Warwick Valley Telephone Co. 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006


o		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 incorporation or organization)		(IRS Employer Identification No.)

47 Main Street, Warwick, New York		10990

(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code (845) 986-8080

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 þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). YES o NO þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 5,351,780 Common Shares, $0.01 par value, outstanding at August 2, 2006.

WARWICK VALLEY TELEPHONE COMPANY

CONSOLIDATED BALANCE SHEETS
($ in thousands except share and per share amounts)


	June 30,			December 31,
	2006			2005
	(Unaudited)
Assets

Current assets:
Cash and cash eqivalents	$	17,780		$	16,956
Accounts receivable — net of reserve for uncollectibles — $144 and $171, in 2006 and 2005, respectively		3,383			3,680
Other accounts receivable		156			354
Materials and supplies		1,190			1,116
Prepaid income taxes		1,269			1,882
Prepaid expenses		771			929
Deferred income taxes		414			167

Total Current Assets		24,963			25,084


Property, plant and equipment, net		36,863			37,854
Unamortized debt issuance costs		83			90
Intangible asset — pension		625			624
Other deferred charges		821			848
Investments		3,859			3,606
Other assets		123			123


Total Assets	$	67,337		$	68,229


Liabilities and Shareholders’ Equity

Current Liabilities:
Accounts payable	$	845		$	823
Current maturities of long-term debt		1,519			1,519
Advance billing and payments		295			253
Customer deposits		138			141
Accrued taxes		13			34
Pension and post retirement benefit obligations		714			1,429
Other accrued expenses		2,335			2,486

Total Current Liabilites		5,859			6,685


Long-term debt, net of current maturities		7,973			8,732
Deferred income taxes		7,103			6,747
Other liabilities and deferred credits		597			561
Pension and post retirement benefit obligations		5,826			5,273


Total Liabilities		27,358			27,998


Shareholders’ Equity
Preferred Shares — $100 par value; authorized and issued shares of 5,000; $0.01 par value authorized and unissued shares of 10,000,000;		500			500
Common stock — $0.01 par value; authorized shares of 10,000,000 issued 5,985,463 shares as of June 30, 2006 and December 31, 2005		60			60
Treasury stock — at cost, 633,683 Common Shares as of June 30, 2006 and December 31, 2005		(4,748	)		(4,748	)
Additional paid in capital		3,487			3,487
Accumulated other comprehensive (loss)		(1,756	)		(1,756	)
Retained earnings		42,436			42,688

Total Shareholders’ Equity		39,979			40,231


Total Liabilities and Shareholders’ Equity	$	67,337		$	68,229

Please see accompanying notes, which are an integral part of the consolidated financial statements.

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,
	2006			2005			2006			2005
Operating Revenues:
Local network service	$	908		$	967		$	1,824		$	1,954
Network access service		2,109			2,062			4,043			4,306
Long distance services		890			880			1,746			1,813
Directory advertising		328			350			668			701
Online services		1,577			1,700			3,206			3,417
Other services and sales		529			426			929			884


Total operating revenues		6,341			6,385			12,416			13,075


Operating Expenses:
Plant specific		1,211			1,160			2,376			2,288
Plant non-specific:
Depreciation and amortization		1,434			1,357			2,905			2,722
Other		890			820			1,760			1,676
Customer operations		1,088			1,049			2,113			2,146
Corporate operations		2,609			1,973			4,489			3,925
Cost of services and sales		230			420			590			839
Property, revenue and payroll taxes		333			334			680			754


Total operating expenses		7,795			7,113			14,913			14,350


Operating loss		(1,454	)		(728	)		(2,497	)		(1,275	)

Other Income (Expense):
Interest income (expense), net of capitalized interest		23			(57	)		6			(120	)
Income from equity method investments, net		2,487			2,450			4,768			4,894
Gain on sale of investment		—			889			611			889
Other income (expense)		(6	)		19			(12	)		73


Total other income (expense) — net		2,504			3,301			5,373			5,736


Income before income taxes		1,050			2,573			2,876			4,461

Income Taxes		356			910			974			1,576


Net Income		694			1,663			1,902			2,885

Preferred Dividends		7			7			13			13


Income Applicable to Common Stock	$	687		$	1,656		$	1,889		$	2,872


Basic and Diluted Earnings per Share of Outstanding Common Stock	$	0.13		$	0.31		$	0.35		$	0.54


Weighted Average Shares of Common Stock Outstanding		5,351,780			5,351,780			5,351,780			5,368,078

Please see accompanying notes, which are an integral part of the consolidated financial statements.

WARWICK VALLEY TELEPHONE COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
($ in thousands)


FOR THE SIX MONTHS ENDED JUNE 30,	2006			2005
CASH FLOW FROM OPERATING ACTIVITIES:

Net income	$	1,902		$	2,885
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,905			2,722
Deferred income taxes		111			1,314
Interest charged to construction					(4	)
Income from equity investments, net of distributions		(342	)		(210	)
Gain on sale of investment		(611	)		(889	)

Changes in assets and liabilities:
(Increase) Decrease in accounts receivable		298			317
(Increase) Decrease in other accounts receivable		198			860
(Increase) Decrease in materials and supplies		(74	)		(76	)
(Increase) Decrease in prepaid income taxes		613			(1,333	)
(Increase) Decrease in prepaid expenses		158			3
(Increase) Decrease in deferred charges		28			37
Increase (Decrease) in accounts payable		23			163
Increase (Decrease) in customers’ deposits		(3	)		(5	)
Increase (Decrease) in advance billing and payment		42			44
Increase (Decrease) in deferred income		—			(889	)
Increase (Decrease) in accrued taxes		(21	)		(425	)
Increase (Decrease) in pension and post retirement benefit obligations		(161	)		(276	)
Increase (Decrease) in other accrued expenses		(150	)		265
Increase (Decrease) in accrued access billing		—			(827	)
Increase (Decrease) in other liabilities and deferred credits		36			(30	)


Net cash provided by operating activities		5,100			3,646


CASH FLOW FROM INVESTING ACTIVITIES:
Capital expenditures		(1,914	)		(1,415	)
Interest charged to construction		—			4
Sale of investment		700			889
Investment contributions		—			(238	)


Net cash used in investing activites		(1,362	)		(760	)


CASH FLOW FROM FINANCING ACTIVITES:
Repayment of long-term debt		(760	)		(760	)
Dividends (Common and Preferred)		(2,154	)		(2,154	)
Purchase of treasury stock		—			(1,150	)


Net cash used in financing activities		(2,914	)		(4,064	)


Increase (decrease) in cash and cash equivalents		824			(1,178	)

Cash and cash equivalents at beginning of period		16,956			16,809


Cash and cash equivalents at end of period	$	17,780		$	15,631

Please see the accompanying notes, which are an integral part of the consolidated financial statements

WARWICK VALLEY TELEPHONE COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
($ in thousands except share and 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, 2006 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.

NOTE 2: EARNINGS PER SHARE

Basic and diluted earnings per share are based on the weighted average number of actual shares outstanding of 5,351,780 for the three months ended June 30, 2006 and 2005 and 5,351,780 and 5,368,078 for the six months ended June 30, 2006 and 2005, respectively.

The Company did not have any common stock equivalents as of June 30, 2006 and 2005.

NOTE 3: COMPREHENSIVE INCOME

Comprehensive income is equivalent to net income for the three and six months ended June 30, 2006 and 2005. The Company’s only component of comprehensive loss consists of minimum pension liability.

WARWICK VALLEY TELEPHONE COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
($ in thousands except share and per share amounts)

NOTE 4: SEGMENT INFORMATION

Warwick Valley Telephone Company’s segments are strategic business units that offer different products and services and are managed as telephone and online services. We evaluate the performance of the segments 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 and long distance services and messaging, and yellow and white pages advertising and electronic publishing.

The Online segment provides high speed and dial-up Internet services and Video over VDSL.

Segment balance sheet information as of June 30, 2006 and December 31, 2005 is set forth below:


	June 30,			December 31,
	2006			2005

Assets
Telephone	$	73,399		$	73,820
Online		10,674			10,508
Elimination		(16,736	)		(16,099	)

Total assets	$	67,337			68,229

Segment cash flow information for the six months ended June 30, 2006 and 2005 is set forth below:


	June 30,		June 30,
	2006		2005

Capital Expenditures
Telephone	$	1,551	$	1,099
Online		363		316

Total Capital Expenditures	$	1,914	$	1,415

WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
($ in thousands except share and per share amounts)

Segment income statement information for the three months ended June 30, 2006 and 2005 is set forth below:


	2006			2005

Revenues
Telephone	$	5,232		$	5,147
Online		1,577			1,700
Eliminations		(468	)		(462	)

Total Revenues	$	6,341		$	6,385


Depreciation and Amortization
Telephone	$	922		$	944
Online		512			413

Total depreciation and amortization	$	1,434		$	1,357


Operating (Loss)
Telephone	$	(1,175	)	$	(589	)
Online		(279	)		(139	)

Total operating loss		(1,454	)		(728	)


Interest expense and income		23			(57	)
Income from equity investments, net		2,487			2,450
Gain on sale of investment		—			889
Other income (expense)		(6	)		19

Income before income taxes	$	1,050		$	2,573

NOTE 5: MATERIALS AND SUPPLIES

Material and supplies are carried at average cost. As of June 30, 2006 and December 31, 2005, material and supplies consisted of the following:


	2006		2005

Materials and supplies for outside plant	$	293	$	274
Materials and supplies for inside plant		544		550
Materials and supplies for online equipment		41		19
Materials and supplies for video equipment		95		105
Material and supplies for equipment held for sale or lease		217		168

	$	1,190	$	1,116

WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
($ in thousands except share and per share amounts)

NOTE 6: PROPERTY, PLANT AND EQUIPMENT

Property, Plant and Equipment at cost, consisted of the following as of June 30, 2006 and December 31, 2005:


	2006		2005

Land, buildings and other support equipment	$	8,222	$	8,219
Network communications equipment		27,468		31,074
Telephone plant		26,236		25,800
Online plant		10,912		10,860

Plant in service		72,838		75,953
Plant under construction		1,297		157

		74,135		76,110
Less: Accumulated depreciation		37,272		38,256

Property, plant and equipment, net	$	36,863	$	37,854

NOTE 7: 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:


	2006		2005

Net Sales	$	81,057	$	83,065
Cellular service cost		14,025		12,551
Operating expenses		3,946		3,103

Operating income		63,086		67,411
Other income		486		326

Net income	$	63,572	$	67,737


Company share of 7.5%	$	4,768	$	5,080

WARWICK VALLEY TELEPHONE COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
($ in thousands except share and per share amounts)

The following summarizes O-P’s income statement for the three months ended June 30:


	2006		2005

Net Sales	$	42,588	$	43,302
Cellular service cost		7,658		7,965
Operating expenses		2,039		1,772

Operating income		32,891		33,565
Other income		268		217

Net income	$	33,159	$	33,782

Company share of 7.5%	$	2,487	$	2,534

The following summarizes O-P’s balance sheet as of June 30, 2006 and December 31, 2005:


	2006		2005

Current assets	$	14,115	$	9,812
Property, plant and equipment, net		38,453		37,516

Total assets	$	52,568	$	47,328


Current liabilities		1,100		432
Partners’ capital		51,468		46,896

Total liabilities and partners’ capital	$	52,568	$	47,328

Investment in Zefcom

As of December 31, 2005, the Company owned a 17% interest in Zefcom, LLC, d.b.a. Telispire, a consortium of small telephone companies that resells Sprint PCS and Verizon Wireless under private label, which was accounted for under the equity method of accounting. The Company’s shares of Zefcom’s losses have been reflected in “Income from equity investments, net” in the Income Statement for the three and six months ended June 30, 2005. In January 2006, the Company sold its interest in Zefcom to an outside investor for $700 in cash and realized a gain of $611, which has been reflected in “Gain from sale of investment” in the Income Statement for the six months ended June 30, 2006.

Investment in EsiNet

As of December 31, 2005, the Company had made total capital contributions of $950 in cash to Empire State Independent Fiber Network, LLC (“EsiNet”), satisfying its entire capital contribution commitment. On November 9, 2005, EsiNet closed a commitment with the Rural Telephone Finance Cooperative (“RTFC”) with respect to a $6,750, 10 year secured term credit facility at a variable rate of interest. The loan is secured by all personal, tangible and intangible property of EsiNet, along with all rents, income, revenue, profits and other benefits derived or received from these properties. The proceeds are to be used mainly to finance a portion of the construction of its fiber optic network throughout upstate New York.

WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
($ in thousands except share and per share amounts)

In March 2006, the Company’s management conducted a review of EsiNet’s 2006 operating cash flow budget. Based upon this review, and subsequent discussions with EsiNet’s management, it became evident to the Company that EsiNet, while continuing its infrastructure build-out in 2006, was also projecting a significant short-term operating cash flow deficit of a magnitude that it could both jeopardize the construction timetable and potentially force EsiNet into insolvency and loan default. EsiNet’s management has indicated to the Company that it intends to address this situation by enacting cost cutting measures, redirecting a portion of the RFTC loan proceeds away from the infrastructure build-out towards operating expenses, and approaching certain vendors, particularly those from whom it currently leases fiber routes, in order to restructure existing agreements to defer costs to a future date and thus conserve cash. In addition, EsiNet is actively seeking additional sources of equity financing from its existing partners and from outside sources. However, EsiNet, to-date, has no restructured agreements in place with vendors and has not secured any commitments for additional equity financing and thus has failed to provide the Company with any reasonable assurance that it will generate sufficient cash flow to remain a viable going concern in the near future. Accordingly, the Company determined that there existed as of December 31, 2005, a permanent impairment of the entire amount of this investment ($705, representing the original capital contribution of $950, less cumulative equity in losses of $245 as of December 31, 2005). Consequently, the entire amount of this investment was written off and reflected in the “Loss from write-down of investments” in the Income Statement for the year ended December 31, 2005. The effects on net income and earnings per share for the year ended December 31, 2005 were $457 and $0.08 per share, respectively.

NOTE 8: PENSION AND POST RETIREMENT OBLIGATIONS

The components of net periodic cost for the three months ended June 30 are as follows:


							Post Retirement
	Pension Benefits						Benefits
	2006			2005			2006			2005

Service cost	$	1		$	—			60			53
Interest cost		209			196			102			96
Expected return on plan assets		(221	)		(201	)		(38	)		(34	)
Amortization of transition asset		—			—			13			13
Amortization of prior service cost		52			—			(5	)		(5	)
Amortization of net loss		—			35			75			68


Net periodic benefit cost	$	41		$	30		$	207		$	191

The components of net periodic cost for the six months ended June 30 are as follows:


							Post Retirement
	Pension Benefits						Benefits
	2006			2005			2006			2005

Service cost	$	2		$	—			120			106
Interest cost		418			392			204			192
Expected return on plan assets		(442	)		(402	)		(76	)		(68	)
Amortization of transition asset		—			—			26			26
Amortization of prior service cost		104			—			(10	)		(10	)
Amortization of net loss		—			70			150			136


Net periodic benefit cost	$	82		$	60		$	414		$	382

WARWICK VALLEY TELEPHONE COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
($ in thousands except share and per share amounts)

The Company has previously disclosed in its financial statements for the year ended December 31, 2005 that it expected to contribute $1,051 to its pension plan and $378 to its post retirement plan in 2006. As of June 30, 2006, the Company made contributions of $525 and $189, respectively.

NOTE 9: SHAREHOLDERS’ EQUITY

The Company has 10,000,000 authorized Common Shares at a par value of $0.01; 5,000 authorized Preferred Shares at a par value of $100; and 10,000,000 authorized Preferred Shares at a par value of $0.01.

NOTE 10: VOLUNTARY TERMINATION INCENTIVE PLAN

On June 29, 2006 the Company reached an agreement with Local Union No. 503 of the International Brotherhood of Electrical Workers AFL-CIO (the “Union”) that allows the Company to offer both its Plant and Clerical employees a Voluntary Termination Incentive Plan (the “VTIP”). The VTIP is part of the corporate restructuring and force reduction plan. Under the VTIP, eligible employees can receive an incentive payment for years of completed service and continued medical coverage for certain periods of time based upon years of service. Eligible employees have until August 13, 2006 to participate in the program. As of June 30, 2006 the Company has accrued $754 to cover the cost of employees who have elected to participate in the VTIP to date. This liability is included in “Other accrued expenses” in the Balance Sheet as of June 30, 2006. The Company cannot now predict how many additional employees will ultimately take advantage of the program or if some of the participants who volunteered and, therefore, cannot estimate what the final cost will be. Given these circumstances, the Company believes that the range of its exposure for the VTIP is between $600 and $900.

NOTE 11: COMMITMENTS

	•		Retention Agreements — The Company has entered into employment retention agreements with its two executive officers Mr. Herbert Gareiss, Jr., Chief Executive Officer, and Mr. Michael A. Cutler, Chief Financial Officer. The agreements are intended to secure the services of the executive officers until the engagement of its investment bankers come to an end or eighteen months after the retention agreements were executed. If they continued to be employed by the Company at that time, they will each receive $200,000.

	•		The Company has entered into a contract on May 16, 2006 with Quintrex Data Systems, a supplier of software for telecommunications companies, for the purpose of improving the Company’s business operating support systems that will simultaneously automate and improve the Company’s internal controls over financial reporting. The Company anticipates the systems will be fully integrated in the fourth quarter of 2006. Anticipated capital costs associated with the implementation are estimated to be at $1.2 million.

	•		The Company has entered into an agreement with Nortel Networks to upgrade the existing switching equipment to its latest software with the inclusion of “Soft Switch” capabilities. This agreement was entered into on April 5, 2006 and is estimated to cost $1.4 million with an implementation timeline of approximately six months. This will provide the Company with the ability to launch new products into both its incumbent local exchange carrier property and expand the competitive local exchange carrier properties.

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

The Company operates in the communications services industry and 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 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.

Voluntary Termination Incentive Plan

Sale of Investment

As of December 31, 2005, the Company owned a 17% interest in Zefcom, LLC, d.b.a. Telispire, a consortium of small telephone companies that resells Sprint PCS and Verizon Wireless under private label, which was accounted for under the equity method of accounting. On January 3, 2006 the Company sold its interest in Zefcom to an outside investor for $700 in cash. The Company’s net investment in Zefcom at the time of the sale was $89. The Company realized a gain on the sale of $611. This gain is reflected in the “Gain on sale of investment” in the Consolidated Statement of Income for the six months ended June 30, 2006.

Results of Operations for the three months ended June 30, 2006 and 2005 — (in thousands)

OPERATING REVENUES

Operating revenues decreased by $44 (or 1%) from $6,385 in 2005 to $6,341 in 2006. This decrease was due primarily to:

	•		A decrease in Online service revenues of $123 (or 7%) mainly due to a decrease of $141 (or 30%) in dial-up service revenues which reflects the continued migration of customers (loss of 32% versus 2005) primarily outside the Company’s service territory who migrated to other high speed Internet providers. DSL and Video revenues increased marginally, DSL $7 (or 1%) and Video $11 (or 2%), largely due to customers choosing lower priced bundle packages while the number of DSL and Video subscribers remained flat. In total, the number of customers choosing the Company’s Internet dial-up services decreased from 7,284 in 2005 to 4,947 in 2006 or a decrease of 32%.

	•		A decrease in Local network service revenues of $59 (or 6%) mainly as a result of customers switching to the competition’s telephone service and the loss of second access lines that were being utilized for dial-up Internet service as customers continue to switch to DSL broadband services for internet access. The number of access lines decreased from 27,398 in 2005 to 25,352 in 2006, a decrease of 7%.

	•		A decrease in Directory advertising revenues of $22 (or 6%) as demand for local regional and national directory ad pages continued to decline in 2006.

Partially offset by:

	•		An increase in Other service and sales revenues of $103 (or 24%) mainly due to increased revenues generated from the ongoing installation of a communications system at a large residential and resort complex located in our New Jersey territory, partially offset by the continued drop in rates that were mandated by FCC for reciprocal compensation and the continued decline in sales of non-regulated ancillary services.

	•		An increase in Long distance sales revenues of $10 or 1% due to an increase in the number of subscribers to the Company’s long distance plan versus the comparable period in 2005.

	•		An increase in Network access service revenues of $47 (or 2%) mainly due to higher local switching support revenues received from the Universal Service Fund (the “USF”), offset mainly by lower switched access revenues, reflecting a 23% decline in total switched access minutes in 2006 versus the comparable period in 2005. The lower switched access were themselves partially offset by the recognition of additional switch access revenues in the second quarter of 2006 that had been previously reserved in full against possible refunds related to billing disputes.

OPERATING EXPENSES

Operating expenses increased $682 (or 10%) from $7,113 in 2005 to $7,795 in 2006. This increase is due mainly to:

	•		Corporate operations expense that were higher by $636 (or 32%) mainly as the result of a reserve established for employees electing the VTIP, higher legal fees and annual meeting expenses associated with the previously reported shareholder suit regarding the recent Annual Meeting, partially offset by lower professional and consulting fees associated with the Company’s ongoing efforts to comply with Section 404 of the Sarbanes-Oxley Act.

	•		Depreciation and amortization expense that was higher by $77 (or 6%) due mainly to the increased depreciation associated with a change in the estimated life of certain video equipment from seven to three years which took effect, on a prospective basis, in the third quarter of 2005.

	•		Plant specific expenses that were higher by $51 (or 4%) mainly the result of increased cost of labor and benefits in 2006. This increase reflects a continued shift in work effort from capital improvements and upgrades to routine repair and maintenance projects versus capital improvements and upgrades (capital expenditures are discussed in “Cash Flow from Investing Activities” below).

	•		Other plant non-specific expenses that were higher by $70 (or 9%) due mainly to higher salaries and benefits for plant support services allocated to operating expenses versus capital projects for the reasons cited with regard to Plant specific expenses above, and higher content costs associated with the video product.

	•		Customer operations expenses that were higher by $39 (or 4%) due mainly to higher outside consulting fees associated with market research and carrier access billing, partially offset by lower salaries and benefits as a result of attrition and lower advertising and promotion expenses.

Partially offset by:

•

Cost of service and sales that were lower by $190 (or 45%) due mainly to a cost savings resulting from ongoing efforts to better manage trunk line capacity requirements, and a reduction in bad debt expense.

OTHER INCOME (EXPENSE)

Other income (expense) decreased $797 (or 24%) from $3,301 in 2005 to $2,504 in 2006. This decrease is due mainly to:

	•		The $889 gain realized in 2005 in the connection with the Company’s previous sale of its investment in Hudson Valley DataNet.

	•		Other income (expense) that was lower by $25 related to sales of business communications equipment in the second quarter of 2006 versus the comparable prior period.

Partially offset by:

	•		Income from equity method investments net increased by $37 mainly as a result of the write-offs in 2005 of $70 of operating losses from Zefcom and $46 from EsiNet offset by the timing of a patronage dividend ($33) received from CoBank in 2005 and by lower earnings from O-P of $47 (or 2%) resulting from a reduction in wholesale rates in 2006 which were partially offset by continued subscriber growth.

	•		Net interest income of $23 in 2006 versus net interest expense of $57 in 2005 is due mainly to interest income earned on interest bearing cash equivalents offsetting higher interest rates on borrowings.

Results of Operations for the six months ended June 30, 2006 and 2005 — (in thousands)

OPERATING REVENUES

Operating revenues decreased by $659 (or 5%) from $13,075 in 2005 to $12,416 in 2006. This decrease was due primarily to:

	•		A decrease in Network access service revenues of $263 (or 6%) mainly due to a 21% decline in total switched access minutes in 2006 versus 2005, partially offset by higher local switching support revenues received from the USF.

	•		A decrease in Online service revenues of $211 (or 6%) mainly due to a decrease of $311 (or 31%) in dial-up service revenues due to the continued migration of customers (loss of 32% versus 2005) primarily outside our service territory to other high speed Internet providers, partially offset by increased Video revenues of $51 (or 6%) and DSL revenues of $49 (or 3%) due to a 2% increase in both Video and DSL subscribers, respectively in 2006 versus 2005.

	•		A decrease in Long distance network service revenues of $67 (or 4%) due to the continued decline in interstate interLATA volume as customers continue to switch to wireless and Internet based communications.

	•		A decrease in Local service revenues of $130 (or 7%) due to a 7% decrease in access lines in 2006 mainly as a result of customers switching to the competition’s telephone service and the loss of second access lines that were being utilized primarily for dial-up Internet service as customers continue to switch to broadband services for Internet access.

	•		A decrease in Directory advertising revenues of $33 (or 5%) as demand for local regional and national directory ad pages continued to decline in 2006.

Partially offset by:

•

An increase in Other service and sales revenues of $45 (or 5%) mainly due to an increase in revenues generated from the ongoing installation of a communications system at a large residential and resort complex located in our New Jersey territory, which was partially offset by lower rates that were mandated by FCC for reciprocal compensation and an overall decrease in sales of non-regulated ancillary services.

OPERATING EXPENSES

Operating expenses increased $563 (or 4%) from $14,350 in 2005 to $14,913 in 2006. This increase is due mainly to:

	•		Corporate operations expense that were higher by $564 (or 14%) mainly as the result of a reserve established for employees electing the VTIP, higher legal fees and annual meeting expenses associated with the previously reported suit brought by certain shareholders regarding the recent Annual Meeting and consulting fees associated with the retention of an investment banking firm engaged to assess strategic options for the Company, partially offset by lower professional and consulting fees associated with the Company’s ongoing efforts to comply with Section 404 of the Sarbanes-Oxley Act.

	•		Depreciation and amortization expense that was higher by $183 (or 7%) due mainly to the increased depreciation associated with a change in the estimated life of certain video equipment from seven to three years which took effect, on a prospective basis, in the third quarter of 2005.

	•		Plant specific expenses that were higher by $88 (or 4%) mainly the result of increased cost of labor and benefits in 2006. This increase reflects a continued shift in work effort as it relates to plant infrastructure towards routine repair and maintenance projects versus capital improvements and upgrades (capital expenditures are discussed in “Cash Flow from Investing Activities” below).

•

Other plant non-specific expenses that were higher by $84 (or 5%) due mainly to higher salaries and benefits for plant support services allocated to operating expenses versus capital projects for the reasons cited in relation to Plant specific expenses above and higher content costs associated with the video product.

Partially offset by:

	•		Cost of service and sales that were lower by $249 (or 30%) due mainly to a cost savings resulting from ongoing efforts to better manage trunk line capacity requirements, and a reduction in bad debt expense.

	•		Property, revenue and payroll taxes that were lower by $74 (or 10%) due mainly to lower state franchise taxes.

	•		Customer operations expenses that were lower by $33 (or 2%) due mainly to lower salaries and benefits as the result of attrition and lower advertising and promotion expenses, partially offset by higher outside consulting fees associated with market research and carrier access billing.

OTHER INCOME (EXPENSE)

Other income (expense) decreased $363 (or 6%) from $5,736 in 2005 to $5,373 in 2006. This decrease is due mainly to:

	•		The $889 gain realized in 2005 in connection with the Company’s previous sale of its investment in Hudson Valley DataNet.

	•		Income from equity method investments, net that was lower by $126 (or 3%) from $4,894 in 2005 to 4,768 in 2006 due mainly to the timing of a patronage dividend ($33) received from CoBank in 2005 and to lower earnings from O-P of $312 (or 6%) resulting from a reduction in wholesale rates in 2006 which could not be completely offset by continued subscriber growth. Partially offsetting this decline was the absence in 2006 of operating losses from Zefcom ($132 in 2005), which was sold in January 2006, and EsiNet ($88 in 2005), which was written-off in December 2005.

	•		Other income (expense) that was lower by $85 due to the absence in 2006 of nonrecurring sales of communications equipment which took place during the comparable period in 2005.

Partially offset by:

	•		A $611 gain realized on the sale of the Company’s investment in Zefcom in January 2006.

	•		A net interest income of $6 in 2006 versus net interest expense of $120 in 2005 due mainly to interest income earned on interest bearing cash equivalents offsetting higher interest rates on borrowings.

LIQUIDITY AND CAPITAL RESOURCES

The Company had $17,780 of cash and cash equivalents available at June 30, 2006. The Company has a $4,000 line of credit with Provident Bank, of which the entire amount remained unused at June 30, 2006. Interest is at a variable rate and borrowings are on a demand basis without restrictions. In addition, the Company had an unsecured credit facility with CoBank ACB at a variable rate averaging 6.9% for the six months ended June 30, 2006. The ability of the Company to draw against the commitment expired on September 30, 2004. The loan remains outstanding until all indebtedness and obligations of the Company under the facility have been paid or satisfied, but no later than July 2012. As of June 30, 2006, $9,491 in principal amount was outstanding under the CoBank ACB term credit facility. In October 2004, the Company began making principal payments on the outstanding debt; the final payment is due July 20, 2012. The Company has no more available borrowings under this facility.

CASH FROM OPERATING ACTIVITIES

The Company’s primary source of funds continues to be generated from operations, supplemented by cash distributions from O-P. The Company’s cash distributions from O-P for the Company’s share of O-P earnings totaled $4,425 and $4,650 for the six months ended June 30, 2006 and 2005, respectively. O-P’s cash distributions are made to the Company on a quarterly basis at the discretion of the general partner.

CASH FROM INVESTING ACTIVITIES

Capital expenditures totaled $1,914 during the six months ended June 30, 2006 as compared to $1,415 for the corresponding period of 2005 The Company’s capital program to-date has largely been focused on the creation of a communication infrastructure for a large and expanding residential and resort complex located in the Company’s New Jersey CLEC territory. In connection with this project the Company has also begun deploying new video technology, and is presently studying the possibility of further deployment of this technology throughout the rest of its market in the second half of 2006.

CASH FROM FINANCING ACTIVITIES

Dividends declared by the Board of Directors of the Company were $0.20 per share for the three months ended June 30, 2006 and 2005, respectively. The total amount of dividends paid by the Company for the six months ended June 30, 2006 and 2005 on its common shares was $2,142. In March 2005, the Company purchased 50,000 of its Common Shares from a shareholder at $23 per share (or $1,150).

OTHER FACTORS:

COMPETITION

The Telecommunications Act of 1996 (the “1996 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 New York and New Jersey in which regional toll service is provided. Regional toll competition reduced the Company’s revenues. The Company itself can provide competitive local exchange telephone service, and has done so 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 WVLD. 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 cellular telephone providers and Internet-based service providers.

The Company’s territory is surrounded by the territories of Verizon Communications, Inc., Frontier — A Citizen’s Communications Company and Sprint-United Telephone, all of which offer residential and business telephone services and equipment. There is also several competitive telephone companies located within a 30-mile radius of Warwick, New York. In the fourth quarter of 2004 Cablevision entered the Company’s Warwick, New York market offering a bundled package of competing voice, video and data services at a low introductory price in an effort to gain market share from the Company.

The Company is currently competing for local service through access lines 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. The Company is reviewing plans to provide limited service in other surrounding areas in both New York and New Jersey. In addition, the Company is looking into business arrangements with other regional telecommunications companies in order to gain access to their transportation networks in order to expand the reach of the Company’s product offerings. There can be no assurances that the Company will implement any such additional plans, or that other companies will not begin providing competitive local exchange telephone service in the Company’s franchise territory.

The present market environment requires that Online compete both on the basis of service and price. There are numerous competitors throughout Online’s market area whose services are available to customers. During 2006, UltraLink increased its market penetration level, increasing the number of subscribers by 1%, while conversely, the number of customers for Online’s dial-up product decreased approximately 12% due to the migration of customers to high speed Internet provided either by the Company itself or by the competition, the latter 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 voice, video and data services.

In addition, our Video product, which was launched in April 2002, is competing against entrenched cable companies including Service Electric Company (“SE”) and Cablevision, and satellite television companies such as Direct TV and Dish Network. In the current market environment, to stay competitive, the Company must be able to offer a video product on par with the Cable companies, which includes such in demand features as HD signal and VOD capability, and at a competitive price. There can be no assurances that the Company will be able to deliver such products profitably at a competitive price.

On November 10, 2003 Federal Communications Commission (the “FCC”) issued an order requiring intermodal portability (wire line to wireless) in the top one hundred Metropolitan Service Areas by November 23, 2004 where the requesting wireless carrier’s “coverage area” overlaps that of the local exchange carrier. As a result, the Company was required to provide intermodal Local Number Portability (“LNP”) by May 24, 2004. LNP assists a competitor in obtaining our customers because it permits customers to keep their current telephone number, even when they switch their telephone service from the Company to another carrier. To date, 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 New York Public Service Commission (the “NYPSC”), and the Company’s New Jersey telephone service operations to the jurisdiction of the New Jersey Board of Public Utilities ( the “NJBPU”). These two bodies have regulatory authority over the Company’s local exchange operations 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 which can slow down or even prevent the desired transaction. 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. The Video business operates in accordance with guidelines established by NYPSC, the NJBPU, and the FCC as well as the municipalities where the Company provides service.

The 1996 Act opened local telecommunications markets to competition, preempting state and local laws to the extent that they prevented competitive entry into a market. The 1996 Act allows states to retain the authority to preserve universal service, protect public safety and welfare, ensure quality of service, protect consumers and mediate and arbitrate disputes involving interconnection agreements between carriers. The 1996 Act generally requires local carriers to interconnect with other carriers, unbundle their services at wholesale rates, permit resale of their services, enable collocation of equipment, provide LNP and dialing parity, provide access to poles, ducts, conduits and rights-of-way, and complete calls originating by competing carriers under termination agreements.

In 2003 the FCC issued an order which essentially kept in place the 1996 Act regulatory regime with respect to Unbundled Network Elements Platform (“UNEP”) competition, allowed authority for the states to implement UNEP competition and pricing and eliminated a previous requirement that ILECs share their high-speed lines with competitors. Although a Federal court reversed some parts of the FCC’s order, including the delegation to the states to implement UNEP competition and pricing, the line sharing provisions of the order were upheld. On February 4, 2005, the FCC released permanent rules governing UNEPs. The Company believes that there will be minimal effect on its ILEC operations because the FCC’s impairment thresholds are at a level beyond the Company’s demographics and it does not currently have UNEP competition in its markets.

The FCC issued a press release in February 2005 announcing additional requirements for the designation of competitive Eligible Telecommunications Carriers (“ETC”) for receipt of high-cost support. In its corresponding order, released on March 17, 2005, the FCC adopted additional mandatory requirements for ETC designation in cases where it has jurisdiction. In that order the FCC encouraged states that have jurisdiction to designate ETCs to adopt similar requirements. The FCC is considering an overall rulemaking regarding the USF support which will be dealt with sometime in the next year. The Commission will consider as part of that rulemaking revisions to the methodology by which contributions to the USF are determined.

The advent of VoIP services being provided by cable television and other companies has heightened the need for Federal and State regulators to determine whether VoIP is subject to the same regulatory and financial constraints as wire line telephone service. On November 9, 2004, the FCC issued an order in response to a petition from Vonage declaring that Vonage-style VoIP services were exempt from state

telecommunications regulations. The FCC order applies to all VoIP offerings provided over broadband services. However, this order did not clarify whether or under what terms VoIP traffic may be subject to intercarrier compensation requirements; whether VoIP was subject to state tax or commercial business regulations; or whether VoIP providers had to comply with obligations related to 911 emergency calls, the USF and the Communications Assistance for Law Enforcement Act (“CALEA”). The FCC is addressing these issues through its “IP-Enabled Services Proceedings”, which opened in February 2004. On June 3, 2005, the FCC issued an order establishing rules requiring VoIP service providers to incorporate 911 emergency call capabilities for their customers as a standard feature of their services, rather than an optional enhancement. On September 23, 2005, the FCC required interconnected VoIP and broadband internet access service providers to comply with CALEA by mid-2007. Both of these 2005 orders have been appealed.

The FCC has decisions pending regarding the USF and inter-carrier compensation issues. The sustainability of the USF and the possible requirement that VoIP providers participate in funding rural carriers will affect and influence decisions to invest in new facilities. The same considerations apply to the continuation of inter-carrier compensation, or access charges, which is another element in the financial health of rural telephone companies. It was expected that the FCC would address issues involving inter-carrier compensation, USF and internet telephony in 2005. On February 10, 2005, the FCC adopted a Further Notice of Proposed Rulemaking (“FNPRM”) addressing inter-carrier compensation. Proposed inter-carrier compensation changes, such as “bill and keep” (under which switched access charges and reciprocal compensation would be reduced or eliminated), could reduce the Company’s access revenues.

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 adjusted by 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.

On June 29, 2005, the NYPSC issued an Order Instituting Proceeding and Inviting Comments in its Proceeding on Motion of the Commission on Issues Related to the Transition to Intermodal Competition in the Provision of Telephone Services (”Comp III”). Comp III seeks to address the state of competition, the impact competition is having on consumers and providers, and how these changes will, or should, impact the New York regulatory model. On August 15, 2005 the New York State Telephone Association (“NYSTA”) on behalf of the Company and other New York State ILECs, filed its comments in regard to Comp III with the NYPSC. In making its case, NYSTA asserted that, primarily driven by new technologies like VoIP and digital cable television voice services, intermodal competition has within a relatively short period of time created strong competitive alternatives to existing wireless and wire line services, and that ILECs need relief in the areas of consumer protection, mergers, sales and acquisitions, service quality reporting, complaint handling and flexible pricing.

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.

Although O-P is an important component of the Company’s revenues and value, the Company continues to believe that the Company is primarily engaged in businesses other than investing, reinvesting, owning, holding or trading in securities and is therefore not required to register as an investment company under the Investment Company Act of 1940. However, changes in circumstances, for example in the valuations of its assets and businesses, including O-P, or its effectiveness in developing new services and businesses or maintaining existing activities, could result in the possibility that the Company might need to restructure its assets or activities in order to remain in compliance with the Investment Company Act of 1940.

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-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 $5,000 of borrowed funds which CoBank has deposited in an interest bearing money market account on the Company’s behalf and a $3,500 certificate of deposit currently held with our primary commercial banker. In regards to its CoBank loan, the Company has the option of choosing the following rate options: 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

(a) Evaluation of Disclosure Controls and Procedures

As of December 31, 2005, the management of the Company carried out an assessment under the supervision of and with the participation of the Company’s Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(b) and 15d-15(b). In the course of completing management’s assessment of the Company’s internal control over financial reporting, management has identified certain control deficiencies that are material weaknesses, as reported in the Company’s Annual Report on Form 10-K for 2005 that was filed on March 28, 2006 (the “2005 Form 10-K”). As of the date of that assessment, the Chief Executive Officer and the Chief Financial Officer concluded that as a result of these material weaknesses, the Company’s disclosure controls and procedures were not effective as of December 31, 2005.

A material weakness is a significant deficiency (as defined in Public Company Accounting Oversight Board Auditing Standard No. 2), or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

The Company’s management with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation they have concluded that the Company’s disclosure controls and procedures are not effective in ensuring that all material information required to be filed with the Securities and Exchange Commission is recorded, processed, summarized and reported within the time period specified in the rules and forms of the Commission because of material weaknesses in its internal control over financial reporting as discussed above and in the Company’s 2005 Form 10-K.

In light of the material weaknesses described in the 2005 Form 10-K, management continues to perform additional analyses and other post-closing procedures to ensure that the Company’s condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in

the United States. Accordingly, management believes that the interim consolidated financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the period presented.

(b) Changes in Internal Control over Financial Reporting

As previously reported in the 2005 Form 10-K, the Company is implementing enhancements and changes to its internal control over financial reporting to provide reasonable assurance that errors and control deficiencies will not recur. For the most part, these remediation initiatives began in 2005 and represent the Company’s plan to remediate the material weaknesses identified above, with some of the remediation plans impacting only one material weakness, while other remediation plans will, after their implementation, remedy several of the material weaknesses.

(c) Recent Developments Relating to the Company’s Internal Control over Financial Reporting

During the quarter ended June 30, 2006, the Company conducted additional assessments and further development of its remediation plan to address material weaknesses. The Company has hired external parties to review, assess and recommend changes to the Company’s internal control over financial reporting. As a result, the Company has made operational and procedural improvements to its controls over financial reporting. The Company continues to use experienced outside resources to assist in the review, analysis and implementation of its internal control process. The Company implemented procedures to effectively manage the Company’s investments ensuring the completeness and accuracy of recording investments, recording gain on the disposition of an equity investment in the appropriate period and the presentation of related cash flows.

The Company continues to further implement its action plan to remediate material weaknesses identified as previously reported in the 2005 Form 10-K and improve its processes and control procedures. While these remediation efforts have improved the design effectiveness of internal controls over financial reporting, the Company has not fully remediated some of these material weaknesses as it is still in the process of testing and assessing there results. During the quarter ended June 30, 2006 the Company has:

	•		Continued efforts to upgrade the skill sets for the accounting group through continuing education and ongoing training while maintaining staffing with appropriate skills and experience in the application of accounting principles generally accepted in the United States of America (“GAAP”) commensurate with the Company’s financial reporting requirements.

	•		Entered into a contract on May 16, 2006 with Quintrex Data Systems, a supplier of software for telecommunications companies, for the purpose of improving the Company’s business operating support systems that will simultaneously automate and improve the Company’s internal controls over financial reporting. The Company anticipates the systems will be fully integrated in the fourth quarter of 2006. Anticipated capital costs associated with the implementation are estimated to be at $1.2 million.

	•		Continued to improve its controls surrounding the development, changes and maintenance of billing rates by restricting access to only authorized personnel.

	•		Continued to implement controls and designed procedures that require approval and processing of customer payments with the appropriate levels of management review and approval.

	•		Continued to improve its controls and procedures related to the switching process for tolls and carrier access billings that require appropriate levels of management review.

	•		Continued to increase controls regarding spreadsheets utilized in the period-end financial reporting process by restricting access to spreadsheets and the back-up of these spreadsheets.

Additional procedures for the controls that have materially affected, or are reasonably likely to materially affect, its internal controls over financial reporting have been implemented and tested as of the end of the period covered by this Quarterly Report.

No other changes to internal controls over financial reporting have come to the Company’s management’s attention during the six months ended June 30, 2006 that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.

PART II — OTHER INFORMATION

ITEM 1A. RISK FACTORS

The following risk factors modify certain portions of the risk factors that were set forth in the 2005 Form 10-K and should be read in connection therewith.

The Company has completed its assessment of the design and operating effectiveness of its internal controls over financial reporting, and has identified material weaknesses in its internal controls over financial reporting that may prevent the Company from being able to accurately report its financial results or prevent fraud. Such weaknesses could harm our business and operating results, the trading price of our stock and our access to capital.

Effective internal controls are necessary for us to provide reliable and accurate financial reports and prevent fraud. In addition, Section 404 under the Sarbanes-Oxley Act of 2002 required the Company to evaluate, and its independent registered public accounting firm to attest to, the design and operating effectiveness of the Company’s internal control over financial reporting. If the Company cannot provide reliable and accurate financial reports and prevent fraud, its business and operating results could be harmed. In connection with the evaluation of its internal control over financial reporting, the Company identified material weaknesses, and may discover in the future, areas of its internal control that need improvement. The Company’s efforts regarding internal controls are discussed in detail in the 2005 Form 10K under Item 9A, “Controls and Procedures.” We cannot be certain that any remedial measures we take will ensure that we design, implement, and maintain adequate controls over our financial processes and reporting in the future or will be sufficient to address and eliminate these material weaknesses. Remedying the material weaknesses that have been identified, and any additional deficiencies, significant deficiencies or material weaknesses that we or our independent registered public accounting firm may identify in the future, could require us to incur additional costs, divert management resources or make other changes.” The Company has not yet remediated all the material weaknesses described in the 2005 Form 10-K under Item 9A, “Controls and Procedures.” If the Company does not remediate these material weaknesses, it will be required to report in its Quarterly Reports on Form 10-Q or in subsequent reports filed with the Securities and Exchange Commission that material weaknesses in the Company’s internal controls over financial reporting continue to exist. Any delay or failure to design and implement new or improved controls, or difficulties encountered in their implementation or operation, could harm its operating results, cause it to fail to meet its financial reporting obligations, or prevent it from providing reliable and accurate financial reports or avoiding or detecting fraud. Disclosure of the Company’s material weaknesses, any failure to remediate such material weaknesses in a timely fashion or having or maintaining ineffective internal controls could cause investors to lose confidence in the Company’s reported financial information, which could have a negative effect on the trading price of its stock and its access to capital.

If the Company is unable to file its financial statements, it could be delisted by Nasdaq and the Company’s stockholders could find it difficult to buy or sell the Company’s Common Shares.

The Company’s Common Shares currently trade on Nasdaq. Nasdaq requires companies to fulfill specific requirements in order for their shares to continue to be listed, including the timely filing of reports with the Securities and Exchange Commission. Consequently, its securities may be considered for delisting if the Company fails to file annual and quarterly reports by the prescribed deadlines, fails to remediate documented material weaknesses in a timely manner or fails to develop and maintain effective controls and procedures. Any of the above could adversely affect the Company’s stock price and subject the Company to sanctions by Nasdaq, or the Securities and Exchange Commission. If the Company’s Common Shares are not listed, it could be more difficult and expensive for investors to buy or sell them.

ITEM 5. OTHER INFORMATION

Shareholders in 401(k) Plan

As of June 30, 2006, 2.5% of the Company’s outstanding Common Shares were held by employees in the Company’s 401(k) plan. These percentages fluctuate quarterly.

Strategic Planning

As previously reported, the Company has retained the investment banking firm Stifel, Nicolaus & Company, Incorporated (“Stifel”) to assist the Company in assessing the strategic options available to the Company. These options could include acquisitions or joint ventures by the Company or the sale of all or a part of the Company. The Company and Stifel are still in the process of evaluating the various options. There can be no assurances that any transaction or action of any kind will result from this engagement.

ITEM 6. EXHIBITS

10.1 Retention agreement-Herbert Gareiss, Jr.-Principal Executive Officer

10.2 Retention agreement-Michael Cutler-Principal Financial Officer

31.1 Rule 13a-14(a)/15d-14(a) Certificate signed by Herbert Gareiss, Jr. — Principal Executive Officer.

31.2 Rule 13a-14(a)/15d-14(a) Certificate signed by Michael Cutler — Principal Financial Officer.

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.

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 Michael Cutler — Principal Financial Officer.


Part I – Financial Information

Item 1. Financial Statements (unaudited)

Consolidated Balance Sheets as of June 30, 2006 (unaudited) and December 31, 2005 (audited)			3

Consolidated Statements of Income for the three and six months ended June 30, 2006 and 2005			4

Consolidated Statements of Cash Flows for the six months ended June 30, 2006 and 2005			5

Notes to Consolidated Financial Statements			6-13

Item. 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			14-21

Item. 3. Quantitative and Qualitative Disclosures about Market Risk			21

Item. 4. Controls and Procedures			21-23

Part II — Other Information

Item 1A. Risk Factors			23-24

Item 5. Other Information			24

Item 6. Exhibits			24
EX-10.1
EX-10.2
EX-31.1
EX-31.2
EX-32.1
EX-32.2


		Warwick Valley Telephone Company
		Registrant

Date 8/09/06		/s/Herbert Gareiss, Jr.
		Herbert Gareiss, Jr.,
		President, Duly Authorized Officer

Date 8/09/06		/s/Michael Cutler
		Michael Cutler,
		Vice President, Principal Financial Officer

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