U. S. SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-QSB

QUARTERLY REPORT PURSUANT TO

SECTION 13 or 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarter ended June 30, 2003

Commission File No. 0-28780

CARDINAL BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)

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)

Indicate by a 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  ¨

The number of shares outstanding of the issuer’s Common Stock, $10 par value as of July 31, 2003 was 1,535,733.

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CARDINAL BANKSHARES CORPORATION

FORM 10-QSB

June 30, 2003

INDEX

		Page
Part I.	Financial Information
Item 1.	Consolidated Balance Sheets as of June 30, 2003 (Unaudited) and December 31, 2002	3
	Consolidated Statements of Income for the three months and six months ended June 30, 2003 and 2002 (Unaudited)	4
	Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002 (Unaudited)	5
	Notes to Consolidated Statements (Unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	7
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

CONSOLIDATED BALANCE SHEETS

Cardinal Bankshares Corporation and Subsidiary

	(Unaudited)
(In thousands, except share data)	June 30, 2003			December 31, 2002
ASSETS
Cash and due from banks	$	4,135		$	5,175
Interest-bearing deposits		5,282			8,065
Federal funds sold		10,425			8,650
Investment securities available for sale, at fair value		24,116			27,963
Investment securities held to maturity (fair value, $20,242—June 30, 2003; $18,044—December 31, 2002)		18,820			17,027
Restricted equity securities		598			864
Total loans		120,133			115,093
Allowance for loan losses		(1,730	)		(1,769	)
Net loans		118,403			113,324
Bank premises and equipment, net		2,058			2,160
Accrued interest receivable		1,105			1,049
Other real estate owned		392			671
Bank owned life insurance		4,226			3,149
Other assets		1,464			1,281
Total assets	$	191,024		$	189,378
LIABILITIES AND STOCKHOLDERS’ EQUITY
Noninterest—bearing deposits	$	21,842		$	21,036
Interest—bearing deposits		141,502			144,356
Total deposits		163,344			165,392
Securities sold under agreements to repurchase		2,849			—
Accrued interest payable		167			181
Other liabilities		751			586
Total liabilities		167,111			166,159
Commitments and contingent liabilities
STOCKHOLDERS’ EQUITY
Common stock, par value $10 per share, 5,000,000 shares authorized, 1,535,733 shares issued and outstanding		15,357			15,357
Paid-in capital		2,925			2,925
Retained earnings		5,298			4,667
Accumulated other comprehensive income, net		333			270
Total stockholders’ equity		23,913			23,219
Total liabilities and stockholders’ equity	$	191,024		$	189,378

See Notes to Consolidated Financial Statements.

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CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

Cardinal Bankshares Corporation and Subsidiary

	Three Months Ended June 30,				Six Months Ended June 30,
(In thousands, except share data)	2003		2002		2003		2002
Interest Income
Interest and fees on loans	$	1,988	$	2,288	$	3,981	$	4,541
Interest on securities:
U.S. government and agencies		251		324		540		717
States and political subdivisions		232		238		453		487
Interest on federal funds sold		33		52		68		99
Deposits with banks		20		37		44		58
Total interest income		2,524		2,939		5,086		5,902
Interest Expense
Interest on deposits		997		1,270		2,040		2,692
Interest on securities sold under agreements to repurchase		1		—		1		—
Total interest expense		998		1,270		2,041		2,692
Net interest income		1,526		1,669		3,045		3,210
Provision for loan losses		—		120		30		270
Net interest income after provision for loan losses		1,526		1,549		3,015		2,940
Noninterest Income
Service charges on deposit accounts		78		82		157		146
Other service charges and fees		21		20		41		38
Securities gains		—		2		—		10
Other operating income		106		61		192		119
Total noninterest income		205		165		390		313
Noninterest Expense
Salaries and benefits		646		512		1,182		974
Occupancy and equipment expense		142		134		289		258
Foreclosed assests, net		32		—		32		—
Other operating expense		180		204		682		408
Total noninterest expense		1,000		850		2,185		1,640
Earnings
Income before income taxes		731		864		1,220		1,613
Income tax expense		165		210		251		406
Net Income	$	566	$	654	$	969	$	1,207
Earnings Per Share
Net income per common share:
Basic	$	0.37	$	0.43	$	0.63	$	0.79
Diluted	$	0.37	$	0.43	$	0.63	$	0.79
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) Six Months Ended June 30,	2003			2002
Cash flows from operating activities
Net income	$	969		$	1,207
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		131			122
Accretion of discount on investment securities		(10	)		2
Provision for loan losses		30			270
Net realized (gains) losses on investment securities		—			(10	)
Deferred compensation and pension expense		89			(16	)
Changes in operating assets and liabilities:
(Increase) in accrued interest receivable		(56	)		(14	)
(Decrease) in accrued interest payable		(14	)		(79	)
Net change in other operating assets and liabilities		139			(778	)
Net cash provided by operating activities		1,278			704
Cash flows from investing activities
Net (increase) decrease in interest-bearing deposits in banks		2,783			(5,000	)
Net (increase) decrease in federal funds sold		(1,775	)		8,415
Purchase of investment securities		(12,168	)		(8,661	)
Sale of investment securities		—			759
Proceeds from maturity and redemption of investment securities		14,328			7,767
Proceeds from redemption of restricted equity securities		266			—
Net (increase) decrease in loans		(5,109	)		4,125
Net purchases of bank premises and equipment		(29	)		(96	)
Investment in bank owned life insurance		(1,077	)		(3,063	)
Net cash (used) provided by investing activities		(2,781	)		4,246
Financing Activities
Net increase in noninterest-bearing deposits		806			1,259
Net (decrease) in interest-bearing deposits		(2,854	)		(4,822	)
Net increase in securites sold under agreements to repurchase		2,849			—
Dividends paid		(338	)		(307	)
Net cash provided (used) by financing activities		463			(3,870	)
Net (decrease) increase in cash and cash equivalents		(1,040	)		1,080
Cash and cash equivalents at beginning of period		5,175			3,986
Cash and cash equivalents at end of period	$	4,135		$	5,066
Supplemental disclosures of cash flow information
Interest paid	$	2,055		$	2,772
Income taxes paid	$	269		$	548

See Notes to Consolidated Financial Statements.

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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, 2002. 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:

Six months ended June 30, (In thousands)	2003			2002
Balance, at January 1	$	1,769		$	1,300
Provision charged to expense		30			270
Recoveries of amounts previously charged off		5			3
Loans charged off		(74	)		(45	)
Balance, at June 30,	$	1,730		$	1,528

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 June 30 for the years indicated follows:

(In thousands)	2003		2002
Commitments to extend credit	$	4,262	$	7,113
Standby letters of credit		673		872
Total	$	4,935	$	7,985

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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 June 30, 2003, 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.

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 June 30, 2003 were $191.0 million, up $1.6 million from year-end 2002. Total loans grew by $5.0 million or 4.4%, driven primarily by increased commercial real estate activity in the form of participation loans purchased from other financial institutions during the second quarter. The investment securities portfolio reflected a net decrease of $2.0 million due largely to issuer calls of U.S. Government Agency securities motivated by the sustained low interest rate environment. Federal funds sold increased $1.8 million, or 20.5%, to $10.4 million as excess funds available from the continued moderate loan demand were temporarily reinvested in overnight funds.

As of June 30, 2003, total deposits were $163.3 million, reflecting a decrease of $2.0 million compared to year-end 2002. Non-interest-bearing core deposits increased $806 thousand while interest-bearing deposits declined $2.9 million due mainly to a shift of approximately $2.8 million in deposits to securities sold under agreements to repurchase.

Stockholders’ equity was $23.9 million as of June 30, 2003 compared to $23.2 million as of December 31, 2002. The $694 thousand increase in stockholders’ equity is primarily the combined result of $969 thousand in net income and the declaration of $338 thousand in cash dividends during the six months ended June 30, 2003.

RESULTS OF OPERATIONS

Net income for the three months ended June 30, 2003 was $566 thousand compared to $654 thousand for the three months ended June 30, 2002. Diluted earnings per share were $.37 for the three months ended June 30, 2003 compared to $.43 for the same prior year period.

Net income for the six months ended June 30, 2003 was $969 thousand compared to $1.2 million for the six months ended June 30, 2002. Diluted earnings per share were $.63 and $.79 for the six months ended June 30, 2003 and 2002, respectively.

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The decline in net income and profitability for the six month period ended was primarily attributable to the Company’s recognition during the period of $255 thousand, or $168 thousand net of taxes, in expenses related to the proposed merger with MountainBank Financial Corporation. On February 26, 2003, the Registrant’s shareholders failed to ratify and approve the proposed merger. Excluding the effect of the merger related expenses; Cardinal Bankshares would have reported net income of $1.1 million or $.74 per diluted share.

Total interest income for the three months ended June 30, 2003 declined $415 thousand to $2.5 million, a decrease of 14.1% over the same prior year quarter. This was primarily the result of the 50 basis point decrease in the prime rate of interest from the second quarter of 2002 to the second quarter of 2003. Noninterest income increased 24.2% to $205 thousand, with residual income from leasing activities and income from bank owned life insurance generating most of the increase. Total interest expense decreased 21.4% to $1.0 million, reflecting the effect of lower levels of interest-bearing deposits and interest rates paid thereon. Noninterest expense increased 17.6% to $1.0 million for the three months ended June 30, 2003, due primarily to increased pension plan expense and the effect of an increase in the 2003 medical insurance premium rate of approximately 21% over the 2002 rate.

Interest income for the six months ended June 30, 2003 was $5.1 million, down 13.8% from the $5.9 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 re-prices in the current declining rate environment. While total interest expense fell $651 thousand for the comparative six-month period ended June 30 2003, the decline was not sufficient to offset the $816 thousand reduction in interest income that drove the $165 thousand decline in net interest income for the period. Total noninterest income grew $77 thousand to $390 thousand primarily due to increased residual income from leasing activities and income from bank owned life insurance. Total noninterest expense increased to $2.2 million, up $545 thousand from the $1.6 million reported a year earlier. As mentioned above, the merger related expenses accounted for the largest portion of the increase. Premiums paid on bank owned life insurance policies, purchased subsequent to the first quarter of 2002, and increased pension expenses were the main reasons for the period-to-period increase. While the merger related expenses dampened the Company’s reported earnings for the periods being reported, Cardinal Bankshares’ core earnings remained sound during what has been one of the most challenging interest rate and restrained economic environments in recent banking history.

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 $1.7 million at June 30, 2003. The allowance for loan losses to period end loans was 1.44% at June 30, 2003 compared to 1.54% and 1.38% at December 31, 2002 and June 30, 2002, respectively. Net charge-offs for the six months ended June 30, 2003 were $69 thousand compared to $42 thousand for the corresponding 2002 period.

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

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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 $3.2 million as of June 30, 2003 compared to $4.2 million and $755 thousand as of March 31, 2003 and December 31, 2002, respectively. Management does not expect to incur any material losses related to nonperforming assets.

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 $23.6 million at June 30, 2003, or 18.45% of risk-weighted assets. Total risk-based capital was $25.2 million or 19.70% 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 June 30, 2003, the Company’s leverage capital ratio was 12.36%.

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 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

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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

Within 90 days prior to the date of 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
	David E. Welch, former Assistant Vice President, Chief Financial Officer, and Cashier of both Cardinal Bankshares and Bank of Floyd was discharged on October 1, 2002, by the Cardinal Bankshares Board of Directors.
	Welch subsequently filed a complaint with the U.S. Department of Labor and served it on or about December 12, 2002, claiming that his discharge violated the Sarbanes-Oxley Act of 2002. Based upon information provided by Cardinal, the Department of Labor dismissed the claims on March 18, 2003, finding that Welch was not dismissed for protected activity but for legitimate business reasons. Claims against Bank of Floyd were dismissed for the additional reason that Bank of Floyd is not a public company and is not subject to the Act.
	Welch subsequently appealed the dismissal, and the appeal is currently pending. Cardinal Bankshares believes there is no merit to the appeal and expects to vigorously defend the appeal.
2	Changes in securities—None
3	Defaults upon senior securities—None
4	Results of votes of security holders
	On April 23, 2003, the Registrant held its 2003 Annual Meeting of Shareholders. At the meeting, the following seven persons were elected to the Board of Directors of the Registrant until the 2004 Annual Meeting. The results of the vote were as follows:

	For	Withheld
K. Venson Bolt	1,105,029	29,181
J. Howard Conduff, Jr.	1,120,209	14,001
William Gardner, Jr.	1,120,209	14,001
C. W. Harman	1,105,029	29,181
Kevin D. Mitchell	1,120,209	14,001
Ronald Leon Moore	1,004,148	130,062
Dorsey H. Thompson	1,120,209	14,001

5	Other information—None
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 906 of the Sarbanes-Oxley Act of 2002
	31.2 – Certification Pursuant To 18 U.S.C. 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
	32.1 – Certification Pursuant To 18 U.S.C. 1350, as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	(b) Reports on Form 8-K

(1) Form 8-K filed on June 20, 2003 announcing that the Registrant’s board of directors approved a regular semi-annual cash dividend of $.22 per share, an increase of ten percent over the dividend paid in June of 2002. The dividend declared was payable on June 30, 2003 to shareholders of record as of June 25, 2003.

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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/Ray A. Fleming

Ray A. Fleming

Executive Vice President and Chief Financial Officer

Date: August 12, 2003

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