Citizens Financial Services - 10-Q quarterly report FY

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2005

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the transition period from_____________________ to ___________________

Commission file number 0-13222

CITIZENS FINANCIAL SERVICES, INC.

(Exact name of registrant as specified in its charter)

PENNSYLVANIA 23-2265045

(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

First Citizens National Bank

15 South Main Street

Mansfield, Pennsylvania 16933

(Address of principal executive offices)(Zip Code)

Registrant's telephone number, including area code: (570) 662-2121

Indicate by checkmark whether the registrant (1) has filed all reports to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes__X___ No_____

Indicate by checkmark whether the registrant is an accelerated filer (as described in Rule 12b-2 of the Exchange Act). Yes____ No __X__

The number of shares outstanding of the Registrant's Common Stock, as of August 1, 2005, 2,846,543 shares of Common Stock, par value $1.00.

Citizens Financial Services, Inc.

Form 10-Q

INDEX

	PAGE
Part I FINANCIAL INFORMATION
Item I - Financial Statements (unaudited)
Consolidated Balance Sheet as of June 30, 2005 and December 31, 2004	1
Consolidated Statement of Income for the Three Months and Six Months Ended June 30, 2005 and 2004	2
Consolidated Statement of Comprehensive Income for the Three Months and Six Months Ended June 30, 2005 and 2004	3
Consolidated Statement of Cash Flows for the Three Months and Six Months Ended June 30, 2005 and 2004	4
Notes to Consolidated Financial Statements	5-7
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations	8-21
Item 3 - Quantitative and Qualitative Disclosure About Market Risk	22
Item 4 - Controls and Procedures	22

Part II OTHER INFORMATION
Item 1 - Legal Proceedings	23
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds	23
Item 3 - Defaults upon Senior Securities	23
Item 4 - Submission of Matters to a Vote of Security Holders	24
Item 5 - Other Information	24
Item 6 - Exhibits and Reports on Form 8-K	25
Signatures	26

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED BALANCE SHEET
(UNAUDITED)

	June 30			December 31
(in thousands)	2005			2004
ASSETS:
Cash and due from banks:
Noninterest-bearing	$	8,607		$	9,162
Interest-bearing		101			177
Total cash and cash equivalents		8,708			9,339

Available-for-sale securities		91,947			95,747

Loans (net of allowance for loan losses of $3,692 and $3,919)		367,684			355,774

Premises and equipment		12,493			11,833
Accrued interest receivable		1,895			1,736
Goodwill		8,605			8,605
Core deposit intangible		973			1,262
Bank owned life insurance		7,598			7,449
Other assets		7,244			7,602

TOTAL ASSETS	$	507,147		$	499,347

LIABILITIES:
Deposits:
Noninterest-bearing	$	46,764		$	46,866
Interest-bearing		375,668			372,208
Total deposits		422,432			419,074
Borrowed funds		39,199			34,975
Accrued interest payable		1,599			1,870
Other liabilities		2,716			2,639
TOTAL LIABILITIES		465,946			458,558
STOCKHOLDERS' EQUITY:
Common Stock
$1.00 par value; authorized 10,000,000 shares;
issued 2,937,519 shares in 2005 and 2004, respectively		2,938			2,938
Additional paid-in capital		10,804			10,804
Retained earnings		30,324			28,894
TOTAL		44,066			42,636
Accumulated other comprehensive (loss) income		(391	)		164
Less: Treasury Stock, at cost
118,715 shares for 2005 and 97,262 for 2004, respectively		(2,474	)		(2,011	)
TOTAL STOCKHOLDERS' EQUITY		41,201			40,789
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY	$	507,147		$	499,347

The accompanying notes are an integral part of these unaudited consolidated financial statements.

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
	Three Months Ended				Six Months Ended
	June 30,				June 30,
(in thousands, except per share data)	2005		2004		2005		2004
INTEREST INCOME:
Interest and fees on loans	$	6,105	$	5,447	$	12,024	$	10,795
Interest-bearing deposits with banks		-		3		-		8
Investment securities:
Taxable		749		852		1,541		1,744
Nontaxable		124		62		242		147
Dividends		55		67		106		129
TOTAL INTEREST INCOME		7,033		6,431		13,913		12,823
INTEREST EXPENSE:
Deposits		2,256		1,992		4,425		3,956
Borrowed funds		379		217		757		430
TOTAL INTEREST EXPENSE		2,635		2,209		5,182		4,386
NET INTEREST INCOME		4,398		4,222		8,731		8,437
Provision for loan losses		-		-		-		-
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES		4,398		4,222		8,731		8,437
NON-INTEREST INCOME:
Service charges		746		751		1,419		1,482
Trust		86		119		208		246
Brokerage		55		58		93		112
Insurance		61		60		144		88
Gains on loans sold		12		12		22		21
Investment securities gains, net		-		204		-		491
Earnings on bank owned life insurance		75		79		149		158
Other		100		93		202		172
TOTAL NON-INTEREST INCOME		1,135		1,376		2,237		2,770
NON-INTEREST EXPENSES:
Salaries and employee benefits		1,974		1,847		3,895		3,772
Occupancy		282		267		585		553
Furniture and equipment		160		165		335		335
Professional fees		131		158		275		312
Amortization		144		109		289		217
Other		1,171		1,129		2,306		2,155
TOTAL NON-INTEREST EXPENSES		3,862		3,675		7,685		7,344
Income before provision for income taxes		1,671		1,923		3,283		3,863
Provision for income taxes		358		455		703		902
NET INCOME	$	1,313	$	1,468	$	2,580	$	2,961

Earnings Per Share	$	0.46	$	0.52	$	0.91	$	1.04
Cash Dividend Declared	$	0.205	$	0.195	$	0.405	$	0.385

Weighted average number of shares outstanding		2,837,899		2,840,504		2,839,072		2,840,531

The accompanying notes are an integral part of these unaudited consolidated financial statements.

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)
	Three Months Ended									Six Months Ended
	June 30									June 30
(in thousands)			2005				2004						2005					2004
Net income			$	1,313			$	1,468					$	2,580				$	2,961
Other comprehensive income:
Unrealized gains (losses) on available for sale securities		821			(2,723	)					(841	)				(2,376	)
Less: Reclassification adjustment for gain included in net income		-			(204	)					-					(491	)
Other comprehensive income (loss) before tax				821				(2,927	)					(841	)				(2,867	)
Income tax expense (benefit) related to other comprehensive income				279				(995	)					(286	)				(975	)
Other comprehensive income (loss), net of tax				542				(1,932	)					(555	)				(1,892	)
Comprehensive income (loss)			$	1,855			$	(464	)				$	2,025				$	1,069

The accompanying notes are an integral part of these unaudited consolidated financial statements.

CITIZENS FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)	Six Months Ended
	June 30,
(in thousands)	2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	2,580		$	2,961
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization		731			675
Amortization and accretion of investment securities		370			501
Deferred income taxes		29			(41	)
Investment securities gains, net		-			(491	)
Realized gains on loans sold		(22	)		(21	)
Earnings on banked owned life insurance		(149	)		(158	)
Originations of loans held for sale		(1,530	)		(1,213	)
Proceeds from sales of loans held for sale		1,552			1,314
Decrease (increase) in accrued interest receivable		(159	)		14
Decrease in accrued interest payable		(271	)		(345	)
Increase in other liabilities		(59	)		(291	)
Net cash provided by operating activities		3,072			2,905

CASH FLOWS FROM INVESTING ACTIVITIES:
Available-for-sale securities:
Proceeds from sales of available-for-sale securities		-			14,045
Proceeds from maturity and principal repayments of securities		8,373			14,434
Purchase of securities		(5,785	)		(23,276	)
Proceeds from redemption of Regulatory Stock		1,280			962
Purchase of Regulatory Stock		(812	)		(951	)
Net increase in loans		(12,142	)		(6,224	)
Purchase of loans		-			(27,340	)
Purchases of premises and equipment		(146	)		(190	)
Proceeds from sale of premises and equipment		200			30
Proceeds from sale of foreclosed assets held for sale		286			138
Property purchased for future expansion		(927	)		-
Deposit acquisition premium		-			(2,200	)
Net cash used in investing activities		(9,673	)		(30,572	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		3,358			8,557
Proceeds from long-term borrowings		8,043			548
Repayments of long-term borrowings		(3,208	)		(559	)
Net increase (decrease) in short-term borrowed funds		(610	)		2,029
Purchase of Treasury Stock		(463	)		(7	)
Dividends paid		(1,150	)		(1,083	)
Deposits of acquired branches		-			20,663
Net cash provided by financing activities		5,970			30,148

Net (decrease) increase in cash and cash equivalents		(631	)		2,481

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		9,339			9,951
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	8,708		$	12,432

Supplemental Disclosures of Cash Flow Information:
Interest paid	$	5,436		$	4,732

Income taxes paid	$	540		$	1,050

The accompanying notes are an integral part of these unaudited consolidated financial statements.

CITIZENS FINANCIAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 - Basis of Presentation

Citizens Financial Service, Inc., (individually and collectively, the “Company”) is a Pennsylvania corporation organized as the holding company of its wholly owned subsidiary, First Citizens National Bank (the “Bank”), and its subsidiary, First Citizens Insurance Agency, Inc. All material inter-company balances and transactions have been eliminated in consolidation.

The accompanying interim financial statements have been prepared by the Company without audit and, in the opinion of management, reflect all adjustments (which include only normal, recurring adjustments) necessary to present fairly the Company's financial position as of June 30, 2005, and the results of operations for the interim periods presented. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. For further information refer to the consolidated financial statements and footnotes thereto incorporated by reference in the Company's Annual Report on Form 10-K for the year ended December 31, 2004.

Note 2 - Earnings per Share

The following table sets forth the computation of earnings per share. Earnings per share calculations give retroactive effect to stock dividends declared by the Company. The Company has no dilutive securities.

	Three months ended				Six months ended
	June 30,				June 30,
	2005		2004		2005		2004

Net income applicable to common stock	$	1,313,000	$	1,468,000	$	2,580,000	$	2,961,000
Weighted average common shares outstanding		2,837,899		2,840,504		2,839,072		2,840,531

Earnings per share	$	0.46	$	0.52	$	0.91	$	1.04

Note 3 - Income Tax Expense

Income tax expense is less than the amount calculated using the statutory tax rate, primarily the result of tax-exempt income earned from state and municipal securities and loans and investment in tax credits.

Note 4 - Employee Benefit Plans

Components of Net Periodic Benefit Cost - Defined Benefit Plans

For a detailed disclosure on the Company's pension and employee benefits plans, please refer to Note 8 of the Company's Consolidated Financial Statements included in the 2004 Annual Report on Form 10-K.

The following sets forth the components of net periodic benefit costs of the defined benefit plans for the three months and six months ended June 30, 2005 and 2004, respectively (dollars presented in thousands):

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2005			2004			2005			2004
Service cost	$	91		$	84		$	159		$	168
Interest cost		83			74			143			148
Expected return on plan assets		(97	)		(83	)		(165	)		(166	)
Net amortization and deferral		20			6			26			12

Net periodic benefit cost	$	97		$	81		$	163		$	162

The Company expects to contribute $382,000 to its defined benefit pension plan in 2005. As of June 30, 2005, no contributions have been made.

Defined Contribution Plan

The Company also sponsors a defined contribution plan covering substantially all of its employees. The Company contributes three percent of applicable salaries into the plan. Through June 30, 2005, the Company contributed $96,000 into the defined contribution plan.

Note 5 - Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (FAS No. 123R). FAS No. 123R revised FAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. FAS No. 123R will require compensation costs related to share-based payment transactions to be recognized in the financial statement (with limited exceptions). The amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award.

In April, the Securities and Exchange Commission adopted a new rule that amends the compliance dates for FAS No. 123R. The Statement requires that compensation cost relating to share-based payment transactions be recognized in financial statements and that this cost be measured based on the fair value of the equity or liability instruments issued. FAS No. 123R covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. The Company will adopt FAS No. 123R on January 1, 2006 and is currently evaluating the impact the adoption of the standard will have on the Company’s results of operations.

In March 2005, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 107 ("SAB No. 107"), Share-Based Payment, providing guidance on option valuation methods, the accounting for income tax effects of share-based payment arrangements upon adoption of FAS No. 123R, and the disclosures in MD&A subsequent to the adoption. The Company will provide SAB No. 107 required disclosures upon adoption of FAS No. 123R on January 1, 2006 and is currently evaluating the impact the adoption of the standard will have on the Company’s financial condition, results of operations, and cash flows.

In December 2004, FASB issued FAS No. 153, Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. FAS No. 153 amends Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of FAS No. 153 are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Early application is permitted and companies must apply the standard prospectively. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

In June 2005, the FASB issued FAS No. 154, Accounting Changes and Errors Corrections, a replacement of APB Opinion No. 20 and FAS No. 3. The Statement applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. FAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impractical. APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. FAS No.154 improves the financial reporting because its requirements enhance the consistency of financial reporting between periods.

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Statement

Forward-looking statements may prove inaccurate. We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of Citizens Financial Services, Inc., First Citizens National Bank, First Citizens Insurance Agency, Inc. or the combined company. When we use such words as "believes," "expects,” "anticipates," or similar expressions, we are making forward-looking statements. For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements. The Company would like to caution readers that the following important factors, among others, may have affected and could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward looking statement:

·	The effects of changing economic conditions in both the market areas served by the Company and nationally.

·	Interest rates could change more rapidly or more significantly than we expect.

·	The economy could change significantly in an unexpected way, which would cause the demand for new loans and the ability of borrowers to repay outstanding loans to change in ways that our models do not anticipate.

·	The stock and bond markets could suffer a significant disruption, which may have a negative effect on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities.

·	It could take us longer than we anticipate implementing strategic initiatives designed to increase revenues or manage expenses, or we may be unable to implement those initiatives at all.

·	Acquisitions and dispositions of assets could affect us in ways that management has not anticipated.

·	We may become subject to new legal obligations or the resolution of litigation may have a negative effect on our financial condition.

·	We may become subject to new and unanticipated accounting, tax, or regulatory practices, regulations or requirements, including the costs of compliance with such changes.

Introduction

The following is management's discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for Citizens Financial Service, Inc., a bank holding company and its subsidiary (the Company). Our Company's consolidated financial condition and results of operations consist almost entirely of our wholly owned subsidiary’s (First Citizens National Bank) financial condition and results of operations. Management’s discussion and analysis should be read in conjunction with the preceding June 30, 2005 financial information. The results of operations for the six months ended June 30, 2005 and 2004 are not necessarily indicative of the results you may expect for the full year.

Our Company currently engages in the general business of banking throughout our service area of Potter, Tioga and Bradford counties in North Central Pennsylvania and Allegany, Steuben, Chemung and Tioga counties in Southern New York. Our lending and deposit products and investment services are offered primarily within the vicinity of our service area.

The market area that First Citizens National Bank operates is rural in nature. The customer makeup consists of small businesses and individuals. The state of the economy in the region is mixed with unemployment rates generally running above the state and national averages at this time.

Risk identification and management are essential elements for the successful management of the Company. In the normal course of business, the Company is subject to various types of risk including interest rate, credit and liquidity risk.

Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in interest rates. Interest rate risk results from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company. The Company uses its asset/liability management policy to control and manage interest rate risk.

Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from loans with customers and purchasing of securities. The Company’s primary credit risk is in the loan portfolio. The Company manages credit risk by adhering to an established credit policy and through a disciplined evaluation of the adequacy of the allowance for loan losses. Also, the investment policy limits the amount of credit risk that may be taken in the investment portfolio.

Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors. The Company has established guidelines within its asset/liability policy to manage liquidity risk. These guidelines include contingent funding alternatives.

Readers should carefully review the risk factors described in other documents our Company files, from time to time, with the Securities and Exchange Commission, including the Annual Report on Form 10-K for the year ended December 31, 2004, filed by our Company and any current reports on Form 8-K filed by our Company.

We face strong competition in the communities we serve from other commercial banks, savings banks, savings and loan associations and credit unions, some of which are substantially larger institutions than our subsidiary. In addition, insurance companies, investment-counseling firms, and other business firms and individuals offer personal and corporate trust services. We also compete with credit unions, issuers of money market funds, securities brokerage firms, consumer finance companies and mortgage brokers. These entities are strong competitors for virtually all types of financial services.

In recent years, the financial services industry has experienced tremendous change to competitive barriers between bank and non-bank institutions. We not only must compete with traditional financial institutions, but also with other business corporations that have begun to deliver competing financial services. Competition for banking services is based on price, nature of product, quality of service, and in the case of certain activities, convenience of location.

Trust and Investment Services

Our Trust and Investment Department services range from professional estate settlement services through management of complex trust accounts to investment management and custody of securities. Our Trust and Investment Department manages retirement accounts for many area companies and individuals. We also manage many individual IRAs, both rollover and contributory.

The Investment Department offers full service brokerage services in selected locations throughout the Bank’s market area and appointments can be made in any First Citizens National Bank branch.

The Bank offers life and health insurance, as well as annuities through our insurance subsidiary, First Citizens Insurance Agency, Inc.

Financial Condition

Total assets (shown in the Consolidated Balance Sheet) of $507.1 million have increased by $7.8 million or 1.6% since the end of last year. Net loans increased 3.3% to $367.7 million and investment securities decreased 4.0% to $91.9 million since year-end 2004. Total deposits increased $3.4 million or .8% to $422.4 million since then as well. Borrowed funds have increased $4.2 million to $39.2 million compared with $35.0 million at year-end. Explanations of variances will be described within the following appropriate sections.

Cash and Cash Equivalents

Cash and cash equivalents totaled $8,708,000 at June 30, 2005 compared to $9,339,000 on December 31, 2004. Noninterest-bearing cash decreased $555,000 since year-end 2004, while interest-bearing cash decreased $76,000 during that same period. We believe the liquidity needs of the Company are satisfied by the current balance of cash and cash equivalents, the availability of traditional funding sources, and the portion of the investment and loan portfolios that mature within one year. These sources of funds will enable the Company to meet cash obligations and off-balance sheet commitments as they come due.

Investments

The total investment portfolio is held as available for sale. Investments available for sale are accounted for at fair value with unrealized gains and losses, net of deferred taxes, reported as a component of stockholders’ equity. The amortized cost and estimated fair value of investment securities at June 30, 2005 and December 31, 2004 were as follows (in thousands):

Gross

Estimated

Amortized

Unrealized

Fair

June 30, 2005

Cost

Gains

Losses

Value

Available-for-sale securities:

U.S. Agency securities

5,796

(67

)

5,729

Obligations of state and

political subdivisions

12,971

231

(13

)

13,189

Corporate obligations

8,504

269

8,773

Mortgage-backed securities

62,170

125

(837

)

61,458

Equity securities

3,099

(301

)

2,798

Total available-for-sale

92,540

625

(1,218

)

91,947

			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
December 31, 2004	Cost		Gains		Losses			Value
Available-for-sale securities:
U.S. Agency securities	$	5,829	$	-	$	(17	)	$	5,812
Obligations of state and
political subdivisions		7,203		249		-			7,452
Corporate obligations		8,523		412		-			8,935
Mortgage-backed securities		70,845		204		(600	)		70,449
Equity securities		3,099		-		-			3,099
Total available-for-sale	$	95,499	$	865	$	(617	)	$	95,747

Our investment portfolio decreased by $3,800,000 or 4.0% from December 31, 2004 to June 30, 2005. During the first half of 2005, we purchased approximately $5.8 million of municipal bonds. Given current interest rates, we have been purchasing high coupon, longer-term municipals with short-term call features during the first half of 2005. Offsetting these purchases is approximately $8.4 million of principal repayments from our mortgage backed securities portfolio, which we continue to receive approximately $1.4 million per month.

Management continues to monitor the earnings performance and the effectiveness of the liquidity of the investment portfolio on a regular basis. Through active balance sheet management and analysis of the securities portfolio, the Company maintains sufficient liquidity to satisfy depositor requirements and various credit needs of its customers.

Loans

The Company’s lending is focused in the north central Pennsylvania market and the southern tier of New York. The composition of our loan portfolio consists principally of retail lending, which includes single-family residential mortgages and other consumer lending, and commercial lending primarily to locally owned small businesses. New loans are generated primarily from direct loans to our existing customer base, with new customers generated by referrals from real estate brokers, building contractors, attorneys, accountants and existing customers.

As shown in the tables below (dollars in thousands), total loans increased approximately $11.7 million or 3.2% during the first six months of 2005. Municipal loans increased $4.0 million due primarily to the addition of one large municipal loan totaling approximately $10 million. Of this amount, approximately $4.0 million was participated out with another financial institution in the second quarter. Residential and commercial real estate loans increased $4.7 million and $3.2 million, respectively. Offsetting these were decreases in agricultural and construction real estate loans of $.7 million and $.6 million, respectively.

We are cautiously optimistic that loan demand will increase for the remainder of the year. With last year’s acquisition of two branches from the Legacy Bank in Bradford County, Pennsylvania, we have increased our customer base and expect to expand upon those new relationships. Secondly, residential mortgage lending continues to be a principal business activity and one our Company expects to continue by providing a full complement of competitively priced conforming, nonconforming and home equity mortgages. Management has worked diligently on a program through Fannie Mae that would allow customers to construct residential homes through a one-closing process. Through this construction-to-permanent lending product, we hope to give our customers another avenue in which to meet their needs. We continue to emphasize branch office personnel training and the focus on flexibility and fast “turn around time” that will continue to aid in growing our loan portfolio. Finally, the Company’s team of strong, experienced business development officers enables us to meet the needs of commercial and agricultural customers within our service area.

									June 30, 2005/
	June 30,				December 31,				December 31, 2004
	2005				2004				Change
	Amount		%		Amount		%		Amount			%
Real estate:
Residential	$	194,455		52.4	$	189,803		52.8	$	4,652			2.5
Commercial		78,470		21.1		75,228		20.9		3,242			4.3
Agricultural		10,885		2.9		11,564		3.2		(679	)		(5.9	)
Construction		6,704		1.8		7,282		2.0		(578	)		(7.9	)
Loans to individuals
for household, family and other purchases		12,703		3.4		12,657		3.5		46			0.4
Commercial and other loans		29,032		7.8		28,069		7.8		963			3.4
State & political subdivision loans		39,127		10.6		35,090		9.8		4,037			11.5
Total loans		371,376		100.0		359,693		100.0		11,683			3.2
Less allowance for loan losses		3,692				3,919				(227	)		-5.8	%
Net loans	$	367,684			$	355,774			$	11,910			3.3	%

Allowance For Loan Losses

As shown in the following table (dollars in thousands), the Allowance for Loan Losses as a percentage of loans decreased from 1.09% at December 31, 2004 to .99% at June 30, 2005. The dollar amount of the reserve has decreased $227,000 since year-end 2004. The decrease is a result of no provision in the first six months of 2005, less net charge-offs. Gross charge-offs for the first six months of 2005 were $243,000, while recoveries were $16,000. Asset quality has improved such that no provision has been recorded for 2005, even with the increase in total loans from December 31, 2004. The adequacy of the allowance for loan losses is subject to a formal analysis by management of the Company. Management deems the allowance to be adequate to absorb inherent losses probable in the portfolio, as of June 30, 2005. The Company has disclosed in its annual report on Form 10-K the process and methodology supporting the loan loss provision.

	June 30,			December 31,
	2005			2004			2003			2002			2001
Balance, at beginning of period	$	3,919		$	3,620		$	3,621		$	3,250		$	2,777
Provision charged to income		-			-			435			435			445
Increase related to acquisition		-			290			-			-			-
Recoveries on loans previously
charged against the allowance		16			324			116			115			175
		3,935			4,234			4,172			3,800			3,397
Loans charged against the allowance		(243	)		(315	)		(552	)		(179	)		(147	)
Balance, at end of year	$	3,692		$	3,919		$	3,620		$	3,621		$	3,250

Allowance for loan losses as a percent
of total loans		0.99	%		1.09	%		1.14	%		1.21	%		1.20	%

Allowance for loan losses as a percent
of non-performing loans		171.16	%		176.53	%		134.62	%		119.94	%		149.56	%

Bank Owned Life Insurance

The Company has elected to purchase bank owned life insurance to offset future employee benefit costs. As of June 30, 2005 the cash surrender value of this life insurance is $7,598,000, an increase of $149,000 since year end. The use of life insurance policies provides the bank with an asset that will generate earnings to partially offset the current costs of benefits, and eventually (at the death of the insureds) provide partial recovery of cash outflows associated with the benefits.

Deposits

Traditional deposits continue to be the most significant source of funds for the Company. As shown in the following tables (dollars in thousands), deposits decreased $3,358,000 or .8%, since December 31, 2004. As of June 30, 2005, NOW accounts decreased by $1,424,000 and certificates of deposit decreased $3,149,000 since the end of the year. Offsetting these decreases was an increase of $7,538,000 in money market deposit accounts. This increase was primarily attributable to a new deposit from a local, non-profit state and political organization for approximately $6.0 million.

									June 30, 2005/
	June 30,				December 31,				December 31, 2004
	2005				2004				Change
	Amount		%		Amount		%		Amount			%
Non-interest-bearing deposits	$	46,764		11.1	$	46,866		11.2	$	(102	)		(0.2	)
NOW accounts		73,022		17.3		74,446		17.7		(1,424	)		(1.9	)
Savings deposits		40,131		9.5		39,636		9.5		495			1.2
Money market deposit accounts		49,887		11.8		42,349		10.1		7,538			17.8
Certificates of deposit		212,628		50.3		215,777		51.5		(3,149	)		(1.5	)
Total	$	422,432		100.0	$	419,074		100.0	$	3,358			0.8

Borrowed Funds

Borrowed funds increased $4,224,000 during the first six months of 2005. Most of this is attributable to funding loan growth in the first six months of the year, offset by a $3,358,000 increase in deposits and cash provided from a $3,800,000 net decrease in available-for-sale securities. The Company's daily cash requirements or short-term investments are met by using the financial instruments available through the Federal Home Loan Bank.

In December 2003, the Company formed a special purpose entity, Citizens Financial Statutory Trust I (“the Entity”), to issue $7,500,000 of floating rate obligated mandatory redeemable securities as part of a pooled offering. The rate is determined quarterly and floats based on the 3 month LIBOR plus 2.80%. At June 30, 2005, the rate was 6.22%. The Entity may redeem them, in whole or in part, at face value after December 17, 2008. The Company borrowed the proceeds of the issuance from the Entity in December 2003 in the form of a $7,500,000 note payable, which is included within borrowed funds in the liabilities section of the Company’s balance sheet. Under current accounting rules, the Company’s minority interest in the Entity was recorded at the initial investment amount and is included in the other assets section of the balance sheet. The Entity is not consolidated as part of the Company’s consolidated financial statements.

Stockholder’s Equity

We evaluate stockholders’ equity in relation to total assets and the risks associated with those assets. The greater the capital resource, the more likely a corporation is to meet its cash obligations and absorb unforeseen losses. For these reasons, capital adequacy has been, and will continue to be, of paramount importance.

Total Stockholders’ Equity was $41,201,000, at June 30, 2005 compared to $40,789,000, at December 31, 2004, an increase of $412,000 or 1.0%. Excluding accumulated other comprehensive income, stockholder’s equity increased $967,000, or 2.4%. In the first six months of 2005, the Company had net income of $2,580,000 and declared dividends of $1,150,000, representing a dividend payout ratio of 44.6%.

All of the Company’s investment securities are classified as available-for-sale making this portion of the Company’s balance sheet more sensitive to the changing market value of investments. The decrease in the market value of the Company’s investment securities since December 31, 2004 has resulted in a decrease in accumulated other comprehensive income of $555,000.

On June 17, 2005, the Company privately purchased 21,453 shares of stock from an individual shareholder. This had the effect of increasing treasury stock $463,000 during the quarter.

The Company has also complied with standards of being well capitalized mandated by the banking regulators. The Company’s primary regulators have established “risk-based” capital requirements designed to measure capital adequacy. Risk-based capital ratios reflect the relative risks associated with various assets entities hold in their portfolios. A weight category of 0% (lowest risk assets), 20%, 50%, or 100% (highest risk assets), is assigned to each asset on the balance sheet. The Company’s computed risk-based capital ratios are as follows (dollars in thousands):

	June 30,					December 31,
	2005					2004
Total capital (to risk-weighted assets)	Amount		Ratio			Amount		Ratio
Company	$	42,989		12.73	%	$	42,156		12.86	%
For capital adequacy purposes		27,008		8.00	%		26,215		8.00	%
To be well capitalized		33,760		10.00	%		32,768		10.00	%

Tier I capital (to risk-weighted assets)
Company	$	39,297		11.64	%	$	38,236		11.67	%
For capital adequacy purposes		13,504		4.00	%		13,107		4.00	%
To be well capitalized		20,256		6.00	%		19,661		6.00	%

Tier I capital (to average assets)
Company	$	39,297		7.94	%	$	38,236		7.84	%
For capital adequacy purposes		19,803		4.00	%		19,504		4.00	%
To be well capitalized		24,754		5.00	%		24,379		5.00	%

Off Balance Sheet Activities

Some financial instruments, such as loan commitments, credit lines and letters of credit, are issued to meet customer financing needs. The contractual amount of financial instruments with off-balance sheet risk was as follows at June 30, 2005 (dollars in thousands):

Commitments to extend credit	$	63,085
Standby letters of credit		1,375
	$	64,460

Results of Operations

Overview of the Income Statement

The Company had net income of $1,313,000 and $2,580,000 for the second quarter and first six months of 2005, respectively. Earnings per share were $.46 and $.91 for the respective periods. This compares to earnings of $1,468,000 and $2,961,000 for the second quarter and first six months of 2004, which equates to earnings per share of $.52 and $1.04, respectively. Overall, 2005 net income through June has decreased $381,000 in 2005 compared to 2004. The annualized return on assets and return on equity for the first six months of 2005 were 1.02% and 12.52%, respectively. Details of the reasons for this change are discussed on the following pages.

Net Interest Income

Net interest income, the most significant component of earnings, is the amount by which interest generated from earning assets exceeds interest expense on interest-bearing liabilities.

Net interest income, after provision for loan losses, totaled $4,398,000 in the second quarter, an increase of $176,000 or 4.2%, compared to the same period in 2004 and totaled $8,731,000 for the first six months of 2005, an increase of $294,000 or 3.5% over the prior year. The Bank experienced an increase in average earning assets since June 30, 2004 of 7.8%, due to our continued efforts to grow our existing offices.

The following table sets forth the average balances of, and the interest earned or incurred on, each principal category of assets, liabilities and stockholders’ equity, the related rates, net interest income and rate “spread” created:

					Analysis of Average Balances and Interest Rates (1)

	June 30, 2005							June 30, 2004							June 30, 2003
	Average				Average			Average				Average			Average				Average
	Balance (1)		Interest		Rate			Balance (1)		Interest		Rate			Balance (1)		Interest		Rate
(dollars in thousands)	$		$		%			$		$		%			$		$		%
ASSETS
Short-term investments:
Interest-bearing deposits at banks		30		-		0.01			1,747		8		0.92			3,924		21		1.08
Total short-term investments		30		-		0.01			1,747		8		0.92			3,924		21		1.08
Investment securities:
Taxable		87,232		1,670		3.83			99,226		1,911		3.85			86,170		1,972		4.58
Tax-exempt (3)		11,643		366		6.29			6,590		223		6.77			11,529		390		6.77
Total investment securities		98,875		2,036		4.12			105,816		2,134		4.03			97,699		2,362		4.84
Loans:
Residential mortgage loans		198,403		6,728		6.84			188,482		6,569		7.03			179,430		6,551		7.36
Commercial & farm loans		116,322		3,980		6.90			85,944		2,920		6.85			75,295		2,883		7.72
Loans to state & political subdivisions		38,704		1,150		5.99			36,858		1,129		6.18			33,032		1,044		6.37
Other loans		12,432		544		8.82			12,343		553		9.03			12,926		586		9.14
Loans, net of discount (2)(3)(4)		365,861		12,402		6.84			323,627		11,171		6.96			300,683		11,064		7.42
Total interest-earning assets		464,766		14,438		6.26			431,190		13,313		6.23			402,306		13,447		6.74
Cash and due from banks		8,529							8,478							9,183
Bank premises and equipment		11,907							10,518							11,122
Other assets		18,667							18,252							9,394
Total non-interest earning assets		39,103							37,248							29,699
Total assets		503,869							468,438							432,005
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
NOW accounts		69,165		259		0.76			60,265		102		0.34			53,291		118		0.45
Savings accounts		40,652		57		0.28			38,325		54		0.28			35,421		71		0.40
Money market accounts		45,841		366		1.61			44,189		206		0.94			47,249		282		1.20
Certificates of deposit		213,729		3,742		3.53			205,251		3,594		3.53			204,475		3,958		3.90
Total interest-bearing deposits		369,387		4,424		2.42			348,030		3,956		2.29			340,436		4,429		2.62
Other borrowed funds		43,387		758		3.52			33,469		430		2.59			12,252		149		2.45
Total interest-bearing liabilities		412,774		5,182		2.53			381,499		4,386		2.32			352,688		4,578		2.62
Demand deposits		45,511							43,874							39,081
Other liabilities		4,370							4,648							3,707
Total non-interest-bearing liabilities		49,881							48,522							42,788
Stockholders' equity		41,214							38,417							36,529
Total liabilities & stockholders' equity		503,869							468,438							432,005
Net interest income				9,256							8,927							8,869
Net interest spread (5)						3.73	%						3.91	%						4.12	%
Net interest income as a percentage
of average interest-earning assets						4.01	%						4.17	%						4.45	%
Ratio of interest-earning assets
to interest-bearing liabilities						1.12							1.13							1.14

(1) Averages are based on daily averages.
(2) Includes loan origination and commitment fees.
(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using
a statutory federal income tax rate of 34%.
(4) Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets.
(5) Interest rate spread represents the difference between the average rate earned on interest-earning assets
and the average rate paid on interest-bearing liabilities.

The following table represents the adjustment to convert net interest income to net interest on a fully taxable equivalent basis for the six months ending June 30, 2005 and 2004:

	For the Six Months
	Ended June 30,
	2005		2004

Total interest income	$	13,913	$	12,823
Total interest expense		5,182		4,386

Net interest income		8,731		8,437
Tax equivalent adjustment		525		490

Net interest income (fully taxable equivalent)	$	9,256	$	8,927

Compared to the first six months of 2004 and 2003, our net interest spread has decreased 18 and 39 basis points, respectively, primarily due to the flattening of the yield curve. While the Federal Reserve has raised the Federal Funds Rate nearly 225 basis points since last June, long-term rates have remained relatively stable. As such, our cost of funds (interest paid on deposits and borrowings) has increased while the rates earned on interest bearing assets have increased only modestly. We continue to review various pricing, investment and funding strategies to improve the current interest margin, given the extended period of a flattened yield curve.

The following table shows the effect of changes in volume and rate on interest income and expense. Tax-exempt interest revenue is shown on a tax-equivalent basis for proper comparison using a statutory federal income tax rate of 34%:

	2005 vs. 2004 (1)									2004 vs. 2003 (1)
	Change in			Change			Total			Change in			Change			Total
	Volume			in Rate			Change			Volume			in Rate			Change
Interest Income:
Short-term investments:
Interest-bearing deposits at banks	$	(18	)	$	9		$	(9	)	$	(9	)	$	(4	)	$	(13	)
Investment securities:
Taxable		(229	)		(11	)		(240	)		276			(337	)		(61	)
Tax-exempt		160			(17	)		143			(167	)		-			(167	)
Total investments		(69	)		(28	)		(97	)		109			(337	)		(228	)
Loans:
Residential mortgage loans		340			(181	)		159			323			(305	)		18
Commercial & farm loans		1,039			21			1,060			382			(345	)		37
Loans to state & political subdivisions		55			(34	)		21			118			(33	)		85
Other loans		4			(13	)		(9	)		(26	)		(7	)		(33	)
Total loans, net of discount		1,438			(207	)		1,231			797			(690	)		107
Total Interest Income		1,351			(226	)		1,125			897			(1,031	)		(134	)
Interest Expense:
Interest-bearing deposits:
NOW accounts		13			144			157			14			(30	)		(16	)
Savings accounts		3			-			3			5			(22	)		(17	)
Money Market accounts		7			153			160			(20	)		(56	)		(76	)
Certificates of deposit		148			-			148			15			(379	)		(364	)
Total interest-bearing deposits		171			297			468			14			(487	)		(473	)
Other borrowed funds		(94	)		421			327			273			8			281
Total interest expense		77			718			795			287			(479	)		(192	)
Net interest income	$	1,274		$	(944	)	$	330		$	610		$	(552	)	$	58

(1) The portion of the total change attributable to both volume and rate changes during the year has been allocated
to volume and rate components based upon the absolute dollar amount of the change in each component prior to allocation.

As can be seen from the preceding tables, tax equivalent net interest income increased from $8,869,000 in 2003 to $8,927,000 in 2004, and increased to $9,257,000 in 2005. In the period ending June 30, 2005, net interest income increased $330,000 on a tax equivalent basis over the same period in 2004. The overall spread decreased from 3.91% to 3.73%, respectively. The increased volume of interest-earning assets generated an increase in interest income of $1,351,000 while the increased volume of interest-bearing liabilities produced an additional $77,000 of interest expense. The change in volume resulted in an increase of $1,274,000 in net interest income. The net change in rate resulted in a negative $944,000 of net interest income. Combined, there was a net increase of $330,000 in net interest income. The yield on interest-earning assets increased 3 basis points from 6.23% to 6.26% and the average interest rate on interest-bearing liabilities increased 21 basis points, from 2.32% to 2.53%, because of the previously described flattening of the yield curve.

Provision For Loan Losses

For the three-month and six-month periods ending June 30, 2005 and 2004, we did not provide any provision as a result of our quarterly review of the allowance for loan losses. Management's quarterly review of the allowance for loan losses is based on the following information: migration analysis of delinquent and non-accrual loans, estimated future losses on loans, recent review of large problem credits, local and national economic conditions, historical loss experience, OCC qualitative adjustments and peer comparisons.

Non-interest Income

Non-interest income, as detailed below, decreased $241,000 or 17.5% for the second quarter of 2005 and $533,000, or 19.2%, when compared to the same periods in 2004.

Most of the decrease is attributable to the lack of investment securities gains. Through the first six months of 2005, we have not recognized any gains, compared with $491,000 of gains realized through the first six months of 2004. For the second quarter of 2004, $204,000 of investment gains were realized compared to none in the second quarter of 2005. Service charge income continues to be the primary source of non-interest income. For the first six months, account service charges totaled $1,419,000 compared to $1,482,000 last year. Most of this $63,000 decrease is attributable to the loss of several large customer accounts which had significant account fees. While trust and brokerage income is down $38,000 and $19,000, respectively, for the first six months from last year, insurance revenue is up $56,000 due to more customers choosing annuity products over mutual funds.

The following tables show the breakdown of non-interest income for the three months and six months ended June 30, 2005 and 2004 (dollars in thousands):

	Three months ended
	June 30,				Change
	2005		2004		Amount			%
Service charges	$	746	$	751	$	(5	)		(0.7	)
Trust		86		119		(33	)		(27.7	)
Brokerage		55		58		(3	)		(5.2	)
Insurance		61		60		1			1.7
Gains on loans sold		12		12		-			-
Investment securities gains, net		-		204		(204	)		(100.0	)
Earnings on bank owned life insurance		75		79		(4	)		(5.1	)
Other		100		93		7			7.5
Total	$	1,135	$	1,376	$	(241	)		(17.5	)

	Six months ended
	June 30,				Change
	2005		2004		Amount			%
Service charges	$	1,419	$	1,482	$	(63	)		(4.3	)
Trust		208		246		(38	)		(15.4	)
Brokerage		93		112		(19	)		(17.0	)
Insurance		144		88		56			63.6
Gains on loans sold		22		21		1			4.8
Investment securities gains, net		-		491		(491	)		(100.0	)
Earnings on bank owned life insurance		149		158		(9	)		(5.7	)
Other		202		172		30			17.4
Total	$	2,237	$	2,770	$	(533	)		(19.2	)

We continue to evaluate means of increasing non-interest income. Our approach is to apply service charges on business transaction accounts by charging fees on transaction activity, reduced by earnings credit based on customers' balances, to more equitably recover costs. We continue to analyze our schedule of fees based on competitive analyses and other opportunities to enhance non-interest income. Management is also focused on growing our trust and brokerage area through our approach to examine and develop a complete customer relationship.

Non-interest Expense

Total non-interest expense, as detailed below, increased $187,000 or 5.1%, for the second quarter of 2005 and $341,000 or 4.6% in the first six months of 2005 when compared to the same periods in 2004:

·	Salaries and benefits increased $123,000 or 3.3% for the six months ended June 30, 2005 compared to last year. This is attributable primarily due to 2005 overall salary increases and a slight increase in full time equivalents.

·	Occupancy expenses have increased $32,000 in 2005 due to additional expenses related to the Elmira Street building in Sayre purchased in July, 2004. Additionally, real estate taxes and general maintenance expenses have increased costs.

Amortization of intangibles has increased $72,000 for the six months of 2005 due to an increase in the core deposit intangible related to the Legacy branch acquisition in June of 2004. Similarly, the increase in the second quarter of 2005 compared to last year’s second quarter is also due to the branch acquisition.

·	Professional fees have decreased for both the three months and six months ended June 30, 2005 compared to the comparable periods last year due to the overall reduced level of consulting fees.

·	Other expenses, which includes the loss on sale of assets of approximately $34,000, increased $151,000 in 2005 compared to the first six months of 2004.

The following tables reflect the breakdown of non-interest expense and professional fees for the three months ended and the six months ended June 30, 2005(dollars in thousands):

	Three months ended
	June 30,				Change
	2005		2004		Amount			%
Salaries and employee benefits	$	1,974	$	1,847	$	127			6.9
Occupancy		282		267		15			5.6
Furniture and equipment		160		165		(5	)		(3.0	)
Professional fees		131		158		(27	)		(17.1	)
Amortization of intangibles		144		109		35			32.1
Other		1,171		1,129		42			3.7
Total	$	3,862	$	3,675	$	187			5.1

	Three months ended
	June 30,				Change
	2005		2004		Amount			%
Other professional fees	$	63	$	86	$	(23	)		(26.7	)
Legal fees		32		34		(2	)		(5.9	)
Examinations and audits		36		38		(2	)		(5.3	)
Total	$	131	$	158	$	(27	)		(17.1	)

	Six months ended
	June 30,				Change
	2005		2004		Amount			%
Salaries and employee benefits	$	3,895	$	3,772	$	123			3.3
Occupancy		585		553		32			5.8
Furniture and equipment		335		335		-			-
Professional fees		275		312		(37	)		(11.9	)
Amortization of intangibles		289		217		72			33.2
Other		2,306		2,155		151			7.0
Total	$	7,685	$	7,344	$	341			4.6


	Six months ended
	June 30,				Change
		2005		2004		Amount			%
Other professional fees	$	150	$	189	$	(39	)		(20.6	)
Legal fees		48		50		(2	)		(4.0	)
Examinations and audits		77		73		4			5.5
Total	$	275	$	312	$	(37	)		(11.9	)

Provision For Income Taxes

The provision for income taxes was $358,000 and $703,000 for the three-month and six-month periods ended June 30, 2005, respectively, compared to $455,000 and $902,000 the same periods in 2004. The decrease was primarily a result of decreased taxable income. On a year to date basis, the effective tax rate is 21.4% for 2005 compared with 23.3% last year.

We had previously entered into two limited partnership agreements to establish low-income housing projects in our market area. We expect to recognize a total of approximately $1,296,000 of tax credits over a ten year period. For tax purposes, we have recognized $433,700 out of a total $911,000 from one project and $134,700 out of a total $385,000 on the second project. Additionally, we entered into a third limited partnership agreement for low-income housing in the second quarter of 2005, which we expect to recognize $492,900 in tax credits over a ten year period beginning in 2006.

Liquidity

Liquidity is a measure of our Company's ability to efficiently meet normal cash flow requirements of both borrowers and depositors. To maintain proper liquidity, we use funds management policies along with our investment policies to assure we can meet our financial obligations to depositors, credit customers and stockholders. Liquidity is needed to meet depositors' withdrawal demands, extend credit to meet borrowers' needs, provide funds for normal operating expenses and cash dividends, and to fund other capital expenditures.

Our Company's historical activity in this area can be seen in the Consolidated Statement of Cash Flows from investing and financing activities.

Cash generated by operating activities, investing activities and financing activities influences liquidity management. The most important source of funds is the deposits that are primarily core deposits (deposits from customers with other relationships). Short-term debt from the Federal Home Loan Bank supplements our Company's availability of funds. Another source of short-term liquidity is the sale of loans if needed.

Our Company's use of funds is shown in the investing activity section of the Consolidated Statement of Cash Flows, where the net loan activity is presented. Other significant uses of funds include purchasing Regulatory Stock, as well as the purchase of capital expenditures. Surplus funds are then invested in investment securities.

Capital expenditures during the first six months of 2005 were $1,073,000, $883,000 more than the same period in 2004. $927,000 of this amount is attributed to purchasing property for possible future expansion.

Our Company achieves additional liquidity primarily from temporary or short-term investments in the Federal Home Loan Bank of Pittsburgh, PA, and investments that mature in less than one year. The Company also has a maximum borrowing capacity at the Federal Home Loan Bank of approximately $204 million as an additional source of liquidity.

Apart from those matters described above, management does not currently believe that there are any current trends, events or uncertainties that would have a material impact on capital.

Credit Quality Risk

The following table identifies amounts of loan losses and non-performing loans. Past due loans are those that were contractually past due 90 days or more as to interest or principal payments (dollars in thousands).

	June 30,			December 31,
	2005			2004			2003			2002			2001
Non-performing loans:
Non-accruing loans	$	627		$	722		$	578		$	1,064		$	985
Impaired loans		1,374			1,061			1,926			1,916			1,077
Accrual loans - 90 days or
more past due		156			437			185			39			111
Total non-performing loans		2,157			2,220			2,689			3,019			2,173
Foreclosed assets held for sale		649			712			305			221			408
Total non-performing assets	$	2,806		$	2,932		$	2,994		$	3,240		$	2,581
Non-performing loans as a percent of loans
net of unearned income		0.58	%		0.62	%		0.85	%		1.01	%		0.80	%
Non-performing assets as a percent of loans
net of unearned income		0.76	%		0.82	%		0.94	%		1.09	%		0.95	%

Interest does not accrue on non-accrual loans. Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management's assessment of its ultimate ability to collect principal and interest.

Interest Rate and Market Risk Management

The objective of interest rate sensitivity management is to maintain an appropriate balance between the stable growth of income and the risks associated with maximizing income through interest sensitivity imbalances and the market value risk of assets and liabilities.

Because of the nature of our operations, we are not subject to foreign currency exchange or commodity price risk and, since our Company has no trading portfolio, it is not subject to trading risk.

Currently, our Company has equity securities that represent only 3.4% of our investment portfolio and, therefore, equity risk is not significant.

The primary components of interest-sensitive assets include adjustable-rate loans and investments, loan repayments, investment maturities and money market investments. The primary components of interest-sensitive liabilities include maturing certificates of deposit, IRA certificates of deposit and short-term borrowings. Savings deposits, NOW accounts and money market investor accounts are considered core deposits and are not short-term interest sensitive (except for the top-tier money market investor accounts which are paid current market interest rates).

Gap analysis, one of the methods used by us to analyze interest rate risk, does not necessarily show the precise impact of specific interest rate movements on our Company's net interest income because the re-pricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures. In addition, assets and liabilities within the same period may, in fact, be repaid at different times and at different rate levels. We have not experienced the kind of earnings volatility that might be indicated from gap analysis.

As such, our Company currently uses a computer simulation model to better measure the impact of interest rate changes on net interest income. We use the model as part of our risk management process that will effectively identify, measure, and monitor our Company's risk exposure. We use numerous interest rate simulations employing a variety of assumptions to evaluate our interest rate risk exposure. A shock analysis during the second quarter of 2005 indicated that a 200 basis point movement in interest rates in either direction would have a minor impact on our Company's anticipated net interest income over the next twenty-four months, well within our policy limits and ability to manage effectively. The simulation model assumed a 200 basis point movement, however not necessarily in a parallel manner. Various assumptions, including a flattened yield curve, were utilized resulting in a more realistic interest rate scenario in order to assess risks.

General

The majority of assets and liabilities of a financial institution are monetary in nature and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets and on non-interest expenses, which tend to rise during periods of general inflation. The action by the Federal Reserve of increasing short-term interest rates will help ensure that the level of inflation remains at a relatively low level.

Various congressional bills have been passed and other proposals have been made for significant changes to the banking system, including provisions for: limitation on deposit insurance coverage; changing the timing and method financial institutions use to pay for deposit insurance; and tightening the regulation of bank derivatives' activities.

Aside from those matters described above, we do not believe that there are any trends, events or uncertainties, which would have a material adverse impact on future operating results, liquidity or capital resources. We are not aware of any current recommendations by the regulatory authorities (except as described herein) which, if they were to be implemented, would have such an effect, although the general cost of compliance with numerous and multiple federal and state laws and regulations does have, and in the future may have, a negative impact on our Company's results of operations.

Item 3-Quantitative and Qualitative Disclosure About Market Risk

In the normal course of conducting business activities, the Company is exposed to market risk, principally interest rate risk, through the operations of its banking subsidiary. Interest rate risk arises from market driven fluctuations in interest rates that affect cash flows, income, expense and values of financial instruments and was discussed previously in this Form 10-Q. Management and a committee of the board of directors manage interest rate risk.

No material changes in market risk strategy occurred during the current period. A detailed discussion of market risk is provided in the SEC Form 10-K for the period ended December 31, 2004.

Item 4-Control and Procedures

We maintain a system of controls and procedures designed to provide reasonable assurance as to the reliability of the financial statements and other disclosures included in this report, as well as to safeguard assets from unauthorized use or disposition. We evaluated the effectiveness of the design and operation of our disclosure controls and procedures under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, within 90 days prior to the filing date of this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic Securities and Exchange Commission filings. No significant changes were made to our internal controls or other factors that could significantly affect these controls subsequent to the date of their evaluation.

PART II - OTHER INFORMATION AND SIGNATURES

Item 1 - Legal Proceedings

Management is not aware of any legal proceeding, which exceeds 10% of the current assets of the Company and its subsidiaries on a consolidated basis. In addition, management may from time to time be engaged in routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings, in the aggregate, are believed by management to be immaterial to the Company's financial condition and results of operations. Furthermore, management is not aware of any pending or contemplated proceedings by governmental authorities.

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

ISSUER PURCHASES OF EQUITY SECURITIES


Period	Total Number of Shares (or units Purchased)	Average Price Paid per Share (or Unit)	Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans of Programs	Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs

4/1/05 to 4/30/05	-	-
5/1/05 to 5/31/05	-	-
6/1/05 to 6/30/05	21,453	$21.55	21,453	16,285

On June 17, 2005, the Company privately purchased 21,453 shares of stock from an individual.Through June 30, 2005, 118,715 shares out of a total of 135,000 shares approved have been purchased.

Item 3 - Defaults Upon Senior Securities

Not applicable.

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

Citizens Financial Services held its Annual Meeting of Shareholders on April 19, 2005, for the purpose of electing five directors and to transact such other business as would properly come before the meeting. Results of shareholder voting on these individuals were as follows:

1.	Election of Class 1 Directors whose term will expire in 2008

	For	Withhold Authority
Carol J. Tama	2,404,010	58,867
R. Lowell Coolidge	2,423,435	39,442
Larry J. Croft	2,408,784	54,093
Randall E. Black	2,421,254	41,623

2.	Election of Class 3 Director whose term will expire in 2006

	For	Withhold Authority
James A. Wagner	2,425,693	37,184

The total shares voted at the annual meeting were 2,462,877.

Item 5 - Other Information

None

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

(a) Exhibits.

(3)(i) - Articles of Incorporation of the Corporation, as amended. (Incorporated by Reference to Exhibit (3)(ii) to the Quarterly Report of Form 10-Q for the period ended December 31, 1999, as filed with the Commission on May 11,2000.)

(3)(ii)- By-laws of the Corporation, (Incorporated by Reference to Exhibit (3)(ii) to the Quarterly Report of Form 10-Q for the period ended March 31, 2005, as filed with the Commission on May 5,2005.)

(4) - Instruments Defining the Rights of Stockholders. (Incorporated by reference to the Registrant's Registration Statement No.2-89103 on Form S-14, as filed with the Commission on February 17, 1984.)

(10.1) - Material Contracts. Consulting and Non-Compete Agreement with Richard E. Wilber, Former Executive Officer of our company. (Incorporated by Reference to Exhibit (10) to the Annual Report of Form 10-K for the fiscal year ended December 31, 2003, as filed with the Commission on March 18, 2004.)

(10.2) - Directors’ Deferred Compensation Plan (Incorporated by Reference to Exhibit (10.2) to the Annual Report of Form 10-K for the fiscal year ended December 31, 2004, as filed with the Commission on March 15, 2005.)

(10.3) - Directors’ Life Insurance Program (Incorporated by Reference to Exhibit (10.3) to the Annual Report of Form 10-K for the fiscal year ended December 31, 2004, as filed with the Commission on March 15, 2005.)

(31.1) - 302 Certification of Principal Executive Officer

(31.2) - 302 Certification of Principal Accounting Officer

(32.1) - Certification of Principal Executive Officer

(32.2) - Certification of Principal Accounting Officer

(99.1) - Independent registered public accounting firm’s review of financial statements for the period ended June 30, 2005.

(b) Reports on Form 8-K - Press release issued by Citizens Financial Services, Inc. titled “Citizens Financial Services Inc. Holds Annual Meeting” filed April 21, 2005. Earnings release entitled “Citizens Financial Services, Inc. Reports First Quarter Earnings” filed April 21, 2005. Press release entitled “Citizens Financial Services, Inc. Announces Loss of Board Member” filed May 17, 2005. Press release issued by Citizens Financial Services, Inc. entitled “Local Bank Expands Northern Tier Real Estate Holdings” filed May 18, 2005. Earnings release entitled “Citizens Financial Services Inc. Reports Second Quarter Earnings” filed July 26, 2005.

Signatures

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

Citizens Financial Services, Inc.

(Registrant)

August 9, 2005 /s/ Randall E. Black

By: Randall E. Black

President and Chief Executive Officer

(Principal Executive Officer)

August 9, 2005 /s/ Mickey L. Jones

By: Mickey L. Jones

Chief Financial Officer

(Principal Accounting Officer)

Citizens Financial Services - 10-Q quarterly report FY

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