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U. S. SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549



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FORM 10-QSB



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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, 2004



Commission File No. 0-28780



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CARDINAL BANKSHARES CORPORATION

(Exact name of small business issuer 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

(Small business issuers telephone number)



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Indicate by a check mark whether the small business issuer (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 small business issuer was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.    Yes  x.    No ̈.



The number of shares outstanding of the
issuers Common Stock, $10 par value as of November 10, 2004 was 1,535,733.



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##### Table of Contents

CARDINAL BANKSHARES CORPORATION



FORM
10-QSB



September 30, 2004



INDEX



|         |  |                                                                                                                      |  |     
|-------- |  | -------------------------------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                                      |  | Page
|Part I.  |  | Financial Information                                                                                                |  |     
|         |  |                                                                                                                     
|Item 1.  |  | Consolidated Balance Sheets as of September 30, 2004 (Unaudited) and December 31, 2003 (Audited)                     |  | 3   
|         |  |                                                                                                                     
|         |  | Consolidated Statements of Income for the three months and nine months ended September 30, 2004 and 2003 (Unaudited) |  | 4   
|         |  |                                                                                                                     
|         |  | Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003 (Unaudited)              |  | 5   
|         |  |                                                                                                                     
|         |  | Notes to Consolidated Statements (Unaudited)                                                                         |  | 6   
|         |  |                                                                                                                     
|Item 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                |  | 6   
|         |  |                                                                                                                     
|Item 3.  |  | Controls and Procedures                                                                                              |  | 10  
|         |  |                                                                                                                     
|Part II. |  | Other Information                                                                                                    |  |     
|         |  |                                                                                                                     
|Item 1.  |  | Legal Proceedings                                                                                                    |  | 11  
|         |  |                                                                                                                     
|Item 2.  |  | Changes in Securities                                                                                                |  | 11  
|         |  |                                                                                                                     
|Item 3.  |  | Defaults Upon Senior Securities                                                                                      |  | 11  
|         |  |                                                                                                                     
|Item 4.  |  | Results of Votes of Security Holders                                                                                 |  | 11  
|         |  |                                                                                                                     
|Item 5.  |  | Other Information                                                                                                    |  | 11  
|         |  |                                                                                                                     
|Item 6.  |  | Exhibits and Reports on Form 8-K                                                                                     |  |     
|         |  | (a)
Exhibits                                                                                                         |  | 11  
|         |  | (b)
Reports on Form 8-K                                                                                              |  | 11  



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##### Table of Contents

Consolidated Balance Sheets

Cardinal Bankshares Corporation and Subsidiary



|                                                                                                               |  |                                |         |   |                       |   |         |  
|-------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | --------------------- | - | ------- | -
|(In thousands, except share data)                                                                              |  | (Unaudited) September 30, 2004 |         |   | (Audited)December2003 |  
|Assets                                                                                                         |  |                                |         |   |                       |   |         |  
|Cash and due from banks                                                                                        |  | $                              | 3,563   |   |                       | $ | 3,419   |  
|Interest-bearing deposits                                                                                      |  |                                | 1,140   |   |                       |   | 4,316   |  
|Federal funds sold                                                                                             |  |                                | 4,125   |   |                       |   | 9,125   |  
|Investment securities available for sale, at fair value                                                        |  |                                | 22,351  |   |                       |   | 21,771  |  
|Investment securities held to maturity (fair value, $19,961 - September 30, 2004; $19,564 - December 31, 2003) |  |                                | 19,110  |   |                       |   | 18,560  |  
|Restricted equity securities                                                                                   |  |                                | 603     |   |                       |   | 598     |  
|                                                                                                               |  |                               
|Total loans                                                                                                    |  |                                | 124,144 |   |                       |   | 120,730 |  
|Allowance for loan losses                                                                                      |  |                                | (1,898  | ) |                       |   | (1,697  | )
|                                                                                                               |  |                                |         |   |                       |   |         |  
|Net loans                                                                                                      |  |                                | 122,246 |   |                       |   | 119,033 |  
|                                                                                                               |  |                                |         |   |                       |   |         |  
|Bank premises and equipment, net                                                                               |  |                                | 4,048   |   |                       |   | 2,437   |  
|Accrued interest receivable                                                                                    |  |                                | 898     |   |                       |   | 883     |  
|Foreclosed properties                                                                                          |  |                                |        |   |                       |   | 385     |  
|Bank owned life insurance                                                                                      |  |                                | 4,444   |   |                       |   | 4,327   |  
|Other assets                                                                                                   |  |                                | 1,788   |   |                       |   | 1,558   |  
|                                                                                                               |  |                                |         |   |                       |   |         |  
|Total assets                                                                                                   |  | $                              | 184,316 |   |                       | $ | 186,412 |  
|                                                                                                               |  |                                |         |   |                       |   |         |  
|Liabilities and Stockholders Equity                                                                           |  |                                |         |   |                       |   |         |  
|Noninterest-bearing deposits                                                                                   |  | $                              | 24,588  |   |                       | $ | 22,959  |  
|Interest-bearing deposits                                                                                      |  |                                | 129,347 |   |                       |   | 136,256 |  
|                                                                                                               |  |                                |         |   |                       |   |         |  
|Total deposits                                                                                                 |  |                                | 153,935 |   |                       |   | 159,215 |  
|                                                                                                               |  |                                |         |   |                       |   |         |  
|Securities sold under agreements to repurchase                                                                 |  |                                | 3,406   |   |                       |   | 1,826   |  
|Accrued interest payable                                                                                       |  |                                | 127     |   |                       |   | 123     |  
|Other liabilities                                                                                              |  |                                | 1,076   |   |                       |   | 794     |  
|                                                                                                               |  |                                |         |   |                       |   |         |  
|Total liabilities                                                                                              |  |                                | 158,544 |   |                       |   | 161,958 |  
|                                                                                                               |  |                                |         |   |                       |   |         |  
|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                                                                                              |  |                                | 7,331   |   |                       |   | 5,970   |  
|Accumulated other comprehensive income, net                                                                    |  |                                | 159     |   |                       |   | 202     |  
|                                                                                                               |  |                                |         |   |                       |   |         |  
|Total stockholders equity                                                                                     |  |                                | 25,772  |   |                       |   | 24,454  |  
|                                                                                                               |  |                                |         |   |                       |   |         |  
|Total liabilities and stockholders equity                                                                     |  | $                              | 184,316 |   |                       | $ | 186,412 |  
|                                                                                                               |  |                                |         |   |                       |   |         |  



See
Notes to Consolidated Financial Statements.



3



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##### Table of Contents

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

Cardinal Bankshares Corporation and Subsidiary



|                                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|---------------------------------------------------------- |  | ------------------------------- | --------- | ------------------------------ | ---- | - | --------- |  | ---- | --------- |  | - | ---------
|                                                           |  | Three Months EndedSeptember 30, |           | Nine Months EndedSeptember 30,
|(In thousands, except share data)                          |  | 2004                            |           |                                | 2003 |   | 2004      |  | 2003
|Interest Income                                            |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Interest and fees on loans                                 |  | $                               | 1,981     |                                |      | $ | 1,947     |  | $    | 5,979     |  | $ | 5,928    
|Interest on securities:                                    |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|U.S. government and agencies                               |  |                                 | 232       |                                |      |   | 192       |  |      | 678       |  |   | 732      
|States and political subdivisions                          |  |                                 | 231       |                                |      |   | 229       |  |      | 686       |  |   | 682      
|Interest on federal funds sold                             |  |                                 | 27        |                                |      |   | 26        |  |      | 71        |  |   | 94       
|Deposits with banks                                        |  |                                 | 4         |                                |      |   | 13        |  |      | 18        |  |   | 57       
|                                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Total interest income                                      |  |                                 | 2,475     |                                |      |   | 2,407     |  |      | 7,432     |  |   | 7,493    
|                                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Interest Expense                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Interest on deposits                                       |  |                                 | 762       |                                |      |   | 905       |  |      | 2,325     |  |   | 2,945    
|Interest on securities sold under agreements to repurchase |  |                                 | 18        |                                |      |   | 15        |  |      | 38        |  |   | 16       
|                                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Total interest expense                                     |  |                                 | 780       |                                |      |   | 920       |  |      | 2,363     |  |   | 2,961    
|                                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Net interest income                                        |  |                                 | 1,695     |                                |      |   | 1,487     |  |      | 5,069     |  |   | 4,532    
|Provision for loan losses                                  |  |                                 | 30        |                                |      |   |          |  |      | 55        |  |   | 30       
|                                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Net interest income after provision for loan losses        |  |                                 | 1,665     |                                |      |   | 1,487     |  |      | 5,014     |  |   | 4,502    
|                                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Noninterest Income                                         |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Service charges on deposit accounts                        |  |                                 | 67        |                                |      |   | 77        |  |      | 201       |  |   | 234      
|Other service charges and fees                             |  |                                 | 22        |                                |      |   | 21        |  |      | 65        |  |   | 62       
|Securities gains                                           |  |                                 |          |                                |      |   |          |  |      | 4         |  |   |         
|Other operating income                                     |  |                                 | 105       |                                |      |   | 136       |  |      | 265       |  |   | 328      
|                                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Total noninterest income                                   |  |                                 | 194       |                                |      |   | 234       |  |      | 535       |  |   | 624      
|                                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Noninterest Expense                                        |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Salaries and benefits                                      |  |                                 | 712       |                                |      |   | 572       |  |      | 1,964     |  |   | 1,754    
|Occupancy and equipment expense                            |  |                                 | 152       |                                |      |   | 144       |  |      | 422       |  |   | 433      
|Foreclosed assests, net                                    |  |                                 | (1        | )                              |      |   | 1         |  |      | 8         |  |   | 33       
|Other operating expense                                    |  |                                 | 278       |                                |      |   | 306       |  |      | 939       |  |   | 988      
|                                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Total noninterest expense                                  |  |                                 | 1,141     |                                |      |   | 1,023     |  |      | 3,333     |  |   | 3,208    
|                                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Earnings                                                   |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Income before income taxes                                 |  |                                 | 718       |                                |      |   | 698       |  |      | 2,216     |  |   | 1,918    
|Income tax expense                                         |  |                                 | 158       |                                |      |   | 149       |  |      | 501       |  |   | 400      
|                                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Net Income                                                 |  | $                               | 560       |                                |      | $ | 549       |  | $    | 1,715     |  | $ | 1,518    
|                                                           |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Earnings Per Share                                         |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Net income per common share:                               |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Basic                                                      |  | $                               | 0.37      |                                |      | $ | 0.36      |  | $    | 1.12      |  | $ | 0.99     
|Diluted                                                    |  | $                               | 0.37      |                                |      | $ | 0.36      |  | $    | 1.12      |  | $ | 0.99     
|Average shares outstanding:                                |  |                                 |           |                                |      |   |           |  |      |           |  |   |          
|Basic                                                      |  |                                 | 1,535,733 |                                |      |   | 1,535,733 |  |      | 1,535,733 |  |   | 1,535,733
|Diluted                                                    |  |                                 | 1,535,733 |                                |      |   | 1,535,733 |  |      | 1,535,733 |  |   | 1,535,733



See
Notes to Consolidated Financial Statements.



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CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

Cardinal Bankshares Corporation and Subsidiary



|                                                                                  |  |      |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|(In thousands) Nine Months Ended September 30,                                    |  | 2004 |         |   | 2003 |  
|Cash flows from operating activities                                              |  |      |         |   |      |   |         |  
|Net income                                                                        |  | $    | 1,715   |   |      | $ | 1,518   |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |         |   |      |   |         |  
|Depreciation and amortization                                                     |  |      | 205     |   |      |   | 200     |  
|Accretion of discount on investment securities                                    |  |      | (12     | ) |      |   | (15     | )
|Provision for loan losses                                                         |  |      | 55      |   |      |   | 30      |  
|Net realized (gains) losses on investment securities                              |  |      | (4      | ) |      |   |        |  
|Deferred compensation and pension expense                                         |  |      | 150     |   |      |   | 134     |  
|Changes in operating assets and liabilities:                                      |  |      |         |   |      |   |         |  
|(Increase) in accrued interest receivable                                         |  |      | (15     | ) |      |   | 37      |  
|Increase in accrued interest payable                                              |  |      | 4       |   |      |   | (18     | )
|Net change in other operating assets and liabilities                              |  |      | 194     |   |      |   | 157     |  
|                                                                                  |  |      |         |   |      |   |         |  
|Net cash provided by operating activities                                         |  |      | 2,292   |   |      |   | 2,043   |  
|                                                                                  |  |      |         |   |      |   |         |  
|Cash flows from investing activities                                              |  |      |         |   |      |   |         |  
|Net decrease in interest-bearing deposits in banks                                |  |      | 3,176   |   |      |   | 2,765   |  
|Net decrease in federal funds sold                                                |  |      | 5,000   |   |      |   | (525    | )
|Purchase of investment securities                                                 |  |      | (10,092 | ) |      |   | (14,815 | )
|Proceeds from sale of available for sale securities                               |  |      | 500     |   |      |   |        |  
|Proceeds from maturity and redemption of investment securities                    |  |      | 8,410   |   |      |   | 19,559  |  
|Purchase of restricted equity securities                                          |  |      | (5      | ) |      |   |        |  
|Proceeds from redemption of restricted equity securities                          |  |      |        |   |      |   | 266     |  
|Net (increase) in loans                                                           |  |      | (3,268  | ) |      |   | (5,096  | )
|Net purchases of bank premises and equipment                                      |  |      | (1,816  | ) |      |   | (395    | )
|Investment in bank owned life insurance                                           |  |      |        |   |      |   | (1,127  | )
|                                                                                  |  |      |         |   |      |   |         |  
|Net cash provided by investing activities                                         |  |      | 1,905   |   |      |   | 632     |  
|                                                                                  |  |      |         |   |      |   |         |  
|Financing Activities                                                              |  |      |         |   |      |   |         |  
|Net increase in noninterest-bearing deposits                                      |  |      | 1,629   |   |      |   | 2,019   |  
|Net (decrease) in interest-bearing deposits                                       |  |      | (6,909  | ) |      |   | (8,016  | )
|Net increase in securities sold under agreements to repurchase                    |  |      | 1,580   |   |      |   | 2,443   |  
|Dividends paid                                                                    |  |      | (353    | ) |      |   | (338    | )
|                                                                                  |  |      |         |   |      |   |         |  
|Net cash (used) by financing activities                                           |  |      | (4,053  | ) |      |   | (3,892  | )
|                                                                                  |  |      |         |   |      |   |         |  
|Net increase in cash and cash equivalents                                         |  |      | 144     |   |      |   | (1,217  | )
|Cash and cash equivalents at beginning of period                                  |  |      | 3,419   |   |      |   | 5,175   |  
|                                                                                  |  |      |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                        |  | $    | 3,563   |   |      | $ | 3,958   |  
|                                                                                  |  |      |         |   |      |   |         |  
|Supplemental disclosures of cash flow information                                 |  |      |         |   |      |   |         |  
|Interest paid                                                                     |  | $    | 2,359   |   |      | $ | 2,962   |  
|Income taxes paid                                                                 |  | $    | 472     |   |      | $ | 444     |  



See
Notes to Consolidated Financial Statements.



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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-QSB 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 for the year ended December 31, 2003. 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) |  | 2004 |       |   | 2003 |  
|Balance, at January 1                          |  | $    | 1,697 |   |      | $ | 1,769 |  
|Provision charged to expense                   |  |      | 55    |   |      |   | 30    |  
|Recoveries of amounts previously charged off   |  |      | 257   |   |      |   | 17    |  
|Loans charged off                              |  |      | (111  | ) |      |   | (106  | )
|                                               |  |      |       |   |      |   |       |  
|Balance, at September 30,                      |  | $    | 1,898 |   |      | $ | 1,710 |  
|                                               |  |      |       |   |      |   |       |  



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)               |  | 2004 |        | 2003
|Commitments to extend credit |  | $    | 11,527 |      | $ | 9,463 
|Standby letters of credit    |  |      | 680    |      |   | 803   
|                             |  |      |        |      |   |       
|Total                        |  | $    | 12,207 |      | $ | 10,266
|                             |  |      |        |      |   |       



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, 2004, the Bank operated five branch facilities in the counties of Floyd, Montgomery, Roanoke and Carroll. The main office is in Floyd with a limited service office located in Willis.
The Roanoke office is in the Cave Spring area of Roanoke County. The Hillsville office is located in Carroll County. The Christiansburg office serves Montgomery County.



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##### Table of Contents

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, 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, 2004 were $184.3 million, a decrease of $2.1 million from year-end 2003. Total loans increased 2.8% or $3.4
million during the quarter to $124.1 million. The key to this increase was activity in the participation loan portion of the Companys loan portfolio as well as improved economy in the banks servicing area. From time to time, Cardinal
Bankshares and Bank of Floyd participate in loans originated by other banks. Participation loans make it possible for large borrowers to obtain financing when the amount involved exceeds the legal lending limit of an individual bank.



The investment securities portfolio totaled $41.5 million at September 30, 2004. While
approximately $10.1 million in securities were purchased during the first nine months of the year, issuer calls of U.S. Government Agency securities combined with the effect of normal maturities and principal pay downs resulted in a net increase of
$1.1 million over the period. Federal funds sold declined $5.0 million during the first three quarters of the year due to decline in higher rate deposits and borrowing needs. The company has also experienced a decline in non-core deposits, thus
affecting the decline in federal funds sold. Interest-bearing deposits in other banks declined $3.2 million, primarily to fund customer deposit activities and to meet other operating needs.



As of September 30, 2004, total deposits were $153.9 million, a decline of $5.3 million
compared to year-end 2003. Noninterest-bearing core deposits increased 7.1% to $24.6 million, while interest-bearing deposits declined 5.1% to $129.3 million. Due to increases in repurchase balances and the continued soft loan demand that continues
to exist in the Companys primary markets it has chosen to remain less competitive on rate sensitive deposits. As a result large denomination deposits, those deposit accounts with balances greater than $100 thousand, have declined over the
first nine months of the year. The Company, however, has maintained its position of attracting and maintaining a strong core deposit base. The decrease also allows the Company to get cost of funds more in line with its peer banks.



Bank premises and equipment at September 30, 2004 reflect an increase of $1.6 million
compared to year-end 2003. In April 2004, Bank of Floyd purchased an existing branch from BB&T which accounted for most of the increase. The branch is located at 4309 Starkey Road, in the Tanglewood Mall area of Roanoke. The grand opening of the
new location is scheduled to occur during the fourth quarter. Also scheduled to occur during the fourth quarter is the construction of a new building in Christiansburg, replacing a leased location on Roanoke Street in Christiansburg.



The $385 thousand reduction in other real estate owned reflects the successful marketing and
sale of two pieces of property previously acquired by the Bank at foreclosure.



Stockholders equity was $25.8 million as of September 30, 2004 compared to $24.5 million as of December 31, 2003. Year-to-date net income of $1.7 million accounted for the major portion of the change in stockholders equity that
occurred over the first nine months of the year. Other factors affecting the change in stockholders equity were the payment on June 30, 2004 of the Companys regular semi-annual cash dividend totaling $353 thousand, and the decline in
accumulated other comprehensive income of $43 thousand caused by a decline in the market value of the available for sale portion of the Companys investment portfolio.



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RESULTS OF OPERATIONS



Net income for the three months ended September 30, 2004 was $560 thousand, up 2.8% compared to $549 thousand for the three months ended September 30, 2003. Diluted
earnings per share increased 2.8% to $.37 for the three months ended September 30, 2004. Diluted earnings per share for the same period a year earlier was $.36.



Increased total interest income and lower total interest expense were the primary drivers of the increase in net income. Total interest income for the quarter
increased $68 thousand to $2.5 million. The increase in interest income can be attributed to more favorable interest rates, an improvement in economic conditions and the decline in non-performing loans. Total interest expense decreased $140 thousand
to $780 thousand reflecting the effect of lower levels of interest-bearing deposits and interest rates paid thereon. The reduction in interest expense helped improve net interest income to $1.7 million for the quarter ended September 30, 2004.



Noninterest expense increased $118 thousand to $1.1 million for the third
quarter of 2004. In comparison to the third quarter of 2003, salaries and benefits expense was the major noninterest expense category reflecting an increase. This was primarily the result of increased legal expense incurred defending a complaint
filed with the U.S. Department of Labor by a former employee. This expense accounted for approximately $39 thousand of the increase in other operating expense. Additional information regarding this matter can be found on page 11 herein, Part II.
Other Information, Item 1. Legal Proceedings, and in the Managements Discussion and Analysis section of the Companys 2003 Annual Report.



Net income for the nine months ended September 30, 2004 was $1.7 million, up 13.3% compared to $1.5 million for the nine months ended September 30, 2003. Diluted earnings
per share increased 13.1% to $1.12 for the nine months ended September 30, 2004. Diluted earnings per share for the same period a year earlier was $.99.



Interest income for the nine months ended September 30, 2004 was $7.4 million, down 1.3% from the $7.5 million reported a year earlier. As mentioned above, this is
largely the combined result of continued suppressed loan demand in the market Cardinal Bankshares serves, and the effect of the overall lowering of interest rates on the variable or floating rate portion of the Companys loan portfolio as it
has re-priced. Total interest expense fell $598 thousand compared to the nine-month period ended September 30, 2003. Net interest income for the nine months ended September 30, 2004 improved $537 thousand to $5.1 million combining the effect of both
factors.



Total noninterest income for the nine months ended September 30, 2004
showed a decline of $89 thousand due to lower service charges on deposit accounts and other fees, and lower residual income on leasing transactions as a result of the Bank winding down its leasing activities. Total noninterest expense for the
comparable nine-month periods ended September 30 increased 3.9% to $3.3 million.



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.



The allowance for loan losses totaled $1.9 million at September 30, 2004. The allowance for loan losses to period end loans was 1.52% at September 30, 2004 compared to 1.41% and 1.42% at December 31, 2003 and September 30, 2003,
respectively. The Company recovered balances on loans previously charged off in the amount of $257 thousand for the nine months ended September 30, 2004, exceeding loans charged



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off of $111 thousand by $146 thousand. This compares with net charge-offs for the nine months ended September 30, 2003 of
$89 thousand. The provision for loan losses for the nine months ended September 30, 2004 was $55 thousand, $25 thousand higher than the same period a year earlier. Based on a review of the activity in the loan portfolio, changes in the components of
nonperforming loans and general economic trends, management feels the current year provision is appropriate.



The allowance for loan losses represents managements estimate of an amount adequate to provide for potential losses inherent in the loan portfolio. The adequacy of the loan loss reserve and the related provision
are based upon managements evaluation of the risk characteristics of the loan portfolio under current economic conditions with consideration to such factors as financial condition of the borrowers, collateral values, growth and composition of
the loan portfolio, the relationship of the allowance to outstanding loans and delinquency trends.



While management uses all available information to recognize 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 $676 thousand as of September 30, 2004 compared to $3.2 million as of December 31, 2003. This decrease is as a result of two loans returning to current and performing status.



LIQUIDITY



In determining the Companys liquidity requirements, both sides of the balance sheet
are managed to ensure that adequate funding sources are available to support loan growth, deposit withdrawals or any unanticipated need for funds.



Securities available for sale that mature within one year, or securities that have a weighted average life of one year or less are sources of liquidity. Anticipated
mortgage-backed securities pay downs and maturing loans also generate cashflows to meet liquidity requirements. Wholesale funding sources are also used to supply liquidity such as federal funds purchased and large denomination certificates of
deposit. The Company considers its sources of liquidity to be adequate to meet its anticipated needs.



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 $25.6 million at September 30, 2004, or 19.55% of risk-weighted assets. Total risk-based capital was $27.3 million or
20.81% of risk-weighted assets.



Tier I capital consists primarily of common
stockholders equity, while total risk-based capital includes the allowance for loan losses. Risk weighted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet activities. Under
current risk-based capital standards, all banks are required to have Tier I capital of at least 4% and total capital of 8%.



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, 2004, the Companys leverage capital ratio was 13.64%.



A WARNING ABOUT FORWARD-LOOKING STATEMENTS



This Form 10-QSB 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



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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 such 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 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. 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 supervised this evaluation and has 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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##### Table of Contents

Part II. OTHER INFORMATION



|                                       |  |   |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |  |           
|-------------------------------------- |  | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------
|                                       |  |  
|Item:                                  |  | 1 |  | Legal proceedings                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                       |  |  
|                                       |  |   |  | On December 12, 2002, Cardinals former Chief Financial Officer Mr. David Welch filed a complaint against Cardinal with the United States Department of Labor under Section
806 of the Sarbanes-Oxley Act. Welch alleges in his complaint that his termination in October 2002 violated the Act and seeks reinstatement, back pay and damages. The Company maintains that the independent members of Cardinals Board of
Directors terminated Welch lawfully because he refused to comply with the directives of the Audit Committee attempting to look into certain matters raised by Mr. Welch. The Audit Committee, after full investigation, later concluded that the matters
raised by Mr. Welch had no merit. The Boards decision was upheld by the Department of Labor initially. Mr. Welch appealed that decision. The Department of Labor Administrative Law Judge reversed the earlier decision in Cardinals favor
and entered a decision in Welchs favor on January 28, 2004. The Administrative Review Board of the Department of Labor agreed to review the decision of the Administrative Law Judge on February 6, 2004. Their decision to review suspended the
decision of the Administrative Law Judge prior to any determination of damages by the Administrative Law Judge. On May 13, 2004, the Administrative Review Board dismissed Cardinals Petition for Review without prejudice. On June 17, 2004, the
Administrative Law Judge then granted Welchs motion to hold a supplemental hearing on damages, without setting a hearing date.
|                                       |  |  
|                                       |  |   |  | On June 24, 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both the January 28, 2004, recommended decision and order of the Administrative Law Judge and the May 13, 2004, decision of the Administrative Review Board. The Fourth Circuit dismissed the appeal without prejudice as premature on
September 3, 2004. The case has been returned to the Administrative Law Judge for a determination of damages.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                       |  |  
|                                       |  | 2 |  | Changes in securities - None                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                       |  |  
|                                       |  | 3 |  | Defaults upon senior securities - None                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                       |  |  
|                                       |  | 4 |  | Results of votes of security holders - None                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                       |  |  
|                                       |  | 5 |  | Other information  None                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Part II. OTHER
INFORMATION - continued
|                                       |  |  
|                                       |  | 6 |  | Exhibits and Reports on Form 8-K                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                       |  |   | 
|                                       |  |   |  | (a)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  | Exhibits 

| |  |  |  |        |  |                                                                                                               
| |  |  |  | ------ |  | --------------------------------------------------------------------------------------------------------------
| |  |  | 
| |  |  |  | 31.1  |  | Certification Pursuant To 18 U.S.C. 1350, as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
| |  |  | 
| |  |  |  | 32.1  |  | Certification Pursuant To 18 U.S.C. 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

| |  |     |  |                     |  |                                                                                                                                                                                                                                                                                                            
| |  | --- |  | ------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |    
| |  | (b) |  | Reports on Form 8-K
| |  |     | 
| |  |     |  | (1)                 |  | Form 8-K filed on August 30, 2004 announcing that on August 25, 2004, the small business issuers Executive Vice President and Principal Financial Officer submitted his resignation
effective September 10, 2004, to return to Richmond, Virginia in a senior position with a large, privately owned bank.



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SIGNATURES



Pursuant to the requirements of the Securities Exchange Act of 1934, the small business issuer 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 & Acting Chief Financial Officer



Date: November 10, 2004



12