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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2004

For the transition period from              to             

Commission File Number 0-18868

PREMIER COMMUNITY BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

(540) 869-6600

(Registrant’s telephone number, including area code)

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 4,904,548, $1.00 par value, as of November 2, 2004.

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PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

PREMIER COMMUNITY BANKSHARES, INC.

Consolidated Balance Sheets

(In Thousands, Except for Share Data)

See Accompanying Notes to Consolidated Financial Statements

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PREMIER COMMUNITY BANKSHARES, INC.

Consolidated Statements of Income

(In Thousands, Except for Share Data)

(Unaudited)

See Accompanying Notes to Consolidated Financial Statements

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PREMIER COMMUNITY BANKSHARES, INC.

Consolidated Statements of Changes in Shareholders’ Equity

For the Nine Months Ended September 30, 2004 and 2003

(In Thousands, Except for Share Amounts)

(Unaudited)

See Accompanying Notes to Consolidated Financial Statements

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PREMIER COMMUNITY BANKSHARES, INC.

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30, 2004 and 2003

(In Thousands)

(Unaudited)

See Accompanying Notes to Consolidated Financial Statements

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PREMIER COMMUNITY BANKSHARES, INC.

Notes to Consolidated Financial Statements

(Unaudited)

Note 1. Accounting Policies

General

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position of Premier Community Bankshares, Inc. (“Premier” or the “Corporation”) at September 30, 2004 and December 31, 2003, and the results of operations and cash flows for the nine months ended September 30, 2004 and 2003. The statements should be read in conjunction with the Notes to Financial Statements included in Premier’s Annual Report on Form 10-K for the year ended December 31, 2003.

Stock Compensation Plan

The Corporation accounts for the plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based compensation cost is reflected in net income, as all options granted under the plan have an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Corporation had applied the fair value recognition provision of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based compensation (dollars in thousands except per share amounts):

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Note 2. Results of Operations

The results of operations for the three-month and nine-month periods ended September 30, 2004 and 2003 are not necessarily indicative of the results to be expected for the full year.

Note 3. Securities

Securities held to maturity as of September 30, 2004 are summarized as follows:

Securities available for sale as of September 30, 2004 are summarized as follows:

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Securities in an unrealized loss position at September 30, 2004, by duration of the unrealized loss, are shown below. No impairment has been recognized on any of the securities in a loss position because of management’s intent and demonstrated ability to hold securities to scheduled maturity or call dates. There are approximately nine securities in the consolidated portfolio of the Corporation that have losses, which are considered to be temporary.

Note 4. Loans

The consolidated loan portfolio was composed of the following at the dates indicated:

Impaired loans totaled $1.7 million and $2.4 million at September 30, 2004 and December 31, 2003, respectively. Non-accrual loans excluded from impaired loans disclosure under FASB 114 amounted to $112 thousand at September 30, 2004. There were no non-accrual loans excluded from impaired loans disclosure under FASB 114 at December 31, 2003.

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Note 5. Reserve for Loan Losses

The Corporation maintains the allowance for loan losses at a sufficient level to provide for potential losses in the loan portfolio. Loan losses are charged directly to the allowance when they occur, while recoveries are credited to the allowance. The adequacy of the provision for loan losses is reviewed periodically by management through consideration of several factors, including changes in the character and size of the loan portfolio and related loan experience, a review and examination of overall loan quality, which includes the assessment of problem loans, and an analysis of anticipated economic conditions in the market area. An analysis of the allowance for loan losses, including charge-off activity, is presented below for the nine months ended September 30, 2004 and 2003.

The following is a summary of information pertaining to risk elements and impaired loans at September 30, 2004 and December 31, 2003.

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The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is past due 90 days or more unless the credit is well-secured and in process of collection. Loans are placed on non-accrual at an earlier date or charged off if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Note 6. Earnings Per Share

The Corporation and its subsidiaries had the following earnings per share for the nine months ended September 30, 2004 and 2003.

Note 7. Other Expenses

The Corporation and its subsidiaries had the following other expenses for the nine months ended September 30, 2004 and 2003.

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Note 8. Recent Accounting Pronouncements

Emerging Issues Task Force Issue No. 03-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”) was issued and is effective March 31, 2004. The EITF 03-1 provides guidance for determining the meaning of “other –than-temporarily impaired” and its application to certain debt and equity securities within the scope of Statement of Financial Accounting Standards No. 115 “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”) and investments accounted for under the cost method. The guidance requires that investments which have declined in value due to credit concerns or solely due to changes in interest rates must be recorded as other-than-temporarily impaired unless the Company can assert and demonstrate its intention to hold the security for a period of time sufficient to allow for a recovery of fair value up to or beyond the cost of the investment which might mean maturity. This issue also requires disclosures assessing the ability and intent to hold investments in instances in which an investor determines that an investment with a fair value less than cost is not other-than-temporarily impaired.

On September 30, 2004, the Financial Accounting Standards Board decided to delay the effective date for the measurement and recognition guidance contained in Issue 03-1. This delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The disclosure guidance in Issue 03-1 was not delayed.

EITF No. 03-16, “Accounting for Investments in Limited Liability Companies was ratified by the Board and is effective for reporting periods beginning after June 15, 2004.” APB Opinion No. 18, “The Equity Method of Accounting Investments in Common Stock,” prescribes the accounting for investments in common stock of corporations that are not consolidated. AICPA Accounting Interpretation 2, “Investments in Partnerships Ventures,” of Opinion 18, indicates that “many of the provisions of the Opinion would be appropriate in accounting” for partnerships. In EITF Abstracts, Topic No. D-46, “Accounting for Limited Partnership Investments,” the SEC staff clarified its view that investments of more than 3 to 5 percent are considered to be more than minor and, therefore, should be accounted for using the equity method. Limited liability companies (LLCs) have characteristics of both characteristics of both corporations and partnerships, but are dissimilar from both in certain respects. Due to those similarities and differences, diversity in practice exists with respect to accounting for non-controlling investments in LLCs. The consensus reached was that an LLC should be viewed as similar to a corporation or similar to a partnership for purposes of determining whether a non-controlling investment should be accounted for using the cost method or the equity method of accounting.

We do not expect that implementation of the above will have a significant impact on the financial statements.

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

General

Premier Community Bankshares, Inc. (“Premier” or the “Corporation”) is a Virginia multi-bank holding company headquartered in Winchester, Virginia. The Corporation owns The Marathon Bank and Rockingham Heritage Bank and its subsidiary, RHB Services, Inc. The consolidated financial statements include the accounts of Premier and its wholly-owned subsidiaries. All significant inter-company accounts have been eliminated.

The Corporation and its subsidiaries, The Marathon Bank and Rockingham Heritage Bank, are engaged in the business of offering banking services to the general public. Premier offers checking accounts, savings and time deposits, and commercial, real estate, personal, home improvement, automobile and other installment and term loans. The Corporation also offers financial services, travelers’ checks, safe deposit boxes, collection, notary public and other customary bank services (with the exception of trust services) to its customers. The three principal types of loans made by Premier are: (1) commercial and industrial loans; (2) real estate loans; and (3) loans to individuals for household, family and other consumer expenditures.

The Corporation intends to organize a third bank in West Virginia, which will be named Premier Bank. The Corporation plans to locate Premier Bank’s headquarters in Martinsburg and its initial branch office in Shepherdstown in West Virginia. State regulatory approvals to operate Premier Bank and FDIC approval have been received. Because of the slower than anticipated approvals from the planning commissions in Jefferson and Berkeley counties, construction of the two banking offices has been delayed. Therefore, the opening date of Premier Bank is projected to be the second quarter of 2005, rather than the originally anticipated fourth quarter of 2004. Premier Bank will offer a wide variety of deposits and loans, including residential loans, commercial loans and commercial construction and development loans. The Corporation currently operates a loan production office in Martinsburg, until the new bank is fully operational.

Critical Accounting Policies

General

The financial condition and results of operations presented in the consolidated financial statements, the accompanying notes to the consolidated financial statements and this section are, to a large degree, dependent upon our accounting policies. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change. We discuss below those accounting policies that we believe are the most important to the portrayal and understanding of our financial condition and results of operations. These critical accounting policies require our most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.

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Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS 5, Accounting for Contingences, which requires that losses be accrued when they are probable of occurring and estimatable and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

Premier’s allowance for loan losses is determined by evaluating its loan portfolio on a monthly basis. Particular attention is paid to individual loan performance, collateral values, borrower financial condition and overall economic conditions. The evaluation includes a close review of the internal watch list and other non-performing loans. Management uses three steps in calculating the balance of the reserve. The first step is the specific classification, which examines problem loans and applies a weight factor to each category. The weight factor is based upon historical data and the loans within each category are reviewed on a monthly basis to determine changes in their status. The second step applies a predetermined rate against total loans with unspecified reserves. Again, this rate is based upon experience and can change over time. The third step is an unallocated allowance that is determined by economic events and conditions that may have a real, but as yet undetermined, impact upon the portfolio. Each of these steps is based on data that can be subjective, and the actual losses may be greater or less than the amount of the allowance. However, management feels that the allowance represents a reasonable assessment of the risk imbedded in the portfolio.

Net Income

Net income for the quarter ended September 30, 2004 was $1.7 million compared to $1.5 million for the same period in 2003. This is an increase of $248 thousand or 17.0% over the same period in 2003. The provision for income tax expense increased $104 thousand from $689 thousand in 2003 to $793 thousand in 2004. The annualized return on assets was 1.22% for the third quarter of 2004 as compared to 1.31% for the same period in 2003. Annualized return on equity was 15.98% and 17.37% for the third quarters of 2004 and 2003, respectively.

Net income for the nine months ended September 30, 2004 was $4.5 million compared to $4.0 million for the same period in 2003. This is an increase of $522 thousand or 13.0% over the same period 2003. The provision for income tax expense increased $205 thousand from $1.9 million in 2003 to $2.1 million in 2004. The annualized return on assets was 1.18% for the first nine months of 2004 as compared to 1.27% for the same period in 2003. For the first nine months of 2004 the annualized return on equity was 14.72% compared to 16.83% for the same period in 2003.

Total Assets

Total assets of Premier increased to $559.3 million at September 30, 2004 compared to $462.9 million at December 31, 2003, representing an increase of $96.4 million or 20.8%. Total loans at September 30, 2004, were $476.5 million, of which $383.0 million were loans secured by real estate. (Of the loans secured by real estate, $98.3 million were construction and land development loans.) The remaining loans consisted of $61.5 million in commercial loans, $26.5 million in consumer installment loans and $5.5 million in all other loans. Net loans at September 30, 2004, were $471.5 million, an increase of $89.0 million or 23.3% from the December

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31, 2003 amount of $382.5 million. The loan to deposit ratio was 101.4% at September 30, 2004 and 97.3% at December 31, 2003. Steady loan demand in an expanding market generated the loan growth experienced for the period.

The investment portfolio increased 6.5% to $25.6 million at September 30, 2004 compared to $24.1 million at December 31, 2003. Federal funds sold increased $204.0 thousand to $17.1 million at September 30, 2004 compared to $16.9 million at December 31, 2003. Total interest earning assets increased $91.6 million or 21.4% from December 31, 2003 to September 30, 2004. This increase was primarily the result of the increase in outstanding loan balances.

Allowance for Loan Losses

We maintain the allowance for loan losses at a sufficient level to provide for potential losses in the loan portfolio. Loan losses are charged directly to the allowance when they occur, while recoveries are credited to the allowance. Specific reserves by loan type are established based on overall historical losses, anticipated losses, and inherit risk. Additionally, specific reserves for individual loans are established depending on the severity of the potential loss. Loans are individually reserved once classified as a “watch item” by management. A higher percentage of the loan is reserved for individual loans with a more severe classification. The adequacy of the provision for loan losses is reviewed regularly by management through consideration of several factors including changes in character and the size of the loan portfolio and related loan loss experience, a review and examination of overall loan quality that includes the identification and assessment of problem loans and an analysis of anticipated economic conditions in the market area.

The allowance for loan losses, at September 30, 2004, was $5.0 million. This is an increase of $853 thousand or 20.8% from December 31, 2003. This gives the Corporation a 1.04% allowance for loan losses to total loans. Management has completed an analysis on the reserve and feels the reserve is adequate.

Liabilities

Total deposits increased to $469.8 million at September 30, 2004, from $397.3 million at December 31, 2003, which is an increase of $72.4 million or 18.2%. Non-interest bearing deposits have increased to $77.4 million at September 30, 2004, an increase of $16.3 million or 26.6% from December 31, 2003. During this period, interest bearing checking and savings accounts increased $14.0 million or 10.7% to $144.3 million. The amount of time deposits was $248.1 million at the end of the third quarter, reflecting an increase of $42.2 million or 20.5% over the end of 2003. At September 30, 2004, non-interest bearing deposits represented 16.5% of total deposits as compared to 15.4% at year-end 2003. Low cost interest bearing deposits, including savings and interest bearing checking, were 30.7% of total deposits, compared to 32.8% at December 31, 2003. Time deposits represented 52.8% of total deposits at September 30, 2004, an increase from 51.8% at year-end 2003.

Shareholders’ Equity

Total equity has increased by $4.5 million or 11.5% since December 31, 2003. The increase was due to a $4.5 million net profit for the first nine months plus exercised stock options of $84 thousand and a decrease of $142 thousand in accumulated other comprehensive income. The primary capital to assets ratio is 7.8%.

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Interest Income

Interest income totaled $22.9 million for the nine months ended September 30, 2004, $3.3 million or 16.8% higher than the nine months ended September 30, 2003. Interest and fees of $21.9 million on loans comprise the vast majority of interest income. Interest income from investment securities was $841 thousand for the first nine months of 2004, down 2.8% from $865 thousand for the same period in 2003. Interest income on federal funds, the third major component of Premier’s interest income, decreased $25 thousand or 13.8%. The decline in interest earned on federal funds was the result of decreased average federal funds balances held during the period.

Interest Expense

Total interest expense for the nine months ended September 30, 2004 was $6.5 million, $219 thousand or 3.5% higher than the nine months ended September 31, 2003. Interest on deposits for the nine-month period decreased by $94 thousand or 1.6% over the same period in 2003. The impact of continued historically low interest rates from September 2003 through September 2004 offset the additional expense generated by an increase of $56.2 million in total interest bearing deposits during the same period. Interest on borrowings increased by $314 thousand or 60.6% over the same period last year. Borrowings are obtained from the Federal Home Loan Bank.

Net Interest Income

Net interest income for the nine months ended September 30, 2004 was $16.4 million, $3.1 million or 23.1% higher than the nine months ended September 30, 2003. This increase is the result of the growth in earning assets of $100.5 million from September 30, 2003. The combination of growth and rates had the effect of increasing the net interest margin from 4.57% on a tax-equivalent basis for the nine months ended September 30, 2003 to 4.65% for the same period of 2004. Premier, like most financial institutions, is liability sensitive for interest bearing balances repricing or maturing within one year.

Noninterest Income

Total other income for the nine months ended September 30, 2004 was $3.4 million, an increase of $729 thousand or 27.5% over $2.7 million for the same period in 2003. This was the result of service charges and fees for overdraft charges, check fees and ATM fees due to an increasing number of customer accounts.

Noninterest Expense

Total other expenses for the nine months ended September 30, 2004 were $12.2 million, $2.9 million or 30.8% higher than the nine months ended September 30, 2003. Salary expense increased $1.5 million or 31.7%, and other expenses increased by $1.3 million over the same period in 2003. The net increase in other expenses is in part a result of additional staffing to handle the growth of the bank and the costs involved in processing an increasing number of accounts and transactions.

The Corporation’s efficiency ratio was 61.2% for the nine months ended September 30, 2004 compared to 57.9% for the same period in 2003. The efficiency ratio is a non-GAAP financial measure, which we believe provides investors with important information regarding our operational efficiency. This gives investors a better look at how well the Corporation is managing non-interest expenses compared to the growth in income.

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We compute our Efficiency Ratio by dividing non-interest expense by the sum of the net interest income on a tax-equivalent basis and non-interest income, net of securities gains or losses. The following table reflects the calculation for the efficiency ratio for the nine months ended September 30, 2004 and 2003: