10-Q 1 june10q.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended June 30, 2004 Commission file number: 33-850626 FULTON BANCSHARES CORPORATION (Exact name of registrant as specified in its charter) Commonwealth of Pennsylvania 25-1598464 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 100 Lincoln Way East McConnellsburg, Pennsylvania 17233 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (717) 485-3144 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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 checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes No X Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at August 3, 2004 (Common stock, .625 par value) 492,790 Page 1 of 32 FULTON BANCSHARES CORPORATION INDEX Page PART I - FINANCIAL INFORMATION Item 1 - Consolidated Financial Statements Condensed consolidated balance sheets - June 30, 2004 and December 31, 2003 4 Condensed consolidated statements of income - three months ended June 30, 2004 and 2003 5 Condensed consolidated statements of comprehensive income - three months ended June 30, 2004 and 2003 6 Condensed consolidated statements of income - six months ended June 30, 2004 and 2003 7 Condensed consolidated statements of comprehensive income - six months ended June 30, 2004 and 2003 8 Condensed consolidated statements of cash flows - six months ended June 30, 2004 and 2003 9 Notes to condensed consolidated financial statements 10 - 12 Item 2 - Management's discussion and analysis of financial condition and results of operations 13 - 21 Item 3 - Quantitative and qualitative disclosures about market risk 21 Item 4 - Controls and procedures 21 PART II - OTHER INFORMATION 22 Item 1 - Legal proceedings 23 Item 2 - Changes in securities, use of proceeds, and issuer purchase of equity securities 23 Item 3 - Defaults upon senior securities 23 Item 4 - Submission of matters to a vote of security holders 23 Item 5 - Other information 23 Item 6 - Exhibits and reports on Form 8-K 24 Signatures 25 Exhibits 26 - 32 Page 2 of 32 PART I - FINANCIAL INFORMATION Page 3 of 32 FULTON BANCSHARES CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS June 30, December 31, 2004 2003* (Unaudited) (000 Omitted) ASSETS Cash and due from banks $ 4,390 $ 3,853 Federal funds sold 1,250 0 Available-for-sale securities 27,740 29,680 Federal Reserve, Atlantic Central Bankers Bank, 1,058 1,401 Federal Home Loan Bank, at cost which approximates market Loans, net of allowance for loan losses 97,800 101,389 Bank building, equipment, furniture & fixtures, net 3,742 3,759 Accrued interest/dividends receivable 673 657 Cash surrender value of life insurance 5,334 5,230 Other real estate owned 1,616 0 Other assets 1,718 1,775 --------- ----------- Total assets $ 145,321 $ 147,744 ========= =========== LIABILITIES Deposits: Noninterest-bearing deposits $ 16,808 $ 13,925 Interest-bearing deposits: Savings deposits 37,368 36,131 Time deposits 58,701 61,069 --------- ----------- Total deposits 112,877 111,125 Accrued interest payable 167 255 Other borrowed money 15,000 18,825 Other liabilities 1,407 1,261 --------- ----------- Total liabilities 129,451 131,466 --------- ----------- STOCKHOLDERS' EQUITY Capital stock, common, par value - $ 0.625; 4,000,000 shares authorized; 495,000 shares issued 309 309 Surplus 2,051 2,051 Retained earnings 14,777 14,576 Net unrealized gains/(losses) available - for-sale securities ( 1,178) ( 570) Treasury stock: 2,210 and 2,185 shares, respectively, at cost ( 89) ( 88) --------- ----------- Total stockholders' equity 15,870 16,278 --------- ----------- Total liabilities and stockholders' equity $ 145,321 $ 147,744 ========= ===========

* Condensed from audited financial statements The accompanying notes are an integral part of these condensed financial statements. Page 4 of 32 FULTON BANCSHARES CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME THREE MONTHS ENDED JUNE 30, 2004 AND 2003 (UNAUDITED) 2004 2003 (000 Omitted, except for per share data) Interest & Dividend Income $ 1,571 $ 1,679 Interest & fees on loans Interest & dividends on investment securities: U.S. Government securities 118 70 Obligations of state & political subdivisions 52 14 Interest on federal funds sold 4 0 Other interest & dividend income 133 272 --------- --------- Total interest & dividend income 1,878 2,035 Interest Expense Interest on deposits 516 537 Interest on other borrowed money 214 270 --------- --------- Total interest expense 730 807 --------- --------- Net interest income before provision for loan losses 1,148 1,228 Provision for loan losses 0 205 --------- --------- Net interest income after provision For loan losses 1,148 1,023 --------- --------- Other Income Service charges on deposit accounts 45 57 Other fee income 42 52 Other non-interest income 76 90 Securities gains (losses) 6 150 Total other income 169 349 --------- --------- Other Expense Salaries and employee benefits 482 411 Fixed asset expenses (including depreciation) 205 188 FDIC insurance premiums 4 4 Other noninterest expenses 398 367 --------- --------- Total other expnese 1,089 970 --------- --------- Net income before income taxes 228 402 Applicable income taxes 82 120 --------- --------- Net income $ 146 $ 282 ========= ========= Weighted average number of shares outstanding 492,801 492,810 Net income per share $ 0.30 $ 0.57 Cash dividends declared per share $ 0.23 $ 0.23

The accompanying notes are an integral part of these condensed financial statements. Page 5 of 32 FULTON BANCSHARES CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME THREE MONTHS ENDED JUNE 30, 2004 AND 2003 (UNAUDITED) 2004 2003 (000 Omitted) Net income $ 146 $ 282 Unrealized gain (loss) on investments available for sale, net of tax ( 1,073) ( 7) Reclassification adjustment for gains (losses) included in net income 6 150 -------- --------- Comprehensive income (loss) ($ 921) $ 425 ======== =========

The accompanying notes are an integral part of these condensed financial statements. Page 6 of 32 FULTON BANCSHARES, CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME Six Months Ended June 30, 2004 and 2003 (UNAUDITED) 2004 2003 (000 Omitted, except for per share data) Interest & Dividend Income $ 3,179 $ 3,477 Interest & fees on loans Interest & dividends on investment securities: U.S. Government securities 185 210 Obligations of state & political subdivisions 104 37 Interest on federal funds sold 4 0 Other interest & dividend income 322 616 --------- --------- Total interest & dividend income 3,794 4,340 --------- --------- Interest Expense Interest on deposits 1,014 1,112 Interest on federal funds purchased 0 0 Interest on other borrowed money 450 544 --------- --------- Total interest expense 1,464 1,656 --------- --------- Net interest income before provision for loan losses 2,330 2,684 Provision for loan losses 0 235 --------- --------- Net interest income after provision for loan losses 2,330 2,449 --------- --------- Other Income Service charges on deposit accounts 90 112 Other fee income 73 126 Other non-interest income 159 155 Securities gains (losses) 10 150 --------- --------- Total other income 332 543 --------- --------- Other Expense Salaries and employee benefits 913 809 Fixed asset expenses (including depreciation) 417 404 FDIC insurance premiums 8 9 Other noninterest expenses 765 717 --------- --------- Total other expenses 2,103 1,939 --------- --------- Net income before income taxes 559 1,053 Applicable income taxes 130 264 --------- --------- Net income 429 $ 789 ========= ========= Weighted average number of shares outstanding 492,808 492,810 Net income per share $ 0.87 $ 1.60 Cash dividends declared per share $ 0.46 $ 0.46

The accompanying notes are an integral part of these condensed financial statements. Page 7 of 32 FULTON BANCSHARES CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME SIX MONTHS ENDED JUNE 30, 2004 AND 2003 (UNAUDITED) 2004 2003 (000 Omitted) Net income $ 429 $ 789 Unrealized gain (loss) on investments available for sale, net of tax ( 608) ( 8) Reclassification adjustment for gains (losses) included in net income 10 150 -------- --------- Comprehensive income (loss) ($ 169) $ 931

The accompanying notes are an integral part of these condensed financial statements. Page 8 of 32 FULTON BANCSHARES CORPORATION AND ITS WHOLLY-OWNED SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30, 2004 and 2003 (UNAUDITED) 2004 2003 (000 Omitted) Cash flows from operating activities: Net income $ 429 $ 789 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 197 182 Provision for loan losses 0 235 Gain on sale - Securities ( 10) ( 150) Gain on sale - OREO ( 12) 0 Gain on sale - loans ( 13) 0 Other - Net 102 237 --------- --------- Net cash provided by operating activities 693 1,293 --------- --------- Cash flows from investing activities: Purchase of investment securities - Available-for-sale ( 3,523) ( 5,503) Redemption of Federal Home Loan Bank Stock 343 28 Sales of available-for-sale securities 1,080 1,614 Maturities of available-for-sale securities 3,451 10,852 Net decrease (increase) in loans 3,602 2,035 (Purchase)/Sale of OREO ( 1,398) ( 53) Purchases of & deposits on bank premises and equipment - net ( 160) ( 107) Purchase of directors and officers life 0 ( 353) insurance --------- --------- Net cash provided (used) by investing activities 3,395 8,513 --------- --------- Cash flows from financing activities: Net increase (decrease) in deposits 1,752 ( 2,410) Purchase of treasury stock ( 1) 0 Dividends paid ( 227) ( 226) Net increase (decrease) in other borrowed money ( 3,825) ( 5,850) --------- --------- Net cash provided (used) by financing activities ( 2,301) ( 8,486) --------- --------- Net increase (decrease) in cash and cash 1,787 1,320 equivalents --------- --------- Cash and cash equivalents, beginning balance 3,853 5,214 --------- --------- Cash and cash equivalents, ending balance $ 5,640 $ 6,534 ========= ========= Supplemental disclosure of cash flows information: Cash paid during the period for: Interest $ 1,552 $ 1,685 Income taxes 0 327 Supplemental schedule of noncash investing and financing activities: Change in unrealized gain (loss) on investments available for sale (net of deferred taxes) ( 608) ( 8)

The accompanying notes are an integral part of these condensed financial statements. Page 9 of 32 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (UNAUDITED) Review of Interim Financial Statements The condensed consolidated financial statements as of and for the six months ended June 30, 2004 and 2003 have been reviewed by independent certified public accountants. Their report on the review is attached as Exhibit 99 to the 10-Q filing. Note 1. Basis of Presentation The financial information presented at and for the six months ended June 30, 2004 and 2003 is unaudited. Information presented at December 31, 2003 is condensed from audited year-end financial statements. However, unaudited information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim period. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal, recurring nature. Operating results for the six- month period ended June 30, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. These statements should be read in conjunction with notes to the financial statements contained in the 2003 Annual Report to Stockholders. In addition to historical information, this Form 10-Q Report contains forward-looking statements. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Important factors that might cause such differences include, but are not limited to, those discussed in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations". Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. Readers should carefully review the risk factors described in other documents the Fulton Bancshares Corporation files from time to time with the Securities and Exchange Commission. Note 2. Principles of Consolidation The consolidated financial statements include the accounts of the Fulton Bancshares Corporation and its wholly-owned subsidiaries, Fulton County National Bank & Trust Company and the Fulton County Community Development Corporation (together, the "Corporation"). All significant intercompany transactions and accounts have been eliminated. Page 10 of 32 Note 3. Cash Flows For purposes of the statements of cash flows, the corporation has defined cash and cash equivalents as those amounts included in the balance sheet captions "cash and due from banks" and "federal funds sold". As permitted by Statement of Financial Accounting Standards No. 104, the corporation has elected to present the net increase or decrease in deposits in banks, loans and time deposits in the statements of cash flows. Note 4. Federal Income Taxes For financial reporting purposes the provision for loan losses charged to operating expense is based on management's judgment, whereas for federal income tax purposes, the amount allowable under present tax law is deducted. Additionally, certain expenses are charged to operating expense in the period the liability is incurred for financial reporting purposes, whereas for federal income tax purposes, these expenses are deducted when paid. As a result of these timing differences, deferred income taxes are provided in the financial statements. Federal income taxes were computed after reducing pretax accounting income for nontaxable municipal and loan income. Note 5. Other Commitments In the normal course of business, the Corporation makes various commitments and incurs certain contingent liabilities which are not reflected in the accompanying financial statements. These commitments include various guarantees and commitments to extend credit and the Corporation does not anticipate any losses as a result of these transactions. Note 6. Investment Securities The carrying amounts of investment securities and their approximate fair values at June 30, 2004 were as follows: Amortized Gross Gross Fair Value Cost Unrealized Unrealized Gains (Losses) Debt securities available for sale: FNMA/FHLMC non - cumulative preferred stocks $ 11,654,968 $ 0 ($ 1,551,443) $ 10,103,525 State & municipal Securities 5,395,136 34,059 ( 124,583) 5,304,612 U.S. Government Agencies 9,743,435 0 ( 81,022) 9,662,413 Mortgage-backed Securities 2,668,612 2,275 ( 58,793) 2,612,094 Equity securities 61,547 0 ( 5,304) 56,245 ------------ ---------- ------------- ------------ $ 29,523,700 $ 36,334 ($ 1,821,145) $ 27,738,889 ============ ========== ============= ============

There were no securities categorized "Held-to-maturity" or "Trading" at June 30, 2004. Page 11 of 32 Note 7. Comprehensive Income Comprehensive income is defined as the change in equity from transactions and other events from nonowner sources. It includes all changes in equity except those resulting from investments by owners and distributions to owners. Consequently, a "Statement of Comprehensive Income" has been included in this filing. Page 12 of 32 FULTON BANCSHARES CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Overview Net after tax income for the first six months of 2004 was $ 429,000 compared to $ 789,000 for the same period in 2003, representing a decrease of $ 360,000, or 45.6%. Net income on an adjusted per share basis for the first six months of 2004 was $ 0.87 compared to $ 1.60 per share realized during the first six months ended June 30, 2003. Net Interest Income Net interest income is the difference between total interest income and total interest expense. Interest income is generated through earning assets, which include loans, deposits with other banks, and investments. Interest income is dependent on many factors including the volume of earning assets; level of interest rates; changes in interest rates; and volumes of nonperforming loans. The cost of funds varies with the volume of funds necessary to support earning assets; rates paid to maintain deposits; rates paid on borrowed funds; and level of interest-free deposits. The net interest margin for the first six months of 2004 was 3.56% compared to 3.72% for the first six months of 2003. Liquidity and interest rate risk are continuously monitored through Asset-Liability Committee reports. Management plans to protect its net interest margin by competitively pricing its loans and deposits and by structuring interest-earning assets and liabilities so they can be repriced in response to changes in market interest rates. Second Quarter 2004 vs. Second Quarter 2003 Interest income for the second quarter of 2004 was $ 1,878,000 compared to $ 2,035,000 earned during the same period in 2003, for a decrease of $ 157,000, or 7.7%. The decrease was due primarily to a significant decrease in the average balance of loans and investments in 2004 compared to the same period in 2003. The average balance of loans during the second quarter of 2004 was $ 100,595,000 versus $ 108,683,000 for the same quarter of 2003, a decline of $ 8,088,000, or 9.26%. Similarly, the average balance of investments (including federal funds sold) dropped from $ 34,319,000 for the second quarter 2003 to $ 30,909,000 for the second quarter of 2004, a decline of 9.94%. Management expects moderate growth in the average balance of loans and investments during the rest of 2004. Management also expects average rates earned on loans and investments to increase slowly over the rest of 2004. Page 13 of 32 Interest expense for the second quarter of 2004 was $ 730,000, a decrease of $ 77,000, or 9.5%. The decrease was due primarily to a decrease in the average balance of time deposits, which typically pay higher yields, and a decrease in interest rates paid on deposits and short-term borrowings. Management expects to control growth of time deposits and concentrate on increasing noninterest-bearing demand deposits, interest-bearing demand deposits, and savings deposits. Management also expects average rates paid on deposits to slowly increase over the rest of 2004. Net interest income (before the provision for loan losses) for the second quarter of 2004 totaled $ 1,148,000, down $ 80,000, or 6.5%, from the second quarter of 2003. Six Months 2004 vs. Six Months 2003 Interest income for the first six months of 2004 was $ 3,794,000 compared to $ 4,340,000 earned during the same period in 2003, for a decrease of $ 546,000, or 12.6%. The decrease was due primarily to a significant decrease in the average balance of loans and investments in 2004 compared to the same period in 2003, consistent with the second quarter results described above. In addition, the Corporation sold approximately $ 5 million in FNMA/FHLMC preferred stocks in the fourth quarter of 2003, which impacts the average balances for the six month periods ended June 30, 2004 versus 2003. Management expects moderate growth in the average balance of loans and investments during the rest of 2004. Management also expects average rates earned on loans and investments to increase slowly over the rest of 2004. Interest expense for the first six months of 2004 was $ 1,464,000, a decrease of $ 192,000, or 11.6%. The decrease was due primarily to a decrease in the average balance of time deposits, which typically pay higher yields, and a decrease in interest rates paid on deposits and short-term borrowings. Management expects to control growth of time deposits and concentrate on increasing noninterest-bearing demand deposits, interest-bearing demand deposits, and savings deposits. Management also expects average rates paid on deposits to slowly increase over the rest of 2004. Other Income Second Quarter 2004 vs. Second Quarter 2003 Second quarter 2004 other income decreased to $ 169,000 from $ 349,000, or 51.6%. Service charges on deposits decreased $ 12,000, or 21.1%, primarily due to a decrease in overdraft charges. Other fee income decreased $10,000, or 19.2%, primarily due to decreases in fee income on the sale of mortgage loans to the Federal Home Loan Bank and fee income from title insurance. Other noninterest income decreased $ 14,000, or 15.6%, primarily due to a $ 24,000 gain on sale of student loans recognized during the second quarter of 2003 which was offset by a $ 12,000 gain on sale of other real estate owned during the second quarter of 2004. Securities gains of $ 150,000 were reported during the second quarter of 2003 compared with $ 6,000 of securities gains reported during the same period of 2004. Page 14 of 32 Six Months 2004 vs. Six Months 2003 Other income for the first six months of 2004 decreased to $ 332,000 from $ 543,000, or 38.9%. Service charges on deposits decreased $ 22,000, or 19.6%, primarily due to a decrease in overdraft charges. Other fee income decreased $ 53,000, or 42.1%, primarily due to decreases in fee income on the sale of mortgage loans to the Federal Home Loan Bank and fee income from title insurance. Other noninterest income increased $ 4,000, or 2.6%. Securities gains of $ 150,000 were reported during the first six months of 2003 compared with $ 10,000 of securities gains reported during the same period of 2004. Other Expense Second Quarter of 2004 vs. Second Quarter 2003 Second quarter 2004 other expenses totaled $ 1,089,000, an increase of $ 119,000, or 12.3%, over the $970,000 for the second quarter of 2003. Salaries and employee-related expenses increased $ 71,000, or 17.3%, primarily due to merit pay increases, temporary full-time training of part-time staff, and the rising cost of fringe benefits. Fixed asset expenses increased $ 17,000, or 9.0%, primarily due to increases in equipment maintenance and building maintenance and supplies costs. Other noninterest expenses increased by $ 31,000, or 8.4%, primarily due to increases in audits and exams, data processing, deferred director compensation, printing and supplies, and repossession and collections costs, and Pennsylvania shares taxes. Six Months 2004 vs. Six Months 2003 Other expenses for the first six months of 2004 totaled $ 2,103,000, an increase of $ 164,000, or 8.5%, over the $ 1,939,000 for the first six months of 2003. Salaries and employee-related expenses increased $ 104,000, or 12.9%, primarily due to merit pay increases, temporary full-time training of part-time staff, and the rising cost of fringe benefits. Fixed asset expenses increased $ 13,000, or 3.2%, primarily due to increases in equipment maintenance and building maintenance and supplies costs. Other noninterest expenses increased by $ 48,000, or 6.7%, primarily due to increases in audits and exams, data processing, deferred director compensation, printing and supplies, and repossession and collections costs, and Pennsylvania shares taxes. Income Taxes The income tax provision for the first six months of 2004 was $ 130,000 compared to $ 264,000 for the first six months of 2003. Effective tax rates (compared to the marginal federal income tax bracket of 34% applicable to each period) were as follows: Six Months Ended June 31 2004 2003 23.3% 25.1% Applicable income taxes changed between 2004 and 2003 because of changes in pretax accounting income and taxable income. The decrease in the effective income tax rate for 2004 was primarily due to a decrease in pretax accounting income in which taxable income was reduced further by Page 15 of 32 tax-exempt interest, dividends received deduction for FNMA/FHLMC preferred stock and non-taxable increase in cash surrender value of life insurance. Provision for Loan Losses No provision for loan losses was made for the first six months of 2004 compared with $ 235,000 for the first six months of 2003. Provisions were based on management's evaluation of the adequacy of the reserve for possible loan losses at June 30, 2004 and 2003 and represent amounts deemed necessary to maintain the reserve at the appropriate level based on the quality of the loan portfolio and economic conditions. Management intends to maintain the reserve at appropriate levels based on an ongoing evaluation of the loan portfolio. A summary of the allowance for loan losses is as follows: ANALYSIS OF ALLOWANCE FOR LOAN LOSSES (in 000's) June 30, June 30, 2004 2003 Allowance for loan losses Beginning of period $ 1,900 $ 1,031 ------- ------- Loans charged-off during the period: Real estate loans 0 0 Installment loans 12 15 Commercial and all other loans 343 362 ------- ------- Total charge-offs 355 377 ------- ------- Recoveries of loans previously charged-off: Real estate loans 0 0 Installment loans 14 5 Commercial and all other loans 7 0 ------- ------- Total recoveries 21 5 ------- ------- Net loans (charged-off) recovered ( 334) ( 372) Provision for loan losses charged to operations 0 235 ------- ------- Allowance for loan losses-end of period $ 1,566 $ 894 ======== ========

Loans 90 days or more past due (still accruing interest) and those on nonaccrual status were as follows at June 30: NONPERFORMING LOANS (in 000's) 90 Days or More Past Due and Still Accruing Nonaccrual Status 2004 2003 2004 2003 Real estate loans $ 0 $ 362 $ 1,400 $ 1,120 Installment loans 5 11 0 0 Commercial and all other loans 0 0 106 1,020 ------ ------- ------- ------- Total loans $ 5 $ 373 $ 1,506 $ 2,140

There were no restructured loans for any of the time periods set forth above. Page 16 of 32 The bank utilizes a comprehensive systematic review of its loan portfolio on a quarterly basis in order to determine the adequacy of the allowance for loan losses. Each quarter the loan portfolio is categorized into various pools as follows: Pool #1 Specific allowances for any individually identified problem loans Pool #2 Commercial Pool #3 Residential real estate Pool #4 Consumer demand and installment Pool #5 Farm loans Business lines of credit over $ 75,000, agribusiness borrowers with lending relationships over $ 250,000 and commercial borrowers with lending relationships over $ 500,000 are individually reviewed. Also, loans that are 90 days or more past due or have been previously classified as substandard are individually reviewed. Allocations to the allowance for loan losses are based upon classifications assigned to those specific loans. Loan classifications utilized are based on past experience and are as follows: Allowance Factors Loss Charge-off Doubtful 35-50% Substandard 3-5% Special Mention 1-3% The remaining portion of the pools are evaluated as groups with allocations made to the allowance based on historical loss experience, current and anticipated trends in delinquencies, trends in volume and terms of loans, concentrations of credit, and general economic conditions within the bank's trading area. Management is not aware of any problem loans that are indicative of trends, events, or uncertainties that would significantly impact operations, liquidity, or capital. The Bank has identified agribusiness lending as a concentration of credit. The reasons for the increase in the provision for loan losses for the six months ended June 30, 2003 compared to 2004 were significant increases in delinquent, classified, nonaccrual, and loan losses, especially agribusiness loans. At June 30, 2003, agribusiness loans comprised $ 2,318,000, or 73.0%, of the classified loans compared with 21.5% at June 30, 2004. Agribusiness losses charged to the Reserve for Loan Losses were $ 336,000 and $ 362,000 for the second quarter of 2004 and 2003, respectively and were attributed to two borrowers. Prior to these charge-offs, net loan losses were less than 0.5% of average loans. In addition, the allowance and loans placed on nonaccrual status were adjusted in the third quarter of 2003 based on preliminary results of an OCC examination conducted in July and August for which an official report has not yet been received. The examiners suggested increasing the allowance to a level more in line with the Bank's peer group (as a percentage of total loans) as a way to provide for the perceived increase in the overall risk associated with the Bank's loan portfolio. In management's judgment, no additional provision to the allowance was deemed necessary for the first six months of 2004 since delinquencies, classified and nonaccrual loans, as well as total loans, have decreased from the same period last year. Page 17 of 32 FINANCIAL CONDITION Assets Total assets on June 30, 2004 were $ 145,321,000 compared to $ 147,744,000 at December 31, 2003, a decrease of 1.6%. Management intends to contain growth and concentrate on maintaining adequate profit margins. Net loans on June 30, 2004 stood at $ 97,800,000, a decrease of 3.5% from $ 101,389,000 on December 31, 2003. The loan loss reserve at June 30, 2004 was $ 1,566,000 and is considered adequate, in management's judgment, to absorb possible loan losses on existing loans. Liabilities Total deposits increased 1.6% to $ 112,877,000 as of June 30, 2004 compared with $ 111,125,000 at December 31, 2003. Noninterest-bearing demand deposits increased 20.7% and interest-bearing savings deposits increased 3.4% while interest-bearing time deposits decreased 3.9%. Off-Balance Sheet Items The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. The contract amounts of those instruments reflect the extent of involvement the corporation has in particular classes of financial instruments. The Corporation's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amounts of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on- balance-sheet instruments. Contract or Notional Amount June 30, 2004 Financial instruments whose contract amounts represent credit risk at December 31: Commitments to extend credit $ 11,631,000 Standby letters of credit and financial 91,000 guarantees written

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration 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 cash requirements. The Corporation evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Corporation upon extension of credit is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, real estate, equipment, and income- producing commercial properties. Page 18 of 32 Standby letters of credit and financial guarantees written are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The corporation holds collateral supporting those commitments when deemed necessary by management. Capital Stockholders' equity was $ 15,870,000 at June 30, 2004 compared with $ 16,278,000 at December 31, 2003, a decrease of 2.5%. Accumulated earnings were partially offset by dividends declared and paid of $ 227,000 and a $ 608,000 increase in net unrealized losses (net of tax effect) for the first six months of 2004. Total stockholders' equity represented 10.9% of total assets at June 30, 2004. Cash dividends of $ 0.46 were paid the first six months of 2004 and 2003. On July 20, 2000, the Board of Directors announced the approval of a plan to purchase, in open market and privately negotiated transactions, up to 2% of its shares of outstanding common stock. Additionally, on December 18, 2003, the company announced the approval of a plan to purchase, in open market and privately negotiated transactions, up to 1,000 shares of outstanding common stock. As of June 30, 2004, the company had repurchased 2,210 shares, representing 0.45% of its shares of outstanding common stock. It is the intention of management and the Board of Directors to continue to pay a fair return on the stockholders' investment while retaining adequate earnings to allow for continued growth. Liquidity and Interest Rate Sensitivity Liquidity and interest rate sensitivity are related to, but distinctly different from, one another. Liquidity involves the bank's ability to meet cash withdrawal needs of customers and their credit needs in the form of loans. Liquidity is provided by cash on hand and transaction balances held at correspondent banks. Adequate liquidity to meet credit demands and/or adverse deposit flows is also made available from sales or maturities of short-term assets. Additional sources of funds to meet credit needs is provided by access to the marketplace to obtain interest-bearing deposits and other borrowings, including special programs available through Federal Home Loan Bank. At June 30, 2004, the Bank had borrowings of $ 15,000,000, a decrease of $ 2,150,000 from March 31, 2004. At June 30, 2004, the Bank had additional borrowing capacity available of approximately $ 56,000,000. Interest rate sensitivity is the matching or mismatching of the maturity and rate structure of the interest-bearing assets and liabilities. It is the objective of management to control the difference in the timing of the rate changes for these assets and liabilities to preserve a satisfactory net interest margin. Management monitors the matching of assets and liabilities maturing within one year and thereafter, and feels it is adequate to meet customer cash and credit needs while maintaining a desired interest rate spread. Page 19 of 32 Market Risk Management The Bank has risk management policies to monitor and limit exposure to market risk, and works diligently to take advantage of profit opportunities available in interest rate movements. Management continuously monitors liquidity and interest rate risk through its Asset-Liability Committee reporting, and reprices products in order to maintain desired net interest margins. Management expects to continue to direct its marketing efforts toward attracting more low cost retail deposits while competitively pricing its time deposits in order to maintain favorable interest spreads, while minimizing structural interest rate risk. Regulatory Capital The Company maintains capital ratios that are well above the minimum total capital levels required by federal regulatory authorities, including risk-based capital guidelines. A comparison of Fulton Bancshares Corporation's capital ratios to regulatory minimum requirements at June 20, 2004 is as follows: Fulton Regulatory Bancshares Minimum Corporation Requirements Leverage ratio 11.6% 4.0% Risk-based capital ratios: Tier I (core capital) 16.2% 4.0% Combined Tier I and Tier II (core capital plus allowance for loan losses) 17.4% 8.0%

Balance Sheet Analysis The following table highlights the changes in the balance sheet. Since quarter end balances can be distorted by one-day fluctuations, an analysis of changes in the quarterly averages is provided to show balance sheet trends. BALANCE SHEET ANALYSIS (in 000's) Balance Sheets Condensed Average Second Second Quarter 2004 Quarter 2003 ASSETS Federal Funds Sold $ 625 $ 0 Securities Available for Sale 29,112 32,530 Other Investments 1,172 1,789 Loans 100,595 108,683 --------- --------- Total interest-earning assets 131,504 143,002 Cash and Due from Banks 4,820 3,701 Bank Premises and Equipment 3,715 3,909 All Other Assets 8,445 5,897 Allowance for Loan Losses ( 1,730) ( 1,062) --------- --------- Total Assets $ 146,754 $ 155,447 ========= =========

Page 20 of 32 Balance Sheets Condensed Average Second Second Quarter 2004 Quarter 2003 LIABILITIES Interest-bearing deposits in domestic offices $ 97,356 $ 95,271 Federal Funds Purchased 0 0 Other Short-term Borrowings 16,075 27,334 --------- --------- Total interest-bearing liabilities 113,431 122,605 Non-interest bearing deposits 15,559 14,868 All Other Liabilities 1,544 971 --------- --------- Total Liabilities 130,534 138,444 --------- --------- STOCKHOLDERS' EQUITY Common Stockholders' Equity 16,861 16,733 Net Unrealized Holding Gains (Losses), net of tax ( 641) 270 --------- --------- Total Stockholders' Equity 16,220 17,003 --------- --------- Total Liabilities and Stockholders' Equity $ 146,754 $ 155,447 ========== ==========

ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no material changes to the quantitative and qualitative disclosures made in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2003. See Management's Discussion and Analysis for further discussion of market risk. ITEM 4 - CONTROLS AND PROCEDURES The company's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Corporation's disclosure controls and procedures (as such term is defined in Rules 13a-14(c) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of June 30, 2004. Based on such evaluation, such officers have concluded that, as of June 30, 2004, the Corporation's disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Corporation (including its consolidated subsidiaries) required to be included in the Corporation's periodic filings under the Exchange Act. There have not been any significant changes in the Corporation's internal control over financial reporting or in other factors that could significantly affect such control during the second quarter of 2004. Page 21 of 32 PART II - OTHER INFORMATION Page 22 of 32 PART II - OTHER INFORMATION Item 1 - Legal Proceedings In the opinion of the management of the Corporation, there are no proceedings pending to which the Corporation or its subsidiary are a party or to which their property is subject, which, if determined adversely to the Corporation or its subsidiary, would be material in relation to the Corporation's or its subsidiary's financial condition. There are no proceedings pending other than ordinary routine litigation incident to the business of the Corporation or its subsidiary. In addition, no material proceedings are pending or are known to be threatened or contemplated against the Corporation or its subsidiary by government authorities. Item 2 - Changes in Securities, Use of Proceeds, and Issuer Purchase of Equity Securities The Corporation purchased shares during the second quarter 2004 as follows: Period (a) (b) (c) (d) Total Average Total Number Maximum Number Number Price Paid of Shares of Shares that of Shares per Share Purchased May Yet Be Purchased as Part of Purchased Under Publicly the Plans or Announced Programs Plans or Programs April 1 - April 30, 2004 15 52.88 15 8,700 shares May 1 - May 31, 2004 0 0 0 8,700 shares June 1 - June 30, 2004 10 50.60 10 8,690 shares Total 25 51.75 25

Item 3 - Defaults Upon Senior Securities Not applicable Item 4 - Submission of Matters to a Vote of Security Holders The annual meeting of the Board of Directors of Fulton Bancshares Corporation was held on Monday, April 19, 2004. Directors were re- appointed based on the following votes cast: For Withhold Authority Clyde H. Bookheimer 202,247 2,670 Robert C. Snyder 202,297 2,620 Ellis L. Yingling 202,297 2,620

Item 5 - Other Information None Page 23 of 32 Item 6 - Exhibits and Reports on Form 8-K (a) Exhibits: Exhibit Number Referred to Item 601 of Regulation S-K: Description of Exhibit: 3(i) Articles of incorporation. Incorporated by reference to registrant's Form 8-A filed with the Securities and Exchange Commission on April 29, 2004. 3(ii) By-laws. Incorporated by reference to registrant's Form 8-A filed with the Securities and Exchange Commission on April 29, 2004. 10 Material Contracts. Incorporated by reference to registrant's Form 10-K for the year ending 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 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 99 Report of Independent Accountant on Interim Financial Statements (b) Reports on Form 8-K None Page 24 of 32 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 thereunto duly authorized. Date August 11, 2004 /s/Clyde H. Bookheimer ----------------------------- ----------------------------- Clyde H. Bookheimer, President and Chief Executive Officer Date August 11, 2004 /s/Doriann Hoffman ----------------------------- ----------------------------- Doriann Hoffman, Vice President (Chief Financial Officer) Page 25 of 32 Exhibit 31.1 CERTIFICATION I, Clyde H. Bookheimer, President/CEO, certify, that: 1. I have reviewed this quarterly report on Form 10-Q of Fulton Bancshares Corporation. 2. Based on my knowledge, the quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report. 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and (c) disclosed in this quarterly report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. Page 26 of 32 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 11, 2004 By: /s/Clyde H. Bookheimer ---------------- -------------------------------- Clyde H. Bookheimer, President and Chief Executive Officer, Director Page 27 of 32 Exhibit 31.2 CERTIFICATION I, Doriann Hoffman, Vice President and CFO, certify, that: 1. I have reviewed this quarterly report on Form 10-Q of Fulton Bancshares Corporation. 2. Based on my knowledge, the quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report. 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report. 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and (c) disclosed in this quarterly report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. Page 28 of 32 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 11, 2004 By: /s/Doriann Hoffman ---------------- -------------------------------- Doriann Hoffman Vice President and Treasurer (Chief Financial Officer) Page 29 of 32 EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Fulton Bancshares Corporation (the "Company") on Form 10-Q for the period ending June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Clyde H. Bookheimer, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes- Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Clyde H. Bookheimer ----------------------------------- Clyde H. Bookheimer President and Chief Executive Officer, Director Dated: August 11, 2004 --------------- Page 30 of 32 EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Fulton Bancshares Corporation (the "Company") on Form 10-Q for the period ending June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Doriann Hoffman, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ DoriAnn Hoffman --------------------------------- DoriAnn Hoffman Vice President and Treasurer (Chief Financial Officer) Dated: August 11, 2004 --------------- Page 31 of 32 Exhibit 99 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors Fulton Bancshares Corporation and Subsidiaries McConnellsburg, Pennsylvania We have reviewed the accompanying consolidated balance sheet of Fulton Bancshares Corporation and Subsidiaries as of June 30, 2004 and the related consolidated statements of income and comprehensive income for the three and six month periods ended June 30, 2004 and 2003, and consolidated statements of cash flows for the six months ended June 30, 2004 and 2003. These financial statements are the responsibility of the corporation's management. We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the consolidated financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to the accompanying consolidated financial statements for them to be in conformity with generally accepted accounting principles. /s/ Smith Elliott Kearns & Company, LLC SMITH ELLIOTT KEARNS & COMPANY, LLC Chambersburg, Pennsylvania August 6, 2004 Page 32 of 32

FULTON BANCSHARES CORP 10-Q