PENNS WOODS BANCORP, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

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The Company paid approximately $6,452,000 and $7,313,000 interest on deposits and borrowings during the first three quarters of 2004 and 2003, respectively.

The Company made income tax payments of approximately $3,250,000 and $2,154,000 during the first nine months of 2004 and 2003, respectively.

See accompanying notes to the unaudited consolidated financial statements.

PENNS WOODS BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1.  Basis of Presentation

The consolidated financial statements include the accounts of Penns Woods Bancorp, Inc. (the “Company”) and its wholly-owned subsidiaries Woods Investment Company, Inc., Woods Real Estate Development Company, Inc., and Jersey Shore State Bank (the “Bank”) and its wholly-owned subsidiary The M Group, Inc. D/B/A The Comprehensive Financial Group (“The M Group”).  All significant inter-company balances and transactions have been eliminated in the consolidation.

The interim financial statements are unaudited but, in the opinion of management, reflect all adjustments necessary for the fair presentation of results for such periods.  All of those adjustments are of a normal, recurring nature.  The results of operations for any interim period are not necessarily indicative of results for the full year.  These financial statements should be read in conjunction with financial statements and notes thereto contained in the Company’s annual report for the year ended December 31, 2003.

Recent Accounting Pronouncements

In March 2004, the Financial Accounting Standards Board (“FASB”) reached consensus on the guidance provided by Emerging Issues Task Force Issue 03-1 (“EITF 03-1”), The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. The guidance is applicable to debt and equity securities that are within the scope of FASB Statement of Financial Accounting Standard (“SFAS”) No. 115, Accounting for Certain Investments In Debt and Equity Securities and certain other investments. EITF 03-1 specifies that an impairment would be considered other-than-temporary unless (a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment and (b) evidence indicating the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. EITF 03-1 cost method investment and disclosure provisions were effective for reporting periods ending after June 15, 2004. The measurement and recognition provisions relating to debt and equity securities have been delayed until the FASB issues additional guidance. The Company adopted cost method investment and disclosure provisions of EITF 03-1 on June 30, 2004. The adoption did not have a material impact on the consolidated financial statements, results of operations or liquidity of the Company.

NOTE 2. Per Share Data

The following table sets forth the composition of the weighted average common shares (denominator) used in the basic and dilutive per share computation.  There are no convertible securities which would affect the numerator in calculating basic and dilutive

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Employer Contributions

The Company previously disclosed in its consolidated financial statements included in the 2003 Annual Report on Form 10-K that it expected to contribute $560,000 to its defined benefit plan in 2004.  As of September 30, 2004, a contribution of $296,000 has been made.  The Company presently anticipates contributing an additional $84,000 to fund its pension plan in 2004 for a total of $380,000.

Note 4.  Off Balance Sheet Risk

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees, elements of credit, interest rate or liquidity risk in excess of the amount recognized in the consolidated balance sheet.  The contract amounts of these instruments express the extent of involvement the Company has in particular classes of financial instruments.

The Company’s exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments.  The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

The Company may require collateral or other security to support financial instruments with off-balance sheet credit risk.

Financial instruments whose contract amounts represent credit risk are as follows:

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Note 5.  Reclassification of Comparative Amounts

Certain comparative amounts for the prior periods have been reclassified to conform to current period presentations. Such reclassifications had no effect on net income or shareholders’ equity.

CAUTIONARY STATEMENT FOR PURPOSES OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Report contains certain “forward-looking statements” including statements concerning plans, objectives, future events or performance and assumptions and other statements which are other than statements of historical fact.  The Company wishes 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 made by or on behalf of the Company herein:  (i) the effect of changes in laws and regulations, including federal and state banking laws and regulations, which the Company must comply, and the associated costs of compliance with such laws and regulations either currently or in the future as applicable; (ii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board, or of changes in the Company’s organization, compensation and benefit plans; (iii) the effect on the Company’s competitive position within its market area of the increasing consolidation within the banking and financial services industries, including the increased competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services; (iv) the effect of changes in interest rates; and (v) the effect of changes in the business cycle and downturns in the local, regional or national economies.

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

EARNINGS SUMMARY

Comparison of the Nine Months Ended September 30, 2004 and 2003

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Interest Income

The $1,159,000 increase of interest income is the result of the expansion of total interest-earning assets partially offset by declining interest rates on interest-earning assets.  Total securities experienced a rate decline of 17 basis points effected by management’s repositioning from longer term States & Political securities to shorter term U.S. Government securities.  While weighted average interest rates in the loan portfolio decreased 70 basis points, the expansion into the Centre County market facilitated loan growth of over $40,903,000.  The opportunity to borrow funds at historically low interest rates, a growth of municipal deposits, and the sale of securities funded the loan growth.

Interest Expense

For the nine months ended September 30, 2004, total interest expense decreased by $613,000 or 8% compared to the first nine months of 2003.  Low interest rates have positively impacted interest expense.  Management’s adjustment of rates paid while continuing to monitor the local competition for all deposit accounts contributed the most substantial decrease in interest expense.  The weighted average rate on interest paid on deposits declined 51 basis points for the nine months ended September 30, 2004 from the same period in 2003 resulting in the decrease of interest paid on savings deposits of $404,000 and $538,000 on time deposits.

Favorable long-term borrowing rates offer opportunities to reduce interest expenses over the coming years.  At the end of the first quarter of 2003, the Company borrowed an additional $20 million in long term advances through the FHLB to minimize future borrowing costs and to enhance asset and liability positioning.  These additional borrowings were utilized by management to take advantage of current investment opportunities while minimizing interest rate risk.  The $240,000 increase in expense on long-term borrowings is the result of these additional advances with average advances of $10,260,000 offset by the 23 basis point decline in the resulting weighted average interest rate for the first three quarters of 2004 compared to the same period of 2003. Interest paid on short-term borrowings increased $89,000 as a result of an increase in the average balances of $11,812,000 offset partially by the decline in the weighted average interest rate of 32 basis points.  Overnight borrowings increased as a result of leveraging the purchase of securities and loan growth.

Provision for Loan Losses

The provision for loan losses is based upon management’s quarterly review of the loan portfolio.  The purpose of the review is to assess loan quality, identify impaired loans, analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets served.  An external independent loan review is also performed annually for the Bank.  Management remains committed to an aggressive program of problem loan identification and resolution.

The allowance is calculated by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined.  Loss factors are

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weighted average interest rate for the period partially offset by the increase of the weighted average balance of $20,321,000.  The weighted average interest rate for time deposits decreased 31 basis points for a savings of $100,000.  The interest expense paid on short-term borrowings increased $25,000 caused by the increase of the weighted average interest rate of 3 basis points along with the increase of the weighted average balance of short-term borrowings increase of $607,000.  Interest paid on long-term borrowings increased $14,000 due to the increase in the weighted average balance of $5,000,000.

Other Operating Income

Total other operating income for the quarter ended September 30, 2004 compared to the same period in 2003 decreased $617,000.  The decrease is due to the decrease of securities gains of $840,000 partially offset by an increase in the insurance and brokerage commissions earned by the Bank’s subsidiary, The M Group, Inc. of $212,000 during the third quarter of this year.  Service charges rose $9,000 as the weighted average balance of demand deposits continued to rise.

Other Operating Expenses

Total other operating expenses increased $219,000.  Salaries and employee benefits increased $210,000 attributed to both the increase of commissions earned by The M Group, Inc. and standard cost of living salary increases for bank employees.  Occupancy expense increased $12,000 and furniture and equipment decreased $37,000 due to an increase in depreciation expense during the third quarter of 2004 compared to the third quarter of 2003.  Pennsylvania shares tax expense increased $17,000 and miscellaneous expenses increased $17,000 due to general inflationary increases.

Provision for Income Taxes

Income taxes increased $15,000 for the quarter ended September 30, 2004 compared to the third quarter of 2003.  The effective tax rates for the quarter ended September 30, 2004 and 2003 were 28.92% and 27.38%, respectively.  This increasing effective tax rate is consistent with management’s repositioning of the investment portfolio from tax-exempt securities to taxable securities.  The tax effects of the repositioning were examined by management as part of the Company’s strategic plan.

ASSET/LIABILITY MANAGEMENT

Assets

At September 30, 2004, total assets were $559.3 million compared to $527.4 million at December 31, 2003.  Cash and due from banks increased $6.7 million during the first three quarters of 2004.  Investment securities totaled $194.3 million at September 30, 2004 for a net decrease of $16.9 million from the corresponding balance

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December 31, 2003.  The decline of investments is primarily due to the principal payments on the mortgage-backed securities of $21.2 million.  Mortgage-backed agency securities were purchased and sold for a net decrease of $7.3 million and tax-free municipals were purchased and sold for a net increase of $14.9 million.  In prior periods, management had shortened the average life of the securities portfolio in anticipation of rising interest rates.  During 2004, management has lengthened the maturities of investments as yields increase.  The unrealized gain on investments decreased $3.3 million from December 31, 2003 to September 30, 2004.   During this period, net loans increased by $40.7 million as a result of expansion into Centre County and increased volume in both Lycoming and Clinton counties.

Deposits

At September 30, 2004, total deposits amounted to $373.1 million representing an increase of $38.8 million from total deposits at December 31, 2003.  Non-interest bearing demand deposits increased $5.2 million and savings deposits increased $2.9 million due to normal operations. Time deposits increased $13.9 million and interest-bearing demand deposits increased $16.8 million due to an increase of municipal deposits.

Capital

The adequacy of the Company’s capital is reviewed on an ongoing basis with reference to the size, composition and quality of the Company’s resources and regulatory guidelines.  Management seeks to maintain a level of capital sufficient to support existing assets and anticipated asset growth, maintain favorable access to capital markets and preserve high quality credit ratings.

Bank holding companies are required to comply with the Federal Reserve Board’s risk-based capital guidelines.  The risk-based capital rules are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies and to minimize disincentives for holding liquid assets.  Specifically, each is required to maintain certain minimum dollar amounts and ratios of Total risk-based, Tier I risk-based and Tier I leverage capital requirements. In addition to the capital requirements, the Federal Deposit Insurance Corporation Improvements Act (FDICIA) established five capital categories ranging from “well capitalized” to “critically undercapitalized.” To be classified as “well capitalized”, Total risk-based, Tier I risked-based and Tier I leverage capital ratios must be at least 10%, 6%, and 5% respectively.

At September 30, 2004, the Company was “well capitalized” with a total capital ratio of 22.11%, a Tier I capital ratio of 20.27% and a Tier I leverage ratio of 12.06%.

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Liquidity and Interest Rate Sensitivity

The asset/liability committee addresses the liquidity needs of the Bank to see that sufficient funds are available to meet credit demands and deposit withdrawals as well as to the placement of available funds in the investment portfolio.  In assessing liquidity requirements, equal consideration is given to the current position as well as the future outlook.

The following liquidity measures are monitored and kept within the limits cited.

1.  Net Loans to Total Assets,  70% maximum

2.  Net Loans to Total Deposits, 92.5% maximum

3.  Net Loans to Core Deposits, 100% maximum

4.  Investments to Total Assets, 40% maximum

5.  Investments to Total Deposits, 50% maximum

6.  Total Liquid Assets to Total Assets, 25% minimum

7.  Total Liquid Assets to Total Liabilities, 25% minimum

8.  Net Core Funding Dependence, 35% maximum

Fundamental objectives of the Company’s asset/liability management process are to maintain adequate liquidity while minimizing interest rate risk.  The maintenance of adequate liquidity provides the Company with the ability to meet its financial obligations to depositors, loan customers and shareholders.  Additionally, it provides funds for normal operating expenditures and business opportunities as they arise.  The objective of interest rate sensitivity management is to increase net interest income by managing interest sensitive assets and liabilities in such a way that they can be repriced in response to changes in market interest rates.

The Bank, like other financial institutions, must have sufficient funds available to meet its liquidity needs for deposit withdrawals, loan commitments and expenses.   In order to control cash flow, the Bank estimates future flows of cash from deposits and loan payments.  The primary sources of funds are deposits, principal and interest payments on loans and mortgage-backed securities, as well as Federal Home Loan Bank borrowings.  Funds generated are used principally to fund loans and purchase investment securities.  Management believes the Company has adequate resources to meet its normal funding requirements.

Management monitors the Company’s liquidity on both a long and short-term basis thereby, providing management necessary information to react to current balance sheet trends.  Cash flow needs are assessed and sources of funds are determined.  Funding strategies consider both customer needs and economical cost.  Both short and long term funding needs are addressed by maturities and sales of available for sale investment

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magnitude as prices of other goods and services, but are reflective of fiscal policy initiatives or economic factors which are not measured by a price index.

In reference to the attached financial statements, all adjustments are of a normal recurring nature pursuant to Rule 10-01 (b) (8) of Regulation S-X`.

Item 3.  Quantitative and Qualitative Disclosure About Market Risk

Market risk for the Company is comprised primarily from interest rate risk exposure and liquidity risk.  Interest rate risk and liquidity risk management is performed at the Bank level as well as the Company level.  The Company’s interest rate sensitivity is monitored by management through selected interest rate risk measures produced internally.  There have been no substantial changes in the Company’s GAP analyses or simulation analyses compared to the information provided in the Company’s SEC 10-K for the period ended December 31, 2003.  Additional information and details are provided in the Interest Sensitivity section of Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Generally, management believes the Company is well positioned to respond expeditiously when the market interest rate outlook changes.

Item 4.  Controls and Procedures

An analysis was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2004. There has been no change in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2004, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II.  OTHER INFORMATION

Item 1.  Legal Proceedings

None.

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

The Company announced a repurchase program on August 10, 2000 which was approved by the Board of Directors on August 8, 2000 for the repurchase of 171,600 shares which

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EXHIBIT INDEX

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