FORM 10-Q
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

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

                  For the quarterly period ended March 31, 2004

                                   No. 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 April 30, 2004

CAPITAL STOCK-COMMON                                           12,274,000
--------------------                                      --------------------
  (Title of Class)                                        (Outstanding Shares)






<PAGE>

<TABLE>
<CAPTION>

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


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

Item 1.     Financial Statements

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

Item 2.     Management's Discussion and Analysis of Financial
            Condition and Results of Operations                                                        12-20

Item 3.     Quantitative and Qualitative Disclosures About Market Risk                                 21-22

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                                                           24-25


SIGNATURES                                                                                                26

</TABLE>



                                       2
<PAGE>


                         PART I - FINANCIAL INFORMATION

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

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

                                                                             March 31,                December 31,
                                                                               2004                       2003
                                                                          --------------            ---------------
ASSETS

<S>                                                                       <C>                       <C>
Cash and due from banks                                                   $       39,744            $        42,790
Federal funds sold                                                                   ---                     17,097
                                                                          --------------            ---------------
   Cash and cash equivalents                                                      39,744                     59,887
Interest-bearing time deposits in other banks                                      2,537                      3,301
Investment securities, available for sale                                        715,055                    646,961
Loans held for sale                                                                4,957                      6,067
Loans                                                                          1,112,557                  1,078,611
   Less: Allowance for loan losses                                               (13,862)                   (13,178)
                                                                          ---------------           ---------------
              Net loans                                                        1,098,695                  1,065,433
Premises and equipment, net                                                       24,979                     24,153
Goodwill and identifiable intangible assets                                        4,759                      4,773
Accrued interest receivable and other assets                                      53,829                     50,488
                                                                          --------------            ---------------
         Total assets                                                     $    1,944,555            $     1,861,063
                                                                          ==============            ===============

LIABILITIES

Deposits:
   Non-interest bearing                                                   $      174,159            $       165,174
   Interest bearing                                                            1,108,251                  1,065,511
                                                                          --------------            ---------------
         Total deposits                                                        1,282,410                  1,230,685
Short-term borrowings                                                             65,007                     27,764
Long-term debt                                                                   399,750                    411,422
Subordinated debt                                                                 30,928                     30,928
Accrued interest payable and other liabilities                                    15,956                     16,858
                                                                          --------------            ---------------
         Total liabilities                                                     1,794,051                  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; 12,424,000 and 11,851,000
   shares issued in 2004 and 2003                                                 62,121                     59,256
Surplus                                                                           72,839                     57,563
Retained earnings                                                                  7,973                     24,297
Accumulated other comprehensive income,
    net of tax                                                                    10,604                      6,596
Treasury stock; 154,000 and 203,000
   shares in 2004 and 2003, at cost                                               (3,033)                    (4,306)
                                                                          --------------            ---------------
         Total stockholders' equity                                              150,504                    143,406
                                                                          --------------            ---------------
         Total liabilities and stockholders' equity                       $    1,944,555            $     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
                                                                                 March 31,
                                                                      ----------------------------
                                                                           2004            2003
                                                                      ----------------------------
<S>                                                                   <C>             <C>
INTEREST INCOME:
   Loans, including fees                                              $     16,658    $     16,066
   Investment securities:
      Taxable                                                                4,562           4,977
      Tax exempt                                                             2,195           2,280
      Dividends                                                                552             446
   Other                                                                        13               2
                                                                      ------------    ------------
      Total interest income                                                 23,980          23,771
                                                                      ------------    ------------

INTEREST EXPENSE:
   Deposits                                                                  5,458           6,018
   Short-term borrowings                                                       124             334
   Long-term debt                                                            4,581           4,167
   Subordinated debt                                                           378             184
                                                                      ------------    ------------
      Total interest expense                                                10,541          10,703
                                                                      ------------    ------------
      Net interest income                                                   13,439          13,068
Provision for loan losses                                                      850             400
                                                                      ------------    ------------
      Net interest income after provision for loan losses                   12,589          12,668
                                                                      ------------    ------------

NON-INTEREST INCOME:
   Investment management and trust services                                    267             317
   Service charges on deposit accounts                                       1,405           1,041
   Other service charges, commissions and fees                                 902             754
   Investment security gains                                                 1,332           1,047
   Insurance premium income and commissions                                    654             410
   Mortgage banking activities                                                 627             426
   Earnings on investment in life insurance                                    365             329
   Other                                                                        71              70
                                                                      ------------    ------------
      Total non-interest income                                              5,623           4,394
                                                                      ------------    ------------

NON-INTEREST EXPENSES:
   Salaries and employee benefits                                            6,835           5,900
   Net occupancy                                                             2,033           1,766
   Marketing expense                                                           420             514
   Telecommunications expense                                                  317             200
   Other                                                                     2,278           2,409
                                                                      ------------    ------------
      Total non-interest expenses                                           11,883          10,789
                                                                      ------------    ------------

      Income before income taxes                                             6,329           6,273
Income taxes                                                                 1,154           1,172
                                                                      ------------    ------------
      Net income                                                      $      5,175    $      5,101
                                                                      ============    ============

CONSOLIDATED PER SHARE DATA:
   Basic earnings per share                                           $        .42    $        .42
   Diluted earnings per share                                         $        .41    $        .41
   Dividends declared                                                 $        .16    $        .15
</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)
(Dollars in thousands except per share data)
<TABLE>
<CAPTION>

                                                                      Three Month Periods Ended March 31
                                                                      ----------------------------------


                                                                                       Accumulated
                                                                                          Other
                                              Common                     Retained      Comprehensive       Treasury        Total
                                               Stock      Surplus        Earnings       Income (Loss)        Stock         Equity
                                              ------------------------------------------------------------------------------------
<S>                                           <C>         <C>            <C>            <C>                <C>            <C>
Balance, January 1, 2003                      $47,053     $46,418        $35,344        $    6,538         $ (6,191)      $129,162
   Comprehensive income:
      Net income                                                           5,101                                             5,101
      Unrealized (loss) on securities,
         net of reclassification adjustment
         and tax effect                                                                       (566)                           (566)
                                                                                                                          --------
      Total comprehensive income                                                                                             4,535
Cash dividends                                                            (1,830)                                           (1,830)
5% stock dividend (470,000 shares)              2,290      10,668        (12,958)                                              ---
Purchases of treasury stock
   (69,000 shares)                                                                                           (1,939)        (1,939)
Issuance of additional shares
   (51,000 net shares of treasury
   stock reissued and 1,000 shares
   of common stock canceled)                       (5)        123           (453)              ---            1,245            910
                                              -------     -------        -------        ----------         --------       --------

Balance, March 31, 2003                       $49,338     $57,209        $25,204        $    5,972         $ (6,885)      $130,838
                                              =======     =======        =======        ==========         ========       ========


Balance, January 1, 2004                      $59,256     $57,563        $24,297        $    6,596         $ (4,306)      $143,406
   Comprehensive income:
     Net income                                                            5,175                                             5,175
     Unrealized gain on securities,
        net of reclassification adjustment
        and tax effect                                                                       4,008                           4,008
                                                                                                                          --------
     Total comprehensive income                                                                                              9,183
Cash dividends                                                            (1,989)                                           (1,989)
5% stock dividend (592,000 shares)              2,958      15,127        (18,085)                                              ---
Stock split paid in the form
     of a 20% stock dividend
     (fractional shares)                           (4)                       (25)                                              (29)
Purchases of treasury stock
   (25,000 shares)                                                                                             (747)          (747)
Issuance of additional shares
    (81,000 net shares of treasury
   stock reissued and 18,000 shares
    of common stock canceled)                     (89)        149         (1,400)              ---            2,020            680
                                              -------     -------        -------        ----------         --------       --------

Balance, March 31, 2004                       $62,121     $72,839        $ 7,973        $   10,604         $ (3,033)      $150,504
                                              =======     =======        =======        ==========         ========       ========
</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>
                                                                                               Three Months Ended
                                                                                                    March 31,
                                                                                     --------------------------------------
                                                                                         2004                       2003
                                                                                     --------------------------------------
<S>                                                                                  <C>                        <C>
Operating Activities:
   Net income                                                                        $     5,175                $     5,101
Adjustments to reconcile net income to net cash
   provided by operating activities:
     Provision for loan losses                                                               850                        400
     Depreciation and amortization                                                           815                        750
     Amortization of security premiums and discounts, net                                    296                        666
     Investment security gains                                                            (1,332)                    (1,047)
     Loans originated for sale                                                            (5,492)                   (20,197)
     Proceeds from sales of loans                                                          6,812                     23,814
     Gains on loan sales                                                                    (209)                      (426)
     Earnings on investment in life insurance                                               (365)                      (329)
     Change in other assets, net                                                            (206)                      (329)
     Change in accrued interest payable and
      other liabilities, net                                                              (1,146)                     1,083
                                                                                     -----------                -----------
           Net cash provided by operating activities                                       5,198                      9,486
                                                                                     -----------                -----------

Investing Activities:
   Net (increase) decrease in interest-bearing time
    deposits in other banks                                                                  764                       (155)
   Proceeds from sales of investment securities                                           11,915                     59,688
   Proceeds from maturities of investment securities                                      64,844                     36,661
   Purchases of investment securities                                                   (137,404)                  (145,734)
   Net increase in total loans                                                           (34,143)                   (36,259)
   Investment in life insurance                                                           (5,000)                       ---
   Net additions to premises and equipment                                                (1,528)                      (512)
                                                                                     -----------                -----------
      Net cash used by investing activities                                             (100,552)                   (86,311)
                                                                                     -----------                -----------

Financing Activities:
   Net increase in deposits                                                               51,725                     13,230
   Net increase in short-term borrowings                                                  37,243                     72,767
   Repayment of long-term debt                                                           (11,672)                      (710)
   Cash dividends and cash paid in lieu of fractional shares                              (2,018)                    (1,830)
   Purchases of treasury stock                                                              (747)                    (1,939)
   Proceeds from issuance of common stock                                                    680                        910
                                                                                     -----------                -----------
         Net cash provided by financing activities                                        75,211                     82,428
                                                                                     -----------                -----------

         Increase (decrease) in cash and cash equivalents                                (20,143)                     5,603

Cash and cash equivalents at beginning of period                                          59,887                     36,137
                                                                                     -----------                -----------
Cash and cash equivalents at end of period                                           $    39,744                $    41,740
                                                                                     ===========                ===========
</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 three months ended March 31, 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.

<TABLE>
<CAPTION>
(Dollars in thousands, except per share data)                                    Three Months Ended
                                                                                      March 31,
                                                                              2004               2003
                                                                           -----------------------------

<S>                                                                        <C>                <C>
         Net income, as reported                                           $    5,175         $    5,101
         Deduct:  Total stock-based compensation
               expense determined under fair value based
               method for all awards, net of related tax effect                  (322)              (187)
                                                                           ----------         ----------

         Pro forma net income                                              $    4,853         $    4,914
                                                                           ==========         ==========

         Earnings per share:
             Basic - as reported                                           $      .42         $      .42
             Basic - pro forma                                             $      .40         $      .41

             Diluted - as reported                                         $      .41         $      .41
             Diluted - pro forma                                           $      .38         $      .40

</TABLE>



                                       7
<PAGE>


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

<TABLE>
<CAPTION>

Comprehensive Income:

The components of other comprehensive income (loss) and related tax effects for
the three months ended March 31 are as follows (in thousands):
                                                                     ----------------------------
                                                                         2004             2003
                                                                     ----------------------------
<S>                                                                  <C>              <C>
             Unrealized holding gains (losses)
                   on available-for-sale securities                  $     7,498      $       176
             Reclassification adjustments for
                   (gains) included in net income                         (1,332)          (1,047)
                                                                     -----------      -----------
             Net unrealized gains (losses)                                 6,166             (871)
             Tax effect                                                   (2,158)             305
                                                                     -----------      -----------

                                                                     $     4,008      $      (566)
                                                                     ===========      ===========
</TABLE>

The components of accumulated  other  comprehensive  income (loss),  included in
stockholders' equity, are as follows at March 31, 2004 (in thousands):

<TABLE>
<CAPTION>
<S>                                                                  <C>
             Net unrealized gain (loss) on
                  available-for-sale securities                      $    19,512
             Tax effect                                                   (6,829)
                                                                     -----------
                  Net-of-tax amount                                       12,683
                                                                     -----------

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

               Accumulated other comprehensive income                $    10,604
                                                                     ===========
</TABLE>


                                       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>

                                                                 Three Months Ended         Year Ended          Three Months Ended
                                                                      March 31,             December 31,             March 31,
                                                                        2004                   2003                    2003
                                                                 ------------------        -------------        ------------------

<S>                                                                  <C>                      <C>                     <C>
       Balance, January 1                                            $  13,178                $12,343                 $12,343
       Provision for loan losses                                           850                  2,500                     400
       Loan charge-offs                                                   (450)                (2,839)                   (292)
       Recoveries                                                          284                  1,174                     202
                                                                     ---------                -------                 -------
       Balance, March 31, 2004, December 31,
        2003, and March 31, 2003                                     $  13,862                $13,178                 $12,653
                                                                     =========                =======                 =======
</TABLE>


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

                                                                      March 31,            December 31,               March 31,
                                                                        2004                   2003                     2003
                                                                     ---------             ------------               -------
<S>                                                                  <C>                      <C>                     <C>
       Loans on which accrual of interest has been
        discontinued:

            Commercial                                               $   2,893                $ 3,066                 $ 2,784
            Residential and commercial mortgages                         3,606                  4,054                   6,832
            Other                                                        1,042                  1,031                     647
                                                                     ---------                -------                 -------
                                                                         7,541                  8,151                  10,263
                                                                     ---------                -------                 -------


       Foreclosed real estate                                            2,057                  4,865                     729
                                                                     ---------                -------                 -------

       Total non-performing assets                                       9,598                 13,016                  10,992

       Loans past due 90 days or more and still accruing interest:
            Commercial                                                      40                      4                      45
            Residential and commercial mortgages                            42                     40                      38
            Consumer                                                        16                     46                      22
                                                                     ---------                -------                 -------
                                                                            98                     90                     105
                                                                     ---------                -------                 -------
       Total risk elements                                           $   9,696                $13,106                 $11,097
                                                                     =========                =======                 =======
</TABLE>


                                       9
<PAGE>



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


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

The following table sets forth the  calculations  of Basic and Diluted  Earnings
Per Share for the periods indicated:
<TABLE>
<CAPTION>
                                                                   ----------------------------------------------------------------
                                                                                      Three Months Ended March 31,
                                                                                2004                                2003
                                                                   ----------------------------------------------------------------
                                                                                        Per-Share                          Per-Share
                                                                    Income     Shares     Amount        Income     Shares     Amount
                                                                    ----------------------------------------------------------------
                                                                                 (In thousands except per share data)
     Basic EPS:

<S>                                                                <C>         <C>        <C>           <C>        <C>         <C>
         Income available to common stockholders                   $ 5,175     12,271     $ .42         $5,101     12,093      $.42
                                                                   =======                =====         ======                 ====

     Effect of Dilutive Securities:

         Incentive stock options outstanding                                      382                                 282
                                                                               ------                              ------

     Diluted EPS:

         Income available to common stockholders &
           assumed conversion                                      $ 5,175     12,653     $ .41         $5,101     12,375      $.41
                                                                   =======                =====         ======                 ====

</TABLE>


Per share and number of share amounts  reflect stock splits and dividends with a
record date prior to  issuance of the  financial  statements,  including  the 5%
stock dividend paid April 30, 2004 to stockholders of record on April 16, 2004.


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
$36.5  million of standby  letters  of credit as of March 31,  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 March 31, 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  when an equity  interest
should be consolidated,  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 indicated that
the Trust  Preferred  Securities  will  continue  to  qualify  as Tier 1 Capital
subject to previously specified limitations, until further notice. If regulators
make a  determination  that the  Trust  Preferred  Securities  can no  longer be
considered in regulatory capital, it is anticipated that Community will continue
to meet its minimum capital requirements.





                                       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 three 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  with a record date prior to
issuance of the financial statements, including the 5% stock dividend paid April
30, 2004 to stockholders of record on April 16, 2004.

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

Summary of Financial Results

Earnings  for the first  quarter of 2004  resulted in net income of $5.2 million
and diluted  earnings per share of $0.41.  Reported net income for 2004 was only
slightly  higher than the amount  recorded for the first quarter of 2003,  which
reflected net income of $5.1 million and earnings per share of $0.41. Results in
2004 produced a return on average  assets of 1.10% and return on average  equity
of 14.13%, compared to 1.21% and 15.82%, respectively,  for the first quarter of
2003.

Robust  growth in both loan and deposit  balances  yielded  increases of 18% and
12%,  respectively,  since the end of the first  quarter of 2003.  Despite  this
growth,  improvement in revenue derived from these activities was constrained by
steadily  declining  interest rates.  This low rate  environment has limited the
financial  services  industry's  capacity to improve the spread between interest
earned on earning assets and the interest paid on funding sources. Despite these
challenges,  Community has continued to achieve growth in both loans and deposit
volumes,  while  simultaneously  expanding revenues from service and fee-related
activities.  Community has also achieved steady improvement in the measures used
to assess overall loan quality, a vital component of future financial success.

Loans grew to $1.1 billion at March 31, 2004,  an 18% increase  from the balance
at the end of the  first  quarter  of 2003,  while  deposits  increased  to $1.3
billion,  reflecting nearly a 12% increase over the same period. Total assets of
Community Banks, Inc., now stand at almost $2.0 billion.

During  the  quarter,  the ratio of  nonperforming  assets  to period  end loans
dropped from 1.21% at the end of the year to 0.86%.  The ratio of the  allowance
for loan losses to loans now stands at 1.25% and provides 184% coverage of loans
that are on nonaccrual  status. Net charge-offs for the period declined to 0.06%
of average loans on an annualized  basis,  well below the annualized  charge-off
rate of 0.17% for all of 2003.  These asset  quality  metrics  provide  tangible
evidence of the underlying  quality of  Community's  loan  portfolio.  Operating
expenses, on the other hand, grew between the first quarter of 2003 and 2004, as
a result of several factors,  including increased costs of acquired  businesses;
expansion of the delivery  network;  and continuing  investment in the growth of
Community.




                                       13
<PAGE>


COMMUNITY BANKS, INC. AND SUBSIDIARIES

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


Average Statement of Condition

The average  balance  sheets for the three  months ended March 31, 2004 and 2003
were as follows (dollars in thousands):

<TABLE>
<CAPTION>

                                                                 March 31,                              Change
                                                    ----------------------------------
                                                         2004                2003                Volume             %
-----------------------------------------------------------------------------------------------------------------------
<S>                                                 <C>                  <C>                   <C>                <C>
Cash and due from banks                             $       36,065       $      32,430         $     3,635         11.2
Federal funds sold and other                                 6,399               1,159               5,240        452.1
Investments                                                671,746             686,204             (14,458)        (2.1)
Loans held for resale                                        5,786               8,890              (3,104)       (34.9)
Loans                                                    1,100,432             915,652             184,780         20.2
Allowance for loan losses                                   13,484              12,641                 843          6.7
-----------------------------------------------------------------------------------------------------------------------
Net loans                                                1,086,948             903,011             183,937         20.4
Goodwill and identifiable intangibles                        4,756               1,753               3,003        171.3
Other assets                                                85,081              69,906              15,175         21.7
-----------------------------------------------------------------------------------------------------------------------

  Total assets                                      $    1,896,781       $   1,703,353         $   193,428         11.4
-----------------------------------------------------------------------------------------------------------------------


Noninterest-bearing deposits                        $      164,295       $     158,128         $     6,167          3.9
Interest-bearing deposits                                1,078,299             969,999             108,300         11.2
Short-term borrowings                                       52,020              96,119             (44,099)       (45.9)
Long-term debt                                             410,148             320,263              89,885         28.1
Subordinated debt                                           30,928              15,464              15,464        100.0
Other liabilities                                           13,783              12,580               1,203          9.6
-----------------------------------------------------------------------------------------------------------------------

  Total liabilities                                      1,749,473           1,572,553             176,920         11.3
-----------------------------------------------------------------------------------------------------------------------

Stockholders' equity                                       147,308             130,800              16,508         12.6
-----------------------------------------------------------------------------------------------------------------------

Total liabilities and
      stockholders' equity                          $    1,896,781       $   1,703,353         $   193,428         11.4
-----------------------------------------------------------------------------------------------------------------------
</TABLE>



Average  loans  reached $1.1 billion at March 31, 2004, a 20% increase  over the
$916  million  of  average  loans  recorded  at March 31,  2003.  The  following
presentation  of average  loans at March 31 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                         $     393,786     $    305,640     $    88,146       29 %
       Commercial real estate                   283,302          251,271          32,031       13 %
       Residential real estate                   97,784          108,403         (10,619)     (10)%
       Consumer                                 325,560          250,338          75,222       30 %
                                          ---------------------------------------------------------
          Total                           $   1,100,432     $    915,652     $   184,780       20 %
                                          =========================================================
</TABLE>




                                       14
<PAGE>



COMMUNITY BANKS, INC. AND SUBSIDIARIES

Part 1 - 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 resurged in the first 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 $120 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 $75 million
between March 31, 2003, and March 31, 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 10% was
recognized,  as indicated by the following  summary of average balances at March
31(dollars in thousands):

<TABLE>
<CAPTION>

                                                                                           Change
                                             2004                2003             Amount           %
                                             ----                ----             ------           -

<S>                                     <C>                 <C>                 <C>                 <C>
              Demand                    $       164,295     $     158,128       $    6,167          4%
              Savings & NOW accounts            457,269           356,668          100,601         28%
              Time                              501,571           503,995           (2,424)        --%
              Time $100,000 or more             119,459           109,336           10,123          9%
                                        --------------------------------------------------------------
                                        $     1,242,594     $   1,128,127       $  114,467         10%
                                        ==============================================================
</TABLE>

Deposit growth  occurred  almost  exclusively 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.  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.


                                       15
<PAGE>


COMMUNITY BANKS, INC. AND SUBSIDIARIES

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


Community  has made  strategic  use of short and  long-term  funding  sources at
historic low rates to augment its ability to generate funding through  increased
deposits.  In early 2003,  Community  used  increases in low-cost  federal funds
borrowings to fund earning asset growth.  In the latter part of 2003,  Community
began to extend the maturities of overnight  borrowings through the Federal Home
Loan Bank to take advantage of lower long-term rates on longer borrowings.

In December, 2003, Community issued $15 million of trust preferred securities in
order to increase  the amount of  qualifying  regulatory  capital  through  this
relatively  inexpensive funding source.  Community previously had executed a $15
million issuance at the end of 2002, bringing the subordinated debt total to $30
million at December 31, 2003 and March 31, 2004.  In the first  quarter of 2004,
the  trusts  that  had  been  used  for  the  trust  preferred   issuances  were
deconsolidated in accordance with FASB Interpretation No. 46,  "Consolidation of
Variable Interest  Entities,  an Interpretation of ARB No. 51" which was revised
in December  2003.  See Note 5 in the Notes to  Consolidated  Interim  Financial
Statements for a further description of the deconsolidation.



Net Interest Income

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

-------------------------------------------------------------------------------------------------------------------------
                                              2004                          2003                    Increase  (Decrease)
                                       Amount     Yield/rate        Amount        Yield/rate          Amount   Yield/rate
-------------------------------------------------------------------------------------------------------------------------
<S>                                  <C>             <C>          <C>                <C>            <C>          <C>
Interest income                      $   25,603      5.77%        $   25,289         6.38%          $    314     (.61)
Interest expense                         10,541      2.70%            10,703         3.10%              (162)    (.40)
-------------------------------------------------------------------------------------------------------------------------
Net interest income                  $   15,062                   $   14,586                        $    476
Interest spread                                      3.07%                           3.28%                       (.21)
Impact of non-interest funds                          .33%                           0.40%                       (.07)
-------------------------------------------------------------------------------------------------------------------------
Net interest margin                                  3.40%                           3.68%                       (.28)
-------------------------------------------------------------------------------------------------------------------------
</TABLE>

Interest Income /Earning Assets

Interest  income  totaled  $25.6  million in 2004,  slightly  ahead of the $25.3
million  recorded in 2003,  despite an earning asset yield decline from 6.38% to
5.77%.  Earning assets  increased from $1.61 billion to $1.78 billion and helped
to offset the effect of lower earning asset yields.  From 2003 to 2004,  earning
assets  grew $177  million,  with an  increase  of $186  million  in loans and a
decrease of $14 million in portfolio investment securities.  Growth in loans was
funded  by  both  runoff  in the  investment  portfolio  and by an  increase  in
deposits.

Interest Expense / Funding Sources

Interest expense on deposits declined,  thus contributing to the increase in net
interest income.  The rate environment that generated only modest improvement in
interest income also enabled  Community to marginally reduce its overall funding
costs from $10.7 million in 2003 to $10.5 million in 2004 while interest-bearing
deposits grew by nearly $108 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 31%  increase  in  long-term
funding, which included the $15 million in trust preferred instruments issued at
the end of 2003.


                                       16
<PAGE>


COMMUNITY BANKS, INC. AND SUBSIDIARIES

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


Interest Spread and Net Interest Margin

As a result of rate trends and other  dynamics  specific  to its balance  sheet,
Community  reported a  quarter-to-quarter  decline in net  interest  spread from
3.28% in 2003 to 3.07% in 2004, and a decline in net interest  margin from 3.68%
to 3.40% 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  0.40%  to  0.33%.   During  periods  of  declining   interest  rates,  the
contribution  from  non-interest  funds to net interest  margin is reduced since
funds are invested at progressively lower rates. During periods of rising rates,
these  funds can be expected  to  contribute  to  improvements  in net  interest
margin.


Provision for Loan Losses

Community  reported a modest  increase in the provision  for loan losses,  which
reflected  continued steady  improvement in the overall asset quality metrics of
its loan portfolio.  The provision  increased from $400 thousand in 2003 to $850
thousand in 2004,  while the  relationship  of the  allowance for loan losses to
loans  declined  from 1.35% at March 31,  2003 to 1.25% at March 31,  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
inherent in a growing loan portfolio.  Net charge-offs  during the first quarter
of 2004 were only $166 thousand, or, when annualized, 0.06% of average loans.


Non-Interest Income

Non-interest  income  grew  during  the first  quarter  of 2004 as the result of
important steps undertaken in 2003 to solidify and expand Community's integrated
businesses and complementary  banking services.  Excluding the impact from sales
of investment  securities,  non-interest  revenue grew 28%, from $3.3 million in
2003 to $4.3 million in 2004.

Though  overall  fees  grew,  fees  derived  from  the  sale of  various  retail
investment products (annuities, brokerage services, mutual funds, etc) and other
fees related to Community's  limited trust department  activities  decreased $50
thousand,  or 16%, in 2004 compared to 2003. While traditional trust fees showed
a modest  increase  in 2004  over  2003,  income  from  the  sale of  additional
investment  products  started slowly early in the quarter,  but rebounded nicely
later in the quarter.

A  substantial  increase  in fees  occurred  in the area of  service  charges on
deposits.  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,  were
responsible for virtually all of the increase in this category.

Other service charges included interchange fees from Community's ATM network and
debit card transactions and increased $148 thousand,  or 20%, in 2004 from 2003.
Nearly  all of the  increases  in these  sources  of fee  income  resulted  from
increased  usage and growing  consumer  acceptance  of  electronic  mediums as a
substitute for cash or check-based transactions.

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.  Fees rose
by a total of $244 thousand, or 60%, from 2003 to 2004. 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.



                                       17
<PAGE>


COMMUNITY BANKS, INC. AND SUBSIDIARIES

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


Income from mortgage banking activities increased $201 thousand,  or 50%, and 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.

Security  gains  increased by nearly $300 thousand from 2003. The total gains of
$1.3 million  recorded in 2004 were  principally  gains related to sales of bank
equity holdings.


Non-Interest Expenses

Total  non-interest  expenses  reached $11.9 million in 2004 and reflected a 10%
increase, or $1.1 million, from the $10.8 million recorded in 2003.  Comparisons
to the first quarter of 2003 were  influenced by the  acquisitions of integrated
businesses acquired later in 2003, for which a full three months of expenses was
included in 2004.  Comparisons  to the most recent  prior  quarter  yielded only
modest increases.

Salaries and employee  benefits,  representing  57% of operating  costs in 2004,
increased  $935  thousand,  or 16%, for 2004 compared to 2003.  The increase was
affected  by a number  of  factors  including  the  annual  merit  increase  and
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.

The increase in occupancy expense of $267 thousand,  or 15%,  similarly includes
the effect of branch expansion and corporate acquisitions.

Marketing expenses  decreased $106 thousand,  or 18%, for 2004 compared to 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.  Community  continues to
execute a targeted strategic marketing campaign that includes radio,  billboard,
direct mail, and television mediums.

Telecommunications  expenses increased $117 thousand, or 58%, from 2003 to 2004,
for costs  associated with upgrades of existing  systems and increased costs for
the growing office network.

Other non-interest expenses decreased modestly.

Income Taxes

The effective  income tax rate for both 2004 and 2003 was  approximately  18.5%.
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.



                                       18
<PAGE>

COMMUNITY BANKS, INC. AND SUBSIDIARIES

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


Stockholders' Equity

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.

The most  fundamental  sources of capital are earnings  and earnings  retention.
This  cornerstone  of capital  adequacy  can be augmented by a number of capital
management  strategies,  many of which  are used by  Community.  As it has for a
number of years,  the Board  approved the issuance of a 5% stock dividend in the
first quarter of 2003 and in the first quarter of 2004. A 20% stock split in the
form of a stock  dividend was declared in November,  2003,  and  distributed  in
January, 2004. In addition to these stock dividends, Community's strong earnings
supported an increase in the return of capital to existing  shareholders  in the
form of an increase in the traditional  cash dividend.  Community also continues
to make  strategic  use of  share  repurchases  as  another  efficient  means of
returning  capital  to  shareholders.  These  strategies  and  techniques  allow
management to maintain capital at levels that represent an efficient use of this
valuable resource.

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 March 31, 2004, along with a comparison to the
various current regulatory capital requirements:
<TABLE>
<CAPTION>

                                                                    March 31,      Regulatory          "Well
                                                                      2004           Minimum        Capitalized"
                                                                      ----           -------        ------------
<S>                                                                   <C>               <C>              <C>
                Leverage ratio
                   Community Banks, Inc.                              8.62%             4%               n/a
                   Community Banks                                    7.66%             4%                5%

                Tier 1 capital ratio
                   Community Banks, Inc.                             11.44%             4%               n/a
                   Community Banks                                   10.08%             4%                6%

                Total risk-based capital ratio
                   Community Banks, Inc.                             12.47%             8%               n/a
                   Community Banks                                   11.08%             8%               10%

</TABLE>


At March 31,  2004,  total  stockholders'  equity  reflected  accumulated  other
comprehensive  income  of  $10.6  million  compared  to  the  accumulated  other
comprehensive  income of $6.6 million reflected in total stockholders' equity at
December 31, 2003.  This  increase  can be  attributed  to the change in the net
unrealized gain on investment  securities  available for sale, net of taxes, due
to the influence of lower interest rates.



                                       19
<PAGE>



COMMUNITY BANKS, INC. AND SUBSIDIARIES

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


Off-Balance-Sheet Commitments

In the normal course of business,  Community is a party to financial instruments
with  off-balance-sheet risk to meet the financing needs of its customers and to
reduce its own  exposure to  fluctuations  in interest  rates.  These  financial
instruments  include  commitments  to  originate  loans and  standby  letters of
credit, which involve, to varying degrees,  elements of credit and interest rate
risk in excess of the amount recognized in the Consolidated Balance Sheets.

Financial  instruments  with  off-balance-sheet  risk at March 31, 2004,  are as
follows (in thousands):

                                                                     Contract
                                                                      Amount
                                                                      ------
         Commitments to fund loans                                  $   54,566
         Unused lines of credit                                     $  302,212
         Standby letters of credit                                  $   34,974
         Unadvanced portions of construction loans                  $   33,789

Substantially  all of  Community's  unused  commitments  to originate  loans and
unused  lines  of  credit  are at  variable  rates  or will be  provided  at the
prevailing fixed rate when the loans are originated or the lines are used.




                                       20
<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.

Interest rate  sensitivity  results when the maturity or repricing  intervals of
interest-earning  assets,  interest-bearing  liabilities,  and off-balance sheet
financial  instruments are different,  creating a risk that changes in the level
of market  interest rates will result in  disproportionate  changes in the value
of, and the net earnings generated from,  Community's  interest-earning  assets,
interest-bearing  liabilities,  and  off-balance  sheet  financial  instruments.
Community's  exposure to interest rate sensitivity is managed  primarily through
Community's strategy of selecting the types and terms of interest-earning assets
and  interest-bearing  liabilities  which  generate  favorable  earnings,  while
limiting the potential  negative  effects of changes in market  interest  rates.
Since  Community's  primary source of  interest-bearing  liabilities is customer
deposits,  its  ability  to manage the types and terms of such  deposits  may be
somewhat  limited  by  customer  preferences  in the  market  areas  in which it
operates.  Borrowings,  which include Federal Home Loan Bank (FHLB) advances and
short-term  loans,  subordinated  notes,  and  other  short-term  and  long-term
borrowings,  are generally  structured with specific terms which in management's
judgment,  when aggregated  with the terms for outstanding  deposits and matched
with  interest-earning  assets,  mitigate  Community's exposure to interest rate
sensitivity.

The rates,  terms and  interest  rate  indices of  Community's  interest-earning
assets result  primarily  from its strategy of investing in loans and securities
(a  substantial  portion  of which  have  adjustable-rate  terms)  which  permit
Community  to limit its exposure to interest  rate  sensitivity,  together  with
credit risk,  while at the same time  achieving a positive  interest rate spread
compared to the cost of interest-bearing liabilities.

The following  table  provides a measure of interest rate  sensitivity  for each
category of interest  earning assets and interest  bearing  liabilities at March
31, 2004.
<TABLE>
<CAPTION>

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

Assets
<S>                                        <C>                <C>               <C>            <C>                <C>
Interest-bearing deposits in
   other banks                             $      2,537       $       ---       $      ---     $         ---      $      2,537
Loans held for sale(1)                               96                96              195             4,425             4,812
Investment securities                           121,903            49,844           81,287           462,021           715,055
Loans(2)                                        405,348            57,141          106,942           543,126         1,112,557
------------------------------------------------------------------------------------------------------------------------------
Earning assets                                  529,884           107,081          188,424         1,009,572         1,834,961
Non-earning assets                                  146               ---              ---           109,448           109,594
------------------------------------------------------------------------------------------------------------------------------
Total assets                               $    530,030       $   107,081       $  188,424     $   1,119,020      $  1,944,555
------------------------------------------------------------------------------------------------------------------------------

Liabilities
Savings                                    $    318,287       $       ---       $      ---     $     154,393      $    472,680
Time                                             66,594            99,002          111,870           236,731           514,197
Time in denominations of
   $100,000 or more                              35,028            23,401           21,493            41,452           121,374
Short-term borrowings                            55,608             9,399              ---               ---            65,007
Long-term debt                                   27,487             1,791            3,582           366,890           399,750
Trust preferred securities                       23,196               ---              ---             7,732            30,928
------------------------------------------------------------------------------------------------------------------------------
Interest bearing liabilities                    526,200           133,593          136,945           807,198         1,603,936
Other liabilities and equity                        ---               ---              ---           340,619           340,619
------------------------------------------------------------------------------------------------------------------------------
Total liabilities and equity               $    526,200       $   133,593       $  136,945     $   1,147,817      $  1,944,555
------------------------------------------------------------------------------------------------------------------------------
</TABLE>

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

                                       21
<PAGE>


COMMUNITY BANKS, INC. AND SUBSIDIARIES

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

<TABLE>

Interest Sensitivity GAP
------------------------------------------------------------------------------------------------------------
                                                1-90             90-180          180-365          1 year
Dollars in thousands                            days              days            days            or more
------------------------------------------------------------------------------------------------------------
<S>                                        <C>                <C>               <C>            <C>
Periodic                                   $      3,830       $   (26,512)      $   51,479     $     (28,797)
Cumulative                                                        (22,682)          28,797
Cumulative GAP as a percentage
   of total assets                                 .20%           (1.17)%            1.48%             0.00%
</TABLE>


The  positive   GAP  between   interest-earning   assets  and   interest-bearing
liabilities  maturing or repricing within one year  approximated  1.50% at March
31, 2004 and has remained relatively constant since December 31, 2003.

Interest rate sensitivity,  and the measurement  thereof, are also influenced by
the optionality of certain earning assets and interest bearing liabilities.  For
example,  a  substantial   portion  of  Community's  loans  and  mortgage-backed
securities and residential  mortgage loans contain significant embedded options,
which permit the borrower to prepay the  principal  balance of the loan prior to
maturity  ("prepayments") without penalty. A loan's propensity for prepayment is
dependent  upon a number of factors,  including  the current  interest  rate and
interest rate index (if any) of the loan, the financial  ability of the borrower
to refinance, the economic benefit to be obtained from refinancing, availability
of  refinancing  at attractive  terms,  as well as economic and other factors in
specific geographic areas which affect the sales and price levels of residential
property.  In a changing interest rate environment,  prepayments may increase or
decrease on fixed and  adjustable-rate  loans  pursuant to the current  relative
levels and expectations of future short and long-term interest rates.

Investment  securities,  other than  mortgage-backed  securities  and those with
early call provisions,  generally do not have  significant  embedded options and
repay  pursuant to specific  terms until  maturity.  While  savings and checking
deposits  generally may be withdrawn upon the customer's  request  without prior
notice, a continuing  relationship with such customers is generally  predictable
resulting in a  dependable  and  uninterrupted  source of funds.  Time  deposits
generally  have  early  withdrawal  penalties,  while term FHLB  borrowings  and
subordinated  notes  have  prepayment   penalties,   which  discourage  customer
withdrawal of time deposits and  prepayment by Community of FHLB  borrowings and
subordinated notes prior to maturity.





                                       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
March 31, 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 the  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>

                                                           Avg Price         Shares Purchased               Capacity to
                                           Shares            Paid               as part of                   Purchase
         Date                            Purchased         Per Share        Repurchase Program              More Shares
         --------------------------------------------------------------------------------------------------------------
<S>                                        <C>              <C>                 <C>                           <C>
         01/1/04-01/31/04                     ---              ---                   ---                      231,834
         02/1/04-02/29/04                     ---              ---                   ---                      231,834
         03/1/04-03/31/04                  24,500           $30.49                24,500                      207,334
</TABLE>


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

          Not applicable.

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

          Not applicable.

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

          Not applicable.

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

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

3.1  Amended  Articles of  Incorporation  (Incorporated  by reference to Exhibit
     3.1,  attached to  Community's  registration  on Form 8-A, filed on May 13,
     2002)
3.2  Amended  By-Laws  (Incorporated  by reference  to Exhibit 3.2,  attached to
     Community's  Quarterly  Report on Form 10-Q for the quarter ended March 31,
     2003, filed with the Commission on May 15, 2003)
4    Instruments  defining the rights of the holders of trust capital securities
     sold by Community in December  2002 and in December  2003 are not attached,
     as the  amount  of such  securities  is less  than 10% of the  consolidated
     assets of Community and its subsidiaries,  and the securities have not been
     registered.  Community  agrees to provide copies of such instruments to the
     SEC upon request.
10.1 Amended and Restated Salary Continuation Agreement of Eddie L. Dunklebarger
10.2 Salary Continuation Agreement of Donald F. Holt
10.3 Amended and Restated Salary Continuation Agreement of Robert W. Lawley
10.4 Amended and Restated Salary Continuation Agreement of Anthony N. Leo
10.5 Amended and Restated Salary Continuation Agreement of Jeffrey M. Seibert



                                       24
<PAGE>


COMMUNITY BANKS, INC. AND SUBSIDIARIES

PART II - Item 6 - Exhibits and Reports on Form 8-K (continued)
---------------------------------------------------------------


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


10.6 Survivor Income Agreement, with Split Dollar Addendum thereto, of Donald F.
     Holt
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)








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

     Registrant filed the following reports on Form 8-K during the quarter ended
     March 31, 2004:


     Report Dated January 21, 2004
     -----------------------------
     Registrant announced its earnings for the period ended December 31, 2003.

     Report Dated February 11, 2004
     ------------------------------
     Registrant  announced  the  declaration  of a first  quarter cash  dividend
     payable April 1, 2004 and a 5% stock dividend payable April 30, 2004.






                                       25
<PAGE>



                                   SIGNATURES

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

                              COMMUNITY BANKS, INC.
                                  (Registrant)


Date   May 10, 2004                                /s/ Eddie L. Dunklebarger
    -----------------------                        -----------------------------
                                                       Eddie L. Dunklebarger
                                                       Chairman and President
                                                      (Chief Executive Officer)

Date   May 10, 2004                                /s/ Donald F. Holt
    -----------------------                        -----------------------------
                                                       Donald F. Holt
                                                       Executive Vice President
                                                      (Chief Financial Officer)



                                       26