10-Q 1 l08684be10vq.txt WARWICK VALLEY TELEPHONE COMPANY 10-Q/QUARTER END 6-30-04 SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES --- EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 ------------- OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES --- EXCHANGE ACT OF 1934 For the transition period from _____ to Commission file number 0-11174 ------- WARWICK VALLEY TELEPHONE COMPANY -------------------------------- (Exact name of registrant as specified in its charter) New York 14-1160510 ----------------------------------------------------------------------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 47 Main Street, Warwick, New York 10990 ----------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (845) 986-8080 -------------- Former name, former address and former fiscal year, if changed since last report. 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 registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES X NO ----- ----- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 5,401,227 Common Shares, $.01 par value, outstanding at August 19, 2004. INDEX TO FORM 10Q PART I - FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Consolidated Balance Sheets as of June 30, 2004 (Unaudited) and December 31, 2003, as restated (Unaudited). 3 Consolidated Statements of Income for the three and six months ended June 30, 2004 and 2003, as restated (Unaudited). 4 Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003, as restated (Unaudited). 5 Notes to Consolidated Financial Statements (Unaudited). 6-13 Item. 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 13-19 Item. 3 Quantitative and Qualitative Disclosures about Market Risk. 19 Item. 4 Controls and Procedures. 19 PART II - OTHER INFORMATION Item 5. Other Information 20 Item 6. Exhibits and Reports on Form 8-K. 20-25
- 2 - ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) WARWICK VALLEY TELEPHONE COMPANY CONSOLIDATED BALANCE SHEETS (Unaudited) ($ in thousands except share amounts)
JUNE 30, DECEMBER 31, 2004 2003 -------- ------------ (RESTATED) ASSETS Current assets: Cash and cash equivalents $ 7,917 $ 5,717 Accounts receivable - net of reserve for uncollectibles-$127 and $508, respectively 3,618 3,420 Other accounts receivable 288 273 Materials and supplies 1,213 1,153 Prepaid expenses 525 681 Deferred income taxes 409 495 -------- -------- Total Current Assets $ 13,970 $ 11,739 -------- -------- Property, plant and equipment, net 41,059 41,322 Unamortized debt issuance costs 109 115 Intangible asset - pension 744 744 Other deferred charges 583 510 Investments 4,425 5,303 -------- -------- TOTAL ASSETS $ 60,890 $ 59,733 ======== ======== LIABILITIES Current Liabilities: Accounts payable $ 516 $ 1,559 Current portion of long term debt 669 223 Advance billing and payments 280 247 Customer deposits 123 135 Accrued taxes 657 506 Pension and post retirement benefit obligations 1,168 1,139 Accrued access billing 825 694 Other accrued expenses 851 1,252 -------- -------- Total Current Liabilities $ 5,089 $ 5,755 -------- -------- Long-term debt 6,480 6,926 Deferred income taxes 4,552 4,119 Other liabilities and deferred credits 521 536 Pension and post retirement benefit obligations 4,560 4,511 -------- -------- TOTAL LIABILITIES $ 21,202 $ 21,847 -------- -------- Shareholders' Equity Preferred Shares - $100 par value; authorized and issued shares 5,000; $0.01 par value authorized and unissued shares 10,000,000; $ 500 $ 500 Common Shares - $0.01 par value; authorized shares 10,000,000 60 60 issued 5,984,910 as of June 30, 2004 and 5,984,883 as of December 31, 2003 Treasury stock - $0.01 par value, 583,683 Common Shares as of June 30, 2004 (3,598) (3,598) and December 31, 2003 Additional paid in capital 3,473 3,473 Accumulated other comprehensive income (765) (765) Retained earnings 40,018 38,216 -------- -------- Total Shareholders' Equity $ 39,688 $ 37,886 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 60,890 $ 59,733 ======== ========
- 3 - WARWICK VALLEY TELEPHONE COMPANY CONSOLIDATED STATEMENTS OF INCOME (Unaudited) ($ in thousands except per share amounts)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2004 2003 2004 2003 ------------ ------------ ------------ ------------ (RESTATED) (RESTATED) Operating Revenues: Local network service $ 1,012 $ 1,007 $ 2,026 $ 2,038 Network access service 2,032 2,392 4,226 4,670 Long distance services 1,035 921 1,972 1,877 Directory advertising 359 345 726 710 Online services 1,724 1,648 3,440 3,243 Other services and sales 766 829 1,535 1,702 ----------- ----------- ----------- ----------- Total operating revenues 6,928 7,142 13,925 14,240 ----------- ----------- ----------- ----------- Operating Expenses: Plant specific 1,028 1,068 2,084 2,142 Plant non-specific: Depreciation & amortization 1,332 1,237 2,670 2,401 Other 839 697 1,533 1,342 Customer operations 1,201 1,060 2,326 2,096 Corporate operations 1,210 1,203 2,557 2,330 Cost of services and sales 465 913 993 1,380 Property, revenue and payroll taxes 395 325 771 715 ----------- ----------- ----------- ----------- Total operating expenses 6,470 6,503 12,934 12,406 ----------- ----------- ----------- ----------- OPERATING INCOME 458 639 991 1,834 Other Income (Expense) Interest income (expense), net of capitalized interest (70) (114) (137) (216) Income from equity method investments 2,670 2,309 5,034 4,148 Other income (expense) (27) 28 22 (2) ----------- ----------- ----------- ----------- Total other income (expense) - net 2,573 2,223 4,919 3,930 ----------- ----------- ----------- ----------- INCOME BEFORE INCOME TAXES 3,031 2,862 5,910 5,764 Income Taxes 1,021 977 2,042 1,950 ----------- ----------- ----------- ----------- NET INCOME 2,010 1,885 3,868 3,814 Preferred Dividends 7 7 13 13 ----------- ----------- ----------- ----------- INCOME APPLICABLE TO COMMON STOCK $ 2,003 $ 1,878 $ 3,855 $ 3,801 =========== =========== =========== =========== Basic & Diluted Earnings per Share of Outstanding Common Stock $ 0.37 $ 0.35 $ 0.71 $ 0.70 =========== =========== =========== =========== Weighted Average Shares of Common Stock Outstanding 5,401,214 5,400,419 5,401,214 5,400,419 =========== =========== =========== ===========
Please see accompanying notes, which are an integral part of the consolidated financial statements. - 4 - WARWICK VALLEY TELEPHONE COMPANY CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) ($ in thousands)
FOR THE SIX MONTHS ENDED JUNE 30, 2004 2003 -------- ---------- (RESTATED) CASH FLOW FROM OPERATING ACTIVITIES: Net income $ 3,868 $ 3,814 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,670 2,401 Deferred income tax 519 232 Interest charged to construction (5) (33) Income from equity investments (5,034) (4,148) Change in assets and liabilities: (Increase) in accounts receivable (198) (168) (Increase) in other receivables (15) (121) (Increase) Decrease in materials and supplies (60) 32 Decrease (Increase) in prepaid expenses 156 (118) (Increase) in deferred charges (73) (235) (Decrease) in accounts payable (1,043) (328) (Decrease) in customers' deposits (12) (7) (Decrease) in advance billing and payments 33 (43) Increase in accrued taxes 151 98 Increase in pension & post retirement benefit obligations 78 215 Increase in accrued access billing 132 112 (Decrease) Increase in other accrued expenses (418) 277 ------- ------- Net cash provided by operating activities $ 749 $ 1,980 ------- ------- CASH FLOW FROM INVESTING ACTIVITIES: Capital expenditures (2,401) (2,297) Interest charged to construction 5 33 Distribution from partnership 6,150 4,125 Investment contributions (238) 0 ------- ------- Net cash provided by investing activities $ 3,516 $ 1,861 ------- ------- CASH FLOW FROM FINANCING ACTIVITIES: (Decrease) in notes payable 0 (5,000) Proceeds from issuance of long term debt 0 3,149 Unamortized debt issuance 0 (119) Dividends (Common) (2,052) (1,786) Dividends (Preferred) (13) (13) Sale of common stock 0 47 ------- ------- Net cash used in financing activities $(2,065) $(3,722) ------- ------- Increase (Decrease) in cash and cash equivalents 2,200 119 Cash and cash equivalents at beginning of period 5,717 1,641 ------- ------- Cash and cash equivalents at end of period $ 7,917 $ 1,760 ------- -------
- 5 - WARWICK VALLEY TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Dollars in thousands except per share amounts NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS Warwick Valley Telephone Company (the "Company") provides communications services to customers in the Towns of Warwick, Goshen, and Wallkill, New York and the Townships of Vernon and West Milford, New Jersey. Its services include providing local, toll telephone service to residential and business customers, access and billing and collection services to interexchange carriers, Internet access and Video service. BASIS OF PRESENTATION The accompanying unaudited interim condensed consolidated financial statements of the Company and its subsidiaries have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of the Company's management, all adjustments consisting only of normal recurring adjustments considered necessary for fair presentation have been included. Operating results for the three and six month periods ended June 30, 2004 are not necessarily indicative of the results that may be expected for the entire year. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All material intercompany transactions and balances have been eliminated in the consolidated financial statements. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and any disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. The interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's latest annual report on Form 10-K. RECLASSIFICATIONS Certain amounts previously reported for prior periods have been reclassified to conform to the current year presentation in the accompanying consolidated financial statements. Such reclassifications had no effect on the results of operations or shareholders' equity as previously recorded. NOTE 2: RESTATEMENT On December 4, 1998, the New York Public Service Commission ("NYPSC") issued Cases 94-C-0095 and 28425 ("Order"), which required the Company to reduce traffic sensitive access charges to inter-exchange carriers. This Order was effective from January 1, 1999 to present. The Company has determined that it did not reduce traffic sensitive charges to inter-exchange carriers during the period January 1, 1999 to March 31, 2004, as stipulated by the Order. As a result, the Company recorded additional revenues from inter-exchange carriers in the amount equal to the incremental difference between the rate charged and the rate that would comply with the Order. The Company has restated its financial statements for all prior periods affected as the cumulative impact for periods prior to fiscal 2004 would have been material if recorded in the current period. The Company has restated the prior periods to reduce revenue, accrue interest, and record the related tax impact. The Company intends to file an amendment to the Company's 2003 Annual Report on Form 10-K reflecting the impact of this restatement. The following tables present the impact of the restatement. The NYPSC has not made a final determination regarding the amount of the Company's obligation and whether the Company will be required to make a refund, the way any refund would be calculated or of the amount or timing of any payments. Therefore, the ultimate amount of repayment may differ from the current liability and such difference, if any, would be reflected in earnings in the period of settlement. - 6 - WARWICK VALLEY TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Dollars in thousands except per share amounts The impact of the restatement on the consolidated statement of income for the three months and six months ended June 30, 2003 was as follows:
Three months ended June 30, 2003 Six months ended June 30, 2003 ------------------------------- ------------------------------ As Previously As Restated As Previously As Restated Reported Reported ------------------------------- ------------------------------ Operating revenues $ 7,191 $ 7,142 $ 14,337 $ 14,240 Operating income $ 688 $ 639 $ 1,931 $ 1,834 Interest expense $ (106) $ (114) $ (201) $ (216) Total other income (expense) $ 2,231 $ 2,223 $ 3,945 $ 3,930 Income before income taxes $ 2,919 $ 2,862 $ 5,876 $ 5,764 Income taxes $ 997 $ 977 $ 1,990 $ 1,950 Net income $ 1,922 $ 1,885 $ 3,886 $ 3,814 Basic & diluted earnings per share $ 0.35 $ 0.35 $ 0.71 $ 0.70
The impact of the restatement on net income and basic and diluted earnings per share for the three months and six months ended June 30, 2003 were $37 and $.00, respectively and $72 and $.01, respectively. The impact of the restatement on the consolidated statement of cash flows for the six months ended June 30, 2003 was as follows:
Six months ended June 30, 2003 ----------------------------- As Previously As Restated Reported ----------------------------- Net income $ 3,886 $ 3,814 Deferred income tax $ 272 $ 232 Increase in accrued access billing $ -- $ 112
The impact of the restatement on the consolidated balance sheet as of December 31, 2003 and 2002 was as follows:
2003 2002 ---------------------------- ---------------------------- As Previously As Restated As Previously As Restated Reported Reported ---------------------------- ---------------------------- Deferred income taxes $ 255 $ 495 $ 60 $ 221 Total current assets $ 11,499 $ 11,739 $ 7,454 $ 7,615 Total Assets $ 59,493 $ 59,733 $ 54,809 $ 54,970 Accrued access billing $ -- $ 694 $ -- $ 466 Total current liabilities $ 4,838 $ 5,755 $ 13,124 $ 13,590 Total Liabilities $ 21,153 $ 21,847 $ 20,098 $ 20,564 Retained earnings $ 38,670 $ 38,216 $ 34,597 $ 34,292 Total Shareholders' Equity $ 38,340 $ 37,886 $ 34,711 $ 34,406 Total Liabilities and Shareholders' Equity $ 59,493 $ 59,733 $ 54,809 $ 54,970
- 7 - WARWICK VALLEY TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Dollars in thousands except per share amounts The impact of the restatement on the consolidated statement of income for the years ended December 31, 2003, 2002 and 2001 was as follows:
2003 2002 2001 -------------------------- -------------------------- -------------------------- As Previously As Restated As Previously As Restated As Previously As Restated Reported Reported Reported -------------------------- -------------------------- -------------------------- Operating revenues $ 28,843 $ 28,649 $ 27,703 $ 27,547 $ 27,538 $ 27,418 Operating income $ 3,371 $ 3,177 $ 5,267 $ 5,111 $ 6,746 $ 6,626 Interest expense $ (380) $ (414) $ (318) $ (344) $ (355) $ (372) Total other income (expense) $ 8,460 $ 8,426 $ 6,335 $ 6,309 $ 4,243 $ 4,226 Income before income taxes $ 11,831 $ 11,603 $ 11,602 $ 11,421 $ 10,989 $ 10,852 Income taxes $ 3,952 $ 3,873 $ 3,851 $ 3,788 $ 3,665 $ 3,618 Net income $ 7,879 $ 7,730 $ 7,751 $ 7,632 $ 7,324 $ 7,234 Basic & diluted earnings per share $ 1.45 $ 1.43 $ 1.43 $ 1.41 $ 1.34 $ 1.33
NOTE 3: IMPACT OF RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS The Company adopted FASB Interpretation No. 46 "Consolidation of Variable Interest Entities" ("FIN 46") in 2003. FIN 46, which is an interpretation of ARB No. 51, "Consolidated Financial Statements", addresses the consolidation of Investments made by a business enterprise, structured in a way that, although the enterprise may have less than a majority interest in the voting rights, the investment exhibits other characteristics making the enterprise the primary beneficiary of the investment, absorbing the majority of the losses, receiving the majority of the expected residual returns, and thereby requiring consolidation by the business enterprise. As of June 30, 2004, FIN 46 did not significantly impact the Company's operating results or financial position. The Company will continue to monitor the impact of FIN 46 on an ongoing basis. Effective January 1, 2003, the Company adopted SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"). SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company's rates are regulated by the Federal Communications Commission ("FCC"), NYPSC, and New Jersey Board of Public Utilities ("NJBPU"); therefore, the Company reflects the effects of the rate making actions of these regulatory bodies in its financial statements. On December 20, 2003, the FCC notified carriers by order that it would not adopt SFAS No. 143 since the FCC concluded that SFAS No. 143 conflicted with the FCC's current accounting rules that require telephone companies to accrue for asset retirement obligations through prescribed depreciation rates. The Company has concluded that it did not have an asset retirement obligation as defined by SFAS No. 143, as of June 30, 2004 or December 31, 2003. The Company historically recorded cost of removals through depreciation rates and accumulated depreciation. In conjunction with the adoption of SFAS No. 143, the Company has reclassified $543 and $505 as of June 30, 2004 and December 31, 2003, respectively, from accumulated depreciation to a regulatory liability for the cost of removal that the Company has recorded through its historical depreciation rates. NOTE 4: EARNINGS PER SHARE Basic and diluted earnings per share are based on the weighted average number of actual shares outstanding of 5,401,214 and 5,400,419 for the three and six month periods ended June 30, 2004 and 2003, respectively. Share amounts have been restated for the three-for-one stock split (see Note 11). The Company did not have any common stock equivalents as of June 30, 2004 and 2003. - 8 - WARWICK VALLEY TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Dollars in thousands except per share amounts NOTE 5: COMPREHENSIVE INCOME Comprehensive income is equivalent to net income for the three and six month periods ended June 30, 2004 and 2003. NOTE 6: SEGMENT INFORMATION The Company's segments are strategic business units that offer different products and services and are managed as telephone and online services. The Company evaluates segment performance based upon factors such as revenue growth, expense containment, market share and operating income. The telephone segment provides landline telecommunications services, including local, network access, long distance services and messaging, and sells customer premise equipment, private business exchange equipment and yellow and white pages advertising and electronic publishing. The online segment provides high speed and dial up Internet services, help desk operations, and Video over VDSL. Segment balance sheet information as of June 30, 2004 and December 31, 2003 is set forth below:
June 30, December 31, 2004 2003 ---------- ------------ Assets Telephone $ 65,875 $ 62,825 Online 10,815 9,883 Elimination (15,800) (12,975) ---------- -------- Total assets $ 60,890 $ 59,733 ========= ========
Segment income statement information for the six months ended June 30, 2004 and 2003 is set forth below:
2004 2003 -------- ---------- Revenues Telephone $ 11,532 $ 11,964 Online 3,440 3,243 Eliminations (1,047) (967) -------- -------- Total revenues $ 13,925 $ 14,240 Operating income Telephone 1,097 2,067 Online (106) (233) -------- -------- Total operating income $ 991 $ 1,834 Interest expense and income (137) (216) Income from equity method investments 5,034 4,148 Other income (expense) 22 (2) -------- -------- Income before taxes $ 5,910 $ 5,764
- 9 - WARWICK VALLEY TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Dollars in thousands except per share amounts Segment income statement information for the three months ended June 30, 2004 and 2003 is set forth below:
2004 2003 -------- ---------- Revenues Telephone $ 5,743 $ 6,021 Online 1,724 1,648 Eliminations (539) (527) ------- ------- Total revenues $ 6,928 $ 7,142 Operating income Telephone 541 997 Online (83) (358) ------- ------- Total operating income $ 458 $ 639 Interest expense and income (70) (114) Income from equity method investments 2,670 2,309 Other income (expense) (27) 28 ------- ------- Income before taxes $ 3,031 $ 2,862
NOTE 7: MATERIAL AND SUPPLIES Material and supplies are carried at average cost except that specific costs are used in the case of large individual items. As of June 30, 2004 and December 31, 2003, the material and supplies inventory consisted of the following:
2004 2003 ------ ------ Inventory for outside plant $ 269 $ 231 Inventory for inside plant 700 472 Inventory for online plant 89 90 Inventory of video equipment 27 283 Inventory of equipment held for sale or lease 128 77 ------ ------ $1,213 $1,153 ====== ======
NOTE 8: PROPERTY, PLANT AND EQUIPMENT Plant in service, at cost, consisted of the following as of June 30, 2004 and December 31, 2003:
2004 2003 ------- ------- Land, buildings, furniture and other support equipment $ 7,527 $ 7,518 Network and communications plant 28,132 27,273 Telephone plant 24,323 23,747 Online plant 10,177 9,513 ------- ------- Plant in service $70,159 $68,051 Plant under construction 1,690 1,467 ------- ------- 71,849 69,518 Less: Accumulated depreciation 30,790 28,196 ------- ------- Property, plant and equipment, net $41,059 $41,322 ======= =======
- 10 - WARWICK VALLEY TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Dollars in thousands except per share amounts NOTE 9: INVESTMENTS The Company is a limited partner in Orange County-Poughkeepsie Limited Partnership (O-P) and has a 7.5% investment interest which is accounted for under the equity method of accounting. The majority owner and general partner is Verizon Wireless of the East L.P. The following summarizes O-P's income statement for the six months ended June 30:
(Unaudited) 2004 2003 -------- -------- Net sales $ 79,634 $ 67,973 Cellular service cost 7,811 8,805 Operating expenses 3,706 2,746 -------- -------- Net operating income 68,117 56,422 Other income 470 914 -------- -------- Net income $ 68,587 $ 57,336 ======== ========
The following summarizes O-P's income statement for the three months ended June 30:
(Unaudited) 2004 2003 -------- -------- Net sales $ 42,193 $ 36,286 Cellular service cost 4,293 3,369 Operating expenses 1,718 2,144 -------- -------- Net operating income 36,182 30,773 Other income 202 298 -------- -------- Net income $ 36,384 $ 31,071 ======== ========
The Company also owns 17% of Zefcom, LLC, d.b.a. Telispire, a consortium of small telephone companies that resells Sprint PCS under private label. Prior to the fourth quarter of 2003, this investment had historically been recorded on the cost method of accounting. Zefcom formed an Executive Operating Committee (the "Operating Committee") consisting of representatives from three of the investors in Zefcom. The Operating Committee's responsibilities are to assist management, as necessary, in relations with consultants and prospective investors and in matters of finance. The Company's Chief Executive Officer was elected to this committee. Accordingly the Company, through the representation of this Operating Committee began exerting significant influence on the financial and operating decisions of Zefcom in the fourth quarter of 2003. As a result of this change, the Company changed its accounting for the Zefcom investment from the cost method to the equity method of accounting. In August 2004, the Company's Chief Financial Officer was elected to this committee replacing the Chief Executive Officer. In accordance with generally accepted accounting principles, the Company has adjusted its prior period financial results to record its 17% investment in Zefcom as if it had been accounted for under the equity method of accounting. The Company's share of Zefcom's losses has been reflected in "Other Income" in the Income Statement for the three and six month periods ended June 30, 2004 and 2003. The impact to net income for the six month period ended June 30, 2003 was a decrease of $72. Earnings per share also decreased by $0.01. In March 2004, the Company made an initial capital contribution of $238 in cash to Empire State Independent Fiber Network, LLC ("EsiNet"). The Company committed to contribute a total of $950 in four payments over the succeeding twelve months in connection with the Company's 25% interest in the venture. Two of these payments have already been made. The remaining payments of approximately $238 each are scheduled for, December 1, 2004 and April 1, 2005, respectively. EsiNet's operations are anticipated to begin in the fourth quarter of 2004. - 11 - WARWICK VALLEY TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Dollars in thousands except per share amounts NOTE 10: PENSION AND POST RETIREMENT OBLIGATIONS The components of net periodic cost for the three months ended June 30:
Post Retirement Pension Benefits Benefits 2004 2003 2004 2003 ---------------- ---------------- Service Cost $ 63 $ 105 $ 47 $ 40 Interest Cost 203 216 77 69 Expected Return On Plan Assets (162) (153) (30) (21) Amortization Of Prior Service Cost 22 32 8 8 Amortization Of Net (Gain) Loss 35 35 52 45 Special Termination Benefits 169 ----- ----- ----- ----- Net Periodic Benefit Cost $ 161 $ 404 $ 154 $ 141 ===== ===== ===== =====
The components of net periodic cost for the six months ended June 30:
Post Retirement Pension Benefits Benefits 2004 2003 2004 2003 ---------------- ---------------- Service Cost $ 126 $ 210 $ 94 $ 80 Interest Cost 406 431 154 139 Expected Return On Plan Assets (325) (306) (60) (42) Amortization Of Prior Service Cost 44 64 16 16 Amortization Of Net (Gain) Loss 71 71 104 89 Special Termination Benefits 338 ----- ----- ----- ----- Net Periodic Benefit Cost $ 322 $ 808 $ 308 $ 282 ===== ===== ===== =====
The Company has previously disclosed in its financial statements for the year ended December 31, 2003 that it expected to contribute $918 to its pension plan and $222 to its post retirement plan, respectively in 2004. During the six months ended June 30, 2004, the Company has contributed $445 to its pension plan and $111 to its post retirement plan. In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act") was signed into law. The Act introduces a prescription drug benefit under Medicare ("Medicare Part D") as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. The Company is impacted by the Act since it sponsors a postretirement health care plan that provides prescription drug benefits In May 2004, the Financial Accounting Standards Board released FASB Staff Position No. FAS 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("FSP 106-2"). FSP 106-2 states that if a company concludes that its single-employer defined benefit postretirement health care plan provides a drug benefit that is actuarially equivalent to the Medicare Part D benefit, the employer should recognize the subsidy in the measurement of the accumulated postretirement benefit obligation (APBO) under FAS 106, and should account for this reduction in the APBO as an actuarial gain. If an employer amends its plan to achieve actuarially equivalent drug benefits, therefore making the employer eligible for the subsidy, the employer is required to consider the combined effect that the amendment and the subsidy have on the APBO. If the combined effect is a decrease in the APBO, the net reduction is accounted for as an actuarial gain. If the combined effect is an increase in the APBO, the net increase is accounted for as a plan amendment. The provisions of FSP 106-2 are effective for the first interim or annual period beginning after June 15, 2004 for all public companies. If the effects of FSP 106-2, including the subsidy, changes in participation rates, and changes in per capita claims costs, lead the employer to conclude that the enactment of FSP 106-2 was not a "significant event" for its plan, the effects should be incorporated in the valuation performed at the next measurement date required by FAS 106. The Company is currently assessing the impact of FSP 106-2. - 12 - WARWICK VALLEY TELEPHONE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Dollars in thousands except per share amounts NOTE 11: SHAREHOLDERS' EQUITY The Company has 10,000,000 authorized Common Shares at $0.01 Par value; 5,000 authorized Preferred Shares at $100 par value; and 10,000,000 authorized Preferred Shares at $0.01 par value. On April 25, 2003, the Company announced a three-for-one stock split of the Company's Common Shares. Approval for the stock split was received from both the New York State Public Service Commission and the New Jersey Board of Public Utilities on October 6, 2003, and the additional shares resulting from the split were made available on October 13, 2003. Also, a par value of one cent per share was established for the Common Shares. As a result, earnings-per-share amounts for the three and six month periods ended June 30, 2003 have been restated to reflect the stock split. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company's critical and primary operations are in the communications services industry and the Company provides telephone, directory advertising services, Internet, Video and other services to its customers. The Company's basic business strategy is directed towards retaining as much of the traditional telecommunications business as possible, while using its existing network to develop and grow its Internet, data and entertainment products. The Company's non-operating investments are in telecommunication service businesses in an effort to obtain future revenue generation or expense savings. The information below reflects all of these factors and efforts. You should read this discussion in conjunction with the consolidated financial statements and the accompanying notes. The presentation of dollar amounts in this discussion is in thousands. RESTATEMENT: On December 4, 1998, the New York Public Service Commission ("NYPSC") issued Cases 94-C-0095 and 28425 ("Order"), which required the Company to reduce traffic sensitive access charges to inter-exchange carriers. This Order was effective from January 1, 1999 to present. The Company has determined that it did not reduce traffic sensitive charges to inter-exchange carriers during the period January 1, 1999 to March 31, 2004, as stipulated by the Order. As a result, the Company recorded additional revenues from inter-exchange carriers in the amount equal to the incremental difference between the rate charged and the rate that would comply with the Order. The Company has restated its financial statements for all prior periods affected as the cumulative impact for periods prior to fiscal 2004 would have been material if recorded in the current period. The Company has restated the prior periods to reduce revenue, accrue interest, and record the related tax impact. The Company intends to file an amendment to the Company's 2003 Annual Report on Form 10-K reflecting the impact of this restatement. The following tables present the impact of the restatement. The NYPSC has not made a final determination regarding the amount of the Company's obligation and whether the Company will be required to make a refund, the way any refund would be calculated or of the amount or timing of any payments. Therefore, the ultimate amount of repayment may differ from the current liability and such difference, if any, would be reflected in earnings in the period of settlement. -13- Restatement (cont'd): The impact of the restatement on the consolidated statement of income for the three months and six months ended June 30, 2003 was as follows:
Three months ended June 30, 2003 Six months ended June 30, 2003 -------------------------------- ------------------------------ As Previously As Restated As Previously As Restated Reported Reported -------------------------------- ------------------------------ Operating revenues $ 7,191 $ 7,142 $ 14,337 $ 14,240 Operating income $ 688 $ 639 $ 1,931 $ 1,834 Interest expense $ (106) $ (114) $ (201) $ (216) Total other income (expense) $ 2,231 $ 2,223 $ 3,945 $ 3,930 Income before income taxes $ 2,919 $ 2,862 $ 5,876 $ 5,764 Income taxes $ 997 $ 977 $ 1,990 $ 1,950 Net income $ 1,922 $ 1,885 $ 3,886 $ 3,814 Basic & diluted earnings per share $ 0.35 $ 0.35 $ 0.71 $ 0.70
The impact of the restatement on net income and basic and diluted earnings per share for the three months and six months ended June 30, 2003 were $37 and $.00, respectively and $72 and $.01, respectively. The impact of the restatement on the consolidated statement of cash flows for the six months ended June 30, 2003 was as follows:
Six months ended June 30, 2003 ------------------------------ As Previously As Restated Reported ------------------------------ Net income $3,886 $3,814 Deferred income tax $ 272 $ 232 Increase in accrued access billing $ -- $ 112
The impact of the restatement on the consolidated balance sheet as of December 31, 2003 was as follows:
2003 -------------------------- As Previously As Restated Reported -------------------------- Deferred income taxes $ 255 $ 495 Total current assets $11,499 $11,739 Total Assets $59,493 $59,733 Accrued access billing $ -- $ 694 Total current liabilities $ 4,838 $ 5,755 Total Liabilities $21,153 $21,847 Retained earnings $38,670 $38,216 Total Shareholders' Equity $38,340 $37,886 Total Liabilities and Shareholders' Equity $59,493 $59,733
-14- The impact of the restatement on the consolidated balance sheet and statement of income for the years ended December 31, 2003, 2002, 2001, 2000, 1999 was as follows:
2003 2002 2001 2000 1999 ------------------- ------------------- ------------------- ------------------- ------------------ As As As As As As As As As As Previously Restated Previously Restated Previously Restated Previously Restated Previously Restated Reported Reported Reported Reported Reported ------------------- ------------------- ------------------- ------------------- ------------------ Operating revenues $ 28,843 $ 28,649 $ 27,703 $ 27,547 $ 27,538 $27,418 $26,691 $26,606 $23,186 $ 23,134 Operating income $ 3,371 $ 3,177 $ 5,267 $ 5,111 $ 6,746 $ 6,626 $ 7,637 $ 7,552 $ 6,059 $ 6,007 Interest expense $ (380) $ (414) $ (318) $ (344) $ (355) $ (372) $ (588) $ (595) $ (594) $ (596) Total other income (expense) $ 8,460 $ 8,426 $ 6,335 $ 6,309 $ 4,243 $ 4,226 $ 2,811 $ 2,803 $ 1,891 $ 1,889 Income before income taxes $ 11,831 $ 11,603 $ 11,602 $ 11,421 $ 10,989 $10,852 $10,448 $10,354 $ 7,950 $ 7,896 Income taxes $ 3,952 $ 3,873 $ 3,851 $ 3,788 $ 3,665 $ 3,618 $ 3,430 $ 3,398 $ 2,368 $ 2,350 Net income $ 7,879 $ 7,730 $ 7,751 $ 7,632 $ 7,324 $ 7,234 $ 7,018 $ 6,956 $ 5,582 $ 5,546 Basic & diluted $ 1.45 $ 1.43 $ 1.43 $ 1.41 $ 1.34 $ 1.33 $ 1.29 $ 1.28 $ 1.02 $ 1.01 earnings per share Total assets $ 59,493 $ 59,733 $ 54,809 $ 54,970 $ 48,058 $48,157 $42,423 $42,474 $37,349 $ 37,368 Total liabilities $ 21,153 $ 21,847 $ 20,098 $ 20,564 $ 17,410 $17,694 $16,029 $16,176 $14,619 $ 14,674 Total shareholders' equity $ 38,340 $ 37,886 $ 34,711 $ 34,406 $ 30,648 $30,463 $26,394 $26,298 $22,730 $ 22,694 Total liabilities and shareholders' equity $ 59,493 $ 59,733 $ 54,809 $ 54,970 $ 48,058 $48,157 $42,423 $42,474 $37,349 $ 37,368
OVERVIEW: RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2004 AND 2003 - OPERATING REVENUES Operating revenues decreased by $214 (or 3%) for the three-month period ended June 30, 2004. The decrease was due primarily to a reduction of network access services revenue of $360 (or 15%) which resulted largely from lower local switching support revenues received from the Universal Service Administration Corporation, and to a lesser degree from the implementation of the aforementioned Order under Restatement. Long Distance service revenues increased $114 (or 12%) for the three month period ended June 30, 2004 due to an increase in revenues from wireless carriers. Online service revenues increased $76 (or 5%) due to increases of $168 (or 32%) in DSL revenues and $184 in Video revenues, resulting from the continued expansion of our customer base for these products. These increases were offset by a decrease of $279 (or 29%) in dial up services due to customers primarily outside of our service territory migrating to other high speed Internet connections. OPERATING EXPENSES Total operating expenses decreased $33 (or 1%) for the three month period ended June 30, 2004. An increase in depreciation expense of $95 (or 8%) reflects ongoing plant upgrades to accommodate the growing DSL business as well as the cost of the Video equipment installed to expand the number of Video service subscribers. Other plant non-specific expenses increased $142 (or 20%) due primarily to Video content costs for our growing Video subscriber base. Customer operations expenses increased $141 (or 13%) due to labor costs resulting from reorganization of some staff. The decrease of $448 (or 49%) in costs of services and sales was due primarily to lower trunk line costs with interconnection companies in 2004. OTHER INCOME (EXPENSE) Other income (expense) increased by $350 (or 16%) for the three month period ended June 30, 2004 from $2,223 in the corresponding period of 2003 due primarily to an increase in income from O-P. The partnership's earnings increased 17% over the comparable period last year. Continuing strong O-P call volume remains the primary factor behind the increase. Interest expense (net) decreased by $44 (or 39%) for the three month period ended June 30, 2004 from $114 in the corresponding period of 2003 due to lower interest rates from refinancing. RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003 - OPERATING REVENUES Operating revenues decreased by $315 (or 2%) to $13,925 for the six-month period ended June 30, 2004. This decrease was due primarily to a decrease in network access revenues of $444 (or 10%), resulted largely from lower local switching support revenues received from the Universal Service Administration Corporation, and to a lesser degree from the implementation of the aforementioned Order under Restatement. Long distance service revenues increased $95 (or 5%) due primarily to an increase in revenues from wireless carriers. Online service revenues increased $197 (or 6%) due to increases of $364 (or 36%) in DSL revenues and $379 in Video revenues, resulting from the continued expansion of our customer base for these products. These increases were offset by a decrease of $548 (or 28%) in dialup services due to the migration of customers (primarily outside of our service territory) to other high speed Internet connections. A decrease of $167 (or 10%) in other services and sales revenue was the result of lower rates that were mandated by the FCC for reciprocal compensation and overall decreases in the sale of other non-regulated ancillary services. -15- OPERATING EXPENSES Total operating expenses increased $528 (or 4%) for the six month period ended June 30, 2004. The increase in depreciation expense of $269 (or 11%) reflects ongoing plant upgrades to accommodate the growing DSL business as well as the cost of the Video equipment to expand the number of Video service subscribers. Other plant non-specific expenses increased $191 (or 14%) due primarily to Video content costs for our growing Video subscriber base. Customer operations expenses increased $230 (or 11%) due to labor costs resulting from reorganization of some staff. Corporate operations increased $227 (or 10%) as the result of increased professional fees. The decrease of $387 (or 28%) in cost of services and sales was due primarily to lower trunk line costs with interconnection companies in 2004. OTHER INCOME (EXPENSE) Other income (expense) increased by $989 (or 25%) for the six month period ended June 30, 2004 from $3,930 in the corresponding period of 2003 due primarily to an increase in income from O-P. The partnership's earnings increased 20% over the comparable period last year. Continuing strong O-P call volume remains the primary factor behind the increase. Interest expense (net) decreased by $79 (or 37%) for the six month period ended June 30, 2004 from $216 in the corresponding period of 2003 due to lower interest rates from refinancing. INVESTMENT IN ZEFCOM The Company has a 17% ownership interest in Zefcom, LLC ("Zefcom"). This investment had historically been recorded on the cost method of accounting. Zefcom formed an Executive Operating Committee consisting of representatives from three of the investors in Zefcom. The Operating Committee's responsibilities are to assist management as necessary in relations with consultants and prospective investors, and in matters of finance. The Company's Chief Executive Officer was elected to this committee. Accordingly the Company, through its representation of this Operating Committee began exerting significant influence on the financial and operating decisions of Zefcom in the fourth quarter of 2003. As a result of this change, the Company changed its accounting for the Zefcom investment from the cost method to the equity method of accounting. In August 2004, the Company's Chief Financial Officer was elected to this committee replacing the Chief Executive Officer. In accordance with generally accepted accounting principles, the Company has adjusted its prior period financial results to record its 17% investment in Zefcom as if it had been accounted for under the equity method of accounting. The Company's percentage of Zefcom's losses have been reflected in the "Other Income" in the Income Statement for the three and six month periods ended June 30, 2004 and 2003. The impact to net income for the three and six month periods ended June 30, 2003 was a loss of $41 and $72, respectively. Earnings per share for 2003 also decreased by $0.01 and $0.01, respectively. LIQUIDITY AND CAPITAL RESOURCES The Company had $7,917 of cash and cash equivalents available at June 30, 2004. The Company has a $4,000 line of credit with a bank, of which the entire amount remained unused at June 30, 2004. Interest is at a variable rate and borrowings are on a demand basis without restrictions. In addition the Company has an $18,475 unsecured term credit facility with CoBank, ACB at a variable rate (approximately 3.2% for the period January 1, through June 30, 2004). As of June 30, 2004, the Company had utilized $7 million of the CoBank, ACB term credit. CASH FROM OPERATING ACTIVITIES During 2004 the Company's primary source of funds continues to be cash generated from operations. For the six month -16- period ended June 30, 2004, net cash from operating activities was less than our capital expenditures due to the Company's continuing growth of the Video business. Cash from operating activities decreased $1,231 as compared to the corresponding period in 2003 mainly due to the timing of payments associated with fourth quarter 2003 liabilities. CASH FROM INVESTING ACTIVITIES Capital expenditures totaled $2,401 during the six month period ended June 30, 2004 as compared to $2,297 for the corresponding period of 2003, reflecting a leveling off of investment required for the rollout of the Video business as it moves towards completion. The Company's cash distribution from O-P for the Company's share of O-P's earnings was $6,150 for the six months ended June 30, 2004 versus $4,125 for the comparable period last year. Strong O-P call volume is the primary factor for the increase. In March 2004, the Company made a capital contribution of $238 to EsiNet. An additional capital contribution of $238 was made on August 1, 2004. The Company is committed to contribute a total of $950. The balance will be remitted in two payments of approximately $238 each on December 1, 2004 and April 1, 2005, respectively. CASH FROM FINANCING ACTIVITIES Dividends declared by the Board of Directors of Warwick Valley Telephone Company were $0.19 per share for the three month period ended June 30, 2004, compared to $0.16 for the corresponding period in 2003. The total dividends paid for the six months ended June 30, 2004 for common stock by Warwick Valley Telephone Company were $2,052, compared to $1,786 for the same period in 2003. In February 2003, the Company used $3,149 of its unsecured credit facility with CoBank to repay existing debt and pay costs associated with closing the commitment with CoBank. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS The Company adopted FASB Interpretation No. 46 "Consolidation of Variable Interest Entities" ("FIN 46") in 2003. FIN 46, which is an interpretation of ARB No. 51, "Consolidated Financial Statements", addresses the consolidation of investments made by a business enterprise, structured in a way that, although the enterprise may have less than a majority interest in the voting rights, the investment exhibits other characteristics making the enterprise the primary beneficiary of the investment, absorbing the majority of the losses, receiving the majority of the expected residual returns, and thereby requiring consolidation by the business enterprise. As of June 30, 2004, FIN 46 did not significantly impact the Company's operating results or financial position. The Company will continue to monitor the impact of FIN 46 on an ongoing basis. Effective January 1, 2003, the Company adopted SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"). SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company's rates are regulated by the Federal Communications Commission ("FCC"), NYPSC, and New Jersey Board of Public Utilities ("NJBPU"); therefore, the Company reflects the effects of the rate making actions of these regulatory bodies in its financial statements. On December 20, 2003, the FCC notified carriers by order that it would not adopt SFAS No. 143 since the FCC concluded that SFAS No. 143 conflicted with the FCC's current accounting rules that require telephone companies to accrue for asset retirement obligations through prescribed depreciation rates. The Company has concluded that it did not have an asset retirement obligation as defined by SFAS No. 143, as of June 30, 2004 or December 31, 2003. The Company historically recorded cost of removals through depreciation rates and accumulated depreciation. In conjunction with the adoption of SFAS No. 143, the Company has reclassified $543 and $505 as of June 30, 2004 and December 31, 2003, respectively, from accumulated depreciation to a regulatory liability for the cost of removal that the Company has recorded through its historical depreciation rates. OTHER FACTORS: COMPETITION The Telecommunications Act of 1996 (the "Act") created a nationwide structure in which competition is allowed and encouraged between local exchange carriers, interexchange carriers, competitive access providers, cable TV companies and other entities. The first markets of the Company that were affected were those in which regional toll service is provided in both states. Regional toll competition reduced the Company's revenues. The Company itself can provide competitive local exchange telephone service outside its franchised territory. The Company currently provides access to the national and international calling markets as well as intrastate calling markets through all interested inter-exchange carriers, including the Company's wholly owned subsidiary Warwick Valley Long Distance Company ("WVLD"). Equal access ("one-plus") service to all toll carriers has been available to the Company's customers since August 1, 1991. Access to the remainder of the intrastate calling markets is provided by the Company as well as other exchange carriers. WVLD, as an inter-exchange carrier, competes against all such other carriers, including accelerating wireless competition, providing full toll services to its customers at discounted rates. The Company's territory is surrounded by the territories of Verizon Communications, Inc., Frontier - A Citizen's Communications Company and Sprint Telephone, all of which offer residential and business telephone services and equipment. There are also several competitive telephone companies located within a 30-mile radius of Warwick, New York. Voice Over Internet Protocol ("VOIP") providers are also beginning to offer limited service within the Company's local service area. The Company's residential customers can purchase telephone sets (including cellular sets) and equipment at other retail outlets inside and outside the Company's territory and not affiliated with the Company. The Company is currently competing with Frontier - A Citizen's Communications Company - in the Middletown, New York area as well as with Sprint United Telephone in the Vernon, New Jersey area for local service through access lines. The Company is reviewing plans to provide limited service in other surrounding areas in both New York and New Jersey. There can -17- be no assurances that the Company will effect any such additional plans, or that other companies will not begin providing competitive local exchange telephone service in the Company's franchise territory. Cablevision has launched a VOIP product in the New York Metro area that also includes their West Milford, New Jersey franchise area. West Milford Township in New Jersey includes Upper Greenwood Lake, which is part of the Company's existing local service area. Online competes both on the basis of service and price. There are numerous competitors throughout Online's market area whose services are available to customers. During the second quarter of 2004 the Company's DSL product, Ultralink, increased its penetration level to 30.9% of establishments passed. Conversely, the number of customers for Online's dial-up product decreased 15.4% due to the migration of customers to high speed Internet provided by the Company and by the competition. Switches to competing service providers occurred primarily outside of our service territory. Whether customer and pricing levels can be maintained depends, in part, on the actions of existing competitors, the possible entry into the market of new competitors, the rate of technological change and the level of demand for services. Our Video product was launched in April of 2002 and is competing against entrenched cable companies including Service Electric Company ("SEC"), Cablevision and satellite TV companies such as Direct TV and Dish Network. On November 10, 2003 the FCC issued an order requiring intermodal portability (wireline to wireless) in the top one hundred Metropolitan Service Areas ("MSA") by November 23, 2004 where the requesting wireless carrier's "coverage area" overlaps that of the local exchange carrier. The Company did provide intermodal Local Number Portability ("LNP") by May 24, 2004. LNP may assist a competitor in obtaining our customers because customers can keep their current telephone number, even when they switch their telephone service from the Company to another carrier. As of June 30, 2004, LNP had not posed a significant competitive risk within the Company's service territory. REGULATION The Company's New York telephone service operations are subject to the jurisdiction of the NYPSC, and the Company's New Jersey telephone service operations to the jurisdiction of the NJBPU. These two bodies have regulatory authority over the Company with respect to rates, facilities, services, reports, issuance of securities and other matters such as corporate restructuring. As a result, the Company's ability to respond quickly to changing market conditions or to implement a new business organization can be limited by the necessity of obtaining regulatory reviews or responding to interrogatories, all of which can slow down or even prevent a desired transaction or change. Interstate toll and access services are subject to the jurisdiction of the FCC. The Company receives reimbursement from carriers in the form of charges for providing carriers access to and from the Company's local network. Video operations are also under the jurisdiction of the NYPSC, the NJBPU, and the FCC as well as the municipalities where the Company provides services. In the Company's two New Jersey exchanges, intrastate toll revenues are retained by toll carriers, of which the Company is one. The associated access charges are retained by the Company. Revenues resulting from traffic between the Company, Verizon and Sprint are reconciled through charges payable to each company for terminating traffic. In addition to charging for access to and from the Company's local network, the Company bills and collects charges for most interstate and intrastate toll messages carried on its facilities. Interstate billing and collection services provided by the Company are not regulated. They are provided under contract by the Company. Intrastate billing and collection remain partly regulated in New York and fully regulated in New Jersey. The regulated services are provided under tariff. Some carriers provide their own billing and collection services. The Company has filed a petition with the NYPSC seeking approval to reorganize its corporate structure in order to create a holding company that would separate its regulated local exchange operations from its deregulated operations. Under this reorganization plan, corporate management and administrative functions would remain at Warwick Valley Telephone Company, proposed to be renamed WVT Communications Inc., which would become the unregulated holding company of a regulated local exchange subsidiary (proposed to be named Warwick Valley Telephone Company) and other, unregulated subsidiaries. Before the Company may complete this proposed reorganization plan, it must first obtain the approval of the NYPSC, the NJBPU and its shareholders. The Company is actively pursuing the resolution of this petition before the two public service commissions. The FCC has pending decisions regarding the USF and inter-carrier compensation issues. Whether the USF can be sustained and whether VOIP providers will be required to participate in funding Rural Carriers will affect and influence decisions to invest in new facilities. The FCC is expected to act on these issues in 2004. CAUTIONARY LANGUAGE CONCERNING FORWARD-LOOKING STATEMENTS Certain statements contained in this Form 10-Q, including, without limitation, statements containing the words "believes," "anticipates," "intends," "expects" and words of similar import, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward- -18- looking statements. Such factors include, among others the following: general economic and business conditions, both nationally and in the geographic regions in which the Company operates; industry capacity; demographic changes; existing governmental regulations and changes in or the failure to comply with, governmental regulations; legislative proposals relating to the businesses in which the Company operates; competition; technological changes; and the loss of any significant ability to attract and retain qualified personnel. Given these uncertainties, current and prospective investors should be cautioned in their reliance on such forward-looking statements. The Company disclaims any obligations to update any such factors or to publicly announce the results of any revision to any of the forward-looking statements contained herein to reflect future events or developments. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company does not hold or issue derivative instruments for any purposes or other financial instruments for trading purposes. The Company's only assets exposed to market risk are its interest bearing bank accounts, into which the Company deposits its excess operating funds on a daily basis. The Company has the option of choosing the following rate options from CoBank: Weekly Quoted Variable Rate, Long-Term Fixed Quote and a Libor Option. The Company does not believe that its exposure to interest rate risk is material. ITEM 4. CONTROLS AND PROCEDURES 1. Evaluation of disclosure controls and procedures The term "disclosure controls and procedures" is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (Exchange Act). These rules refer to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods. Our Chief Executive Officer and our Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report, and they have concluded that such controls and procedures were not effective since the material weakness described below was identified. Our Chief Executive Officer and our Chief Financial Officer believe that such controls and procedures have now been rendered effective because of the changes described below. 2. Changes in internal controls over financial reporting During the second quarter of 2004 it was discovered that a material weakness existed in internal controls related to the Company's N.Y. Intrastate access tariff filings. The identified deficiency was that the Company inadvertently did not monitor a New York Public Service Commission (NYPSC) order regarding the implementation of N.Y. Intrastate Access rates. As a result of the findings, the Company has assigned a designated contact for all written correspondence from regulatory agencies. This contact will be responsible for summarizing, recording and analyzing all material received from regulatory agencies and disseminating all such material to the proper department. If any department receives information directly from a regulatory agency they are instructed to forward it to the designated contact for the Company. In addition, the Company's Controller's Group will review all such correspondence from regulatory agencies and will document the related accounting and financial reporting issues. The evaluation process will be reviewed by the Chief Financial Officer and periodically by the Company's Audit Committee. Finally, the process will be subject to random and periodic reviews by senior management to verify that regulatory information has been distributed appropriately, analyzed and that the Company is in full compliance with all regulatory requirements. PART II - OTHER INFORMATION ITEM 5. OTHER INFORMATION SHAREHOLDERS IN 401(K) PLAN As of June 30, 2004 3.1% of the Company's outstanding Common Shares were held by employees in the Company's 401(k) plan. These percentages fluctuate quarterly. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits - 31.1 Chief Executive Officer Certification 31.2 Chief Financial Officer Certification 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by Herbert Gareiss, Jr.-principal Executive Officer. -19- 32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by Philip A. Grybas-principal Financial Officer. b) Reports on Form 8-K - On April 7, 2004, the Company issued a press release announcing that it will bring advanced broadband communications services to 54 cities and surrounding communities in rural New York by participating with a team of 13 telecommunications firms to organize the Empire State Independent Fiber Network LLC. On April 30, 2004 Lynn Pike, then the President of Warwick Valley Telephone Company ("the Company"), discussed certain aspects of the Company's business at its Annual Shareholders Meeting. On June 25, 2004, the Board of Directors accepted the resignation of Mr. M. Lynn Pike as President, CEO, and Director of Warwick Valley Telephone Company and designated Mr. Herbert Gareiss, Jr. a Director and Vice President, as acting President, also effective June 25, 2004, while it conducted a search for Mr. Pike's successor. On July 21, 2004, the Board of Directors appointed Mr. Herbert Gareiss, Jr. the Company's President and CEO. Mr. Gareiss, who joined the Company in 1980, had previously been designated acting President on June 25, 2004. Mr. Gareiss has been a Director of the Company since 1998 and will retain his Board membership. The Board of Directors also named Zigmund C. Nowicki Jr., Director of Information Technology and Human Resources, as Corporate Secretary to replace Mr. Gareiss in that position. On August 16, 2004, Warwick Valley Telephone Company (the "Company") gave notice that form 12b-25 was filed on August 10, 2004 with the Securities and Exchange Commission ("SEC"), informing the SEC of the late filing of its Quarterly Report on Form 10-Q for the period ended June 30, 2004. On August 18, 2004, the Company issued a statement that as previously reported on Form 8-K filed August 16, 2004, Warwick Valley Telephone Company, National Association of Securities Dealers Automated Quotation (Nasdaq) Symbol WWVY (the "Company"), had been delayed in filing its Quarterly Report on Form 10-Q for the period ended June 30, 2004. The Company stated that it expected to file its Quarterly Report no later than August 25,2004. From the opening of business on August 19, 2004 until such time as the Company files its Quarterly Report or this matter is otherwise resolved, the Company's Common Shares will trade under the symbol WWVYE. -20- 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, thereunto duly authorized. Warwick Valley Telephone Company Registrant Date 8/24/04 /s/Herbert Gareiss, Jr. Herbert Gareiss, Jr., President (Chief Executive Officer) Date 8/24/04 /s/Philip A. Grybas Philip A. Grybas, Vice President, Chief Financial Officer (Principal Financial and Chief Accounting Officer) -21-