        4,422          6.54%
            - residential real estate             95,009         1,574          6.66%       103,291        1,943          7.55%
            - consumer (1)                       340,942         5,563          6.56%       274,439        5,046          7.37%
      ------------------------------------    ---------------------------------------    ---------------------------------------
      Total earning assets                    $1,854,485    $   26,521          5.75%    $1,679,159    $  25,312          6.05%
      ------------------------------------    ---------------------------------------    ---------------------------------------

      Deposits - savings and NOW accounts     $  516,409    $    1,127          0.88%    $  386,797    $     807          0.84%
              -  time                            629,837         4,548          2.90%       614,035        5,067          3.31%
      Short-term borrowings                       83,333           198          0.96%       125,384          430          1.38%
      Long-term debt                             367,757         4,428          4.84%       319,550        4,214          5.29%
      Subordinated debt                           30,928           377          4.90%        15,464          181          4.49%
      ------------------------------------    ---------------------------------------    ---------------------------------------
      Total interest-bearing liabilities      $1,628,264    $   10,678          2.64%    $1,461,230    $  10,699          2.94%
      ------------------------------------    ---------------------------------------    ---------------------------------------

      Interest income to earning assets                                         5.75%                                     6.05%
      Interest expense to paying
      liabilities                                                               2.64%                                     2.94%
      ------------------------------------    ---------------------------------------    ---------------------------------------
      Interest spread                                                           3.11%                                     3.11%
      Impact of non-interest funds                                              0.33%                                     0.38%
      ------------------------------------    ---------------------------------------    ---------------------------------------
      Net interest margin                                   $   15,843          3.44%                  $  14,613          3.49%
      ------------------------------------    ---------------------------------------    ---------------------------------------
</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 $26.5
million in 2004,  with an increase in earning assets from $1.68 billion to $1.85
billion  offset by a decline in earning asset yields from 6.05% to 5.75%.  Loans
grew $158  million and were  principally  funded by a $145  million  increase in
deposits.

Interest   expense  on   deposits   remained   steady,   with  an   increase  in
interest-bearing liabilities offset by a decrease in rates from 2.94% to 2.64%.

                                       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 was 3.11% for each quarter, with a reduced contribution from
non-interest funding sources resulting in a decrease in net interest margin from
3.49% in 2003 to 3.44% in 2004.


Provision for Loan Losses

The provision for loan losses increased from $600 thousand for the quarter ended
June 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 $5.0 million for the quarter ended June 30,
2003, to $6.2 million for the quarter ended June 30, 2004.  Excluding investment
securities gains,  non-interest income increased $801 thousand,  or 18%. 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 $409  thousand,  an
increase of $76 thousand,  or 23%, over 2003,  reflecting a general  increase in
income related to  Community's  limited trust  department  activities as well as
from the sale of additional investment products.

Income from service charges on deposit accounts increased 32%, from $1.3 million
in 2003 to $1.7 million in 2004,  reflecting  primarily  the  "Overdraft  Honor"
service started in the first quarter of 2003.

Investment security gains were $844 thousand for 2004, compared to $500 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  $1.0
million,  an increase of $177 thousand over 2003. Income from insurance agencies
acquired after the second quarter of 2003 contributed to the increase.

Mortgage  banking income  increased $383 thousand,  or 86%, to $828 thousand for
2004. The increase is attributable to activity generated from the acquisition of
Erie Financial Group, LTD, in July, 2003.

Non-Interest Expenses

Non-interest expenses totaled $13.0 million for the quarter ended June 30, 2004,
and reflected a 14% increase,  or $1.6 million,  from the $11.4 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 second half of
2003, for which a full six months of expenses was included in 2004.

Salaries and employee benefits  totaling $7.0 million for 2004,  represented 54%
of operating costs, and increased $765 thousand, or 12%, compared to 2003.

Occupancy expenses were $2.0 million for 2004, an increase of $217 thousand,  or
12%, over 2003.

Marketing expenses increased $298 thousand,  or 52%, to a total of $869 thousand
for 2004 versus 2003,  for  continued  expansion of  marketing  and  promotional
efforts.

Other non-interest expenses increased $276 thousand, or 11%, to $2.7 million for
2004 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)
-------------------------------------

Income Taxes

Income tax expense for the quarter  ended June 30, 2004,  totaled $1.2  million,
resulting in an effective tax rate of 18.2%,  which was similar to the effective
rate of 17.7% for 2003.  The relative mix of tax exempt  income  influences  the
effective income tax rate.


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

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

                                                                   June 30,                            Change
                                                      ---------------------------------      --------------------------
                                                            2004              2003               Volume             %
           ------------------------------------------------------------------------------------------------------------
<S>                                                   <C>                <C>                 <C>
           Cash and due from banks                    $         35,215   $       35,187      $          28         ---
           Federal funds sold and other                          9,179            1,036              8,143         786
           Investments                                         686,825          690,800             (3,975)          1
           Loans held for sale                                   4,151            8,335             (4,184)        (50)
           Loans                                             1,119,358          947,413            171,945          18
           Allowance for loan losses                            13,828           12,750              1,078           8
           ------------------------------------------------------------------------------------------------------------
           Net loans                                         1,105,530          934,663            170,867          18
           Goodwill and identifiable intangibles                 4,800            1,953              2,847         146
           Other assets                                         83,627           69,629             13,998          20
           ------------------------------------------------------------------------------------------------------------

           Total assets                               $      1,929,327   $    1,741,603      $     187,724          11
           ============================================================================================================

           Noninterest-bearing deposits               $        170,700   $      163,674      $       7,026           4
           Interest-bearing deposits                         1,112,272          985,416            126,856          13
           Short-term borrowings                                67,677          110,751            (43,074)        (39)
           Long-term debt                                      388,952          319,906             69,046          22
           Subordinated debt                                    30,928           15,464             15,464         100
           Other liabilities                                    13,980           12,747              1,233          10
           ------------------------------------------------------------------------------------------------------------

           Total liabilities                                 1,784,509        1,607,958            176,551          11
           ------------------------------------------------------------------------------------------------------------

           Stockholders' equity                                144,818          133,645             11,173           8
           ------------------------------------------------------------------------------------------------------------

           Total liabilities and stockholders'
           equity                                     $      1,929,327   $    1,741,603      $     187,724          11
           ============================================================================================================
</TABLE>


Average loans reached $1.1 billion at June 30, 2004, an 18 % increase over the
$947 million of average loans recorded at June 30, 2003. The following
presentation of average loans at June 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                          $        398,176   $       319,833   $      78,343       25%
               Commercial real estate                       292,703           261,183          31,520       12%
               Residential real estate                       96,397           105,847          (9,450)     (9)%
               Consumer                                     332,082           260,550          71,532       27%
               --------------------------------------------------------------------------------------------------
               --------------------------------------------------------------------------------------------------
                    Total                          $      1,119,358   $       947,413   $     171,945       18%
               ==================================================================================================
</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)
--------------------------------------

Commercial  borrowing  began to  increase  during  the  second  quarter of 2003,
leveled off in the fourth quarter,  then resumed in the first and second quarter
of 2004.  After the end of the first quarter of 2003,  declines in interest rate
trends caused many 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 was 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 since  business  lending has been  constrained  on both a
national level and in certain segments of Community's  market. 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 $72 million
between June 30, 2003, and June 30, 2004,  particularly  in home equity lending.
As part of  Community's  effort to increase its  visibility in core  markets,  a
concerted effort was made to become a more effective consumer lender,  including
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.  These
efforts were also aided by the growth  achieved as a result of the  expansion of
the office network and sales efforts over the last several years.

Residential  real  estate  lending,  which  is  composed  primarily  of 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
recognized, as indicated by the following summary of average balances at June 30
(dollars in thousands):
<TABLE>
<CAPTION>

                                                                                                  Change
                                                           2004             2003           Amount          %
                    -------------------------------------------------------------------------------------------
<S>                                                   <C>              <C>              <C>               <C>
                    Demand                            $       170,700  $       163,674  $      7,026       4%
                    Savings & NOW accounts                    486,839          371,733       115,106      31%
                    Time                                      506,177          501,335         4,842       1%
                    Time $100,000 or more                     119,256          112,348         6,908       6%
                    -------------------------------------------------------------------------------------------
                                                      $     1,282,972  $     1,149,090  $    133,882      12%
                    ===========================================================================================
</TABLE>

Deposit growth occurred primarily in savings and NOW deposits; more specifically
Community's Power Checking account. This account, with characteristics of both a
money market and checking  account,  grew steadily  throughout 2003 and 2004. At
the same time,  longer term time deposit  growth was relatively  flat.  Consumer
preferences were clearly weighted in favor of maintaining  adequate liquidity in
anticipation of a gradual 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.

                                       20
<PAGE>

COMMUNITY BANKS, INC. AND SUBSIDIARIES

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

Capital

Capital strength is a critical metric with which to judge the overall  stability
of a financial  institution.  A strong capital base is also a  prerequisite  for
sustaining  franchise  growth  through both  internal  expansion  and  strategic
acquisition   opportunities.   Regulatory  authorities  impose  constraints  and
restrictions  on bank  capital  levels  that are  designed  to help  ensure  the
vitality of the nation's banking system.

Regulators  have  established  standards for the monitoring  and  maintenance of
appropriate levels of capital for financial institutions. All regulatory capital
guidelines  are now based upon a risk-based  supervisory  approach that has been
designed  to ensure  effective  management  of  capital  levels  and  associated
business risk. Such regulatory  guidelines are continually  under review and are
expected  to undergo  some  change as a result of the Basel II  capital  accords
which are currently under review by U.S. banking regulators. The following table
provides  the  risk-based   capital  positions  of  Community  and  its  banking
subsidiary,  Community  Banks, at June 30, 2004,  along with a comparison to the
various current regulatory capital requirements:
<TABLE>
<CAPTION>

                                                                      June 30,       Regulatory         "Well
                                                                        2004          Minimum        Capitalized"
                                                                    ---------------------------------------------
<S>                                                                     <C>              <C>             <C>
                   Leverage ratio
                       Community Banks, Inc.                            8.41%            4%              n/a
                       Community Banks                                  7.59%            4%              5%

                   Tier 1 capital ratio
                       Community Banks, Inc.                           11.22%            4%              n/a
                       Community Banks                                 10.12%            4%              6%

                   Total risk-based capital ratio
                       Community Banks, Inc.                           12.20%            8%              n/a
                       Community Banks                                 11.10%            8%              10%
</TABLE>

At June  30,  2004,  total  stockholders'  equity  reflected  accumulated  other
comprehensive  loss of $5.6 million compared to accumulated other  comprehensive
income of $6.6 million at December 31, 2003.  This decrease can be attributed to
the change in the net unrealized  gain(loss) on investment  securities available
for sale,  net of taxes,  and is  considered a temporary  impairment  due to the
influence of increasing interest rates.


Off-Balance-Sheet Commitments


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

                                                                             Contract Amount
                                                                             ---------------
<S>                                                                          <C>
                     Commitments to fund loans                               $       118,469
                     Unused lines of credit                                  $       311,497
                     Standby letters of credit                               $        35,960
                     Unadvanced portions of construction loans               $        38,435

</TABLE>





                                       21
<PAGE>



COMMUNITY BANKS, INC. AND SUBSIDIARIES

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

Market risk is defined as 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.  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 June 30,
2004.
<TABLE>
<CAPTION>

           Interest Rate Sensitivity
           -----------------------------------------------------------------------------------------------------------
                                                1-90          90-180         180-365        1 year or
           Dollars in thousands                 days           days           days            more           Total
           -----------------------------------------------------------------------------------------------------------
<S>                                         <C>            <C>            <C>             <C>            <C>
           Assets
           Interest-bearing deposits in
           other banks                      $       2,803  $         ---  $         ---   $         ---  $       2,803
           Loans held for sale(1)                     ---            ---            ---             235            235
           Investment securities                  117,662         44,014         55,041         462,138        678,856
           Loans(2)                               420,106         69,170        102,159         569,934      1,161,368
           -----------------------------------------------------------------------------------------------------------
           Earning assets                         540,571        113,184        157,200       1,032,307      1,843,262
           Non-earning assets                         412            ---            ---         117,387        117,799
           -----------------------------------------------------------------------------------------------------------
           Total assets                     $     540,983  $     113,184  $     157,200   $   1,149,694  $   1,961,061
           -----------------------------------------------------------------------------------------------------------

           Liabilities
           Savings                          $     255,819  $         ---  $         ---   $     243,825  $     499,644
           Time                                   107,281         79,484        100,474         222,858        510,097
           Time in denominations of
               $100,000 or more                    28,289         15,374         20,605          39,247        103,515
           Short-term borrowings                  110,475            ---            ---             ---        110,475
           Long-term debt                           1,797          1,797         13,595         355,877        373,066
           Subordinated debt                       23,196            ---            ---           7,732         30,928
           -----------------------------------------------------------------------------------------------------------
           Interest bearing liabilities           526,857         96,655        134,674         869,539      1,627,725
           Other liabilities and equity               ---            ---            ---         333,336        333,336
           -----------------------------------------------------------------------------------------------------------
           Total liabilities and equity     $     526,857  $      96,655  $     134,674   $   1,202,875  $   1,961,061
           -----------------------------------------------------------------------------------------------------------
</TABLE>

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

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

<S>                                                  <C>            <C>             <C>             <C>
        Periodic                                     $      14,126  $      16,529   $     22,526    $    (53,181)
        Cumulative                                          14,126         30,655         53,181             ---
        Cumulative GAP as a percentage
        of total assets                                       .72%          1.56%          2.71%           0.00%
</TABLE>


The  positive   GAP  between   interest-earning   assets  and   interest-bearing
liabilities maturing or repricing within one year approximated 2.71% at June 30,
2004 and has increased modestly 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 June
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 - Changes in Securities,  Use of Proceeds and Issuer  Purchases of Equity
--------------------------------------------------------------------------------
Securities
----------

     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>
             04/1/04-04/30/04           13,000             $30.27                13,000                 194,334
             05/1/04-05/31/04           45,400             $29.78                45,400                 148,934
             06/1/04-06/30/04           19,000             $28.61                19,000                 129,934
</TABLE>


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

          Not applicable.

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

          The annual meeting of shareholders of Community  Banks,  Inc. was held
     on May 4,  2004,  for the  purpose  of  considering  and  voting  upon  the
     following matter:

          To elect four (4) directors:  Ronald E. Boyer, Peter DeSoto, Thomas L.
     Miller,  and James A.  Ulsh,  to serve  until the 2008  annual  meeting  of
     shareholders.  Each director  received  affirmative  votes  representing at
     least 69.7% of the shares outstanding.

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

          Not applicable.





                                       24
<PAGE>



COMMUNITY BANKS, INC. AND SUBSIDIARIES

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



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

 (a)          Exhibits
 ---------------------

<TABLE>

           <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.
           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>



(b)    Reports on Form 8-K
--------------------------

          Registrant filed the following  reports on Form 8-K during the quarter
          ended June 30, 2004:


          Report Dated April 19, 2004
          ---------------------------
          Registrant announced its earnings for the period ended March 31, 2004.

          Report Dated May 5, 2004
          ------------------------
          Registrant announced the declaration of a second quarter cash dividend
          payable July 1, 2004.

          Report Dated May 5, 2004
          ------------------------
          Registrant announced that its annual shareholders' meeting was held on
          May 4, 2004. The presentation was included by exhibit.





                                       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.
<TABLE>
<CAPTION>

                              COMMUNITY BANKS, INC.
                                  (Registrant)

<S>                                                              <C>
Date          August 9, 2004                                     /s/ Eddie L. Dunklebarger
    -----------------------------------------------              ----------------------------------------------
                                                                     Eddie L. Dunklebarger
                                                                     Chairman and President
                                                                     (Chief Executive Officer)

Date          August 9, 2004                                     /s/ Donald F. Holt
    -----------------------------------------------              ----------------------------------------------
                                                                     Donald F. Holt
                                                                     Executive Vice President
                                                                     (Chief Financial Officer)
</TABLE>


                                       26