In connection with acquisitions, the Company generally records as assets on its financial statements both goodwill and identifiable intangible assets such as core deposit intangibles. Due to a change in an accounting principlestandard, since January 1, 2002, the Company no longer amortizes the amount of goodwill through a charge to expense over the expected life. Instead, the Company evaluates whether the carrying value of its goodwill become impaired, in which case the value is reduced through a charge to its earnings. Core deposit and other identifiable intangible assets are amortized to expense over their estimated useful lives and are reviewed for financial instruments created beforeimpairment whenever events or changes in circumstances indicate that the issuance datecarrying amount of the Statementasset may not be recoverable. The valuation techniques used by the Company to determine the carrying value of tangible and still existing atintangible assets acquired in acquisitions and the beginningestimated lives of identifiable intangible assets involve estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based upon changes in economic conditions and other factors. Any changes in the interim periodestimates used by the Company to determine the carrying value of adoption. This Statement is not expected to have a material effectour goodwill and identifiable intangible assets, or which otherwise adversely affects their value or estimated lives, would adversely affect the Company’s results of operations.

Note 3: Goodwill and Other Intangible Assets

A summary of goodwill, by subsidiary, capitalized on the Company’s consolidated financial statements.balance sheet follows:

Financial Accounting Standards Board (FASB) Interpretation Number 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others"(FIN 45), an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34, was issuedThe Company acquired $2,816 in November 2002.

The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective ofgoodwill in connection with the guarantor’s fiscal year-end. The disclosure requirements in this Interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002.

Financial and standby letters of credit are included in the scope of FIN 45, while commercial letters of credit are not. A guarantor of financial and standby letters of credit is required to recognize, at the inceptionacquisition of a guarantee, a liability for the fair value of the obligation undertakenbranch in issuing the guarantee.

This Interpretation contains disclosures to be madeRockland, Maine by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. This interpretation does not have a material effect on the Company’s consolidated financial statements.

Note 3: Line of Business Reporting

The Company manages and operates two major lines of business: Community Banking and Financial Services. Community Banking, through the wholly owned subsidiary, Bar Harbor Banking and Trust Company (the “Bank”"Bank"), includes lending and deposit-gathering activities and related services to businesses and consumers. Financial Services, through the wholly owned subsidiary BTI Financial Group (“BTI”) and its three operating subsidiaries, includes Dirigo Investments, Inc., a NASD registered broker-dealer; Block Capital Management, an SEC registered investment advisor; and Bar Harbor Trust Services, a Maine chartered trust company. The business lines are identified by the entities through which the product or service is delivered..

The reported linesCompany has a finite-lived intangible asset capitalized on its consolidated balance sheet in the form of business results reflecta core deposit intangible asset related to the underlyingBank’s acquisition of the Rockland branch. The core operating performance within the business units. “Other”deposit intangible asset is comprisedbeing amortized over an estimated useful life of inter-company eliminationsseven years, and parent company only items.

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Selected segment information is included in other assets on the following tables.March 31, 2004 consolidated balance sheet. There was no such intangible asset at December 31, 2003.

THREE MONTHS ENDED SEPTEMBER 30, 2003
(Dollars in thousands)
(Unaudited)A summary of the core deposit intangible asset follows as of March 31, 2004:

Amortization expense on finite-lived intangible assets is expected to total $50 for the remainder of 2004 and $67 for each of 2005, 2006, 2007, 2008 and 2009.

THREE MONTHS ENDED SEPTEMBER 30, 2002
(Dollars in thousands)
(Unaudited)

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NINE MONTHS ENDED SEPTEMBER 30, 2003
(Dollars in thousands)
(Unaudited)

NINE MONTHS ENDED SEPTEMBER 30, 2002
(Dollars in thousands)
(Unaudited)

Note 4: GoodwillEarnings Per Share

DuringBasic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the first halfweighted average number of 2002,common shares outstanding for the Company completed implementationperiod. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of SFAS No. 142, “Goodwill and Other Intangible Assets,” which requires most goodwill to be tested for impairment at least annually, rather than amortized over a period of time. The Company estimatedcommon stock that then shared in the value of goodwill utilizing several standard valuation techniques, including discounted cash flow analysis, as well as an estimationearnings of the impact of current business conditions on the long-term value of the goodwill carried on the balance sheet. Management and the Board of Directors determined the impact of the overall deterioration of the stock and bond markets on investor activities within its target market area had negatively impacted the value ofentity, such as the Company’s goodwill balance related todilutive stock options.

The following is a reconciliation of basis and diluted earnings per share for the acquisition of Dirigo Investments, Inc., its broker-dealer subsidiary of BTI. This resulted in an estimation of impairment of $247 thousand, net of tax, recorded during the quarterthree months ended March 31, 2002. As of June 30, 20032004 and 2002, in accordance with SFAS No. 142, the Company completed its annual review of the goodwill and determined there has been no additional impairment.2003:

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Note 5: Derivative Financial Instruments

At September 30, 2003 the Company had three interest rate swap agreements, each with notional principal amounts of $10 million. The interest rate swap agreements are used to hedge prime-based home equity loans to fixed rates of 6.425%, 6.040% and 6.250%, and mature in April 2004, September 2007 and January 2009, respectively. The swap agreements are designated as cash flow hedges since they convert a portion of the loan portfolio from a variable rate, based upon the prime rate, to a fixed rate. The hedge relationships are estimated to be 100% effective; therefore, there is no impact on the statement of income based on changes in fair value. The interest rate swap agreements are recorded in other assets at their total fair value of $388 thousand, with the change in fair value recorded as other comprehensive income in the statement of changes in shareholders’ equity. At September 30, 2002, the Company held one interest rate swap agreement with a notional amount of $10 million.

Note 6: Stock OptionsBased Compensation

The Bar Harbor Bankshares and Subsidiaries IncentiveCompany’s Stock Option Plan (“ISO”)(SOP) for officers and employees was established October 3, 2000, providing for the issuance of up to 450 thousand shares of common stock. The purchase price of the stock covered by each option shall berepresents its fair market value, which must be equal to at least 100% of the fair market value on the date such option is granted. As of December 31, 2003 a total of 435 thousand options had been granted. During the first quarter of 2004, nine thousand additional options were granted, bringing the total to 444 thousand options granted, all having a 5-7 year vesting schedule. No option will be granted after October 3, 2010, ten years after the effective date of the SOP, unless otherwise approved by the shareholders of the Company.

The Company accountsIn December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for these options in accordance withStock-Based Compensation - Transition and Disclosure" which provides guidance on how to transition from the intrinsic value method of accounting for stock-based employee compensation under Accounting Principles Board (APB) Opinion No. 25, “Accounting"Accounting for Stock Issued to Employees.”Employees" to SFAS No. 123 "Accounting for Stock-Based Compensation," which accounts for stock-based compensation using the fair value method of accounting, if a company so elects. The Company currently accounts for stock-based employee compensation under APB No. 25. As the exercise price of each option equalssuch, compensation expense would be recorded only if the market price of the Company’sunderlying stock on the date of grant exceeded the exercise price. Because the fair value on the date of grant of the underlying stock of all stock options granted by the Company is equal to the exercise price of the options granted, no compensation cost has been recognized for stock options in the plan. accompanying consolidated statements of income.

Had compensation costs for the plan been determined based on the fair value of the options at the grant dates consistent with the method described in SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company’s net income and earnings per share for the three and nine month periods would have been reduced to the pro forma amounts indicated below (in thousands except for per-share data):

Note 6: Employee Benefit Plans

The following table provides the net periodic benefit costs for the three months ended March 31, 2004 and 2003:

The Company is expected to contribute $434 to the foregoing plans in 2004. As of March 31, 2004, the Company had contributed $109 to the plans.

Note 7: Commitments and Contingencies

The Company is a party to financial instruments in the normal course of business to meet financing needs of its customers. These financial instruments include commitments to extend credit, unused lines of credit, and standby letters of credit.

Exposure to credit loss in the event of nonperformance by the counter-party to the financial instrument for commitments to make loans, unused lines of credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policy to make such commitments as it uses for on-balance-sheet items, such as loans. At March 31, 2004 and December 31, 2003, commitments to extend credit and unused lines of credit totaled $100,374 and $98,894, respectively. Since commitments to extend credit and unused lines of credit may expire without being fully drawn upon, this amount does not necessarily represent future cash commitments. Collateral obtained upon exercise of the commitment is determined on a case-by-case basis using management’s credit evaluation of the borrower.

The Company guarantees the obligations or performance of customers by issuing stand-by letters of credit to third parties. These stand-by letters of credit are frequently issued in support of third party debt or obligations. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance sheet instruments. Typically, these standby letters of credit have terms of five years or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements. Standby letters of credit totaled $3,669 at March 31, 2004 and December 31, 2003. As of March 31, 2004, the fair value of standby letters of credit was not material to the Company’s consolidated financial statements.

Note 8: Financial Derivative Instruments

At March 31, 2003 the Company had three outstanding derivative instruments with notional principal amounts totaling $30 million, all of which were interest rate swap agreements. The details are summarized as follows:

The Company is required to pay a counter-party monthly variable rate payments indexed to prime, while receiving monthly fixed rate payments based upon interest rates of 6.425%, 6.040%, and 6.250%, respectively over the term of each agreement.

Financial instruments are reviewed as part of the asset/liability management process and are factored into the Company’s overall interest rate risk position. The Company regularly reviews the credit quality of the counterparty from which the interest rate swap agreements have been purchased. The notional amounts of the agreements do not represent exposure to credit loss. The Company is exposed to credit loss only to the extent the counter-party defaults in its responsibility to pay interest under the terms of the agreements.

These interest rate swap agreements were designated as cash flow hedges at December 31, 2003 and had total unrealized gains of $86. The fair value of each option is estimatedthese instruments, net of tax, was recorded as a component of accumulated other comprehensive income on the dateconsolidated balance sheet. Changes in fair value were recorded as a component of grant usingother comprehensive income.

During the Black-Scholes options-pricing model with the following weighted-average assumptions used for all grants: dividend yieldfirst quarter of 3.30% in 2003 and 4.04% in 2002, risk-free2004, these interest rate swap agreements were de-designated as cash flow hedges and prospectively changes in their fair value and current period net cash flows related to these agreements will be recorded in the consolidated statement of 2.38%income and will be included as part of other operating income or expense. The unrealized gain on these interest rate swap agreements at December 31, 2003 of $86 will remain in 2003other comprehensive income, net of tax, and 1.88% in 2002, expected lifewill be accreted into interest income over the remaining terms of 3.5 years,the respective swap agreements.

During the quarter ended March 31, 2004, the Company recorded other operating income of $328 related to the unrealized appreciation of these interest rate swap agreements and expected volatility of 11% in 2003 and 12% in 2002.

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$167 related to the net cash flows during the quarter resulting from the agreements. The fair value of each optionthe interest rate swap agreements at March 31, 2004 was $414 and is estimatedincluded in other assets on the dateconsolidated balance sheet.

Note 9: Business Segments

SFAS No. 131 "Disclosure about Segments of grant usingan Enterprise and Related Information" requires public companies to report certain financial information about operating segments for which such information is available and utilized by the Black-Scholes options-pricingchief operating decision maker in deciding how to allocate resources and in assessing performance. The Company has determined that its operations are solely in the community banking industry, and include the traditional commercial banking services. In prior reporting periods the Company had also included Financial Services as a business segment and, accordingly, provided segment reporting for that segment. For the year ended December 31, 2003 revenue from Financial Services represented only 5.8% of the Company’s total revenue.

As more fully described in Part I, Item 1 of the Company’s Annual Report of Form 10-K, and Part I, Item 2, Other Events of this Form 10-Q, in December 2003 the Company’s Board of Directors approved a restructuring plan for its wholly owned subsidiary, BTI Financial Group ("BTI"). The restructuring plan simplified and aligned BTI’s brand names and operating model with the Bank. During the first quarter of 2004 the principal elements of the plan were completed, with the results of all operations now viewed as a single strategic unit by the chief operating decision maker.

The Company has determined that its operations are solely in the community banking industry and include the traditional community banking services, including lending activities, acceptance of demand, savings and time deposits, business services, investment management, trust and brokerage services. These products and services have similar distribution methods, types of customers and regulatory responsibilities. Accordingly, segment information is not required with respect to investment management, trust and brokerage services provided by the Company (which total less than 10% of total revenue).

Note 10: Recently Issued Accounting Pronouncements

In December 2003, the Financial Accounting Standards Board ("FASB") issued a revised version of Statement of Financial Accounting Standard ("SFAS") No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." The Statement retains all of the previous requirements and introduces additional disclosure requirements and interim reporting requirements. This revised statement is effective for years ending after December 15, 2003, and its disclosure requirements have been reflected in these financial statements.

In December 2003, President George W. Bush signed the Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("the Act") into law. The Act includes the following weighted-average assumptionstwo new features to Medicare (Medicare Part D) that could affect the measurement of accumulated postretirement benefit obligations ("APBO") and net periodic postretirement benefit costs: (1) A subsidy to plan sponsors that is based on 28% of an individual beneficiary’s annual prescription drug costs between $250 dollars and $5,000 dollars, (2) The opportunity for a retiree to obtain a prescription drug benefit under Medicare. The effects of the Act on the APBO or net periodic postretirement benefit cost are not reflected in the Company’s financial statements or accompanying notes. Pending specific authoritative guidance on the accounting for the federal subsidy could require the Company to change previously reported information when the guidance is issued.

In May 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. In addition, the Statement requires an issuer to classify certain instruments with specific characteristics described in its liabilities. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The effective date has been deferred indefinitely for certain types of mandatorily redeemable financial instruments. The adoption of SFAS No. 150 did not have a significant impact on the Company's financial position, results of operations, or liquidity.

In April 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. Statement No. 149 amends Statement 133 for decisions made (1) as part of the Derivatives Implementation Group process that effectively required amendments to Statement 133, (2) in connection with other Board projects dealing with financial instruments, and (3) in connection with implementation issues raised in relation to the application of the definition of a derivative. The Statement clarifies under what circumstances a contract with an initial net investment meets the characteristics of a derivative discussed in paragraph 6(b) of Statement 133, clarifies when a derivative contains a financing component, amends the definition of an underlying to conform it to language used in FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, and amends certain other existing pronouncements. This statement is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not have a significant impact on either of the Company's financial position or results of operations.

In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46 ("FIN 46"), Consolidation of Variable Interest Entities, (or VIEs). The objective of this interpretation is to provide guidance on how to identify a VIE and determine when the assets, liabilities, non-controlling interests and results of operations of a VIE need to be included in the company’s consolidated financial statements. A company that holds variable interests in an entity will need to consolidate the entity if the company’s interest in the VIE is such that the company will absorb a majority of the VIE’s expected losses and/or receive a majority of the entity’s expected residual returns, if they occur. FIN 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders. FIN 46 was effective for all grants: dividend yieldVIE’s created after January 31, 2003. However, the FASB postponed that effective dates to December 31, 2003. In December 2003, the FASB issued a revised FIN 46 (FIN 46 R), which has an effective date of 3.30% inMarch 31, 2004 for VIE’s created prior to February 1, 2003, and 4.04% in 2002, risk-free interest rateexcept for special purpose entities, which much adopt either FIN 46 or FIN 46 R as of 2.38% in 2003 and 1.88% in 2002, expected lifeDecember 31, 2003. The adoption of 3.5 years, and expected volatilityFIN 46 did not have an impact on the Company's financial position or results of 11% in 2003 and 12% in 2002.

Item 2. MANAGEMENT’SMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS

The following discussion and analysis of the financial condition and results of operations of the Company and its subsidiaries should be read in conjunction with the consolidated financial statements and notes thereto, and selected financial and statistical information appearing elsewhere in this Form 10-Q. The purpose of this discussion is to highlight significant changes in the financial condition and results of operations of the Company and its subsidiaries.

Unless otherwise noted, all dollars are expressed in thousands, except per share data.

Use of Non-GAAP Financial Measures: Certain information is discussed on a fully taxable equivalent basis. Specifically, included in thirdfirst quarter 20032004 and 20022003 net interest income was $472$363 and $394 thousand$398, respectively, of tax-exempt interest income from certain tax-exempt investment securities and loans, which effectively resulted in a tax-equivalent adjustment of $179 and $164 thousand, respectively. Forloans. An amount equal to the nine-months ended September 30, 2003 and 2002,tax benefit derived from this tax-exempt income has been added back to the interest income included inand net interest income amounted to $1,218totals discussed in this Managements Discussion and $1,089 thousand,Analysis, effectively resulting in a $522tax-equivalent adjustments of $154 and $445 thousand reduction$170, respectively, in the first quarter of the Company’s tax expense,2004 and 2003, respectively. The analysis of net interest income tables included in this Form 10-Q provide a reconciliation of tax-equivalent financial information to the Company’sCompany's consolidated financial statements, which have been prepared in accordance with Generally Accepted Accounting Principles. Principles in the United States of America.

Management believes the disclosure of tax-equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in the Company’sCompany's results of operations. Net interest income is commonly presented by other financial institutions on a tax-equivalent basis. This adjustment is considered helpful in the comparison of one financial institution's net interest income to that of another institution, as each will have a different proportion of tax-exempt interest from their earning asset portfolios. Moreover, net interest income is a component of a second financial measure commonly used by financial institutions, net interest margin, which is the ratio of net interest income to average earning assets. For purposes of this measure as well, tax-equivalent net interest income is generally used by institutions to provide a better basis of comparison from institution to institution. The Company follows these practices.

Certain amounts for prior periods have been reclassified to conform with the presentation used currently.

Unless otherwise noted, all dollars are expressed in thousands except per share data.

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FORWARD LOOKING STATEMENTS DISCLAIMER

The following discussion, as well as certain other statements contained in this Form 10-Q, or incorporated herein by reference, contain statements which may be considered to be forward-looking within the meaning of the Private Securities Litigation and Reform Act of 1995 (the “PSLRA”"PSLRA"). You can identify these forward-looking statements by the use of words like “strategy,” “expects,” “plans,” “believes,” “will,” “estimates,” “intends,” “projects,” “goals,” “targets,”"strategy," "expects," "plans," "believes," "will," "estimates," "intends," "projects," "goals," "targets," and other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. For these statements, the Company claims the protection of the safe harbor for forward-looking statements provided by the PSLRA.

Investors are cautioned that forward-looking statements are inherently uncertain. Forward-looking statements include, but are not limited to, those made in connection with estimates with respect to the future results of operation, financial condition, and the business of the Company which are subject to change based on the impact of various factors that could cause actual results to differ materially from those projected or suggested due to certain risks and uncertainties. Those factors include but are not limited to:

(i) the Company’sThe Company's success is dependant to a significant extent upon general economic conditions in Maine, and Maine’sMaine's ability to attract new business;

(ii) the Company’sThe Company's earnings depend to a great extent on the level of net interest income (the difference between interest income earned on loans and investments and the interest expense paid on deposits and borrowings) generated by the Bank, and thus the Bank’sBank's results of operations may be adversely affected by increases or decreases in interest rates;

(iii) theThe banking business is highly competitive and the profitability of the Company depends on the Bank’sBank's ability to attract loans and deposits in Maine, where the Bank competes with a variety of traditional banking and nontraditional institutions, such as credit unions and finance companies;

(iv) aA significant portion of the Bank’sBank's loan portfolio is comprised of commercial loans and loans secured by real estate, exposing the Company to the risks inherent in financings based upon analysis of credit risk, the value of underlying collateral, and other intangible factors which are considered in making commercial loans and, accordingly, the Company’sCompany's profitability may be negatively impacted by judgment errors in risk analysis, by loan defaults, and the ability of certain borrowers to repay such loans during a downturn in general economic conditions;

(v) aA significant delay in or inability to execute strategic initiatives designed to grow revenues and or control expenses;

(vi) The potential need to adapt to changes in information technology systems, on which the Company is highly dependant, could present operational issues or require significant capital spending;

(vii) Acts or threats of terrorism and actions taken by the United States or other governments as a result of such threats, including military action, could further adversely affect business and economic conditions in the United States generally and in the Company’s markets, which could have an adverse effect on the Company’s financial performance and that of borrowers and on the financial markets and the price of the Company’s common stock; and

          (vi) significant(viii) Significant changes in the extensive laws, regulations, and policies governing bank holding companies and their subsidiaries could alter the Company’sCompany's business environment or affect its operations.

The forward looking statements contained herein represent the Company’sCompany's judgment as of the date of this Form 10-Q, and the Company cautions readers not to place undue reliance on such statements. The Company disclaims any obligation to publicly update or revise any forward-looking statement contained in the foregoingsucceeding discussion, or elsewhere in this Form 10-Q, except to the extent required by federal securities laws.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

Management’s discussion and analysis of the Company’s financial condition are based on the consolidated financial statementsConsolidated Financial Statements, which are prepared in accordance with accounting principles generally accepted in the United States.States of America. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Management evaluates its estimates, including

14

those related to the allowance for loan losses, and review of goodwill for impairment, on an ongoing basis. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis in making judgments about the carrying values of assets that are not readily apparent from other sources. Actual results could differ from the amount derived from management’s estimates and assumptions under different assumptions or conditions.

The Company’s significant accounting policies are more fully enumerated in Note 1 to the Consolidated Financial Statements included in Item 8 of its December 31, 2003 report on Form 10-K. Management believes the following critical accounting policies represent the more significant estimates and assumptions used in the preparation of the consolidated financial statements:

Allowance for Loan Losses - Management believes the allowance for loan losses ("allowance") is a significant accounting estimate used in the preparation of the Company’s consolidated financial statements. The allowance, for loan losses, which is established through a charge to the provision for loan losses,loss expense, is based on management’s evaluation of the level of allowance required in relation to the estimated inherent risk of loss exposure in the loan portfolio. Management regularly evaluates the allowance for loan losses for adequacy by taking into consideration factors such as previous loss experience, the size and composition of the portfolio, current economic and real estate market conditions and the performance of individual loans in relation to contract terms and estimated fair values of properties to be foreclosed.collateral. The use of different estimates or assumptions could produce different provisions for loan losses. A smaller provision for loan losses results in higher net income and when a greater amount of provisions for loan losses is necessary the result is lower net income. Refer to Part I, Item 2, Allowance for Loan Losses and Provision in this Report on Form 10-Q, for further discussion covering the discussionAllowance.

Income Taxes – The Company estimates its income taxes for each period for which a statement of “Credit Risk” inoperations is presented. This involves estimating the “Risk Management” section of this report for a detailed description of management’s estimation process and methodology related to the reserve for loan losses.

Management utilizes numerous techniques to estimate the value of various assets held by the Company. Management utilized various methods to determine the appropriate carrying value of goodwill as required under Statement of Financial Accounting Standards (“SFAS”) No. 142. At September 30, 2003, the carrying value of goodwill amounted to $375. Goodwill from a purchase acquisition is subject to ongoing periodic impairment tests. Goodwill is evaluated for impairment using several standard valuation techniques including discounted cash flow analyses,Company’s actual current tax liability, as well as an estimationassessing temporary timing differences, resulting from differing timing of recognition of expenses, income and tax credits, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and to the extent that the recovery is not likely a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of March 31, 2004, there was no valuation allowance for deferred tax assets.

Interest Income Recognition on Loans - Interest income on loans is included in income as earned based upon the unpaid principal balance of the impactloan. The Company’s policy is to discontinue the accrual of business conditions. Different estimatesinterest, and to reverse and uncollected interest recorded on loans, when scheduled payments become contractually past due in excess of 90 days or, assumptions are also utilized to determinein the appropriate carrying valuejudgment of other assets including, but not limited to, premises and equipment, mortgage servicing rights, andmanagement, the overallultimate collectibility of loansprincipal or interest becomes doubtful.

Goodwill and receivables. The useOther Intangible Assets - Refer to Note 3 of differentthe consolidated financial statements in Part 1, Item 1 of this Form 10-Q for details of the Company’s accounting policies and estimates or assumptions could produce different estimates of carrying value.covering goodwill and other intangible assets.

OVERVIEW

RESULTS OF OPERATIONS

Executive Overview

The Company reported consolidated net income of $1,229$1,436 for the three months ended March 31, 2004, compared with $1,304 for the same period in 2003, representing an increase of $132, or 10.1%.

For the three months ended March 31, 2004 fully diluted earnings per share of 37amounted to 45 cents, for the three months ended September 30, 2003, compared with $1,147, or fully diluted earnings per share of 3541 cents for the same period a year earlier, representing increasesan increase of 7.1% and 5.7% respectively.9.8%. The return on average assets and average shareholders’ equity amounted to 0.87% and 9.29% respectively, compared with 0.86% and 8.62% for the third quarter of 2002.

For the nine months ended September 30, 2003, net income amounted to $3,945 orpercentage increase in fully diluted earnings per share lagged the percentage increase in net income due to changes in the dilutive effect of $1.23,employee stock options, which at March 31, 2004 amounted to 119,873 shares compared with $3,237 or fully diluted earnings per share of $0.99 for43,689 shares at the same perioddate in 2002, representing increases2003. The change in the dilutive effect of $708 and 24 cents, or 21.9% and 24.2% respectively. Theemployee stock options was principally the result of the year-over-year increase in the price of the Company’s common stock.

For the three months ended March 31, 2004, the annualized return on average assets and average shareholders’ equity("ROA") amounted to 0.95% and 9.88% respectively,0.97% compared with 0.85% and 8.23%0.98% for the first nine monthsquarter of 2002.

Included in prior year earnings was an after tax charge of $247 recorded in2003. The annualized return on average shareholders equity ("ROE") amounted to 10.88% for the current quarter, compared with 9.84% during the first quarter resulting fromof 2003.

A variety of factors impacted the cumulative effectCompany’s first quarter performance. These included a $369 decline in net gains on the sale of investment securities, income of $328 related to a mark-to-market adjustment for unrealized appreciation on interest rate swap agreements, one time expenses approximating $110 associated with the Bar Harbor Banking and Trust Company’s ("the Bank") completion of a changebranch office acquisition in accounting required by the adoptioncommunity of a new accounting standard, SFAS No. 142, “GoodwillRockland Maine, and Other Intangible Assets”. Excluding this adjustment, the increases inimpact of continued low interest rates on the Company’s net income and fully diluted earnings per share for the nine months ended September 30, 2003 compared with the same period in 2002 amounted to 13.2% and 16.0%, respectively.interest margin.

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RESULTS OF OPERATIONS

Net Interest Income

Net interest income is the principal component of the Company’sCompany's income stream and represents the difference or spread between interest generated from earning assets and the interest expense incurred on deposits and borrowed funds. Net interest income is entirely generated by the Bank. Fluctuations in market interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income.

For the quarter ended September 30, 2003,March 31, 2004, net interest income on a fully tax equivalent basis amounted to $4,964,$5,023, compared with $5,046$5,115 during the same quarter in 2002,2003, representing a decrease of $82,$92, or 1.7%1.8%. The decline in net interest income was principally attributed to the net interest margin, whichas total average earning assets increased $53,980, or 10.5%, on a year-over-year basis. During the first quarter of 2004, the net interest margin amounted to 3.55% compared with 4.03% during the third quarter ended March 31, 2003, representing a decline of 2002 amounted48 basis points.

Other factors contributing to 4.08% compared with 3.73% during the current quarter.

For the nine month period ended September 30, 2003, net interest income on a fully tax equivalent basis amounted to $15,084, compared with $14,781 for the same period in 2002, representing an increase of $303, or 2.0%. The increasechanges in net interest income was principally attributed to average earning asset growth of $44,788, or 9.5% between periods, asand the net interest margin declined 29 basis points.are enumerated in the succeeding discussion and analysis.

Net Interest Income Analysis: The following table set forth an analysis of net interest income by each major category of interest earning assets and interest bearing liabilities for the three months ended March 31, 2004, and 2003, respectively:

AVERAGE BALANCE SHEET AND
ANALYSIS OF NET INTEREST INCOME
THREE MONTHS ENDED
MARCH 31, 2004 AND 2003