**FORM 10-QSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

x        Quarterly Report pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934 forthe quarterly period ended March 31, 2006.

**Or**

**o        Transition Report pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934 forthe transition periodfrom              to**

**Fulton Bancshares Corporation**

(Exact name of registrantas specified in its charter)

| **Pennsylvania**                                        |   | **33-85626**              |   | **25-1598464**                     |
|---------------------------------------------------------|--------|---------------------------|--------|------------------------------------|
| (State or other jurisdiction  of  incorporation)        |   | (Commission  File Number) |   | (IRS Employer  Identification No.) |
| **100 Lincoln Way East, McConnellsburg,  Pennsylvania** |   | **17233**                 |
| (Address of  principal executive offices)               |   | (Zip Code)                |

 

**(717)485-3144**(Registrant’s telephonenumber, including area code)

Securities registeredunder Section 12 (b) of the Exchange Act:**None**

Securities registeredunder Section 12 (g) of the Exchange Act:**Common Stock, $.625 par value**

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

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer  o                        Accelerated filer  o                           Non-accelerated filer  x

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes  o  No  x

The number of shares ofthe Issuer’s common stock, par value $.625 per share, outstanding as of April 10,2006 was 492,790.

 

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**FULTON BANCSHARESCORPORATION**

**INDEX**

|                                                                                                                 | **PAGE** |
|-----------------------------------------------------------------------------------------------------------------|----------|
| **PART I—FINANCIAL  INFORMATION**                                                                     |     |   | 3 |   |
| Item  1—Consolidated Financial Statements                                                                  |     |   | 3 |   |
| Condensed consolidated balance sheets—March 31,  2006 and December 31, 2005                      |     |   | 3 |   |
| Condensed consolidated statements of income—three  months ended March 31, 2006 and 2005          |     |   | 4 |   |
| Condensed consolidated statements of comprehensive  income—three months ended March 31, 2006 and 2005 |     |   | 5 |   |
| Condensed consolidated statements of cash flows—three  months ended March 31, 2006 and 2005      |     |   | 6 |   |
| Notes to condensed consolidated financial statements                                                            |     |   | 7 |   |
| Item 2—Management’s discussion and analysis of  financial condition and results of operations         |     |   | 12 |   |
| Item 3—Quantitative and qualitative disclosures about  market risk                                         |     |   | 17 |   |
| Item  4—Controls and procedures                                                                            |     |   | 17 |   |
| **PART II—OTHER  INFORMATION**                                                                        |     |   | 18 |   |
| Item  1—Legal proceedings                                                                                  |     |   | 18 |   |
| Item  1A—Risk factors                                                                                      |     |   | 18 |   |
| Item 2—Unregistered sales of equity securities and use  of proceeds                                        |     |   | 18 |   |
| Item 3—Defaults upon senior securities                                                                     |     |   | 19 |   |
| Item 4—Submission of matters to a vote of security  holders                                                |     |   | 19 |   |
| Item  5—Other information                                                                                  |     |   | 19 |   |
| Item  6—Exhibits                                                                                           |     |   | 19 |   |
| Signatures                                                                                                      |     |   | 21 |   |
| Exhibits                                                                                                        |     |   |   |   |

 

 

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**PART I—FINANCIAL INFORMATIONFULTON BANCSHARES CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS(In thousands)**

| ** **                                                                                                               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                               | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| ** **                                                                                                               | ** ** | **(Unaudited)**    | ** ** | **(Audited)**         | ** ** |
| **ASSETS**                                                                                                               | ** ** |               | ** ** | ** **            |       |   | ** ** | ** ** |   |
| Cash and due from banks                                                                                                  |       |               | $          | 3,949                 |       |   |   | $ | 4,225 |   |   |
| Interest-bearing deposits in other banks                                                                                 |       |               | 1,480      |                  |       |   | 665 |   |   |
| Federal funds sold                                                                                                       |       |               | 8,200      |                  |       |   | 7,850 |   |   |
| Cash and cash equivalents                                                                                                |       |               | 13,629     |                  |       |   | 12,740 |   |   |
| Investment securities available for sale                                                                                 |       |               | 33,477     |                  |       |   | 34,792 |   |   |
| Federal Reserve, Atlantic Central Bankers Bank and  Federal Home Loan Bank stocks                                        |       |               | 943        |                  |       |   | 988 |   |   |
| Loans, net of reserve for loan losses 2006—$1,389;  2005—$1,354                                                |       |               | 78,952     |                  |       |   | 78,426 |   |   |
| Premises and equipment                                                                                                   |       |               | 3,434      |                  |       |   | 3,509 |   |   |
| Cash surrender value of life insurance                                                                                   |       |               | 5,665      |                  |       |   | 5,610 |   |   |
| Accrued interest receivable                                                                                              |       |               | 582        |                  |       |   | 627 |   |   |
| Real estate owned other than premises                                                                                    |       |               | 726        |                  |       |   | 671 |   |   |
| Other assets                                                                                                             |       |               | 2,229      |                  |       |   | 1,768 |   |   |
| Total assets                                                                                                             |       |               | $          | 139,637               |       |   |   | $ | 139,131 |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                           | ** ** |               | ** ** | ** **            |       |   | ** ** | ** ** |   |
| Deposits                                                                                                                 |       |               |       |                  |       |   |   |   |   |
| Noninterest bearing                                                                                                      |       |               | $          | 18,565                |       |   |   | $ | 18,365 |   |   |
| Interest bearing                                                                                                         |       |               | 89,555     |                  |       |   | 89,121 |   |   |
|                                                                                                                     |       |               | 108,120    |                  |       |   | 107,486 |   |   |
| Other borrowed funds                                                                                                     |       |               | 15,000     |                  |       |   | 15,000 |   |   |
| Accrued interest payable                                                                                                 |       |               | 314        |                  |       |   | 270 |   |   |
| Other liabilities                                                                                                        |       |               | 1,453      |                  |       |   | 1,474 |   |   |
| Total liabilities                                                                                                        |       |               | 124,887    |                  |       |   | 124,230 |   |   |
| Stockholders’  Equity                                                                                               |       |               |       |                  |       |   |   |   |   |
| Common stock: par value $.625 per share; 4,000,000  shares authorized; 495,000 shares issued, 492,790 shares outstanding |       |               | 309        |                  |       |   | 309 |   |   |
| Additional paid-in capital                                                                                               |       |               | 2,051      |                  |       |   | 2,051 |   |   |
| Retained earnings                                                                                                        |       |               | 12,985     |                  |       |   | 12,938 |   |   |
| Accumulated other comprehensive income (loss)                                                                            |       |               | (506       | )                     |       |   | (308 | ) |   |
| Treaury stock; at cost- 2,210 shares                                                                                     |       |               | (89        | )                     |       |   | (89 | ) |   |
| Total stockholders’ equity                                                                                          |       |               | 14,750     |                  |       |   | 14,901 |   |   |
| Total liabilities  and stockholders’ equity                                                                         |       |               | $          | 139,637               |       |   |   | $ | 139,131 |   |   |

 

**The Notes to Condensed Consolidated Financial Statements are an integral part of these statements.**

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**FULTON BANCSHARES CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF INCOMEThree Months Ended March 31, 2006 and 2005(Dollars in thousands, except per share data)**

| ** **                                                                  | ** ** | **2006**        | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------|------------|----------|------------|
| ** **                                                                  | ** ** | **(Unaudited)** | ** ** |
| **Interest Income**                                                         |       |            |       |     |       |
| Interest and fees  on loans                                                 |       | $               | 1,368      |     | $          | 1,507 |   |
| Interest and dividends on investment securities:                            |       |            |       |     |       |
| Other U.S.  Government agencies                                             |       | 129             |       | 64       |       |
| Mortgage-backed  securities                                                 |       | 170             |       | 132      |       |
| Obligations of  state and political subdivisions- tax exempt                |       | 51              |       | 52       |       |
| Other interest  and dividends                                               |       | 24              |       | 10       |       |
| Interest on  federal funds sold                                             |       | 95              |       | 19       |       |
| Total interest  income                                                      |       | 1,837           |       | 1,784    |       |
| **Interest  Expense**                                                       |       |            |       |     |       |
| Interest on  deposits                                                       |       | 571             |       | 474      |       |
| Interest on other  borrowed money                                           |       | 222             |       | 222      |       |
| Total interest  expense                                                     |       | 793             |       | 696      |       |
| Net interest  income before provision for loan losses                       |       | 1,044           |       | 1,088    |       |
| **Provision for Loan Losses**                                               |       | 0               |       | 70       |       |
| Net interest  income after provision for loan losses                        |       | 1,044           |       | 1,018    |       |
| **Other  Income**                                                           |       |            |       |     |       |
| Service charges  on deposit accounts                                        |       | 40              |       | 38       |       |
| Other service  charges and fees                                             |       | 45              |       | 52       |       |
| Earnings—Cash  surrender value of life insurance                       |       | 69              |       | 58       |       |
| Trust services                                                              |       | 0               |       | 2        |       |
| Gain on sale of  loans                                                      |       | 0               |       | 1        |       |
| Gain on sale of  OREO property                                              |       | 0               |       | 19       |       |
| Other income                                                                |       | 3               |       | 2        |       |
| Total other  income                                                         |       | 157             |       | 172      |       |
| **Other  Expenses**                                                         |       |            |       |     |       |
| Salaries, fees,  and employee benefits                                      |       | 512             |       | 438      |       |
| Net occupancy  expense of bank premises and furniture and equipment expense |       | 205             |       | 207      |       |
| Professional and  loan-related fees                                         |       | 97              |       | 153      |       |
| Data processing                                                             |       | 85              |       | 74       |       |
| FDIC insurance  premiums                                                    |       | 48              |       | 50       |       |
| Other expenses                                                              |       | 257             |       | 225      |       |
| Total other  expenses                                                       |       | 1,204           |       | 1,147    |       |
| Income (loss)  before income taxes                                          |       | (3              | )          | 43       |       |
| Applicable income  tax (benefit)                                            |       | (50             | )          | (17      | )          |
| Net income                                                                  |       | $               | 47         |     | $          | 60 |   |
| Earnings per  common share                                                  |       | $               | .09        |     | $          | .12 |   |

 

**The Notes to Condensed Consolidated Financial Statements are an integral part of these statements.**

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**FULTON BANCSHARES CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOMEThree Months Ended March 31, 2006 And 2005(In Thousands)**

| ** **                                                       | ** ** | **2006**        | ** ** | **2005** | ** ** |
|------------------------------------------------------------------|------------|-----------------|------------|----------|------------|
| ** **                                                       | ** ** | **(Unaudited)** | ** ** |
| Net Income                                                       |       | $               | 47         |     | $          | 60 |   |
| Unrealized (loss) on investments available for sale,  net of tax |       | (198            | )          | (287     | )          |
| Comprehensive  (loss)                                            |       | $               | (151       | )        | $          | (227 | ) |

 

**The Notes to Condensed Consolidated Financial Statements are an integral part of these statements.**

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**FULTON BANCSHARES, CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWSThree Months Ended March 31, 2006 and 2005(In thousands)**

| ** **                                                                           | ** ** | **2006**        | ** ** | **2005** | ** ** |
|--------------------------------------------------------------------------------------|------------|-----------------|------------|----------|------------|
| ** **                                                                           | ** ** | **(Unaudited)** | ** ** |
| **Cash flows from operating  activities:**                                           |       |            |       |     |       |
| Net Income                                                                           |       | $               | 47         |     | $          | 60 |   |
| Adjustments to  reconcile net income to net cash provided by operating   activities: |       |            |       |     |       |
| Depreciation and amortization                                                        |       | 87              |       | 86       |       |
| Provision for loan losses                                                            |       | 0               |       | 70       |       |
| Deferred income taxes                                                                |       | (50             | )          | 0        |       |
| Decrease in accrued interest receivable                                              |       | 45              |       | 95       |       |
| Increase (decrease) in accrued interest payable                                      |       | 44              |       | (3       | )          |
| Increase in CSV—Life Insurance                                                  |       | (55             | )          | (47      | )          |
| Gain on sale—OREO                                                               |       | 0               |       | (19      | )          |
| Other—Net                                                                       |       | (329            | )          | (213     | )          |
| Net cash provided (used) by operating activities                                     |       | (211            | )          | 29       |       |
| **Cash  flows from investing activities:**                                           |       |            |       |     |       |
| Purchase of investment securities—Available-for-sale                            |       | 0               |       | (10,055  | )          |
| Net redemption of Federal Home Loan Bank Stock                                       |       | 45              |       | 229      |       |
| Maturities of available-for-sale securities                                          |       | 1,014           |       | 421      |       |
| Net (increase) decrease in loans                                                     |       | (585            | )          | 2,175    |       |
| Proceeds from sale of OREO                                                           |       | 3               |       | 749      |       |
| Purchases of & deposits on bank premises  and equipment—net            |       | (12             | )          | (46      | )          |
| Net cash provided (used) by investing activities                                     |       | 465             |       | (6,527   | )          |
| **Cash  flows from financing activities:**                                           |       |            |       |     |       |
| Net increase (decrease) in deposits                                                  |       | 634             |       | (629     | )          |
| Net cash provided (used) by financing activities                                     |       | 634             |       | (629     | )          |
| Net increase (decrease) in cash and cash equivalents                                 |       | 888             |       | (7,127   | )          |
| Cash and cash equivalents, beginning balance                                         |       | 12,741          |       | 16,364   |       |
| Cash and cash equivalents, ending balance                                            |       | $               | 13,629     |     | $          | 9,237 |   |
| **Supplemental  disclosure of cash flows information:**                              |       |            |       |     |       |
| Cash paid during  the period for:                                                    |       |            |       |     |       |
| Interest                                                                             |       | $               | 749        |     | $          | 699 |   |
| **Supplemental  disclosure of cash flows information:**                              |       |            |       |     |       |
| Unrealized holding (loss) net of tax                                                 |       | (198            | )          | (287     | )          |
| Other real estate  acquired in settlement of loans                                   |       | 58              |       | 0        |       |

 

**The Notes to Condensed Consolidated Financial Statements are an integral part of these statements.**

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**FULTON BANCSHARES CORPORATION AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSMarch 31, 2006(UNAUDITED)**

**Review of InterimFinancial Statements**

The condensed consolidatedfinancial statements as of and for the three months ended March 31, 2006and 2005 have been reviewed by independent certified public accountants. Theirreport on the review is attached as Exhibit 99 to the 10-Q filing.

**Note 1.   Basisof Presentation**

The financial information presented at and for thethree months ended March 31, 2006 and 2005 is unaudited. Informationpresented at December 31, 2005 is condensed from audited year-endfinancial statements. However, unaudited information reflects all adjustments(consisting solely of normal recurring adjustments) that are, in the opinion ofmanagement, necessary for a fair presentation of the financial position,results of operations and cash flows for the interim period.

The accompanying unaudited consolidated financialstatements have been prepared in accordance with generally accepted accountingprinciples in the United States of America for interim financial information.Accordingly, they do not include all of the information and footnotes requiredby generally accepted accounting principles for complete financial statements.In the opinion of management, all adjustments considered necessary for a fairpresentation have been included and are of a normal, recurring nature. Operatingresults for the three month period ended March 31, 2006, are notnecessarily indicative of the results that may be expected for the year ending December 31,2006. These statements should be read in conjunction with notes to thefinancial statements contained in the 2005 Annual Report to Stockholders.

In addition to historicalinformation, this Form 10-Q Report contains forward-lookingstatements. The forward-looking statements contained herein are subject tocertain risks and uncertainties that could cause actual results to differmaterially from those projected in the forward-looking statements. Importantfactors that might cause such differences include, but are not limited to,those discussed in the section entitled “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations”. Readers are cautioned not toplace undue reliance on these forward-looking statements, which reflectmanagement’s analysis only as of the date hereof. Readers should carefullyreview the risk factors described in other documents the Fulton BancsharesCorporation files from time to time with the Securities and ExchangeCommission.

**Note 2.   Principlesof Consolidation**

The consolidated financialstatements include the accounts of the Fulton Bancshares Corporation and itswholly-owned subsidiaries, The Fulton County National Bank & TrustCompany and the Fulton County Community Development Corporation (together, the “Corporation”).All significant intercompany transactions and accounts have been eliminated.

**Note 3.   CashFlows**

For purposes of thestatements of cash flows, the Corporation has defined cash and cash equivalentsas those amounts included in the balance sheet captions “cash and due frombanks” and “federal funds sold”. As permitted by Statement of FinancialAccounting Standards No. 104, the Corporation has elected 

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topresent the net increase or decrease in deposits in banks, loans and timedeposits in the statements of cash flows.

**Note 4.   FederalIncome Taxes**

For financial reportingpurposes the provision for loan losses charged to operating expense is based onmanagement’s judgment, whereas for federal income tax purposes, the amountallowable under present tax law is deducted. Additionally, certain expenses arecharged to operating expense in the period the liability is incurred forfinancial reporting purposes, whereas for federal income tax purposes, theseexpenses are deducted when paid. As a result of these timing differences, deferredincome taxes are provided in the financial statements. Federal income taxeswere computed after reducing pretax accounting income for nontaxable municipaland loan income.

**Note 5.   OtherCommitments**

In the normal course ofbusiness, the Corporation makes various commitments and incurs certaincontingent liabilities which are not reflected in the accompanying financialstatements. These commitments include various guarantees and commitments toextend credit and the Corporation does not anticipate any losses as a result ofthese transactions.

**Note 6.   InvestmentSecurities**

Thecarrying amounts of investment securities and their approximate fair values at March 31,2006 were as follows:

| ** **                                 | ** ** | ** **              | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|----------------|------------|----------------|------------|------------|------------|
| ** **                                 | ** ** | **Amortized**           | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| ** **                                 | ** ** | **Cost**                | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
| ** **                                 | ** ** | **(In thousands)** | ** ** |
| INVESTMENT SECURITIES  AVAILABLE FOR SALE: |       |                    |       |           |       |           |       |       |       |   |   |   |   |   |   |
| State and Municipal Securities             |       |                    | $          | 5,194          |       |           |       | $          | 16         |   |   |   | $ | (74 | ) |   | $ | 5,136 |   |
| U.S. Government Agency Securities          |       |                    | 13,811     |           |       |           | 0          |       |       |   | (194 | ) |   | 13,617 |   |
| Mortgage-backed Securities                 |       |                    | 15,181     |           |       |           | 4          |       |       |   | (535 | ) |   | 14,650 |   |
| Equity Securities                          |       |                    | 59         |           |       |           | 15         |       |       |   | 0 |   |   | 74 |   |
|                                       |       |                    | $          | 34,245         |       |           |       | $          | 35         |   |   |   | $ | (803 | ) |   | $ | 33,477 |   |

 

There were no securitiescategorized “Held-to-maturity” or “Trading” at March 31, 2006.

**Note 7.   ComprehensiveIncome**

Comprehensive income isdefined as the change in equity from transactions and other events from nonowner sources. It includes all changes in equity except those resulting frominvestments by owners and distributions to owners. Consequently, a “Statementof Comprehensive Income” has been included in this filing.

**Note 8.   EarningsPer Share**

Earnings per common sharewere computed based on the weighted average of shares of common stock outstanding,which was 492,790 shares.

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**Note 9.   RegulatoryMatters and Settlement with Former President**

The Fulton County National Bank and Trust Company, asa National Bank, is subject to the dividend restrictions set forth by theComptroller of the Currency. The Corporation is also subject to variousregulatory capital requirements administered by federal banking agencies. Failureto meet minimum capital requirements can initiate certain mandatory, andpossibly additional discretionary actions by regulators that, if undertaken,could have a direct material effect on the Corporation’s financial statements.

On March 23, 2005, the Bank’s Board of Directorsentered into a “Stipulation and Consent to the Issuance of a Consent Order”(the “Consent Order”) with the Office of the Comptroller of the Currency (OCC).The Consent Order includes 24 articles that commence by requiring the Bank toform a Compliance Committee and develop an action plan (“Plan”) to comply withthe remaining articles. The Plan requires the development of a strategic plan,the appointment of certain management and officers and the commission of amanagement and board supervision study. The Plan also requires the developmentof a three-year profit plan and capital plan, the requirement to maintain certaincapital ratios, improvement in interest rate risk management, a consultantstudy of compliance with Truth-In-Lending and RESPA, and a review of themethodology of determining ALLL. The Plan further requires the Bank to engageand retain a qualified third-party loan review, to develop a criticized assetsimprovement program, to implement a loan portfolio management improvementprogram and to implement improved reporting and information systems for theloan portfolio. Further articles of the Plan require a qualified, independentconsultant to assess compliance with the Bank Secrecy Act (“BSA”), MoneyLaundering Control Act, suspicious activities, and the rules andregulations of the Office of Foreign Assets and Control, the development of aBSA compliance program, a study of the audit function with emphasis on BSAcompliance, and a written program on Suspicious Activity Reports. Otherarticles of the Plan require the development of a customer information securityprogram, a disaster recovery plan, and a liquidity contingency plan. Finally,an article requires the Board to take all necessary steps to ensure that theBank corrects each violation of law, rule or regulation cited in Reportsof Examination. The remaining articles are administrative in nature.

Under the Consent Order, the Bank must obtain OCCapproval before any executive officers or directors can be added to the Bank’smanagement. The payment of dividends has also been temporarily suspendedwithout prior OCC approval.

Similar restrictions have been placed on the holdingcompany, Fulton Bancshares Corporation, by the Federal Reserve Bank. TheCorporation is considered to be in “troubled” condition, as that term isdefined in Regulation Y, 12 C.F.R.225.71(d). The designation was due to seriousconcerns in a Federal Reserve Inspection Report commenced January 31, 2005and concluded February 17, 2005 and the Office of the Comptroller of theCurrency (OCC) Report of Examination on the Corporation’s wholly-owned banksubsidiary commenced August 10, 2004 and received in the final form inFebruary, 2005. The OCC, the Bank’s primary regulator, provided a letter ofconcern based on the preliminary findings of the Examination dated November 23,2004. The concerns in the OCC Report of Examination were reflected in theConsent Order referenced above.

On May 9, 2005 the Board of Directors of theCorporation signed a Memorandum of Understanding (“MOU”) dated May 9, 2005issued by Federal Reserve Bank (“Reserve Bank”). The principle elements of theMOU are as follows: The Corporation may not issue dividends nor incur debt notin the ordinary course of business without approval of the Reserve Bank, theCorporation may not repurchase its own stock without approval of the ReserveBank, the Corporation must appoint a compliance committee and conduct anassessment of the external audit firm’s ability to audit an organization, suchas the Corporation, which is subject to the Sarbanes Oxley Act and theCorporation is required to ensure that its wholly owned 

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subsidiary, The FultonCounty National Bank & Trust Company, complies with the supervisoryactions imposed by the Office of the Comptroller of the Currency.

The OCC has also informed the Bank of possibleviolations of laws and regulations with regard to the Bank Secrecy Act, theTruth-In-Lending Act, and the Real Estate Settlement Procedures Act which couldresult in future fines and penalties to the Bank and possible reimbursements. Theamount of any future fines or reimbursements cannot be reasonably estimated at March 31,2006.

Because compliance with the Order will requirereallocation and increases in internal resources and the engagement of variousvendors and consultants, the cost of compliance and the effect on results ofoperations is expected to be material; however the cost of compliance with theOrder cannot be reasonably estimated at this time.

Due to the regulatory ratings and increased scrutinyof the OCC, the Bank expects OCC and exam fees to be approximately $168,000,the same as in 2005.

As of March 31, 2006, the Bank has formed aCompliance Committee, developed a written action plan, written a strategicplan, developed a capital plan, engaged a consultant to prepare the managementstudy, improved interest rate risk management, hired an independent consultantto conduct a Bank Secrecy Act (BSA) assessment, completed and implemented a BSAcompliance program, engaged an internal audit firm to conduct an audit riskassessment and perform internal audits, developed and implemented a writtenprogram regarding the filing of Suspicious Activity Reports, completed acustomer information security program and testing, engaged a qualified thirdparty loan review firm to conduct quarterly assessments of the loan portfolio,prepared a disaster recovery plan, and completed a liquidity contingency plan.

In addition, on March 4,2005, the Bank terminated its President. The Boards of Directors ofFulton Bancshares Corporation and The Fulton National Bank and Trust Companyentered into a Settlement Agreement and General Release with its formerPresident which became effective on June 15, 2005. The terms of theSettlement Agreement are summarized as follows.

The former President’s termination on March 4,2005 from employment as an officer or employee of the Bank remained in effect.The former President resigned as a member of the Boards of Directors and anyother officer or employment position he held with the Corporation and the Bank,effective June 15, 2005. The former President acknowledged his March 4,2005 separation from employment by the Corporation and the Bank and agreed thathe will not challenge the legal validity of that separation. The formerPresident agreed not to seek employment with the Corporation or the Bank.

The principal balances of a loan to the former Presidentand two other loans in the aggregate approximate amount of $185,000 were paidto the Bank in full with interest and other charges as required by theapplicable loan documents. In addition, the former President assignedPittsburgh Steelers ticket licensing rights for six seats to the Bank.

The Bank agreed to no longer take the position underthe Salary Continuation Agreement known generically as a Supplemental EmployeeRetirement Plan dated September 1, 1995 and subsequently amended(together, “SERP”) that the former President’s termination was for cause,thereby allowing the former President to apply to the OCC and the FederalDeposit Insurance Corporation (“FDIC”) for permission to obtain such part ofhis SERP as the regulators or the courts determine that the Bank must pay. Ifthe SERP payments are not approved by the OCC and FDIC, and such regulatorydisapproval is upheld by any subsequent judicial review, then the Bank agreedto pay the former President only one year of severance pay at his final annualsalary, if authorized by the regulators to do so. The former President agreedto not challenge the legal validity of the Bank’s payment under the SERP of theamount determined by the regulators or a final valid court order. The Bankagreed to not file a civil action 

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requesting the return bythe former President of monies paid to him under the Bank’s 401(k) plan orthe SERP.

The Directors asindividuals and shareholders released the former President from liabilityrelated to his employment with the Corporation and the Bank. The formerPresident released the Corporation, Bank, and Directors from any liabilityrelated to termination of his employment with the Corporation and the Bank.

**Note 10.   Entryinto a Material Definitive Agreement**

On January 23, 2006, the Corporation entered intoan Agreement and Plan of Merger (the “Merger Agreement”) with FranklinFinancial Services Corporation (“Franklin”) pursuant to which the Corporationwill merge with and into Franklin (the “Merger”) with Franklin being thesurviving corporation in the Merger. In connection with the Merger, theCorporation will also cause its wholly-owned subsidiary, the Bank, to mergewith and into Franklin’s wholly-owned subsidiary, Farmers and Merchants TrustCompany of Chambersburg (“F&M Trust”), (the “Bank Merger”) with F&MTrust being the surviving bank in the Bank Merger. Under the terms of theMerger Agreement, shareholders of the Corporation will have the right to electto receive, for each share of the Corporation’s common stock they own: (1) 1.864shares of validly issued, fully paid and nonassessable shares of Franklin’scommon stock, or (2) $ 48.00 in cash. Each shareholder of theCorporation will be entitled to elect all cash, all Franklin common stock or amix of cash and Franklin common stock for their shares of the Corporation’scommon stock. Shareholder elections, however, will be subject to allocationprocedures designed to ensure that the aggregate number of shares of Franklincommon stock to be issued and the aggregate amount of cash to be paid shall notexceed 492,790 shares and $ 10,964,577 in cash. Consummation of the Mergeris subject to certain customary terms and conditions, including, but notlimited to, receipt of various regulatory approvals and approval by theCorporation’s shareholders.

On January 24, 2006, the Corporation filed theMerger Agreement on a Form 8-K with the Securities and ExchangeCommission. Franklin has filed a Registration Statement on Form S-4with the Securities and Exchange Commission addressing the proposed Merger andissuance of Franklin Common Stock in the Merger, which may be subsequentlyamended and which includes the Corporation’s proxy statement to be used for itsannual meeting of shareholders to consider and vote on adoption of the MergerAgreement.

Under the Merger Agreement, the Corporation agreed totake all reasonable efforts to close the Breezewood branch office, located at200 South Breezewood Road, Breezewood, Pennsylvania 15536 as soon aspracticable after the date of the Merger Agreement in accordance with allapplicable regulatory requirements.

Notices of the closing of the branch office were sentto customers on February 24, 2006. The anticipated closing date is June 3,2006.

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**FULTON BANCSHARES CORPORATION MANAGEMENT’S DISCUSSIONAND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**OVERVIEW**

Net after tax income forthe first three months of 2006 was $47,000 compared to net income of $61,000for the same period in 2005, representing a decrease of $14,000, or 23.0%. Netincome on an adjusted per share basis for the first three months of 2006 was$0.09 compared to $0.12 income per share realized during the first three monthsended March 31, 2005.

**RESULTS OFOPERATIONS**

Interest income for the first quarter of 2006 was$1,837,000 compared to $1,784,000 earned during the same period in 2005, for anincrease of $53,000, or 3.0%. The increase was due primarily to rising interestrates in 2006. Without a senior lending officer and with the emphasis onworking out problem credits, loans declined on average by $14,585,000. Theaverage balance of Federal Funds Sold and Interest-bearing Balances with Banksincreased $5,344,000 as the Bank held a higher mix of liquid assets inanticipation of the merger with F & M. In addition, higher Bankcapital ratio requirements in the OCC Consent Order signed on March 23,2005 and related borrowing restrictions, have constrained asset growth andrequired more liquid assets to be maintained.

Interest expense for the first quarter of 2006 was$793,000, an increase of $97,000, or 13.9% compared to the first quarter of2005. The increase was due primarily to higher market rates paid on depositsand a change in the mix to higher cost deposits and away from core savingsaccounts. Net interest income before the provision for loan losses for thefirst quarter of 2006 totaled $1,044,000, down $44,000, or 4.0%, from the firstquarter of 2005.

Net interest income is thedifference between total interest income and total interest expense. Interestincome is generated through earning assets, which include loans, deposits withother banks, and investments. Interest income is dependent on many factorsincluding the volume of earning assets; level of interest rates; changes ininterest rates; and volumes of nonperforming loans. The cost of funds varieswith the volume of funds necessary to support earning assets; rates paid tomaintain deposits; rates paid on borrowed funds; and level of interest-freedeposits.

**NET INTEREST MARGIN**

The net interest marginwas 3.52% for both the first quarter of 2006 and 2005. The yield on earningassets increased 35 basis points from 5.77% to 6.12% for the first quarter of2006 versus the first quarter of 2005. The cost of earning assets (interestexpense divided by average interest earning assets) increased 35 basispoints from 2.25% to 2.60% for the same periods, resulting in no change in netinterest margin. Liquidity and interest rate risk are monitored through assetliability management modeling to evaluate the impact of rising and fallingrates. Fulton manages its net interest margin by structuring the maturities andcash flow of interest-earning assets and liabilities so they can be repriced inresponse to changes in market interest rates.

**NONINTEREST INCOME**

First quarter 2006noninterest income decreased $15,000 to $157,000, down 8.7% from $172,000earned in the first quarter of 2005. Earnings on the cash surrender value ofbank owned life insurance increased $11,000, or 19.0%, over the first quarterof 2005. The Corporation sold no loans, other real estate, investmentsecurities, or other assets during the first quarter of 2006, which causedother income to decrease by $20,000 versus the same period in 2005.

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**NONINTEREST EXPENSE**

First quarter 2006noninterest expenses totaled $1,204,000, an increase of $57,000, or 5.0%, overthe $1,147,000 reported in the first quarter of 2005. Salaries andemployee-related expenses increased $74,000, or 16.9%, primarily due to thecosts incurred for contract employees filling the roles of CEO and CFO, who areon staff on an interim basis. Professional and loan-related fees, which were$153,000 in the first quarter of 2005, declined to $97,000, a drop of $56,000or 36.6% during 2006. Legal and professional expenses were extremely highduring 2005, as the Corporation dealt with the resignation of the formerPresident and the issues related to the Consent Order with the OCC and the MOUwith the Federal Reserve. Legal and other expenses related to the plannedmerger with Franklin Financial have been booked as prepaid expenses untilconsummation. Other expenses increased $32,000 or 14.2% from the first quarterof 2005 to the first quarter of 2006.

**INCOME TAXES**

The income tax benefit forthe first quarter of 2006 was ($50,000) compared to a benefit of ($17,000) forthe first quarter of 2005. Effective tax rates (compared to the marginalfederal income tax bracket of 34% applicable to each period) were different foreach period primarily due to the relationship of non taxable income to totaltaxable loss.

**PROVISION FOR LOANLOSSES**

Provisionfor loan losses was $0 for the first quarter of 2006 compared with $70,000 forthe first quarter of 2005. Provisions were based on management’s evaluation ofthe adequacy of the reserve for possible loan losses at March 31, 2006 and2005 and represent amounts deemed necessary to maintain the reserve at theappropriate level based on size, mix, and quality of the loan portfolio, andconsidering economic conditions and other relevant risk factors. A summary ofthe allowance for loan losses follows: 

| ** **                                      | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **March 31,  2006**         | ** ** | **March 31,  2005** | ** ** |
| ** **                                      | ** ** | **(In thousands)**          | ** ** |
| Beginning of period                             |       |                             | $          | 1,354 |   |   |   | $ | 1,821 |   |   |
| Loans charged-off during the period:            |       |                             |       |   |   |   |   |   |   |
| Real estate loans                               |       |                             | 0          |   |   |   | 0 |   |   |
| Installment loans                               |       |                             | 0          |   |   |   | 8 |   |   |
| Commercial and all other loans                  |       |                             | 1          |   |   |   | 0 |   |   |
| Total charge-offs                               |       |                             | 1          |   |   |   | 8 |   |   |
| Recoveries of Loans previously charged-off:     |       |                             |       |   |   |   |   |   |   |
| Real estate loans                               |       |                             | 0          |   |   |   | 1 |   |   |
| Installment loans                               |       |                             | 1          |   |   |   | 1 |   |   |
| Commercial and all other loans                  |       |                             | 35         |   |   |   | 0 |   |   |
| Total recoveries                                |       |                             | 36         |   |   |   | 2 |   |   |
| Net loans (charged off) recovered               |       |                             | 35         |   |   |   | (6 | ) |   |
| Provision for loan losses charged to operations |       |                             | 0          |   |   |   | 70 |   |   |
| Allowance for  loan losses-end of period        |       |                             | $          | 1,389 |   |   |   | $ | 1,885 |   |   |

 

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Loans90 days or more past due (still accruing interest) and those on nonaccrualstatus were as follows at March 31: 

| ** **                    | ** ** | **90 Days or  More Past Due**        | ** ** | **Nonaccrual Status**                               | ** ** |
|-------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                    | ** ** | **    2006    ** | ** ** | **    2005    ** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Loans secured by  real estate |       |                                                     | $          | 0                                                        |       |   |   | $ | 0 |   |   | $ | 1,048 |   | $ | 693 |   |
| Installment loans             |       |                                                     | 0          |                                                     |       |   | 0 |   |   | 29 |   | 0 |   |
| Commercial and other loans    |       |                                                     | 0          |                                                     |       |   | 0 |   |   | 760 |   | 774 |   |
| Total                         |       |                                                     | $          | 0                                                        |       |   |   | $ | 0 |   |   | $ | 1,837 |   | $ | 1,467 |   |

 

The Corporation reviewsits loan portfolio on a quarterly basis to determine the adequacy of theallowance for loan losses. The allowance for loan losses consists of a numberof allocations from various segments of the portfolio. A specific allocation isdetermined for individual impaired loans based on the loan’s collateral fairvalue and other observable data. A watch list of loans is identified forevaluation based on internal and external loan reviews and a general allocationis made for each category of loans on the list. Loans not on the watch list aregrouped into pools of loans with similar credit risk characteristics, includingagricultural, residential real estate, non-farm/non-residential, commercial andloans to individuals. Loans in these pools are evaluated as groups withallocations made to the allowance based on historical loss experience adjustedfor current trends in delinquencies, underwriting and oversight; concentrationsof credit; and general economic conditions within the Corporation’s tradingarea. The result of the first quarter loan portfolio evaluation was a provisionof $0 in the first quarter of 2006, compared to $70,000 in the first quarter of2005. The balance in the reserve for loan losses was lower than at the end ofthe first quarter of 2005, largely due to the charge-off of a singlerelationship late in 2005, which continues to pay according to terms. Thequarterly review also included the anticipated payoff of several loans innonaccrual status, which occurred subsequent to the end of the first quarter of2006.

**FINANCIAL CONDITION**

Assets and Liabilities

The overall balance sheetwas relatively stable from year-end 2005 to the end of the first quarter of2006. Total assets on March 31, 2006 were $139,637,000 compared to$139,131,000 at December 31, 2005, an increase of $506,000 or 0.4%. Netloans on March 31, 2006 were $78,952,000, an increase of 0.7% from$78,426,000 on December 31, 2005. Total deposits increased $634,000 or0.6% to $108,120,000 as of March 31, 2006, compared with $107,486,000 at December 31,2005. Noninterest bearing demand deposits increased 1.1% to $18,565,000 andinterest bearing deposits increased .5% to $89,555,000. Interest bearingdeposits continued to shift from lower yielding savings accounts to higheryielding certificates of deposit and money market accounts as rates movedhigher during the quarter.

Off-Balance Sheet Items

The Corporation is a partyto financial instruments with off-balance-sheet risk in the normal course ofbusiness to meet the financial needs of its customers. These financialinstruments include commitments to extend credit and standby letters of credit.Those instruments involve, to varying degrees, elements of credit and interestrate risk in excess of the amount recognized in the balance sheet. The contractamounts of those instruments reflect the extent of involvement the corporationhas in particular classes of financial instruments. The Corporation’s exposureto credit loss in the event of nonperformance by the other party to thefinancial instrument for commitments to extend credit and standby letters ofcredit and financial guarantees written is represented by the contractualamounts of those instruments. The Corporation uses 

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the samecredit policies in making commitments and conditional obligations as it doesfor on-balance-sheet instruments.

**Contract orNotional Amount**

(In thousands)

FinancialInstruments whose contract amounts represent credit risk at March 31,2006:

| Commitments to  extend credit                               |   | $ | 10,187 |   |
|-------------------------------------------------------------|--------|---|--------|--------|
| Standby letters of  credit and financial guarantees written |   | $ | 21     |   |

 

Commitments to extendcredit are agreements to lend to a customer as long as there is no violation ofany condition established in the contract. Commitments generally have fixedexpiration dates or other termination clauses and may require payment of a fee.Since many of the commitments are expected to expire without being drawn upon,the total commitment amounts do not necessarily represent future cashrequirements. The Corporation evaluates each customer’s credit worthiness on acase-by-case basis. The amount of collateral obtained, if deemed necessary bythe Corporation upon extension of credit, is based on management’s creditevaluation of the customer. Collateral held varies but may include accountsreceivable, inventory, real estate, equipment, and income- producing commercialproperties. Standby letters of credit and financial guarantees written areconditional commitments issued by the Corporation to guarantee the performanceof a customer to a second party. Those guarantees are primarily issued tosupport public and private borrowing arrangements. The credit risk involved in issuingletters of credit is essentially the same as that involved in extending loansto customers. The Corporation holds collateral supporting those commitmentswhen deemed necessary by management.

Liquidity and Interest Rate Sensitivity

Liquidity and interest rate sensitivity are relatedto, but distinctly different from one another. Liquidity involves the bank’sability to meet cash withdrawal needs of customers and their credit needs inthe form of loans. Liquidity is provided by cash on hand and transactionbalances held at correspondent banks. Adequate liquidity to meet credit demandsand/or adverse deposit flows is also made available from sales or maturities ofshort-term assets. Additional sources of funds to meet credit needs havetraditionally been provided by access to the marketplace to obtain interestbearing deposits and other borrowings, including significant borrowing capacityavailable through Federal Home Loan Bank (FHLB) of Pittsburgh. At March 31,2006, the Bank had borrowings of $15,000,000 at FHLB, representing no changefrom December 31, 2005. Management measures liquidity ratios and balancesheet trends on a frequent basis to monitor and control liquidity risk.

Interest rate sensitivityis the matching or mismatching of the maturity and rate structure of theinterest-bearing assets and liabilities. Management strives to control thedifference in the timing and magnitude of the rate changes for these assets andliabilities to preserve a satisfactory net interest margin. With the aid of an outsidefirm, Fulton models net interest income at risk in various interest rateenvironments on a quarterly basis in order to determine the degree to which anychanges should be made in the structure of the balance sheet.

Capital

Stockholders’ equity was $14,750,000at March 31, 2006 compared with $14,901,000 at December 31, 2005, adecrease of $151,000. Accumulated other comprehensive income (loss) decreasedby $198,000, or 64.3% to ($506,000) at March 31, 2006 from ($308,000) at December 31,2005. The decrease was caused by a decline in the market value of investmentsecurities available for sale. Total stockholders’ equity 

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represented10.6% of total assets at March 31, 2006. In compliance with regulatoryrestrictions, no cash dividends were paid in the first quarter of 2006 orduring the year of 2005.

**REGULATORY CAPITAL**

TheConsent Order requires the Bank to maintain capital ratios that are well abovethe capital levels normally required by federal regulatory authorities,including risk-based capital guidelines. A comparison of Fulton BancsharesCorporation’s capital ratios to regulatory minimum requirements at March 31,2006 is as follows:

| ** **                                                                      | ** ** | **Fulton**      | ** ** | **Regulatory**   | ** ** | **Increased Regulatory**                                                                          | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------|------------|------------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **Bancshares**  | ** ** | **Minimum**      | ** ** | **Bank Minimum Requirement**                                                                 | ** ** |
| ** **                                                                      | ** ** | **Corporation** | ** ** | **Requirements** | ** ** | **      By Consent Order      ** | ** ** |
| Leverage ratio                                                                  |       |            | 11.00      | %                |       |                                                                                                   | 4.00       | % |   |   | 10.00 | % |   |
| Risk-based  capital ratios:                                                     |       |            |       |             |       |                                                                                                   |       |   |   |   |   |   |   |
| Tier I (core capital)                                                           |       |            | 17.80      | %                |       |                                                                                                   | 4.00       | % |   |   | 14.00 | % |   |
| Combined Tier I  and Tier II (core capital plus allowance for loan losses) |       |            | 19.05      | %                |       |                                                                                                   | 8.00       | % |   |   |   |   |   |

 

**BALANCE SHEET ANALYSIS**

The following table highlights the changes in thebalance sheet. Because quarter end balances can be distorted by one-dayfluctuations, an analysis of changes in the quarterly averages is provided toshow balance sheet trends.

**BALANCE SHEET ANALYSIS(in 000’s)Balance Sheets CondensedAverage**

| ** **                                                      | ** ** | **First**             | ** ** | **First**             | ** ** |
|-----------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                      | ** ** | **Quarter 2006** | ** ** | **Quarter 2005** | ** ** |
| ASSETS                                                          |       |                  |       |                  |       |   |   |   |   |
| Federal funds sold and interest bearing balances  with banks    |       |                  | $          | 9,713                 |       |   |   | $ | 4,369 |   |   |
| Investment securities available for sale and other  investments |       |                  | 35,244     |                  |       |   | 27,563 |   |   |
| Loans                                                           |       |                  | 78,858     |                  |       |   | 93,443 |   |   |
| Total interest earning assets                                   |       |                  | 123,815    |                  |       |   | 125,375 |   |   |
| Cash and due from banks                                         |       |                  | 3,994      |                  |       |   | 3,441 |   |   |
| Premises and equipment                                          |       |                  | 3,486      |                  |       |   | 3,579 |   |   |
| Other assets                                                    |       |                  | 8,790      |                  |       |   | 8,193 |   |   |
| Reserve for loan losses                                         |       |                  | (1,366     | )                     |       |   | (1,827 | ) |   |
| Total assets                                                    |       |                  | $          | 138,719               |       |   |   | $ | 138,761 |   |   |
| LIABILITIES                                                     |       |                  |       |                  |       |   |   |   |   |
| Interest bearing deposits                                       |       |                  | $          | 89,210                |       |   |   | $ | 91,953 |   |   |
| Federal funds purchased                                         |       |                  | 0          |                  |       |   | 7 |   |   |
| Other borrowed funds                                            |       |                  | 15,000     |                  |       |   | 15,000 |   |   |
| Total interest bearing liabilities                              |       |                  | 104,210    |                  |       |   | 106,960 |   |   |
| Noninterest bearing deposits                                    |       |                  | 17,841     |                  |       |   | 15,495 |   |   |
| Other liabilities                                               |       |                  | 1,780      |                  |       |   | 738 |   |   |
| Total Liabilities                                               |       |                  | 123,831    |                  |       |   | 123,193 |   |   |
| STOCKHOLDERS’ EQUITY                                       |       |                  |       |                  |       |   |   |   |   |
| Common Stockholders’ Equity                                |       |                  | 14,888     |                  |       |   | 15,568 |   |   |
| Total Liabilities and Stockholders’ Equity                 |       |                  | $          | 138,719               |       |   |   | $ | 138,761 |   |   |

 

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**ITEM 3—QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

There have been nomaterial changes to the quantitative and qualitative disclosures made in theCorporation’s Annual Report on Form 10-K for the year ended December 31,2005. See Management’s Discussion and Analysis for further discussion of marketrisk.

**ITEM 4—CONTROLS ANDPROCEDURES**

The Corporation’s Chief Executive Officer and ChiefFinancial Officer evaluated the effectiveness of the Corporation’s disclosurecontrols and procedures (as such term is defined in Rules 13a-14(c) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of March 31,2006. Based on such evaluation, such officers have concluded that, as of March 31,2006, the Corporation’s disclosure controls and procedures are effective inalerting them on a timely basis to material information relating to theCorporation (including its consolidated subsidiaries) required to be includedin the Corporation’s periodic filings under the Exchange Act. There have notbeen any significant changes in the Corporation’s internal control overfinancial reporting or in other factors that materially affected or arereasonably likely to materially affect such control during the first quarter of2006.

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**PART II—OTHERINFORMATION**

**ITEM 1—LEGALPROCEEDINGS**

In the opinion of themanagement of the Corporation, there are no material pending legal proceedingsother than ordinary routine litigation incidental to the business, to which thecorporation or its subsidiary are a party or to which their property issubject.

**ITEM 1A—RISKFACTORS**

*During the first quarter of 2006, the Corporationsigned a merger agreement with Franklin Financial Services Corporation (“Franklin”).If the transaction between the Corporation and Franklin is not completed, theCorporation will have incurred substantial expenses without realizing theexpected benefits.*

The Corporation hasincurred substantial expenses in connection with the transaction between theCorporation and Franklin (the “transaction”). The completion of the transactiondepends on the satisfaction of specified conditions and the receipt ofregulatory approvals. The Corporation cannot guarantee that these conditionswill be met. If the transaction is not completed, these expenses could have amaterial adverse impact on the financial condition of the Corporation becausethe Corporation would not have realized the expected benefits.

*The transactionmust be approved by multiple governmental agencies.*

Before the transaction maybe completed, various approvals or consents must be obtained from the FederalReserve Board and various domestic bank regulatory, antitrust, insurance andother authorities. These governmental entities, including the Federal ReserveBoard, may impose conditions on the completion of the transaction or requirechanges to the terms of the transaction. Although the Corporation and Franklindo not currently expect that any such conditions or changes would be imposed,there can be no assurance that they will not be, and such conditions or changescould have the effect of delaying completion of the transaction or imposingadditional costs on or limiting the revenues of Franklin following thetransaction, any of which might have a material adverse effect on Franklin followingthe transaction. Franklin is not obligated to complete the transaction if theregulatory approvals received in connection with the completion of thetransaction include any conditions or restrictions that, in the aggregate,would reasonably be expected to have a material adverse effect on theCorporation or Franklin, measured relative to the Corporation, but Franklincould choose to waive this condition.

*The merger agreement limits the Corporation’s abilityto pursue alternatives to the merger transaction with Franklin and requires theCorporation to pay a termination fee under certain circumstances.*

The merger agreementbetween the Corporation and Franklin contains “no shop” provisions that,subject to certain exceptions, limit the Corporation’s ability to discuss,facilitate or commit to competing third-party proposals to acquire all or asignificant part of the Corporation. Additionally, if the merger would fail tooccur in certain circumstances that relate to a possible combination of theCorporation with another acquirer, the Corporation could be obligated to payFranklin $850,000 as a termination fee. These provisions may discourage apotential competing acquirer that might have an interest in acquiring all or asignificant part of the Corporation from considering or proposing anacquisition of the Corporation even if it were prepared to pay considerationwith a higher per share market price than that proposed in the merger, or mightresult in a potential competing acquirer proposing to pay a lower per shareprice to acquire the Corporation than it might otherwise have proposed to pay.

**ITEM 2—UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

Not applicable

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**ITEM 3—DEFAULTSUPON SENIOR SECURITIES**

Not applicable

**ITEM 4—SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

Not applicable

**ITEM 5—OTHERINFORMATION**

Not applicable

**ITEM 6—EXHIBITS**

(a) (1)—Listof Financial Statements.   The following consolidated financial statementsof Fulton Bancshares Corporation and its subsidiaries, included in the annualreport of the registrant to its shareholders for the year ended December 31,2005, are incorporated by reference to the registrant’s Form 10-K for the yearended December 31, 2005.

Consolidatedbalance sheets—December 31, 2005 and 2004

Consolidatedstatements of income—Years ended December 31, 2005, 2004, and 2003

Consolidatedstatements of stockholders’ equity—Years ended December 31, 2005, 2004,and 2003

Consolidatedstatements of cash flows—Years ended December 31, 2005, 2004, and 2003

Notes to consolidated financial statements—December 31,2005

(2) List of Financial Statement Schedules.   Allfinancial statement schedules for which provision is made in the applicableaccounting regulations of the Securities and Exchange Commission are notrequired under the related instructions or are inapplicable and therefore havebeen omitted.

(b) Listing of Exhibits
| 2.1    |   | Agreement and Plan of Merger dated January 23,  2006 by and between Franklin Financial Services Corporation and Fulton  Bancshares Corporation (Incorporated by reference to the registrant’s  Form 8-K filed on January 23, 2006).                                     |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3      |   | (i)                                                                                                                                                                                                                                                                                         | Articles of  Incorporation (Incorporated by reference to the registrant’s Form 10-K/A  for the year ended December 31, 2004). |
|   |   | (ii)                                                                                                                                                                                                                                                                                        | Bylaws (Incorporated by  reference to the registrant’s Form 10-K/A for the year ended  December 31, 2004). |
| 10.1   |   | Salary Continuation  Agreement/Supplemental Executive Retirement Plan for the Chief Executive  Officer: Clyde H. Bookheimer (Incorporated by reference to the Registrant’s  Form 10-K for the year ended December 31, 2002).                                                 |
| 10.2   |   | Director Deferred  Compensation Plan Agreement applicable to Cecil B. Mellott, David L. Seiders,  Clair R. Miller, Ellis L. Yingling, Martin R. Brown and Robert C. Snyder  (Incorporated by reference to the Registrant’s Form 10-K for the  year ended December 31, 2002). |
| 10.3   |   | Director Emeritus  Retirement Agreement applicable to Raleigh Barnett, K.G. Richards and Merill  Kerlin (Incorporated by reference to the registrant’s Form 10-K  for the year ended December 31, 2002).                                                                     |
| 10.4   |   | Salary Continuation  Agreement/Supplemental Executive Retirement Plan for Alice Clark, Vice President  (Incorporated by reference to the registrant’s Form 10-K/A for the  year ended December 31, 2004).                                                               |

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| 10.5 |   | Survivor Income Agreement for Sharon Sowers  (Incorporated by reference to the registrant’s Form 10-K for the  year ended December 31, 2005)        |
|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.6 |   | Survivor Income  Agreement for Alice Clark (Incorporated by reference to the registrant’s  Form 10-K for the year ended December 31, 2005)          |
| 10.7 |   | Survivor Income  Agreement for Neil L. Berkstresser (Incorporated by reference to the  registrant’s Form 10-K for the year ended December 31, 2005) |
| 14   |   | Code of Ethics  (Incorporated by reference to the Registrant’s Form 10-K for the  year ended December 31, 2003)                                     |
| 31.1 |   | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                          |
| 31.2 |   | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                          |
| 32.1 |   | Certification of Chief  Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002       |
| 32.2 |   | Certification of Chief  Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002       |
| 99   |   | Report of Independent  Registered Public Accounting Firm on Interim Financial Statements                                                                           |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
| Date: May 11, 2006 | By:      | /s/ GEORGE W.  MILLWARD                         |   |
|-------------------------|----------|-------------------------------------------------|--------|
|                    |     | George W. Millward,                             |
|                    | * * | *Interim President and Chief Executive Officer* |
| Date: May 11, 2006 | By:      | /s/ DEBRA A. GOODLING                           |   |
|                    |     | Debra A. Goodling,                              |
|                    | * * | *Interim Chief Financial Officer*               |
|                         |          |                                                 |        |  |

 

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