##### Table of Contents

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U. S. SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549



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FORM 10-Q



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QUARTERLY REPORT PURSUANT TO

SECTION 13 or 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934



For the quarter ended September 30, 2005



Commission File No. 0-28780



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CARDINAL BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)



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|                         |  |                                     
|------------------------ |  | ------------------------------------
|Virginia                 |  | 54-1804471                          
|(State of Incorporation) |  | (I.R.S. Employer Identification No.)



101 Jacksonville
Circle, P. O. Box 215, Floyd, Virginia 24091

(Address of principal executive offices)



(540) 745-4191

(Registrants telephone number)



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Indicate by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.    Yes  x.    No ̈.



Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).    Yes ̈.    No  x.



Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ̈.    No  x.



The number of shares outstanding of the issuers Common Stock, $10 par value as of November 10, 2005 was 1,535,733.



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##### Table of Contents

CARDINAL BANKSHARES CORPORATION



FORM
10-Q



September 30, 2005



INDEX



|         |  |                                                                                                                     |  |     
|-------- |  | ------------------------------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                                     |  | Page
|Part I.  |  | Financial Information                                                                                               |  |     
|         |  |                                                                                                                    
|Item 1.  |  | Consolidated Balance Sheets as of September 30, 2005(Unaudited) and December 31, 2004 (Audited)                     |  | 3   
|         |  |                                                                                                                    
|         |  | Consolidated Statements of Income for the three months and nine monthsended September 30, 2005 and 2004 (Unaudited) |  | 4   
|         |  |                                                                                                                    
|         |  | Consolidated Statements of Cash Flows for the ninemonths ended September 30, 2005 and 2004 (Unaudited)              |  | 5   
|         |  |                                                                                                                    
|         |  | Notes to Consolidated Statements (Unaudited)                                                                        |  | 6   
|         |  |                                                                                                                    
|Item 2.  |  | Managements Discussion and Analysis of FinancialCondition and Results of Operations                                |  | 7   
|         |  |                                                                                                                    
|Item 3.  |  | Quantitative and Qualitative Disclosures About Market Risk                                                          |  | 10  
|         |  |                                                                                                                    
|Item 4.  |  | Controls and Procedures                                                                                             |  | 11  
|         |  |                                                                                                                    
|Part II. |  | Other Information                                                                                                   |  |     
|         |  |                                                                                                                    
|Item 1.  |  | Legal Proceedings                                                                                                   |  | 12  
|         |  |                                                                                                                    
|Item 2.  |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                         |  | 12  
|         |  |                                                                                                                    
|Item 3.  |  | Defaults Upon Senior Securities                                                                                     |  | 12  
|         |  |                                                                                                                    
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                                 |  | 12  
|         |  |                                                                                                                    
|Item 5.  |  | Other Information                                                                                                   |  | 12  
|         |  |                                                                                                                    
|Item 6.  |  | Exhibits                                                                                                            |  | 13  



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##### Table of Contents

Cardinal Bankshares Corporation and Subsidiary

Consolidated Balance Sheets



|                                                                                                              |  |                              |         |   |                           |   |         |  
|------------------------------------------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ------------------------- | - | ------- | -
|(In thousands, except share data)                                                                             |  | (Unaudited)September 30,2005 |         |   | (Audited)December 31,2004 |  
|Assets                                                                                                        |  |                              |         |   |                           |   |         |  
|Cash and due from banks                                                                                       |  | $                            | 4,085   |   |                           | $ | 4,162   |  
|Interest-bearing deposits                                                                                     |  |                              | 8,610   |   |                           |   | 3,602   |  
|Federal funds sold                                                                                            |  |                              | 1,725   |   |                           |   | 7,175   |  
|Investment securities available for sale, at fair value                                                       |  |                              | 16,733  |   |                           |   | 20,942  |  
|Investment securities held to maturity (fair value September 30, 2005 - $18,907; December 31, 2004 - $20,729) |  |                              | 18,468  |   |                           |   | 20,001  |  
|Restricted equity securities                                                                                  |  |                              | 546     |   |                           |   | 603     |  
|                                                                                                              |  |                             
|Total loans                                                                                                   |  |                              | 132,593 |   |                           |   | 124,673 |  
|Allowance for loan losses                                                                                     |  |                              | (1,437  | ) |                           |   | (1,631  | )
|                                                                                                              |  |                              |         |   |                           |   |         |  
|Net loans                                                                                                     |  |                              | 131,156 |   |                           |   | 123,042 |  
|                                                                                                              |  |                              |         |   |                           |   |         |  
|Bank premises and equipment, net                                                                              |  |                              | 4,044   |   |                           |   | 4,205   |  
|Accrued interest receivable                                                                                   |  |                              | 949     |   |                           |   | 933     |  
|Foreclosed properties                                                                                         |  |                              | 418     |   |                           |   | 2       |  
|Bank owned life insurance                                                                                     |  |                              | 4,588   |   |                           |   | 4,483   |  
|Other assets                                                                                                  |  |                              | 2,005   |   |                           |   | 1,441   |  
|                                                                                                              |  |                              |         |   |                           |   |         |  
|Total assets                                                                                                  |  | $                            | 193,327 |   |                           | $ | 190,591 |  
|                                                                                                              |  |                              |         |   |                           |   |         |  
|Liabilities and Stockholders Equity                                                                          |  |                              |         |   |                           |   |         |  
|Noninterest-bearing deposits                                                                                  |  | $                            | 27,217  |   |                           | $ | 27,211  |  
|Interest-bearing deposits                                                                                     |  |                              | 137,592 |   |                           |   | 134,044 |  
|                                                                                                              |  |                              |         |   |                           |   |         |  
|Total deposits                                                                                                |  |                              | 164,809 |   |                           |   | 161,255 |  
|                                                                                                              |  |                              |         |   |                           |   |         |  
|Securities sold under agreements to repurchase                                                                |  |                              | 121     |   |                           |   | 2,493   |  
|Accrued interest payable                                                                                      |  |                              | 131     |   |                           |   | 110     |  
|Other liabilities                                                                                             |  |                              | 1,323   |   |                           |   | 883     |  
|                                                                                                              |  |                              |         |   |                           |   |         |  
|Total liabilities                                                                                             |  |                              | 166,384 |   |                           |   | 164,741 |  
|                                                                                                              |  |                              |         |   |                           |   |         |  
|Commitments and contingent liabilities                                                                        |  |                              |        |   |                           |   |        |  
|                                                                                                              |  |                             
|Stockholders Equity                                                                                          |  |                              |         |   |                           |   |         |  
|Common stock, $10 par value, 5,000,000 shares authorized, 1,535,733 shares issued and outstanding             |  |                              | 15,357  |   |                           |   | 15,357  |  
|Additional paid-in capital                                                                                    |  |                              | 2,925   |   |                           |   | 2,925   |  
|Retained earnings                                                                                             |  |                              | 8,665   |   |                           |   | 7,444   |  
|Accumulated other comprehensive income, net                                                                   |  |                              | (4      | ) |                           |   | 124     |  
|                                                                                                              |  |                              |         |   |                           |   |         |  
|Total stockholders equity                                                                                    |  |                              | 26,943  |   |                           |   | 25,850  |  
|                                                                                                              |  |                              |         |   |                           |   |         |  
|Total liabilities and stockholders equity                                                                    |  | $                            | 193,327 |   |                           | $ | 190,591 |  
|                                                                                                              |  |                              |         |   |                           |   |         |  



See Notes to Consolidated Financial
Statements.



3



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##### Table of Contents

Cardinal Bankshares Corporation and Subsidiary

Consolidated Statements of Income (Unaudited)



|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|---------------------------------------------------------------------- | ---- | ------------------------------- | --------- | ---- | ------------------------------ | - | --------- | - |  | ---- | --------- | - |  | - | ---------
|(In thousands, except share data)                                      |      | Three months endedSeptember 30, |           |      | Nine months endedSeptember 30,
|                                                                       | 2005 |                                 |           | 2004 |                                |   | 2005      |   |  | 2004
|Interest income                                                        |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Loans and fees on loans                                                |      | $                               | 2,211     |      |                                | $ | 1,981     |   |  | $    | 6,378     |   |  | $ | 5,979    
|Federal funds sold and securities purchased under agreements to resell |      |                                 | 52        |      |                                |   | 27        |   |  |      | 110       |   |  |   | 71       
|Investment securities:                                                 |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Taxable                                                                |      |                                 | 178       |      |                                |   | 232       |   |  |      | 596       |   |  |   | 678      
|Exempt from federal income tax                                         |      |                                 | 227       |      |                                |   | 231       |   |  |      | 695       |   |  |   | 686      
|Deposits with banks                                                    |      |                                 | 55        |      |                                |   | 4         |   |  |      | 89        |   |  |   | 18       
|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Total interest income                                                  |      |                                 | 2,723     |      |                                |   | 2,475     |   |  |      | 7,868     |   |  |   | 7,432    
|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Interest expense                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Deposits                                                               |      |                                 | 925       |      |                                |   | 762       |   |  |      | 2,544     |   |  |   | 2,325    
|Borrowings                                                             |      |                                 | 3         |      |                                |   | 18        |   |  |      | 25        |   |  |   | 38       
|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Total interest expense                                                 |      |                                 | 928       |      |                                |   | 780       |   |  |      | 2,569     |   |  |   | 2,363    
|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Net interest income                                                    |      |                                 | 1,795     |      |                                |   | 1,695     |   |  |      | 5,299     |   |  |   | 5,069    
|Provision for loan losses                                              |      |                                 | 12        |      |                                |   | 30        |   |  |      | 48        |   |  |   | 55       
|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Net interest income after provision for loan losses                    |      |                                 | 1,783     |      |                                |   | 1,665     |   |  |      | 5,251     |   |  |   | 5,014    
|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Noninterest income                                                     |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Service charges on deposit accounts                                    |      |                                 | 68        |      |                                |   | 67        |   |  |      | 197       |   |  |   | 201      
|Other service charges and fees                                         |      |                                 | 27        |      |                                |   | 22        |   |  |      | 76        |   |  |   | 65       
|Net realized gains on sales of securities                              |      |                                 |          |      |                                |   |          |   |  |      | 9         |   |  |   | 4        
|Other operating income                                                 |      |                                 | 82        |      |                                |   | 105       |   |  |      | 244       |   |  |   | 265      
|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Total noninterest income                                               |      |                                 | 177       |      |                                |   | 194       |   |  |      | 526       |   |  |   | 535      
|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Noninterest expense                                                    |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Salaries and employee benefits                                         |      |                                 | 781       |      |                                |   | 712       |   |  |      | 2,166     |   |  |   | 1,964    
|Occupancy and equipment                                                |      |                                 | 170       |      |                                |   | 152       |   |  |      | 535       |   |  |   | 422      
|Foreclosed assets, net                                                 |      |                                 | (17       | )    |                                |   | (1        | ) |  |      | (17       | ) |  |   | 8        
|Other operating expense                                                |      |                                 | 398       |      |                                |   | 278       |   |  |      | 1,058     |   |  |   | 939      
|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Total noninterest expense                                              |      |                                 | 1,332     |      |                                |   | 1,141     |   |  |      | 3,742     |   |  |   | 3,333    
|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Income before income taxes                                             |      |                                 | 628       |      |                                |   | 718       |   |  |      | 2,035     |   |  |   | 2,216    
|Income tax expense                                                     |      |                                 | 126       |      |                                |   | 158       |   |  |      | 430       |   |  |   | 501      
|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Net Income                                                             |      | $                               | 502       |      |                                | $ | 560       |   |  | $    | 1,605     |   |  | $ | 1,715    
|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          
|Basic earnings per share                                               |      | $                               | 0.33      |      |                                | $ | 0.37      |   |  | $    | 1.05      |   |  | $ | 1.12     
|Diluted earnings per share                                             |      | $                               | 0.33      |      |                                | $ | 0.37      |   |  | $    | 1.05      |   |  | $ | 1.12     
|Weighted average basic shares outstanding                              |      |                                 | 1,535,733 |      |                                |   | 1,535,733 |   |  |      | 1,535,733 |   |  |   | 1,535,733
|Weighted average diluted shares outstanding                            |      |                                 | 1,535,733 |      |                                |   | 1,535,733 |   |  |      | 1,535,733 |   |  |   | 1,535,733
|                                                                       |      |                                 |           |      |                                |   |           |   |  |      |           |   |  |   |          



See Notes to Consolidated Financial
Statements.



4



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##### Table of Contents

Cardinal Bankshares Corporation and Subsidiary

Consolidated Statements of Cash Flows (Unaudited)



|                                                                                  |  |      |        |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------- | -
|(In thousands) Nine Months Ended September 30,                                    |  | 2005 |        |   | 2004 |  
|Cash flows from operating activities                                              |  |      |        |   |      |   |         |  
|Net income                                                                        |  | $    | 1,605  |   |      | $ | 1,715   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |        |   |      |   |         |  
|Depreciation and amortization                                                     |  |      | 261    |   |      |   | 205     |  
|Net amortization (accretion) of bond premiums/discounts                           |  |      | (1     | ) |      |   | (12     | )
|Provision for loan losses                                                         |  |      | 48     |   |      |   | 55      |  
|Net realized (gains) losses on investment securities                              |  |      | (9     | ) |      |   | (4      | )
|Deferred compensation and pension expense                                         |  |      | 153    |   |      |   | 150     |  
|Changes in operating assets and liabilities:                                      |  |      |        |   |      |   |         |  
|(Increase) decrease in accrued interest receivable                                |  |      | (16    | ) |      |   | (15     | )
|Increase (decrease) in accrued interest payable                                   |  |      | 21     |   |      |   | 4       |  
|Net change in other operating assets and liabilities                              |  |      | (314   | ) |      |   | 194     |  
|                                                                                  |  |      |        |   |      |   |         |  
|Net cash provided by operating activities                                         |  |      | 1,748  |   |      |   | 2,292   |  
|                                                                                  |  |      |        |   |      |   |         |  
|Cash flows from investing activities                                              |  |      |        |   |      |   |         |  
|Net (increase) decrease in interest-bearing deposits in banks                     |  |      | (5,008 | ) |      |   | 3,176   |  
|Net (increase) decrease in federal funds sold                                     |  |      | 5,450  |   |      |   | 5,000   |  
|Purchase of investment securities                                                 |  |      | (3,127 | ) |      |   | (10,092 | )
|Proceeds from sale of available for sale securities                               |  |      | 750    |   |      |   | 500     |  
|Purchase of restricted equity securities                                          |  |      |       |   |      |   | (5      | )
|Proceeds from redemption of equity securities                                     |  |      | 57     |   |      |   |        |  
|Proceeds from maturity and redemption of investment securities                    |  |      | 7,935  |   |      |   | 8,410   |  
|Net (increase) decrease in loans                                                  |  |      | (8,580 | ) |      |   | (3,268  | )
|Net purchases of bank premises and equipment                                      |  |      | (100   | ) |      |   | (1,816  | )
|                                                                                  |  |      |        |   |      |   |         |  
|Net cash (used) provided by investing activities                                  |  |      | (2,623 | ) |      |   | 1,905   |  
|                                                                                  |  |      |        |   |      |   |         |  
|Financing Activities                                                              |  |      |        |   |      |   |         |  
|Net increase (decrease) in noninterest-bearing deposits                           |  |      | 6      |   |      |   | 1,629   |  
|Net increase (decrease) in interest-bearing deposits                              |  |      | 3,548  |   |      |   | (6,909  | )
|Net increase (decrease) in securities sold                                        |  |      | (2,372 | ) |      |   | 1,580   |  
|Dividends paid                                                                    |  |      | (384   | ) |      |   | (353    | )
|                                                                                  |  |      |        |   |      |   |         |  
|Net cash (used) provided by financing activities                                  |  |      | 798    |   |      |   | (4,053  | )
|                                                                                  |  |      |        |   |      |   |         |  
|Net (decrease) increase in cash and cash equivalents                              |  |      | (77    | ) |      |   | 144     |  
|Cash and cash equivalents at beginning of year                                    |  |      | 4,162  |   |      |   | 3,419   |  
|                                                                                  |  |      |        |   |      |   |         |  
|Cash and cash equivalents at end of year                                          |  | $    | 4,085  |   |      | $ | 3,563   |  
|                                                                                  |  |      |        |   |      |   |         |  
|Supplemental disclosures of cash flow information                                 |  |      |        |   |      |   |         |  
|Interest paid                                                                     |  | $    | 2,548  |   |      | $ | 2,359   |  
|Income taxes paid                                                                 |  | $    | 471    |   |      | $ | 472     |  
|                                                                                  |  |      |        |   |      |   |         |  
|Supplemental disclosures of noncash activities                                    |  |      |        |   |      |   |         |  
|Other real estate acquired in settlement of loans                                 |  | $    | 418    |   |      | $ |        |  
|                                                                                  |  |      |        |   |      |   |         |  



|See | Notes to Consolidated Financial Statements.
|--- | -------------------------------------------



5



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##### Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)



Note 1. Basis of Presentation



The accompanying unaudited
consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all of the disclosures and notes required by generally accepted accounting principles. In the opinion of management,
all material adjustments (which are of a normal recurring nature) considered necessary for a fair presentation have been made. The results for the interim period are not necessarily indicative of the results to be expected for the entire year or any
other interim period. The information reported herein should be read in conjunction with the Notes to Consolidated Financial Statements included in the Companys Annual Report on Form 10-KSB for the year ended December 31, 2004. Certain
previously reported amounts have been reclassified to conform to current presentations.



Note 2. Allowance for Loan Losses



Changes in the allowance for loan
losses are as follows:



|                                               |  |      |       |   |      |   |       |  
|---------------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | -
|Nine months ended September 30, (In thousands) |  | 2005 |       |   | 2004 |  
|Balance, at January 1                          |  | $    | 1,631 |   |      | $ | 1,697 |  
|Provision charged to expense                   |  |      | 48    |   |      |   | 55    |  
|Recoveries of amounts previously charged off   |  |      | 87    |   |      |   | 257   |  
|Loans charged off                              |  |      | (329  | ) |      |   | (111  | )
|                                               |  |      |       |   |      |   |       |  
|Balance, at September 30,                      |  | $    | 1,437 |   |      | $ | 1,898 |  
|                                               |  |      |       |   |      |   |       |  



Note 3. Commitments and Contingencies



The Companys exposure to credit loss in the event of nonperformance by
the other party for commitments to extend credit and stand-by letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as for
on-balance sheet instruments. A summary of the Companys commitments at September 30 for the years indicated follows:



|                             |  |      |        |      |   |       
|---------------------------- |  | ---- | ------ | ---- | - | ------
|(In thousands)               |  | 2005 |        | 2004
|Commitments to extend credit |  | $    | 20,576 |      | $ | 11,527
|Standby letters of credit    |  |      | 648    |      |   | 680   
|                             |  |      |        |      |   |       
|Total                        |  | $    | 21,224 |      | $ | 12,207
|                             |  |      |        |      |   |       



Note 4. Employee Benefit Plan



The Bank has a qualified noncontributory, defined benefit pension plan which
covers substantially all of its employees. The benefits are primarily based on years of service and earnings. The following is a summary of the components of the net periodic benefit cost.



|                                                |  |      |         |   |      |   |         |  
|----------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|Three months ended September 30, (In thousands) |  | 2005 |         |   | 2004 |  
|Service cost                                    |  | $    | 44,275  |   |      | $ | 41,828  |  
|Interest cost                                   |  |      | 43,907  |   |      |   | 40,623  |  
|Expected return on plan assets                  |  |      | (42,622 | ) |      |   | (36,672 | )
|Amortization of net obligation at transition    |  |      | (1,007  | ) |      |   | (1,007  | )
|Amortization of prior service cost              |  |      | 1,495   |   |      |   | 1,495   |  
|Amortization of net (gain) or loss              |  |      | 4,834   |   |      |   | 3,590   |  
|                                                |  |      |         |   |      |   |         |  
|Total net periodic benefit cost                 |  | $    | 50,882  |   |      | $ | 49,857  |  
|                                                |  |      |         |   |      |   |         |  



6



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##### Table of Contents

|                                               |  |      |          |   |      |   |          |  
|---------------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | -
|Nine months ended September 30, (In thousands) |  | 2005 |          |   | 2004 |  
|Service cost                                   |  | $    | 132,825  |   |      | $ | 125,484  |  
|Interest cost                                  |  |      | 131,721  |   |      |   | 121,869  |  
|Expected return on plan assets                 |  |      | (127,866 | ) |      |   | (110,016 | )
|Amortization of net obligation at transition   |  |      | (3,021   | ) |      |   | (3,021   | )
|Amortization of prior service cost             |  |      | 4,485    |   |      |   | 4,485    |  
|Amortization of net (gain) or loss             |  |      | 14,502   |   |      |   | 10,770   |  
|                                               |  |      |          |   |      |   |          |  
|Total net periodic benefit cost                |  | $    | 152,646  |   |      | $ | 149,571  |  
|                                               |  |      |          |   |      |   |          |  



The Company previously disclosed in
its financial statements for the year ended December 31, 2004, that it expected to contribute $204 thousand to its pension plan in 2005. As of September 30, 2005, $89 thousand of contributions have been made. The Company presently
anticipates contributing an additional $115 thousand to fund its pension plan in 2005 for a total of $204 thousand.



Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



Cardinal Bankshares Corporation (the Company and Cardinal Bankshares), a Virginia corporation, is a bank holding company headquartered in Floyd,
Virginia. The Company serves the marketplace primarily through its wholly owned banking subsidiary, Bank of Floyd (the Bank), a Virginia chartered, Federal Reserve member commercial bank. The Banks deposits are insured by the
Federal Deposit Insurance Corporation (the FDIC) to the extent provided by law. Bank of Floyd is supervised and examined by the Federal Reserve and the Bureau of Financial Institutions of the State Corporation Commission of the
Commonwealth of Virginia (the SCC). At September 30, 2005, the Bank operated seven branch facilities serving the counties of Floyd, Montgomery, Roanoke and Carroll and the City of Salem.



Through Bank of Floyds network of banking facilities, Cardinal Bankshares provides a
wide range of commercial banking services to individuals, small to medium-sized businesses, institutions and governments located in Virginia. The Company conducts substantially all of the business operations of a typical independent commercial bank,
including the acceptance of checking and savings deposits, and the making of commercial, real estate, personal, home improvement, automobile and other installment loans. The Company also offers other related services, such as travelers checks,
safe deposit boxes, depositor transfer, customer note payment, collection, notary public, escrow, drive-in and ATM facilities, and other customary banking services. Cardinal Bankshares does not offer trust services.



The following discussion provides information about the major components of the financial
condition, results of operations, asset quality, liquidity, and capital resources of Cardinal Bankshares. The discussion and analysis should be read in conjunction with the Consolidated Financial Statements.



FINANCIAL CONDITION



Total assets as of September 30, 2005 were $193.3 million, an increase of $2.7 million from year-end 2004. Total loans rose 6.4% or
$7.9 million during the first nine months of this year to $132.6 million.



The
investment securities portfolio reflected a net decrease of $5.7 million. This decrease was a result of the sale of one $750 thousand Mortgage Backed Security, maturities of $1.7 million in Municipal Securities and usual pay downs in the amount of
$5.2 million in Mortgage Backed Securities offset by purchases of investment securities totaling approximately $2.9 million combined with the effect of normal issuer calls in the amount of $1.0 million. Federal funds sold declined approximately $5.5
million during the first nine months of 2005 as the Company continues to strategically reduce rate sensitive deposit balances in light of continued moderate loan demand in its principal market area.



As of September 30, 2005, total deposits were $164.8 million, up approximately $3.6
million compared to year-end 2004. Non-interest-bearing core deposits remained level at $27.2 million as compared to year-end 2004. Interest-bearing deposits grew by 2.6% or $3.5 million to $137.6 million. The Company has



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focused on repositioning core deposits to improve the net margin. Core deposits, defined as the sum of demand deposits,
NOW accounts, MMDA savings, other savings deposits and time deposits under $100,000, are generally stable, lower cost funding sources that typically lag behind other funding sources in the need for repricing. This focus resulted in a $3.5 million
decline in large denomination deposits, those deposit accounts with balances greater than $100 thousand. Deposits greater than $100 thousand amounted to $40.5 million at September 30, 2005 as compared to $44.0 million at year-end 2004.



Stockholders equity was $26.9 million as of September 30, 2005
compared to $25.9 million as of December 31, 2004. Year-to-date net income of $1.6 million accounted for the major portion of the change in stockholders equity occurring over the first nine months of the year. Other factors affecting the
change in stockholders equity were the payment on June 30, 2005 of the Companys regular semi-annual cash dividend totaling $384 thousand, and the decline in accumulated other comprehensive income of $128 thousand caused by a decline
in the market value of the available for sale portion of the Companys investment portfolio. Management believes this decline in market value is a temporary decline.



RESULTS OF OPERATIONS



Net income for the three months ended September 30, 2005 was $502 thousand, down 10.4% compared to $560 thousand for the three months ended September 30, 2004.
As discussed below, the majority of this decline was as a result of increased noninterest expenses related to branches opened since the third quarter of 2005. Diluted earnings per share decreased 10.8% to $.33 for the three months ended
September 30, 2005. Diluted earnings per share for the same period a year earlier was $.37.



Total interest income for the three months ended September 30, 2005 increased to $2.7 million compared to $2.5 million the same prior year quarter. Noninterest income declined slightly to $177 thousand compared
to the same prior year quarter at $194 thousand. Total interest expense increased $148 thousand to $928 thousand, reflecting the effect of certificate of deposit promotions during the current year and interest rates paid thereon. Noninterest expense
increased 16.7% to $1.3 million for the third quarter of 2005 as compared to the third quarter of 2004. The primary expenses that attributed to this noninterest expense increase were expenses in EDP services and supplies and salary expense as
related to the addition of new branches since the third quarter of 2004.



Net
income for the nine months ended September 30, 2005 was $1.6 million, down 6.4% compared to $1.7 million for the nine months ended September 30, 2004. In 2004, net income benefited from the recognition of approximately $300 thousand in
interest on a loan that had been classified as nonaccrual in 2003. The loan returned to a current and performing status in June 2004 and remains current. Diluted earnings per share decreased 6.3% to $1.05 for the nine months ended September 30,
2005. Diluted earnings per share for the same period a year earlier was $1.12.



Interest income for the nine months ended September 30, 2005 was $7.9 million, up 5.9% from the $7.4 million reported a year earlier. This increase reflects the slight increase in loans and overall portfolio yield when compared to the
same period a year earlier. Total interest expense rose $206 thousand compared to the nine-month period ended September 30, 2004. Net interest income after the provision for loan losses for the nine months ended September 30, 2005 improved
$237 thousand to $5.3 million.



Total noninterest income for the nine months
ended September 30, 2005 showed a slight decrease of $9 thousand. Total noninterest expense for the comparable nine-month period ended September 30 rose 12.3% to $3.7 million. As discussed earlier, this increase relates to expenses for new
branches added in late 2004 and early 2005.



ASSET QUALITY



The allowance for loan losses represents managements estimate of an amount adequate
to absorb potential future losses inherent in the loan portfolio. In assessing the adequacy of the allowance, management relies predominately on its ongoing review of the lending process and the risk characteristics of the portfolio in the
aggregate. Among other factors, management considers the Companys loan loss experience, the amount of past-due loans, current and anticipated economic conditions, and the estimated current values of collateral securing loans in assessing the
level of the allowance for loan losses. In the first nine months of



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2005, the provision for loan losses was $48 thousand as compared to $55 thousand for the same period in 2004. Based upon
managements periodic reviews of the loan portfolio using the above mentioned factors, the current year increase in the provision for loan losses was felt appropriate. Management believes the provision recorded in 2005 maintains the allowance
at a level adequate to cover potential losses.



The allowance for loan losses
totaled $1.4 million at September 30, 2005. The allowance for loan losses to period end loans was 1.08% at September 30, 2005 compared to 1.31% and 1.52% at December 31, 2004 and September 30, 2004, respectively. The Company had
net charge offs in the amount of $242 thousand during the nine months ended September 30, 2005. This compares with net recoveries for the nine months ended September 30, 2004 of $146 thousand. The increase in net charge offs for 2005 was
primarily related to the charge off of a participated note, offset by recoveries of previously charged off amounts.



While management uses all available information to recognize potential losses on loans, future additions to the allowance may be necessary based on changes in economic
conditions. Various regulatory agencies, as an integral part of their examination process, periodically review the Companys allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their
judgments about information available to them at the time of their examination.



Nonperforming assets, which consist of nonaccrual loans, loans 90 days or more past due, and other real estate owned, were $418 thousand as of September 30, 2005 level with $418 thousand as of December 31, 2004. Management does
not expect to incur any material losses related to nonperforming assets.



CAPITAL RESOURCES



Cardinal Bankshares capital position
provides the necessary assurance required to support anticipated asset growth and to absorb potential losses.



The Companys Tier I capital position was $26.9 million at September 30, 2005, or 19.13% of risk-weighted assets. Total risk-based capital was $28.4 million or 20.15% of risk-weighted assets.



Tier I capital consists primarily of common stockholders equity, while total risk-based
capital includes the allowance for loan losses not to exceed 1.25% of risk weighted assets. Risk weighted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet activities. To be well
capitalized under current risk-based capital standards, all banks are required to have Tier I capital of at least 4% and total capital of 8%. Based on these standards, Cardinal Bankshares is categorized as well capitalized at September 30,
2005.



In addition to the risk-based capital guidelines, banking regulatory
agencies have adopted leverage capital ratio requirements. The leverage ratio  or core capital to assets ratio  works in tandem with the risk-capital guidelines. The minimum leverage ratios range from three to five percent. At
September 30, 2005, the Companys leverage capital ratio was 13.78%.



A WARNING ABOUT FORWARD-LOOKING STATEMENTS



This Form 10-Q
contains forward-looking statements. The Company may also make written forward-looking statements in periodic reports to the Securities and Exchange Commission, proxy statements, offering circulars and prospectuses, press releases and other written
materials and oral statements made by Cardinal Bankshares officers, directors or employees to third parties. Statements that are not historical facts, including statements about the Companys beliefs and expectations, are forward-looking
statements. These statements are based on beliefs and assumptions of the Companys management, and on information currently available to management. Forward-looking statements include statements preceded by, followed by or that include the
words believes, expects, estimates, anticipates, plans, or similar expressions. Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation
to update publicly any of them in light of new information or future events.



Forward-looking statements involve inherent risks and uncertainties. Management cautions the readers that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement.
Such factors include, but are not limited to, the following: competitive



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pressures among depository and other financial institutions may increase significantly; changes in the interest rate
environment may reduce margins; general economic or business conditions may lead to a deterioration in credit quality or a reduced demand for credit; legislative or regulatory changes, including changes in accounting standards, may adversely affect
the business in which Cardinal Bankshares is engaged; changes may occur in the securities markets; and competitors of the Company may have greater financial resources and develop products that enable such competitors to compete more successfully
than Cardinal Bankshares.



Other factors that may cause actual results to
differ from the forward-looking statements include the following: the timely development of competitive new products and services by the Company and the acceptance of such products and services by customers; changes in consumer spending and savings
habits; the effects of competitors pricing policies; the Companys success in managing the costs associated with the expansion of existing distribution channels and developing new ones, and in realizing increased revenues from such
distribution channels, including cross-selling initiatives; and mergers and acquisitions and their integration into the Company and managements ability to manage these other risks.



Management of Cardinal Bankshares believes these forward-looking statements are reasonable; however undue reliance should not be placed on
such forward-looking statements, which are based on current expectations.



Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. The future results and stockholder values of Cardinal Bankshares may differ materially from those expressed in forward-looking
statements contained in this report. Many of the factors that will determine these results and values are beyond the Companys ability to control or predict.



Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



The principal goals of the Companys asset and liability management strategy are the maintenance of adequate liquidity and the management of interest rate risk. Liquidity is the ability to convert assets to cash
to fund depositors withdrawals or borrowers loans without significant loss. Interest rate risk management seeks to balance the effects of interest rate changes on assets that earn interest or liabilities on which interest is paid, to
protect the Company from wide fluctuations in its net interest income.



Management must insure that adequate funds are available at all times to meet the needs of its customers. On the asset side of the balance sheet, maturing investments, loan payments, maturing loans, federal funds sold, and unpledged
investment securities are principal sources of liquidity. On the liability side of the balance sheet, liquidity sources include core deposits, the ability to increase large denomination certificates, federal funds lines from correspondent banks,
borrowings from the Federal Reserve Bank and the Federal Home Loan Bank, as well as the ability to generate funds through the issuance of long-term debt and equity.



Interest rate risk is the effect that changes in interest rates would have on interest income and interest expense as interest-sensitive
assets and interest-sensitive liabilities either reprice or mature. Management attempts to maintain the portfolios of earning assets and interest-bearing liabilities with maturities or repricing opportunities at levels that will afford protection
from erosion of net interest margin, to the extent practical, from changes in interest rates.



The Company uses a number of tools to manage its interest rate risk, including simulating net interest income under various scenarios, monitoring the present value change in equity under the same scenarios, and
monitoring the difference or gap between rate sensitive assets and rate sensitive liabilities over various time periods.



The earnings simulation model forecasts annual net income under a variety of scenarios that incorporate changes in absolute level of interest rates, changes in the shape
of the yield curve and changes in interest rate relationships. Management evaluates the effect on net interest income from gradual changes in the



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Prime Rate of up to 200 basis points up or down over a 12-month period. The current model indicates that an increase in
rates of 200 basis points over the next twelve months would result in an increase in net interest income of $914 thousand, or 13.71%, while a similar decrease in rates would result in a decrease in net interest income of $813 thousand, or 12.19%.
The model also incorporates managements forecasts for balance sheet growth, noninterest income and noninterest expense. The interest rate scenarios are used for analytical purposes and do not represent managements view of future market
movements. Rather, these are intended to provide a measure of the degree of volatility interest rate movements may apply to the earnings of the Company. Modeling the sensitivity of earnings to interest rate risk is highly dependent on numerous
assumptions embedded in the simulation model. While the earnings sensitivity analysis incorporates managements best estimate of interest rate and balance sheet dynamics under various market rate movements, the actual behavior and resulting
earning impact likely will differ from projected.



Additional qualitative
information about interest rate risk is included in the Companys Annual Report on Form 10-KSB for the year ended December 31, 2004. There have not been any material changes since December 31, 2004.



Item 4. CONTROLS AND PROCEDURES



As of the
end of the period covered by this report, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, including internal controls and procedures for financial reporting. Our principal
executive officer and principal financial officer supervised this evaluation and have concluded that our disclosure controls and procedures are effective. Subsequent to this evaluation, (i) there have been no significant changes in our internal
controls or in other factors that could significantly affect our disclosure controls and procedures and (ii) we have not taken any corrective actions with regard to our disclosure controls and procedures to correct any significant deficiencies
and weaknesses.



The design of any system of controls is based in part upon
certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goal under every potential condition, regardless of how remote. In addition, the operation of any system of
controls and procedures is dependent upon the employees responsible for executing it. While we have evaluated the operation of our disclosure controls and procedures and found them effective, there can be no assurance that they will succeed in every
instance to achieve their objective.



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Part II. OTHER INFORMATION



|      |  |   |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|----- |  | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Item: |  | 1 |  | Legal proceedings                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|      |  |  
|      |  |   |  | Cardinal was named as a defendant in a complaint filed by a former employee with the United States Department of Labor under Section 806 of the Sarbanes-Oxley
Act. The plaintiff alleged in his complaint that his termination in October, 2002 violated the Act. He is seeking reinstatement, back pay and damages. The Company maintains that the independent members of Cardinals Board of Directors
terminated the plaintiff lawfully because he refused to comply with the directives of the Audit Committee in their attempt to look into certain matters raised by the plaintiff. The Audit Committee, after full investigation, later concluded that the
matters raised by the plaintiff had no merit. The Boards decision was initially upheld by the Department of Labor. The plaintiff appealed that decision. The Department of Labor Administrative Law Judge reversed the earlier decision in
Cardinals favor and entered a decision in favor of the plaintiff in January 2004. Cardinal appealed that decision. The Administrative Review Board of the Department of Labor agreed to review the decision of the Administrative Law Judge in
February 2004. Their decision to review suspended the decision of the Administrative Law Judge prior to any determination of damages by the Administrative Law Judge. In May 2004, the Administrative Review Board within the Department of Labor
determined that it had accepted Cardinals petition for review prematurely.
|      |  |  
|      |  |   |  | Because of the uncertainty regarding the procedural handling of this case within the DOL, to preserve its ultimate ability to appeal to the Federal Courts, in
June 2004, Cardinal filed with the United States Court of Appeals for the Fourth Circuit a Petition for Review of the decisions of the United States Department of Labor. The appeal was determined to be premature. The parties submitted evidence to
the Administrative Law Judge of damages without a further hearing in December 2004 and January 2005. The Administrative Law Judge rendered a Supplemental Recommended Decision and Order in February 2005, which awarded damages to the plaintiff of $65
thousand, plus attorneys fees of $108 thousand, and ordered the plaintiffs reinstatement. The Company filed a petition for review to the Administrative Review Board of the Department of Labor. The case was accepted for review by the
Administrative Review Board in March 2005. The Companys management believes it has substantial grounds for a successful appeal of the decision in the plaintiffs favor and is pursuing appeal vigorously. Both sides have submitted briefs to
the Administrative Review Board and are awaiting the Administrative Review Boards decision.                                                                                                                                                                                                                      
|      |  |  
|      |  |   |  | On August 30, 2005, the plaintiff filed a complaint in the United States District Court for the Western District of Virginia seeking to enforce what he claimed
was a preliminary order of reinstatement issued by the Administrative Law Judge. On September 14, 2005, the plaintiff moved for a preliminary injunction, and on September 29, 2005, Cardinal moved to dismiss the complaint. The two motions will be
argued on November 14, 2005. The Companys management believes that the complaint is without merit and is defending it vigoroulsy.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|      |  |  
|      |  | 2 |  | Unregistered sales of equity securities and use of proceeds - None                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|      |  |  
|      |  | 3 |  | Defaults upon senior securities  None                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|      |  |  
|      |  | 4 |  | Submission of matters to a vote of security holders - None                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|      |  |  
|      |  | 5 |  | Other information - None                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    



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| |  |   |  |                                                                                                                   
| |  | - |  | ------------------------------------------------------------------------------------------------------------------
| |  | 6 |  | Exhibits                                                                                                          
| |  |   |  | 31.1  Certification of Chief Executive Officer Pursuant To Rule 13a-14(a)                                        
| |  |   |  | 31.2  Certification of Principal Financial Officer Pursuant To Rule 13a-14(a)                                    
| |  |   |  | 32.1  Certification of Chief Executive Officer and Principal Financial Officer Pursuant To 18 U.S.C. Section 1350



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SIGNATURES



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



|                                                                 
|-----------------------------------------------------------------
|CARDINAL BANKSHARES CORPORATION                                  
|                                                                 
|/s/ Ronald Leon Moore                                            
|Ronald Leon Moore                                                
|Chairman of the Board, President and Chief Executive Officer     
|                                                                 
|/s/ Stephanie Kent                                               
|Stephanie Kent                                                   
|Senior Vice President, Controller and Principal Financial Officer



Date: November 10, 2005



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