FORM 10-Q

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

For the transition period from:                                         to                                         

Commission File Number: 0-19297

First Community Bancshares, Inc.

(276) 326-9000

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.

Yes þ     Noo

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

Yes þ     Noo

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. General

Unaudited Financial Statements

The unaudited consolidated balance sheet as of March 31, 2005, the unaudited consolidated statements of income for the three months ended March 31, 2005 and 2004 and the consolidated statements of cash flows and changes in stockholders’ equity for the three months ended March 31, 2005 and 2004 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 March 31, 2005 and its results of operations, cash flows, and changes in stockholders’ equity for the three months ended March 31, 2005 and 2004 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, 2004 has been derived from the audited financial statements included in the Company’s 2004 Annual Report to Stockholders on Form 10-K. 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 2004 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, 2004. Further discussion of the Company’s 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.

Stock-Based Compensation

The Company has stock option plans 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 following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123R, “Accounting for Stock-Based Compensation,” to stock-based employee compensation for the three month periods ended March 31, 2005 and 2004.

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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 completed the previously announced plan to exit the mortgage banking business segment.

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 three months ended March 31, 2005 and 2004 are as follows:

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All assets and liabilities of UFM were disposed of in the third quarter of 2004. Accordingly, there were no assets or liabilities related to discontinued operations included in the March 31, 2005, consolidated balance sheet, or the December 31, 2004 consolidated balance sheet.

Note 3. Mergers, Acquisitions and Branch Development

In December 2004, First Community Bank, NA (the “Bank”) opened its newest full-service branch in Princeton, West Virginia. The Company 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 currently exercise paying and receiving privileges. Also in the second quarter of 2004, two new loan production offices were opened in Blacksburg and Norfolk, Virginia.

After the close of business on March 31, 2004, PCB Bancorp, Inc., a Tennessee-chartered bank holding company (“PCB”) headquartered in Johnson City, Tennessee, was acquired by merger into the Company. PCB had five full service branch offices located in Johnson City, Kingsport and surrounding areas in Washington and Sullivan Counties in East Tennessee. At acquisition, PCB 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 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 acquisition, Peoples Community Bank, the wholly-owned subsidiary of PCB, was merged into the Bank. 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.

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Note 4. Securities

As of March 31, 2005 and December 31, 2004, the amortized cost and estimated fair value of securities are as follows:

At March 31, 2005, the combined depreciation in value of the individual securities in an unrealized loss position for more than 12 months was less than 1% of the combined reported value of the aggregate securities portfolio. Management does not believe any individual unrealized loss as of March 31, 2005 represents an other-than-temporary impairment. The Company has the intent and ability to hold these securities until such time as the value recovers or the securities mature. Furthermore, the Company believes the value is attributable to changes in market interest rates and not the credit quality of the issuer.

The following table reflects those investments in a continuous unrealized loss position for less than 12 months at March 31, 2005 and December 31, 2004. There were no securities in a continuous unrealized loss position for 12 or more months for which the Company does not have the ability to hold until the security matures or recovers in value.

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Note 5. Loans

Loans net of unearned income consist of the following:

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, 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 March, 31, 2005 are commitments to extend credit (including availability of lines of credit) of $188.7 million and standby letters of credit and financial guarantees written of $11.1 million.

Note 6. Borrowings

Federal Home Loan Bank (“FHLB”) borrowings and other indebtedness include $132.4 million in convertible and callable advances and $9.4 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 March 31, 2005. Also 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 $194,000 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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Also included in other indebtedness is $15 million of junior subordinated debentures (the “Debentures”) issued by the Company in October 2003 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 Debentures through the issuance of trust preferred securities which had substantially identical terms as the Debentures. The 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.

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.

In March 2005, the Federal Reserve Board (“FRB”) issued a final rule regarding trust preferred securities and the definition of capital. In general, the FRB will 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 five-year transition period.

Note 7. 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 Company is engaged in a state tax audit involving state income, franchise and sales tax in one of its state tax jurisdictions. While the Company has received early indications of the state tax department’s estimates 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 to the Company. The Company and tax counsel continue to evaluate possible exposure under the state tax audit as well as the advancement of the referenced favorable tax position and believe that the Company has established appropriate provisions for state income and franchise taxes, consistent with 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 Company agreed to indemnify the purchaser of UFM from various losses or claims arising from certain defaults on loans sold through August 2005, and as to specific litigation and certain contracts, pursuant to indemnification agreements with national investors and the Department of Housing and Urban Development and as to certain employment related claims, if any, all as more specifically set forth in the stock purchase agreement. The Company estimates that its obligations under this agreement will not materially impact its financial statements.

Note 8. Recent Accounting Developments

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment,” which is an amendment of SFAS No. 123. SFAS No. 123R changes, among other things, the manner in which share-based compensation, such as stock options, will be accounted for by both public and non-public companies. For public companies, the cost of employee services received in exchange for equity instruments including options and restricted stock awards generally will be measured at fair value at the grant date. The grant date fair value will be estimated using option-pricing models adjusted for the unique characteristics of those options and instruments, unless observable market prices for the same or similar options are available. The cost will be recognized over the requisite service period, often the vesting period, and will be re-measured subsequently at each reporting date through settlement date. In April 2005, the SEC announced that it would provide for a phased-in implementation process for FASB Statement No. 123R, and require registrants to adopt the standard’s fair-value method of accounting for share-based payments to employees no later than the beginning of the first fiscal year beginning after December 15, 2005.

The changes in accounting will replace existing requirements under SFAS No. 123, “Accounting for Stock-Based Compensation,” and will eliminate the ability to account for share-based compensation transactions using APB Opinion No, 25, “Accounting for Stock Issued to Employees,” which does not require companies to expense options if the exercise price is equal to the trading price at the date of grant. The accounting for similar transactions involving parties other than employees or the accounting for stock ownership plans that are subject to American Institute of Certified Public Accounts (“AICPA”) Statement of Position 93-6, “Employer’s Accounting for Employee Stock Ownership Plans,” would remain unchanged. The expected impact of this standard on options issued under the Company’s 1999 Plan and options currently issued under the 2004 Plan will be realized in periods beginning after December 15, 2005.

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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 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 allowance for loans losses will be permitted to be transferred on loans acquired in a transfer that are within the scope of SOP 03-3. The impact of the statement is prospective and will require new recognition and measurement techniques upon adoption. Management does not expect the adoption of this statement to have a material impact on the Company’s consolidated financial statements.

Note 9. Earnings per Share

The following schedule details earnings and shares used in computing basic and diluted earnings per share for the three months ended March 31, 2005 and 2004.

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Note 10. Provision and Allowance for Loan Losses

The following table details the Company’s allowance for loan loss activity for the three month periods ended March 31, 2005 and 2004:

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Report of Independent Registered Public Accounting Firm

The Board of Directors
First Community Bancshares, Inc.

We have reviewed the condensed consolidated balance sheet of First Community Bancshares, Inc. and subsidiary (the Company) as of March 31, 2005, and the related condensed consolidated statements of income for the three month periods ended March 31, 2005 and 2004 and the condensed consolidated statements of cash flows and changes in stockholders’ equity for the three month periods ended March 31, 2005 and 2004. These financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U. S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) the consolidated balance sheet of the Company as of December 31, 2004, and the related consolidated statements of income, cash flows and changes in stockholders’ equity for the year then ended (not presented herein) and in our report dated March 11, 2005, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Ernst & Young LLP

Charleston, West Virginia
May 5, 2005

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First Community Bancshares, Inc.

The following discussion and analysis is provided to address information about the Company’s financial condition and results of operations. This discussion and analysis should be read in conjunction with the 2004 Annual Report to Shareholders on Form 10-K and the other financial information included in this report.

The Company is a multi-state bank holding company headquartered in Bluefield, Virginia with total assets of $1.89 billion at March 31, 2005. Through its community bank subsidiary, First Community Bank, NA, the company provides financial, trust and investment advisory services to individuals and commercial customers through 53 full-service banking locations, six loan production offices and two trust and investment management offices located in the four states of Virginia, West Virginia, North Carolina and Tennessee. The First Community Bank, NA is the parent of Stone Capital, a SEC registered investment advisory firm that offers wealth management and investment advice. The Company’s common stock is traded on the Nasdaq National Market under the symbol “FCBC”.

FORWARD LOOKING STATEMENTS

The Company may from time to time make written or oral “forward-looking statements”, including statements contained in its filings with the SEC (including this Quarterly Report on Form 10-Q and the Exhibits hereto and thereto), in its reports to stockholders and in other communications which are made in good faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements include, among others, statements with respect to the Company’s beliefs, plans, objectives, goals, guidelines, expectations, anticipations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors (many of which are beyond the Company’s control). The words “may”, “could”, “should”, “would”, “believe”, “anticipate”, “estimate”, “expect”, “intend”, “plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause the Company’s financial performance to differ materially from that expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; the timely development of competitive new products and services of the Company and the acceptance of these products and services by new and existing customers; the willingness of customers to substitute competitors’ products and services for the Company’s products and services and vice versa; the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes; the effect of acquisitions, including, without limitation, the failure to achieve the expected revenue growth and/or expense savings from such acquisitions; the growth and profitability of the Company’s non-interest or fee income being less than expected; unanticipated regulatory or judicial proceedings; changes in consumer spending and saving habits; and the success of the Company at managing the risks involved in the foregoing.

The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

The Company’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles and conform to general practices within the banking industry. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and/or consolidated results of operations.

Estimates, assumptions, and judgments are necessary principally when assets and liabilities are required to be recorded at estimated fair value, when a decline in the value of an asset carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded based upon the probability of occurrence of a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by third party sources, when available. When third party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal modeling techniques and/or appraisal estimates.

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The Company’s accounting policies are fundamental to understanding Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following is a summary of the Company’s more subjective and complex “critical accounting policies.” In addition, the disclosures presented in the Notes to the Consolidated Financial Statements and in management’s discussion and analysis, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses, acquisitions and intangible assets, and income taxes as the accounting areas that require the most subjective or complex judgments. Derivatives hedging practices were eliminated in August 2004 with the disposition of UFM.

Allowance for Loan Losses

The allowance for loan losses is established and maintained at levels management deems adequate to cover losses inherent in the portfolio as of the balance sheet date and is based on management’s evaluation of the risks in the loan portfolio and changes in the nature and volume of loan activity. Estimates for loan losses are determined by analyzing historical loan losses, current trends in delinquencies and charge-offs, plans for problem loan resolution, the opinions of FCBI’s regulators, changes in the size and composition of the loan portfolio and industry information. Also included in management’s estimates for loan losses are considerations with respect to the impact of economic events, the outcome of which are uncertain. These events may include, but are not limited to, a general slowdown in the economy, fluctuations in overall lending rates, political conditions, legislation that may directly or indirectly affect the banking industry and economic conditions affecting specific geographic areas in which First Community conducts business.

As more fully described in the management’s discussion and analysis, the Company determines the allowance for loan losses by making specific allocations to impaired loans and loan pools that exhibit inherent weaknesses and various credit risk factors. Allocations to loan pools are developed giving weight to risk ratings, historical loss trends and management’s judgment concerning those trends and other relevant factors. These factors may include, among others, actual versus estimated losses, regional and national economic conditions, business segment and portfolio concentrations, industry competition and consolidation, and the impact of government regulations. The foregoing analysis is performed by the Company’s credit administration department to evaluate the portfolio and calculate an estimated valuation allowance through a quantitative and qualitative analysis that applies risk factors to those identified risk areas.

This risk management evaluation is applied at both the portfolio level and the individual loan level for commercial loans and credit relationships while the level of consumer and residential mortgage loan allowance is determined primarily on a total portfolio level based on a review of historical loss percentages and other qualitative factors including concentrations, industry specific factors and economic conditions. The commercial and commercial real estate portfolios require more specific analysis of individually significant loans and the borrower’s underlying cash flow, business conditions, capacity for debt repayment and the valuation of secondary sources of payment (collateral). This analysis may result in specifically identified weaknesses and corresponding specific impairment allowances.

The use of various estimates and judgments in the Company’s ongoing evaluation of the required level of allowance can significantly impact the Company’s results of operations and financial condition and may result in either greater provisions against earnings to increase the allowance or reduced provisions based upon management’s current view of portfolio and economic conditions and the application of revised estimates and assumptions.

Acquisitions and Intangible Assets

As part of its growth plan, the Company engages in business combinations with other companies. The acquisition of a business is generally accounted for under purchase accounting rules promulgated by the FASB. Purchase accounting requires the recording of underlying assets and liabilities of the entity acquired at their fair market value. Any excess of the purchase price of the business over the net assets acquired and any identified intangibles is recorded as goodwill. Fair values are assigned based on quoted prices for similar assets, if readily available, or appraisal by qualified independent parties for relevant asset and liability categories. Financial assets and liabilities are typically valued using discount models which apply current discount rates to streams of cash flow. All of these valuation methods require the use of assumptions which can result in alternate valuations and varying levels of goodwill and, in some cases, amortization expense or accretion income.

Management must also make estimates of useful or economic lives of certain acquired assets and liabilities. These lives are used in establishing amortization and accretion of some intangible assets and liabilities, such as the intangible associated with core deposits acquired in the acquisition of a commercial bank.

Goodwill is recorded as the excess of the purchase price, if any, over the fair value of the revalued net assets. Goodwill is tested at least annually in the month of November for possible impairment. This testing again uses a discounted cash flow model applied to the anticipated stream of cash flows from operations of the business or segment being tested. Impairment

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testing necessarily uses estimates in the form of growth and attrition rates and anticipated rates of return. These estimates have a direct bearing on the results of the impairment testing and serve as the basis for management’s conclusions as to impairment.

Income Taxes

The establishment of provisions for federal and state income taxes is a complex area of accounting which also involves the use of judgments and estimates in applying relevant tax statutes. The Company operates in multiple state tax jurisdictions and this requires the appropriate allocation of income and expense to each state based on a variety of apportionment or allocation bases. Management strives to keep abreast of changes in tax law and the issuance of regulations which may impact tax reporting and provisions for income tax expense. The Company is also subject to audit by federal and state tax authorities. Results of these audits may produce indicated liabilities which differ from Company estimates and provisions. The Company continually evaluates its exposure to possible tax assessments arising from audits and records its estimate of possible exposure based on current facts and circumstances.

EXECUTIVE OVERVIEW

First Community Bancshares is a full service commercial bank holding company which operates within the four state region of Virginia, West Virginia, North Carolina and Tennessee. The Company operates through its community bank subsidiary, First Community Bank, N.A. and offers a wide range of financial services. The Company presently reports total assets of $1.89 billion and operates through 53 full service banking offices and six commercial loan production offices in addition to its two Trust and Wealth Management offices.

The Company funds its lending activities primarily through the retail deposit operations of its branch banking network. At March 31, 2005 total customer deposits and repurchase agreements were $1.53 billion, an increase of 4.17% from December 31, 2004. Borrowings from the Federal Home Loan Bank provide additional funding and totaled $156.8 million at March 31, 2005, up from $131.9 million at year end 2004.

The Company invests its funds primarily in loans to retail and commercial customers. Total loans held for investment, net of unearned income, at March 31, 2005 were $1.28 billion, an increase of 3.53% from December 31, 2004. In addition to loans, the Company also invests a portion of its funds in various debt securities, including those of United States agencies and state and political subdivisions. Total securities available for sale at March 31, 2005 were $372.6 million. The Company also maintains overnight interest-bearing balances with the FHLB and correspondent banks totaling $48.9 million and other securities held to maturity of $32.0 million at March 31, 2005.

Consolidated net income for the first quarter of 2005 was $6.0 million, a 43.5% increase over the corresponding quarter in 2004. The significant increase in net income between the two quarters relates primarily to the reduction in the Company’s loss from discontinued operations between the two quarters. The discontinued operations stem from the Company’s ownership of a mortgage banking subsidiary which was sold in August 2004. The loss from discontinued operations was reduced from $1.44 million in the first quarter of 2004 to $80,000 in the first quarter of 2005. The 2005 quarterly loss from discontinued operations includes residual costs of remaining leases and trailing personnel costs associated with the divested mortgage subsidiary.

Net interest income, the Company’s primary source of earnings, increased $1.77 million between the first quarter of 2004 and 2005. This 11.06% increase includes the effect of the Company’s acquisition of People’s Community Bank (PCB) on March 31, 2004. PCB contributed an additional $128 million in loans held for investment and substantially increased average earning assets over the comparable periods.

Basic and diluted earnings per share for the first quarter of 2005 were $0.53 per share compared with $0.37 per share in the first quarter of 2004. Basic earnings per share from continuing operations for the first quarter of 2005 were $0.54 per share, up from $0.50 per share in the first quarter of 2004. Diluted earnings per share from continuing operations also increased to $0.53 per share, up from $0.49 per share for the corresponding quarter of 2004. Return on equity for the first quarter of 2005 was 13%, up from 9.4% in the corresponding quarter of 2004. Return on equity from continuing operations also increased to 13.17% in the first quarter of 2005, up from 12.66% in the corresponding quarter of 2004.

Other improvements during the first quarter of 2005 relate to stronger net revenues and fee income, including the effect of the PCB acquisition. Non-interest expense increased at a higher rate between the two quarters due to a $1.2 million increase in salaries and benefits, which included not only the addition of PCB salaries, but also the costs of office expansion in Virginia and North Carolina as well as increases in support salaries and increased health care costs.

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RECENT ACQUISITIONS AND BRANCHING ACTIVITY

In December 2004, First Community Bank, NA opened its newest full-service branch in Princeton, West Virginia. The new branch is the first of its type for the Company, and is designed to deliver retail and commercial financial services in a comfortable atmosphere. The branch also houses offices of the Trust and Financial Services Division and Stone Capital Management.

The Company acquired PCB Bancorp, Inc., a Tennessee-chartered bank holding company (“PCB Bancorp”) after the close of business on March 31, 2004. PCB Bancorp had five full service branch offices located in Johnson City, Kingsport and surrounding areas in Washington and Sullivan Counties in East Tennessee. PCB Bancorp had total assets of $171 million, loans of $128 million and total deposits of $150 million as of the date of the merger. The assets, liabilities and results of operations have been included in the Company’s financial statements beginning with the second quarter 2004.

Under the terms of the acquisition 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., a wholly-owned subsidiary of the Company.

RESULTS OF OPERATIONS

General

Net income for the three months ended March 31, 2005 was $6.0 million or $0.53 per basic and diluted share, compared with $4.2 million or $0.37 per basic and diluted share for the three months ended March 31, 2004. Return on average equity for the three months ended March 31, 2005 was 13.00% compared to 9.40% for the three months ended March 31, 2004. Return on average assets was 1.30% for the three months ended March 31, 2005 compared to 1.00% for the three months ended March 31, 2004. Income from continuing operations for the three months ended March 31, 2005 was $6.1 million, versus $5.6 million for the three months ended March 31, 2004. Return on average equity from continuing operations for the first three months of 2005 was 13.17% compared to 12.66% for the first three months of last year. Return on average assets from continuing operations was 1.32% compared to 1.36% for the first three months of 2004.

In August 2004, the Company sold its UFM subsidiary. The transaction resulted in the sale of 100% of the stock of UFM for cash consideration of approximately $250,000. In connection with the exit from the mortgage banking business and as previously reported, the Company recorded impairment charges of $452,000 in the first quarter of 2004, and $933,000 in the second quarter of 2004. Exiting the mortgage business eliminated the Company’s exposure to risk associated with the large fluctuations previously experienced in the volume-driven, wholesale business and its hedged interest rate lock commitments and closed loans. The change in strategic direction and exit of the mortgage business permitted the Company to focus its resources on its core community banking business. The loss from discontinued operations was $80,000 for the first quarter of 2005, compared to $1.4 million or $0.13 per basic and $0.12 per diluted share, respectively, for the three months ended March 31, 2004.

Net Interest Income (See Table I)

Net interest income, the largest contributor to earnings, was $17.8 million for the three months ended March 31, 2005 compared to $16.0 million for the corresponding period in 2004. For purposes of the following discussion, comparison of net interest income is done on a tax equivalent basis, which provides a common basis for comparing yields on earning assets exempt from federal income taxes to those which are fully taxable. As indicated in Table I, tax equivalent net interest income totaled $18.8 million for the three months ended March 31, 2005, an increase of $1.9 million from the $16.9 million reported in the first three months of 2004. This $1.9 million increase reflects a $3.1 million increase due to increased volume, which was partially offset by a $1.2 million decrease due to rate changes on the underlying assets and liabilities. In comparing the periods, assets were added during the first quarter of 2005 at slightly lower rates while liabilities were added or replaced at slightly higher rates than were paid at the end of the first quarter 2004.

During the first quarter of 2005, average earning assets increased $165.1 million while interest-bearing liabilities increased $154.5 million over the comparable period. As indicated in Table I, the yield on average earning assets increased 21 basis points from 6.03% for the three months ended March 31, 2004 to 6.24% for the three months ended March 31, 2005. However, this increase was partially offset by a 14 basis point increase in the cost of funds during the same period leaving the net interest rate spread (the difference between interest income on earning assets and expense on interest bearing liabilities) 7 basis points higher at 4.14% compared to 4.07% for the same period last year. The Company’s tax equivalent net interest margin of 4.47% for the three months ended March 31, 2005 increased 7 basis points from 4.40% in 2004.

The largest contributor to the increase in the yield on average earning assets in 2005, on a volume-weighted basis, was the $244.0 million increase in loans held for investment ($126.3 million attributable to PCB). The loan portfolio contributed

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approximately $3.6 million to the change in net interest income even though the average yield decreased 11 basis points from the prior year to 6.68%. The current interest rate environment continues to create refinancing or repricing incentives for fixed rate borrowers to lower their current borrowing costs. In addition, due to the volume of loans directly tied to prime and other indices that are either adjustable incrementally or are variable rate advances, certain loan yields have declined in response to the current rate environment.

During the three months ended March 31, 2005, the taxable equivalent yield on securities available for sale increased 10 basis points to 4.89% while the average balance decreased by $41.8 million. Although the total portfolio at March 31, 2005 decreased from March 31, 2004, the average tax equivalent yield increased because of the addition of approximately $41.8 million in tax free municipal securities while taxable securities in the portfolio decreased by $83.5 million. Funds received from the paydowns, maturities and calls of investment securities helped fund the loan growth.

The March 31, 2005 average balance of investment securities held to maturity decreased by $4.8 million to $32.8 million as a result of maturities and calls, while the yield increased 60 basis points to 8.25% versus March 31, 2004 yield of 7.65%.

Compared to March 31, 2004 average interest-bearing balances with banks decreased $32.5 million to $30.8 million at March 31, 2005 while the yield increased 156 basis points to 2.81%.

The Company actively manages its product pricing by staying abreast of the current economic climate and competitive forces in order to enhance repricing opportunities available with respect to the liability side of its balance sheet. In doing so, the cost of interest-bearing liabilities increased slightly by 14 basis points from 1.96% for the three months ended March 31, 2004 to 2.10% for the same period of 2005 while the average volume increased $154.5 million.

The average balance of short-term borrowings decreased slightly by $2.8 million in 2005 to $127.6 million, while the rate increased 83 basis points. These changes were due to the combined effects of the addition of balances added from the PCB acquisition, the allocation of FHLB borrowings to the discontinued segment in 2004, the call of a $25.0 million advance at the end of the fourth quarter of 2004 and the subsequent take-down of an additional $25.0 million FHLB advance mid first quarter 2005.

Compared to the same period in 2004, average fed funds and repurchase agreements increased $32.0 million at March 31, 2005, while the average rate increased 55 basis points. In addition, the average balances of interest-bearing demand and savings deposits increased $17.0 million and $81.8 million, respectively, for the three months ended March 31, 2005, again, largely due to the PCB acquisition. While the average rate paid on demand deposits remained consistent increasing only 2 basis points, the average rate paid on savings increased 27 basis points due in part to the higher rate paid on certain money market accounts acquired with PCB. Average time deposits increased $26.5 million (almost entirely attributable to PCB) while the average rate paid increased 7 basis points from 2.49% in 2004 to 2.56% in 2005. The level of average non-interest-bearing demand deposits increased $33.7 million ($17.5 million attributable to PCB) to $219.7 million at March 31, 2005 compared to the corresponding period of the prior year.

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Table I            AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS