FORM 10-Q

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

For the Quarterly Period Ended:             September 30, 2004

OR

For the transition period from:                   to                   

Commission File Number: 0-19297

First Community Bancshares, Inc.

One Community Place, Bluefield, Virginia 24605

(276) 326-9000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 of 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.

Indicate by check mark whether Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

First Community Bancshares, Inc.

FORM 10-Q

INDEX

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PART I. ITEM 1. Financial Statements

FIRST COMMUNITY BANCSHARES, INC.

See Notes to Consolidated Financial Statements.

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FIRST COMMUNITY BANCSHARES, INC.

See Notes to Consolidated Financial Statements.

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FIRST COMMUNITY BANCSHARES, INC.

See Notes to Consolidated Financial Statements.

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FIRST COMMUNITY BANCSHARES, INC.

See Notes to Consolidated Financial Statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Unaudited Financial Statements

The unaudited consolidated balance sheet as of September 30, 2004, the unaudited consolidated statements of income for the nine and three months ended September 30, 2004 and 2003 and the consolidated statements of cash flows and changes in stockholders’ equity for the nine months ended September 30, 2004 and 2003 have been prepared by the management of First Community Bancshares, Inc. (“FCBI” or the “Company”). In the opinion of management, all adjustments (including normal recurring accruals) necessary to present fairly the financial position of FCBI and subsidiary at September 30, 2004 and its results of operations, cash flows, and changes in stockholders’ equity for the nine months ended September 30, 2004 and 2003 have been made. These results are not necessarily indicative of the results of consolidated operations that might be expected for the full calendar year.

The consolidated balance sheet as of December 31, 2003 has been extracted from the audited financial statements included in the Company’s 2003 Annual Report to Stockholders on Form 10-K and has been revised to reflect the discontinued operations of the Company’s mortgage subsidiary, United First Mortgage, which was sold during the third quarter 2004. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted in accordance with standards for the preparation of interim financial statements. These financial statements should be read in conjunction with the financial statements and notes thereto included in the 2003 Annual Report of FCBI on Form 10-K.

A more complete and detailed description of FCBI’s significant accounting policies is included within Footnote 1 to the Company’s Annual Report on Form 10-K for December 31, 2003. In addition, the Company’s required disclosure of the application of critical accounting policies is included within the “Application of Critical Accounting Policies” section of Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein.

The following is an update of certain required disclosures pursuant to the requirements of Financial Accounting Standards Board (“FASB”) Statement 148.

Summary of Significant Accounting Policy Update for Certain Required Disclosures: Stock Options

The Company has a stock option plan for certain executives and directors accounted for under the intrinsic value method. Because the exercise price of the Company’s employee/director stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The effect of option shares on earnings per share relates to the dilutive effect of the underlying options outstanding. To the extent the granted exercise share price is less than the current market price (“in the money”) there is an economic incentive for the shares to be exercised and an increase in the dilutive effect on earnings per share results.

A new Omnibus Stock Option Plan (“Stock Option Plan”) was approved by shareholders at the annual 2004 meeting of shareholders to be used in conjunction with retention, recruitment and hiring of employees. Options to acquire 42,000 shares of the Company’s common stock and an additional 5,000 stock awards were granted and reserved for future issuance in May 2004 subject to acceptance of agreements by the optionees. The maximum number of grants and awards under this Stock Option Plan is limited to 200,000 shares.

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Assuming use of the fair value method of accounting for stock options, pro forma net income and earnings per share for the nine and three month periods ended September 30, 2004 and 2003 would have been estimated as follows:

Note 2. Discontinued Operations

On August 18, 2004, the Company sold its United First Mortgage, Inc. (“UFM”) subsidiary headquartered in Richmond, Virginia. The transaction resulted in the sale of 100% of the stock of UFM for cash consideration of approximately $250,000. The transaction produced a third quarter after-tax gain of approximately $380,000. This sale completes the previously announced plan to exit the mortgage banking business segment.

In connection with the exit from the mortgage banking business and as previously reported, the Company recorded impairment charges of $1,385,000 in the first half of 2004, reducing the carrying value of UFM to its estimated fair value less costs to sell. The loss from discontinued operations was $212,000 for the three months ended September 30, 2004 and $3.5 million for the nine months ended September 30, 2004. Exiting the mortgage banking business eliminated the Company’s exposure to risk associated with the large fluctuations previously experienced in the volume-driven, wholesale mortgage business and its hedged interest rate lock commitments and loans. This change in strategic direction and exit from the mortgage banking business will permit the Company to focus its resources on its core community banking business, which has continued to grow and perform.

The business related to UFM is accounted for as discontinued operations and, therefore, the results of operations and cash flows have been removed from the Company’s results of continuing operations in accordance with Financial Accounting Standard (“FAS’) 144 for all periods presented in this report. The results of UFM are presented, along with the after-tax gain on sale, as discontinued operations in a separate category on the income statement following results from continuing operations. The results of discontinued operations for the nine months and three months ended September 30, 2004 and 2003 are as follows:

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All assets and liabilities of UFM were disposed of in the third quarter of 2004. Accordingly, these assets and liabilities were not included in the September 30, 2004 interim condensed, consolidated balance sheet. UFM assets and liabilities for the prior period are classified as discontinued in this report. The major asset and liability categories of discontinued operations for the prior period are presented as follows:

Note 3. Reclassifications

Certain Stone Capital fees reflected as fiduciary revenues in the September 30, 2003 income statement were reclassified from fiduciary revenues to “Other Service charges, Commissions and Fees” to conform to the income statement presentation used in preparation of the September 30, 2004 financial statements that are included in this periodic report on Form 10Q. Fiduciary revenues reported for the three and nine month periods ended September 30, 2003 included $87,000 and $255,000, respectively, which related to asset management services provided by Stone Capital. The reclassification had no effect on net income or stockholders equity.

Note 4. Mergers, Acquisitions and Branch Development

After the close of business on March 31, 2004, the Company acquired PCB Bancorp, Inc., a Tennessee-chartered bank holding company (“PCB Bancorp”) headquartered in Johnson City, Tennessee. PCB Bancorp had six full service branch offices located in Johnson City, Kingsport and surrounding areas in Washington and Sullivan Counties in East Tennessee. At acquisition, PCB Bancorp had total assets of $171.0 million, total net loans of $128.0 million and total deposits of $150.0 million. These resources were included in the Company’s financial statements beginning with the second quarter of 2004.

Under the terms of the merger agreement, shares of PCB Bancorp common stock were purchased for $40.00 per share in cash. The total deal value, including the cash-out of outstanding stock options, was approximately $36.0 million. Concurrent with the PCB Bancorp acquisition, Peoples Community Bank, the wholly-owned subsidiary of PCB Bancorp, was merged into First Community Bank, N.A. (the “Bank”), a wholly-owned subsidiary of the Company. As a result of the acquisition and preliminary purchase price allocation, approximately $21.3 million in goodwill was recorded which represents the excess of the purchase price over the fair market value of the net assets acquired and identified intangibles.

On June 6, 2003, the Company acquired The CommonWealth Bank, a Virginia-chartered commercial bank (“CommonWealth”). CommonWealth’s four branch facilities located in the Richmond, Virginia metro area were simultaneously merged with and into the Bank. The completion of this transaction resulted in the addition of $136.5 million in assets, including $120.0 million in loans, and $105.0 million in deposits to the Bank. As a result of the purchase price allocation, approximately $14.1 million of goodwill was recorded.

In the second and third quarters of 2003, the Company opened three de novo branches in Winston-Salem, North Carolina. The Company also opened two additional loan production offices during the first quarter of 2004 in Mount Airy and Charlotte, North Carolina. The Charlotte office has since been converted to a full-service branch although it does not exercise paying and

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receiving privileges. Also in the second quarter of 2004, two new loan production offices were opened in Blacksburg and Norfolk, Virginia.

In January 2003, the Bank completed the acquisition of Stone Capital Management, Inc. (“Stone Capital”) based in Beckley, West Virginia. This acquisition expanded the Bank’s operations to include a broader range of financial services, including wealth management, asset allocation, financial planning and investment advice. At December 31, 2003, Stone Capital had total assets of $59 million under management and today continues to operate as a separate subsidiary under the name of Stone Capital Management Inc. Stone Capital was acquired through the issuance of 8,409 shares of Company common stock, which represented 50% of the total consideration. In 2003, Stone Capital exceeded the annual revenue requirement outlined in the acquisition agreement and another 2,541 shares were paid to the original shareholders subsequent to December 31, 2003. The balance of the remaining consideration ($175,000) is payable over the next two years in the form of Company common stock, subject to the achievement of minimum requirements set forth in the acquisition agreement. As a result of the purchase price allocation, approximately $360,000 of goodwill was recorded.

Note 5. Securities

As of September 30, 2004, the amortized cost and estimated fair value of securities are as follows:

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Note 6. Loans

As of September 30, 2004, loans net of unearned income consist of the following:

Note 7. Borrowings

Federal Home Loan Bank (“FHLB”) borrowings and other indebtedness are comprised of $107.5 million in convertible and callable advances and $34.6 million of noncallable term advances from the FHLB of Atlanta. The callable advances may be redeemed at quarterly intervals after various lockout periods. These call options may substantially shorten the lives of these instruments. If these advances are called, the debt may be paid in full, converted to another FHLB credit product, or converted to an adjustable rate advance. Prepayment of the advances may result in substantial penalties based upon the differential between contractual note rates and current advance rates for similar remaining time periods. Advances from the FHLB are secured by stock in the FHLB of Atlanta, qualifying first mortgage loans, mortgage-backed securities, and certain other securities.

The following schedule details the contractual terms of outstanding FHLB advances, rates and corresponding final maturities at September 30, 2004. Also included in the table are the fair value adjustments related to debt obligations acquired in the CommonWealth Bank and People’s Community Bank acquisitions. The unamortized premium of approximately $390,000 is being amortized as interest expense over the anticipated life of the borrowings and is reflected as an adjustment to the effective rate paid.

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UFM maintained a warehouse line of credit (maximum available $15 million) with a third party which was entered into in the third quarter of 2003 and used to fund mortgage loan inventory. Following the decision to sell UFM, this line was paid off and then terminated with the sale of UFM. Other various debt obligations of the Company were approximately $22,000 at September 30, 2004.

In September 2003, the Company issued $15 million of junior subordinated debentures to an unconsolidated trust subsidiary, FCBI Capital Trust (the “Trust”) with an interest rate of three month LIBOR plus 2.95%. The Trust was able to purchase the junior subordinated debentures through the issuance of trust preferred securities which had substantially identical terms as the junior subordinated debentures. The junior subordinated debentures mature on October 8, 2033 and are callable beginning October 8, 2008. The net proceeds from the offering were contributed as capital to the Bank to support further growth.

On May 6, 2004, the Federal Reserve Board (“FRB”) issued a notice of proposed rulemaking in regards to trust preferred securities and the definition of capital. In general, the FRB proposed to allow the continued inclusion of outstanding and prospective issuances of trust preferred securities as Tier 1 capital of bank holding companies, subject to stricter quantitative limits and qualitative standards. The quantitative limits would become effective after a three-year transition period.

Note 8. Commitments and Contingencies

In the normal course of business, the Company is a defendant in various legal actions and asserted claims, most of which involve lending, collection and employment matters. While the Company and legal counsel are unable to assess the ultimate outcome of each of these matters with certainty, they are of the belief that the resolution of these actions, singly or in the aggregate, should not have a material adverse effect on the financial condition, results of operations or cash flows of the Company.

The Bank 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, standby letters of credit and financial guarantees. These instruments involve, to varying degrees, elements of credit and interest rate risk beyond the amount recognized on the balance sheet. The contractual amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company’s exposure to credit loss in the event of non-performance 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 amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

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Commitments to extend credit are agreements to lend to a customer as long as there is not a 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 Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company, upon extension of credit is based on management’s credit evaluation of the counterparties. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

Standby letters of credit and written financial guarantees are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. To the extent deemed necessary, collateral of varying types and amounts is held to secure customer performance under certain of those letters of credit outstanding.

Financial instruments whose contract amounts represent credit risk at September 30, 2004 are commitments to extend credit (including availability of lines of credit) of $150.0 million and standby letters of credit and financial guarantees written of $8.0 million.

In September 2003, the Company issued, through the Trust, $15.0 million of trust preferred securities in a private placement. In connection with the issuance of the preferred securities, the Company has committed to irrevocably and unconditionally guarantee the following payments or distributions with respect to the preferred securities to the holders thereof to the extent that the Trust has not made such payments or distributions and has the funds therefore: (i) accrued and unpaid distributions, (ii) the redemption price, and (iii) upon a dissolution or termination of the trust, the lesser of the liquidation amount including all accrued and unpaid distributions or the amount of assets of the trust remaining available for distribution.

Throughout 2004 the Company has been engaged in a state tax audit involving state income, franchise and sales tax in one of the states whose the Company operates. During the third quarter of fiscal 2004, the Company received early indications of the state tax department’s position on various income and franchise tax matters and ultimately received estimates, from the state tax representatives of potential additional state income and franchise tax liabilities. The Company’s review of the potential assessments revealed a position, which favors the Company and which, if sustained, could result in state income and franchise tax refunds. The Company and tax counsel continue to evaluate possible exposure under the state tax audit as well as the advancement of the more favorable tax positions and believe that the Company has established appropriate provisions for state income and franchise taxes within a range of possible outcomes, given the uncertainty of the state tax audit and changes in the Company’s state tax filings.

Pursuant to the August 2004 sale of UFM the Bank agreed to indemnify the purchaser of UFM from various losses or claims arising from redemption of service release premiums (through January 2005), certain defaults on loans sold through August 2005 and up to a maximum of $1.25 million, specific litigation, certain contracts, indemnification agreements with national investors and the Department of Housing and Urban Development and certain employment related claims, if any (up to a maximum of $1.0 million), all as more specifically set forth in a Stock Purchase Agreement dated August 17, 2004 and previously filed as an exhibit to Form 8-K filed with the Securities and Exchange Commission (“SEC”) on August 18, 2004.

Note 9. Other Comprehensive Income

The Company currently has one component of other comprehensive income, which is comprised of unrealized gains and losses on securities available for sale, detailed as follows:

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Note 10. Recent Accounting Developments

In March 2004, the Emerging Issue Task Force reached a consensus opinion on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments” regarding the determination of whether an investment is considered impaired, whether the identified impairment is considered other-than-temporary, how to measure other-than-temporary impairment, and how to disclose unrealized losses on investments that are not other-than-temporarily impaired. Adoption of the new measurement requirements has been delayed by the FASB pending reconsideration of implementation guidance relating to debt securities that are impaired solely due to market interest rate fluctuations. The contractual cashflows of the Company’s mortgage-backed securities are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. Because a decline in the fair value is attributable to changes in rates and not credit quality, and because the Company has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.

On March 9, 2004, the SEC issued SAB 105, “Application of Accounting Principles to Loan Commitments” to inform registrants of the SEC Staff’s view that the fair value of the recorded loan commitments, that are required to follow derivative accounting under Statement 133, Accounting for Derivative Instruments and Hedging Activities, should not consider the expected future cash flows related to the associated servicing of the future loan. The provisions of SAB 105 must be applied to loan commitments accounted for as derivatives that are entered into after March 31, 2004. Though the Company sold its loans through the discontinued segment on a servicing released basis, the Company adopted the provisions of SAB 105 on January 1, 2004 and this had the impact of reducing the fair value of such instruments by $252,000 at March 31, 2004.

In December 2003, the AICPA issued Statement of Position (“SOP”) 03-3 “Accounting for Certain Loans or Debt Securities Acquired in a Transfer". This statement, which is effective for loans acquired in fiscal years beginning after December 15, 2004, addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. This standard will require a fair value measure of loans acquired and as such no corresponding loss reserve will be permitted on loans acquired in a transfer that are within the scope of SOP 03-3. The impact of the Standard is prospective and will require new recognition and measurement techniques upon adoption.

In July 2003, the Board of Governors of the Federal Reserve System issued a supervisory letter instructing bank holding companies to continue to include trust preferred securities in their Tier 1 capital for regulatory capital purposes until notice is given to the contrary. The Federal Reserve intends to review the regulatory implications of any accounting treatment changes and, if necessary or warranted, provide further appropriate guidance. On May 6, 2004, the Federal Reserve issued a proposed rule that would continue to allow trust preferred securities, such as the Trust, to constitute Tier 1 capital for bank holding companies. The proposed rules would impose stricter quantitative and qualitative limits on the Tier 1 treatment of trust preferred securities. Currently, trust preferred securities and qualifying perpetual preferred stock are limited in the aggregate to no more than 25% of a holding company’s core capital elements. The proposed rule would amend the existing limit by providing that restricted core capital elements (including trust preferred securities and qualifying perpetual preferred stock) can be no more than 25% of core capital, net of goodwill. It is possible that the Federal Reserve rules will not be adopted as proposed and that the Federal Reserve will conclude that trust preferred securities should no longer be treated as Tier 1 regulatory capital. At June 30, 2004, $15 million in trust preferred securities issued by FCBI Capital Trust were outstanding and treated as Tier 1 capital for bank regulatory purposes. If FCBI’s outstanding trust preferred securities at September 30, 2004 were not treated as Tier 1 capital at that date, FCBI’s Tier 1 leverage capital ratio would have declined from 7.40% to 6.55%, its Tier 1 risk-based capital ratio would have declined from 10.44% to 9.24%, and its total risk-based capital ratio would have declined from 11.72% to 10.52% as of September 30, 2004. These reduced capital ratios would continue to meet the applicable “well capitalized” Federal Reserve capital requirements.

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Note 11. Earnings per Share

The following schedule details earnings and shares used in computing basic and diluted earnings per share for the nine and three months ended September 30, 2004 and 2003.