FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

(Mark One)

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

For the quarterly period ended September 30, 2005

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 0-13716

NORTH PITTSBURGH SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Pennsylvania	25-1485389
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

4008 Gibsonia Road, Gibsonia, Pennsylvania 15044-9311

(Address of principal executive offices)

(Zip Code)

724.443.9600

(Registrant’s telephone number, including area code)

No Change

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

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

The number of shares of the registrant’s Common Stock (par value $.15625 per share) outstanding as of October 31, 2005 was 15,005,000.

TABLE OF CONTENTS

PART I	Financial Information
	Report of Independent Registered Public Accounting Firm	3
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Statements of Income For the three and nine months ended September 30, 2005 and 2004	4
	Condensed Consolidated Balance Sheets September 30, 2005 and December 31, 2004	5
	Condensed Consolidated Statements of Cash Flows For the nine months ended September 30, 2005 and 2004	7
	Notes to Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	28
Item 4.	Controls and Procedures	28
PART II	Other Information
Item 6.	Exhibits	29
SIGNATURES		31

2

PART I

FINANCIAL INFORMATION

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

North Pittsburgh Systems, Inc.:

We have reviewed the condensed consolidated balance sheet of North Pittsburgh Systems, Inc. and subsidiaries (the Company) as of September 30, 2005, the related condensed consolidated statements of income for the three-month and nine-month periods ended September 30, 2005 and 2004, and the related condensed consolidated statements of cash flows for the nine-month periods ended September 30, 2005 and 2004. These condensed consolidated financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of North Pittsburgh Systems, Inc. and subsidiaries as of December 31, 2004, and the related consolidated statements of income, shareholders’ equity and comprehensive income, and cash flows for the year then ended (not presented herein); and in our report dated March 4, 2005, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ KPMG LLP

KPMG LLP

Pittsburgh, Pennsylvania

November 7, 2005

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PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Income (Unaudited)

(Amounts in Thousands – Except Per Share Data)

	For the Three Months Ended September 30						For the Nine Months Ended September 30
	2005			2004			2005			2004
Operating revenues:
Local network services	$	7,982		$	7,218		$	23,714		$	21,350
Long distance and access services		15,899			16,174			49,269			49,394
Directory advertising, billing & other services		339			322			1,053			1,033
Telecommunication equipment sales		339			394			1,187			1,510
Other operating revenues		2,973			2,983			9,352			8,620
Total operating revenues		27,532			27,091			84,575			81,907
Operating expenses:
Network and other operating expenses (exclusive of depreciation and amortization shown separately below)		14,672			14,463			43,244			43,050
Depreciation and amortization		4,926			4,738			14,701			14,073
State and local taxes		808			823			2,712			2,791
Telecommunication equipment expenses		249			262			862			1,049
Total operating expenses		20,655			20,286			61,519			60,963
Net operating income		6,877			6,805			23,056			20,944
Other income (expense), net:
Interest expense		(405	)		(466	)		(1,239	)		(1,436	)
Interest income		387			107			963			233
Equity income of affiliated companies		1,676			1,637			4,720			3,807
Sundry income (expense), net		9			(47	)		(20	)		(120	)
Total other income (expense), net		1,667			1,231			4,424			2,484
Income before income taxes		8,544			8,036			27,480			23,428
Provision for income taxes		3,509			3,315			11,297			9,662
Net income	$	5,035		$	4,721		$	16,183		$	13,766
Weighted average common shares outstanding		15,005			15,005			15,005			15,005
Basic and diluted earnings per share	$	.34		$	.31		$	1.08		$	.92
Dividends per share	$	.19		$	.18		$	.56		$	.54

See accompanying notes to unaudited condensed consolidated financial statements.

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NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Amounts in Thousands)

	(Unaudited) Sept. 30 2005		Dec. 31 2004
ASSETS
Current Assets:
Cash and temporary investments	$	49,270	$	42,569
Marketable securities available for sale		464		487
Accounts receivable:
Customers, net of allowance for doubtful accounts of $683 and $565, respectively		6,075		5,320
Access services, settlements and other		5,649		7,027
Unbilled revenues		594		591
Prepaid expenses		946		748
Inventories		1,616		1,539
Prepaid taxes other than income taxes		234		—
Deferred income taxes		1,076		1,199
Total current assets		65,924		59,480
Property, plant and equipment:
Land		475		475
Buildings		14,817		14,107
Equipment		205,316		200,484
Assets held under capital lease		10,498		10,498
		231,106		225,564
Less accumulated depreciation and amortization		161,599		148,730
		69,507		76,834
Construction in progress		3,687		3,212
Total property, plant and equipment, net		73,194		80,046
Investments		14,590		13,902
Intangible asset		824		824
Other assets		1,246		1,248
Total assets	$	155,778	$	155,500

(Continued)

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NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Amounts in Thousands)

	(Unaudited) Sept. 30 2005			Dec. 31 2004
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	3,085		$	3,085
Obligation under capital lease		927			1,086
Accounts payable		4,095			6,322
Advance billings		1,780			1,714
Dividend payable		2,851			2,701
Other accrued liabilities		3,081			3,702
Federal and state income taxes		2,078			1,713
Total current liabilities		17,897			20,323
Long-term debt		19,283			21,597
Obligation under capital lease		3,952			4,588
Deferred income taxes		6,498			8,490
Accrued pension and postretirement benefits		12,403			13,038
Other liabilities		1,117			603
Total liabilities		61,150			68,639
Shareholders’ equity:
Capital stock: authorized 50,000 shares:
Common stock, par value $.15625; issued 15,040 shares and outstanding 15,005 shares		2,350			2,350
Preferred stock, par value $1.00; none issued		—			—
Capital in excess of par value		2,215			2,215
Retained earnings		92,607			84,827
Less cost of treasury stock (35 shares)		(508	)		(508	)
Accumulated other comprehensive loss		(2,036	)		(2,023	)
Total shareholders’ equity		94,628			86,861
Total liabilities and shareholders’ equity	$	155,778		$	155,500

See accompanying notes to unaudited condensed consolidated financial statements.

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NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)

(Amounts in Thousands)

	For the Nine Months Ended Sept. 30
	2005			2004
Cash from operating activities:
Net income	$	16,183		$	13,766
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		14,701			14,073
Equity income of affiliated companies		(4,720	)		(3,807	)
Deferred income taxes		(1,859	)		(297	)
Changes in assets and liabilities:
Accounts receivable and unbilled revenues		620			834
Inventories		(77	)		(42	)
Prepaid expenses and other assets		(196	)		(20	)
Prepaid taxes other than income taxes		(234	)		(206	)
Accounts payable and advanced billings		(2,161	)		(35	)
Other accrued liabilities		(107	)		(272	)
Accrued pension and postretirement benefits		(635	)		(622	)
Federal and state income taxes		365			(936	)
Other, net		(139	)		236
Total adjustments		5,558			8,906
Net cash from operating activities		21,741			22,672
Cash used for investing activities:
Expenditures for property and equipment		(7,709	)		(10,655	)
Purchase of marketable securities available for sale		—			(25	)
Distributions from affiliated companies		4,032			3,201
Net cash used for investing activities		(3,677	)		(7,479	)
Cash used for financing activities:
Cash dividends		(8,253	)		(7,953	)
Payments of capital lease obligation		(796	)		(796	)
Retirement of debt		(2,314	)		(2,314	)
Net cash used for financing activities		(11,363	)		(11,063	)
Net increase in cash and temporary investments		6,701			4,130
Cash and temporary investments at beginning of period		42,569			32,026
Cash and temporary investments at end of period	$	49,270		$	36,156
Supplemental disclosure of cash flow information:
Interest paid	$	1,278		$	1,450
Income taxes paid	$	12,835		$	10,899

See accompanying notes to unaudited condensed consolidated financial statements.

7

NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in Thousands)

(1) Basis of Presentation and Consolidation

The condensed consolidated financial statements included herein have been prepared by North Pittsburgh Systems, Inc. (hereafter referred to as the Registrant, the Company, we, us or our), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Consolidated herein are the financial results of the Company’s wholly owned subsidiaries, North Pittsburgh Telephone Company (North Pittsburgh), Penn Telecom, Inc. (Penn Telecom) and Pinnatech, Inc. (Pinnatech). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. Nevertheless, the Company believes that its disclosures herein are adequate to make the information presented not misleading and, in the opinion of management, all adjustments necessary to present fairly the results of operations for the interim periods have been reflected. These condensed consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 (2004 Form 10-K) filed with the Securities and Exchange Commission.

The preparation of the condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. The estimates and assumptions used in the accompanying condensed consolidated financial statements are based upon management’s evaluation of the relevant facts and circumstances as of the date of the financial statements. Actual results may differ from the estimates and assumptions used in preparing the accompanying condensed consolidated financial statements.

Certain amounts in the Company’s 2004 condensed consolidated financial statements have been reclassified to conform with the presentation of its 2005 condensed consolidated financial statements.

(2) Comprehensive Income

Statement of Financial Accounting Standards (SFAS) No. 130, “Reporting Comprehensive Income”, establishes requirements for disclosure of comprehensive income. The objective of SFAS No. 130 is to report all changes in equity that result from transactions and economic events other than transactions with owners. Comprehensive income is the total of net income and all other non-owner changes in equity. The reconciliation of net income to comprehensive income is as follows:

	For the Three Months Ended September 30						For the Nine Months Ended September 30
	2005			2004			2005			2004
Net income	$	5,035		$	4,721		$	16,183		$	13,766
Unrealized loss on marketable securities including reclassification adjustments, net of tax		(6	)		(4	)		(13	)		(8	)
Comprehensive income	$	5,029		$	4,717		$	16,170		$	13,758

(3) Postretirement Benefits

Substantially all employees of North Pittsburgh are covered by a noncontributory, defined benefit retirement plan (Pension Plan). The benefits are based on each employee’s years of service and compensation. North Pittsburgh’s funding policy is to contribute an amount annually that satisfies at least the minimum funding required under the Employee Retirement Income Security Act of 1974. The assets of the Pension Plan are held in a trust and are invested in a variety of equity and fixed income securities.

Pursuant to North Pittsburgh’s collective bargaining agreement negotiated during 2004, eligibility for the Pension Plan is limited to those employees whose active service with North Pittsburgh commenced prior to November 1, 2004. Any employees hired on or after November 1, 2004 are not eligible to participate in the Pension Plan. Instead, for those employees covered by the collective bargaining agreement but hired on or after November 1, 2004, North Pittsburgh will contribute an amount equal to 2% of the employee’s gross wages into a union sponsored 401(k) plan. All employees hired by North Pittsburgh on or after November 1, 2004 who are not covered by the collective bargaining agreement are eligible to participate in North Pittsburgh’s 401(k) plan, in which the Company makes contributions based on the gross wages of the employees as well as on a specified percentage of each participating employee’s contributions.

8

Eligible retirees of North Pittsburgh are provided healthcare benefits under an unfunded plan until the retiree reaches Medicare eligibility (currently 65 years of age) and life insurance benefits based on a specified percentage of pre-retirement salary until the retiree reaches the age of 65, at which time the coverage is limited to $5. The costs associated with these plans are reflected in the “Other Postretirement Benefits” table that follows.

Components of Net Periodic Benefit Cost:

The following table summarizes the components of net periodic benefit cost:

	Pension Benefits
	Three Months Ended September 30						Nine Months Ended September 30
	2005			2004			2005			2004
Service cost	$	371		$	331		$	1,113		$	994
Interest cost		724			690			2,172			2,070
Expected return on plan assets		(795	)		(716	)		(2,385	)		(2,149	)
Amortization of prior service cost		35			31			106			95
Amortization of transition asset		(38	)		(38	)		(115	)		(115	)
Recognized actuarial loss		133			116			399			347
Net periodic benefit cost	$	430		$	414		$	1,290		$	1,242

	Other Postretirement Benefits
	Three Months Ended September 30						Nine Months Ended September 30
	2005			2004			2005			2004
Service cost	$	87		$	88		$	262		$	265
Interest cost		168			171			504			512
Amortization of prior service cost		(1	)		(1	)		(4	)		(3	)
Recognized actuarial loss		55			59			165			178
Net periodic benefit cost	$	309		$	317		$	927		$	952

North Pittsburgh also has a nonqualified supplemental pension plan covering former and current employees, which provides for incremental pension payments to the extent that income tax regulations limit the amount payable from North Pittsburgh’s qualified defined benefit Pension Plan. Pension expense for the supplemental plan for the three-month periods ended September 30, 2005 and 2004 was $63 and $55, respectively, and for the nine-month periods ended September 30, 2005 and 2004 was $189 and $165, respectively.

Employer Contributions:

The Company disclosed in its financial statements included in its 2004 Form 10-K that the Company expected to make discretionary contributions totaling $2,500 to its Pension Plan in 2005. Due to elective additional tax-deductible contributions made in both 2003 and 2004, no minimum contribution to the Pension Plan is required in 2005. However, the Company made tax-deductible discretionary contributions of $2,000 and $500 in January and June of 2005, respectively.

Contributions for the other postretirement benefits are made on a pay-as-you-go basis, with total contributions of $540 having been made during the nine-month period ended September 30, 2005. The $540 of contributions for the nine-month period ended September 30, 2005 were in line with the expected annual contributions of $719 disclosed in the Company’s 2004 Form 10-K.

(4) Transactions with Related Parties

Since 1998, we have had an agreement to obtain certain data processing functions from a third party processor (Processor), which is a member of the Armstrong Group of Companies (the Armstrong Group). We are related to the Armstrong Group by a common shareholder. This shareholder also for 25 years served on the Company’s Board of Directors until our Annual Shareholders Meeting on May 20, 2005. Payments to the Processor under this agreement were $2,331 and $2,127 for the nine-month periods ended September 30, 2005 and 2004, respectively. Also, we paid $175 and $186 in those same periods, respectively, to the law firms of two members of the Board of Directors for various legal services. As of September 30, 2005, we had amounts outstanding of $223 and $113 to the Processor and law firms, respectively.

9

In addition, in the ordinary course of business, we both provide and receive telecommunication transport services from Boulevard Communications, LLP (Boulevard), a competitive access provider jointly owned by us and a company in the Armstrong Group. Total revenues recognized from providing services to Boulevard were approximately $22 and $19, and total expenses incurred from receiving services from Boulevard were approximately $128 and $146, for the nine-month periods ended September 30, 2005 and 2004, respectively. We also provide, in the ordinary course of business, telecommunications and transport services to other member companies of the Armstrong Group, with total revenues recognized of approximately $88 and $90 for those same periods, respectively. The amounts outstanding from and/or due to Boulevard and the companies in the Armstrong Group were negligible as of September 30, 2005.

(5) Recent Accounting Pronouncements

The Financial Accounting Standards Board (FASB) issued Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities”, in January 2003 and amended the Interpretation in December 2003. A variable interest entity (VIE) is an entity in which its voting equity investors lack the characteristics of having a controlling financial interest or where the existing capital at risk is insufficient to permit the entity to finance its activities without receiving additional financial support from other parties. FIN 46 requires the consolidation of entities which are determined to be VIEs when the reporting company determines itself to be the primary beneficiary (the entity that will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s residual returns, or both). The amended Interpretation became effective for the first interim or annual reporting period ending after March 15, 2004, with the exception of special purpose entities for which the statement was effective for periods ending after December 15, 2003. We have completed a review of our partnership investments and have determined that those entities do not qualify as VIEs.

In May 2004, the FASB issued FASB Staff Position (FSP) No. FAS 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.” FSP 106-2 provides guidance on the accounting for the effects of the new Medicare prescription drug benefit available to employers who sponsor postretirement health care plans that provide a benefit that is at least actuarially equivalent to the drug benefit provided under Medicare Part D. FSP 106-2 was effective for the first interim reporting period beginning after June 15, 2004. The Company’s current accumulated projected benefit obligation and net periodic postretirement benefit cost do not reflect any amount associated with the federal subsidy provided by that Act. Medical coverage, including prescription drug benefits, provided by the North Pittsburgh postretirement benefit plan ceases when the retiree becomes Medicare eligible (currently age 65). The adoption of FSP 106-2 therefore did not impact the Company’s consolidated financial statements.

In March 2005, the FASB issued Interpretation No. 47 (FIN 47), “Accounting for Conditional Asset Retirement Obligations – an interpretation of FASB Statement No. 143”. FIN 47 clarifies that the term “conditional asset retirement obligation” as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligations,” refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. An entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. Any uncertainty about the amount and/or timing of future settlement should be factored into the measurement of the liability when sufficient information exists. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. We are currently evaluating the potential impact of this accounting interpretation on our results of operations and financial position.

10

PART I

Item 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations

(Amounts in Thousands Except Per Share Data and Operating Statistics)

Cautionary Language Concerning Forward-Looking Statements

In addition to historical information, this Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (Section 27A) and Section 21E of the Securities Exchange Act of 1934 (Section 21E) regarding events, financial trends and critical accounting policies that may affect our future operating results, financial position and cash flows. We intend that such forward-looking statements be subject to the safe harbors within Section 27A and Section 21E as provided by the Private Securities Litigation Act of 1995.

Forward-looking statements are usually accompanied by words such as “believes”, “anticipates”, “expects”, “estimates”, “intends” or similar words or expressions. Such statements are based on our assumptions and estimates and are subject to risks and uncertainties. You should understand that various factors, including (but not limited to) those items discussed below and elsewhere in this document, could cause our actual results to differ materially from the results expressed in or implied by these forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which are current only as of the date of this filing. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

While the following list of risks and uncertainties is not exhaustive, some factors, in addition to those contained throughout this document, that could affect future operating results, financial position and cash flows and could cause actual results to differ materially from those expressed in or implied by the forward-looking statements are:

• a change in economic conditions in the markets in which we operate;

• government and regulatory policies at both the federal and state levels;

• unanticipated higher capital spending for, or delays in, the deployment of new technologies;

• the pricing and availability of equipment, materials and inventories;

• changes in the competitive environment in which we operate, including the intensity of competitive activity, pricing pressures and new and/or alternative product offerings;

• our ability to continue to successfully penetrate our edge-out markets.

We also refer you to the section titled “Factors Affecting Our Prospects” under Item 1 of our 2004 Form 10-K for additional discussions concerning items which pose risks and uncertainties that could affect our future results.

Overview

We are a telecommunications company with annualized revenues of over $100 million. Our original core business, which dates back to 1906, consisted primarily of providing telecommunications services in our Incumbent Local Exchange Carrier (ILEC) territory, which today covers approximately 285 square miles and is located north of the City of Pittsburgh, Pennsylvania. In 1995, as the Internet was still in its relatively early stages, we purchased a small Internet Service Provider (ISP) as a segue into that area of the communications marketplace. During 1999, we began to expand our business beyond our ILEC territory via a Competitive Local Exchange Carrier (CLEC) edge-out strategy. In addition, from 1997 through 2001, we invested approximately $83 million in our ILEC territory to upgrade the majority of our network and to deploy a Carrier Serving Area (CSA) architecture in order to allow us to offer advanced broadband products.

Today, the investments that we have made to develop our Internet related products, to expand our business via our edge-out strategy and to modernize our network for advanced broadband products have provided the majority of our revenue growth. The great majority of our revenues are generated based on monthly recurring services and are therefore not subject to large short-term fluctuations.

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In addition to our core businesses described above, we also derive a portion of our net income and cash flow from our limited partner interests in three wireless partnerships, all of which are majority owned and operated by Verizon Wireless. These partnerships, which have their origin in the 1980s with the allocation by the Federal Communications Commission (FCC) of B licenses, cover territories which overlap the majority of our ILEC and edge-out markets.

General Description of Our Company and Business

The Registrant, organized May 31, 1985, is a holding company. Its predecessor, North Pittsburgh Telephone Company (North Pittsburgh), a telephone public utility incorporated in 1906, became a wholly owned subsidiary of the Registrant on May 31, 1985. Penn Telecom, Inc. (Penn Telecom) became a wholly owned subsidiary of the Registrant on January 30, 1988. Prior to this date, Penn Telecom was a wholly owned subsidiary of North Pittsburgh. Penn Telecom is certificated as a Competitive Access Provider (CAP), a CLEC and an Interexchange Carrier (IXC) and has entered into these businesses. Pinnatech, Inc. (Pinnatech), a wholly owned subsidiary of the Registrant, formed in 1995, principally provides Internet and broadband related services. The Registrant, North Pittsburgh, Penn Telecom and Pinnatech operate under the provisions of the Pennsylvania Business Corporation Law.

North Pittsburgh Telephone Company

North Pittsburgh, our ILEC, was founded in 1906 and operates in an approximately 285 square mile territory in Western Pennsylvania, which includes portions of Allegheny, Armstrong, Butler and Westmoreland Counties. We provide service to approximately 71,000 business and residential access lines in our ILEC territory. Over the past decade, our ILEC territory has experienced very robust population growth due to the continued expansion of suburban communities into our serving area, with the southernmost point of our territory only 12 miles from the City of Pittsburgh. According to the most recent census, the population in our ILEC service territory grew 14.3% from 1990 to 2000. Although no formal census has been published since 2000, business activity and new housing starts have remained robust in our territory over the last several years and census estimates, which are published on a yearly basis, continue to show population growth.

We operate a 100% digital switching network, comprised of nine central offices and 85 CSAs. The core of the network consists of two main host switches, a Nortel DMS 500 and a Nortel DMS 100. The current CSA architecture, in which nearly all loop lengths are kept to 12,000 feet or less, has enabled us to provide digital subscriber line (DSL) service to over 99% of our access lines. In addition, we have deployed fiber optic cable extensively throughout the network, resulting in a 100% Synchronous Optical Network (SONET) that supports all of the inter-office and host-remote links as well as the majority of business parks within our ILEC serving area. We believe that our network is built for the future, in which our ability to satisfy the growing customer demand for broadband and multi-megabit services will be a key critical success factor.

Penn Telecom

Penn Telecom furnishes telecommunication and broadband services south of North Pittsburgh’s territory to customers in Pittsburgh and its surrounding suburbs as well as north of North Pittsburgh’s territory in the City of Butler and its surrounding areas. Verizon is the ILEC in the Pittsburgh area, while Sprint is the ILEC in the City of Butler and its surrounding areas. Our CLEC operation follows a true “edge-out” strategy, in which it has leveraged North Pittsburgh’s network, human capital skills and reputation in the surrounding markets.

We operate an extensive SONET optical network with over 300 route miles of fiber optic facilities in the Pittsburgh metropolitan market. We have physical collocation in 27 Verizon central offices and one Sprint central office and primarily serve our customers using unbundled network element (UNE) loops. Twenty-seven of these collocations are connected to our SONET using a combination of leased and owned fiber optic facilities. We have also deployed a next-generation switching system to support our Integrated Services Digital Network (ISDN) primary rate interface (PRI) service, achieving significant cost reductions over traditional switching systems. In the Pittsburgh market, a carrier hotel that we operate serves as the hub for the fiber optic network. In addition, we also offer space in the carrier hotel to ISPs, IXCs, other CLECs and other customers who need a carrier-class location to house voice and data equipment as well as gain access to a number of networks, including ours. In the City of Butler, we have overbuilt a portion of the Sprint distribution plant in the central business district and continue to expand these facilities as we increase our penetration of the Butler area business market.

Our sales strategy in our edge-out markets has been to focus on small to mid-sized business customers (defined as 5 to 500 lines), educational institutions and healthcare facilities, offering local and long distance voice services as well as broadband services. Our fiber-based network, comprised of multiple rings, enables us to compete against Verizon and other CAPs to offer high capacity

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special access circuits (from DS-1s up to OC-48s) to IXCs, ISPs and even other CLECs. As of September 30, 2005, Penn Telecom served 40,534 dial tone access lines and 20,278 access line equivalents¹, for a grand total of 60,812 equivalent access lines².

In addition to the CLEC operations, Penn Telecom also provides long distance services and maintains an enterprise equipment business providing traditional key and private branch exchange (PBX) systems to business customers. Prior to our CLEC operations, the majority of our long distance customers resided in our ILEC market. However, with the growth of our CLEC customer base and the effective bundling of toll with local dial tone services, we have been able to greatly expand this service offering throughout Western Pennsylvania.

Pinnatech

Pinnatech, an ISP doing business under the Nauticom name, furnishes Internet access and broadband services in Western Pennsylvania. We serve the majority of our DSL and other broadband customers over our ILEC and CLEC networks with Pinnatech serving as the ISP providing a gateway to the Internet. In addition, Pinnatech also provides virtual hosting services, web page design and e-commerce enabling technologies to customers.

Additional Information

For a more complete understanding of our business, industry, principal services rendered, properties and other interests, we suggest you read our 2004 Form 10-K. There have been no significant changes in the mode of conducting business or the properties owned by the Company or its subsidiaries since the filing of that Form 10-K report. Current updates to the regulatory environment under which our subsidiaries operate can be found below in the “Regulatory Environment” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Industry Dynamics

Demand for the traditional voice telecommunications business has been negatively impacted by the proliferation of wireless services led by one-rate bundled pricing plans that include large (if not unlimited) buckets of minutes, the popularity of alternative communication technologies such as email and instant messaging and by technological advances such as cable modems and DSL that obviate the need for secondary, and in some cases primary, access lines.

In addition, the telecommunications industry has experienced a very difficult period of contraction brought on by over-investments in the late 1990s that have created excess capacity in certain markets. As a result, the industry has experienced a relatively high number of major bankruptcies over the past several years. Besides the negative financial ramifications of absorbing write-offs of pre-petition amounts owed from such carriers, we are now faced with many of these companies emerging from bankruptcy with restructured balance sheets and greater financial flexibility.

Broadband growth has been a bright spot in the overall industry over the past several years. However, the broadband market is very competitive, with little differentiation to the end-user customer between products offered by telephone, cable, wireless and satellite companies. As such, pricing has been the main focus in winning new customers and retaining existing customers. Although the costs to deliver broadband technologies have decreased over the past several years, margins have continued to be squeezed by pricing decreases to customers.

The proliferation of broadband access has also resulted in new threats from innovative technologies, such as Voice over Internet Protocol (VoIP), that could further decrease the revenues received from the traditional voice business. Besides potentially displacing the need for a secondary or primary line, the potential regulatory definition and classification of VoIP services (which takes on many forms) may have a significant impact on the current access compensation structure.

Regulation and Competition

The telecommunications industry was greatly impacted by the passage of the Telecommunications Act of 1996 (the 1996 Act), which was the legislative instrument that opened the industry to significantly greater competition. The degree and pace at which markets have been experiencing competition have varied, with most of the original regulatory barriers to entry removed

¹ Access line equivalents represent a conversion of data circuits to an access line basis and are presented for comparability purposes. Equivalents are calculated by converting data circuits (basic rate interface (BRI), PRI, DSL, DS-1 and DS-3) and SONET-based (optical) services (OC-3 and OC-48) to the equivalent of an access line. While the revenues generated by access line equivalents have a directional relationship with these counts, growth rates cannot be compared on an equivalent basis.

² Equivalent access lines include dial tone access lines and access line equivalents.

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in the markets served by the country’s largest local exchange carriers, also referred to as the Regional Bell Operating Companies (RBOCs). Smaller rural companies, such as our ILEC, North Pittsburgh, were given regulatory relief in the form of exemptions and temporary suspensions from many of the competitive portions of the 1996 Act in order to allow state regulators sufficient time to examine the public policy implications of allowing competition in rural areas and, if deemed in the public interest, to allow smaller companies to gradually prepare for competition and to restructure rates. Although we still maintain in our ILEC territory some of the regulatory protections against non-facilities-based competition, we expect that over time these protections will be reduced or eliminated.

While the 1996 Act has placed a higher degree of uncertainty on our future revenue streams and margins in our ILEC territory, it has given us the opportunity to selectively expand outside of that territory by taking advantage of the pro-competitive aspects of the Act. We have pursued an edge-out strategy into Pittsburgh and its surrounding communities as well as into the City of Butler and its surrounding areas, leveraging the network, human capital skills and solid reputation of our traditional ILEC business.

The 1996 Act primarily deals with regulations concerning intra-modal competition—that is, competition among traditional wireline companies. At the same time, however, we have begun to experience a great deal of inter-modal competition from wireless carriers and cable companies. We view these facilities-based competitors to be the most formidable, as these companies can totally bypass our existing networks.

Highlights and Outlook

Net income for the nine-month period ended September 30, 2005 was $16,183, or $1.08 per share, as compared to $13,766, or $.92 per share, for the comparable prior year period. The $2,417 increase in net income was predominately a result of an increase in earnings recorded from the Company’s investment in three wireless partnerships, an increase in income recorded from the Company’s temporary investments and the favorable impact of a settlement agreement reached with a carrier in the second quarter of 2005. The $2,404 settlement, which covered the exchange of traffic between North Pittsburgh and the carrier over a multi-year period of time, resulted in a $1,604 increase in revenues and an $800 decrease in operating expenses. On an after tax basis, the settlement contributed $1,406 to the increase in net income for the first nine months of 2005.

Revenues for the nine-month period ended September 30, 2005 increased $2,668, or 3.3%, over the prior year comparable period. The impact from the aforementioned settlement contributed $1,604 to this increase. Revenues from all other sources increased $1,064, or 1.3%, in the nine-month period ended September 30, 2005 over the prior year comparable period. The majority of this growth was attributable to our ability to continue to effectively penetrate our edge-out markets as well as expand our broadband service offerings. As was our experience also for the full year 2004, for which our revenue growth rate of 2.6% was lower than recent historical rates, our ability during the first nine months of 2005 to grow end-user revenues by adding customers in our CLEC markets and by expanding our broadband service offerings was partially offset by decreases in access revenues. The phased reduction of Penn Telecom’s interstate access rates in conjunction with the FCC’s Access Charge Reform Order, decreases in access and transit rates charged for wireless traffic and decreases in the National Exchange Carrier Association (NECA) average schedule formulas used to determine North Pittsburgh’s interstate revenue requirement, as well as some regulatory modifications and other events which have diminished the Company’s ability to earn above the historical allowable rate of return, have caused access revenues to decrease. In addition, a $323 decrease in telecommunication equipment sales, which is our only notable revenue source that is non-recurring in nature and therefore subject to greater fluctuation, also negatively impacted our revenue growth rate for the first nine months of 2005 as compared to the prior year comparable period.

We expect that competition for all of our service offerings will continue to intensify, resulting in further pressures on operating revenues and margins. We expect that revenue growth will continue to be driven by the addition of new customers in our edge-out markets and by further broadband penetration. We have also started to focus to an even greater extent on bundled product offerings, which we anticipate will drive value to our customers and serve as a tool for retention of our existing customer base.

Total operating expenses for the nine-month period ended September 30, 2005 increased $556, or 0.9%, over the prior year comparable period. The current year period benefited, though, from the $800 cumulative reduction to operating expenses associated with the aforementioned settlement. All other operating expenses increased $1,356, or 2.2%, in the nine-month period ended September 30, 2005 over the prior year comparable period. This increase in operating expenses was predominantly due to increases in the direct costs associated with the growth in access lines and access line equivalents, such as fees paid for leasing unbundled network elements in the portions of our edge-out markets that we do not wholly provision over our own facilities and fees paid to terminate the increased local, toll and Internet traffic generated by our growing customer base. In addition, depreciation expense increased as a result of an increase in our depreciable asset base.

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With respect to our operating costs in our edge-out CLEC markets, we continue to monitor the developments in the FCC’s Triennial Review Order (TRO). Based on our interpretation of the most recent authoritative guidelines set forth in the FCC’s Order on Remand released on February 4, 2005, we do not believe that the Order on Remand will have a material impact on our cost structure. Currently, we provision only 8% of our CLEC access lines utilizing Unbundled Network Element Platform (UNE-P) loops. This represents only 3% of our consolidated access lines.. Although costs for UNE-P loops will increase over time, our relatively low use of UNE-P and the ability to migrate some of the lines to alternative provisioning methodologies will limit the overall impact. Based on our interpretation of the rules concerning access to unbundled high capacity loops, interoffice transport facilities and dark fiber, we believe we will experience moderate increases in the overall cost to provision such loops and facilities in the future. However, we caution that although the FCC’s Order on Remand defines impairment of such circuits based on a review of the number of business lines and fiber-based collocators in a serving wiring center, the practical definitions of what constitutes a business line or fiber-based collocator have yet to be decided. In a separate matter, the Pennsylvania Public Utility Commission (PA PUC) revised many of Verizon’s unbundled rates for loops as well as high capacity circuits effective October 2004. Although the revised rates reflect a mixture of both increases and decreases, based on the specific types of circuits and markets in which we operate, we have experienced in 2005 an overall slight decrease in the average costs (on a per line basis) to provision our CLEC access lines located in Verizon markets. Verizon challenged the PA PUC’s revisions of these Verizon rates in Federal court. In August of 2005, the U.S. District Court for the Eastern District of Pennsylvania ruled in favor of the PA PUC, affirming the rates set for access to unbundled elements of Verizon’s network.

Our cost structure is heavily weighted towards labor and depreciation. As such, there is not a great deal of direct correlation between our revenues and our largest operating expenses. We have taken steps to address our overall labor costs, including the workforce reduction program implemented in 2003, the continuing use of attrition to manage our workforce levels and using our excess cash reserves to make additional contributions into the North Pittsburgh Pension Plan over the past several years. In addition, pursuant to a renegotiated collective bargaining agreement in 2004 covering our North Pittsburgh subsidiary, future hires are not eligible to participate in the North Pittsburgh Pension Plan. Although we will not see immediate benefits from this in 2005 and estimate only modest benefits in the next few years thereafter, the long-term impact should be a reduction in postretirement benefit expenses, which currently exceed $3,000 per year.

We also have implemented a targeted capital expenditure program, in which the majority of our expenditures are directly related to new customer additions. The significant network modernization investments which we made from 1997 through 2001 have enabled us to keep our maintenance capital expenditures (defined as capital expenditures needed to continually replace and/or expand our network capabilities to address our existing customer base) at levels of 5-7% of revenues over the last several years, which is much lower than the industry average of over 10%. Maintaining our existing operating margins going forward will be challenging as competition intensifies and lower margin services, such as DSL and CLEC access lines, generate a larger percentage of our overall revenues. Nevertheless, we will continue to manage our cost structure and capital spending aggressively.

In addition, we have benefited from investments made in the last two decades in wireless partnerships, all of which today are majority owned and operated by Verizon Wireless. Instead of deploying the majority of our investment capital into forming and operating our own wireless business, which would be at a tremendous disadvantage competing in a market dominated by national carriers with billions of dollars in capital resources, we alternatively invested in three wireless partnerships serving Pittsburgh and other portions of Western Pennsylvania. Total equity income recorded from our investments in the wireless partnerships increased $919 in the first nine months of 2005 over the prior year comparable period.

Our financial condition and balance sheet have continually improved over the last several years through prudent investment strategies and strong cash flows generated from operating activities. Unlike many telecommunication companies that have substantially leveraged their businesses, we have a greater amount of cash and temporary investments on hand ($49,270) than our total debt outstanding ($22,368). Our financial condition gives us the ability to invest in new products and/or opportunities and the flexibility to continue to evaluate ways to create greater shareholder value, whether through our dividend policy, stock repurchases or other investment opportunities.

Results of Operations

The following discussion should be read in conjunction with our condensed consolidated financial statements, and the notes thereto, included in this quarterly report and with our audited financial statements, and notes thereto, included in our 2004 Form 10-K.

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Nine Months Ended September 30, 2005 and 2004

Net income for the nine-month period ended September 30, 2005 was $16,183, or $1.08 per share, compared to net income of $13,766, or $.92 per share, for the comparable prior year period. The increase in net income was attributable to the following factors:

Operating Revenues

Total operating revenues increased $2,668, or 3.3%, in the nine-month period ended September 30, 2005 over the comparable period in 2004. This increase was the result of increases in local network services revenues of $2,364 (11.1%), directory advertising, billing and other services revenues of $20 (1.9%) and other operating revenues of $732 (8.5%), offset partially by a decrease in long distance and access services revenues of $125 (0.3%) and telecommunication equipment sales of $323 (21.4%).

Increases in local network services revenues of $2,364, or 11.1%, were primarily attributable to the following factors:

• Local dial tone revenues increased $1,340, partially as a result of total access lines (including CLEC) growing by 2,401 lines, or 2.2%, from 109,136 access lines as of September 30, 2004 to 111,537 access lines as of September 30, 2005. More specifically, the total growth was a result of a 4,304 access line increase in our edge-out markets offset partially by a 1,903 access line decrease in our ILEC market. Also contributing to the increase was an approximate $1,080 increase in local dial tone revenues due to a revenue neutral rate re-balancing at North Pittsburgh during January of 2005, which increased local residential and business rates and decreased intrastate access rates.

• Enhanced feature revenues (which include revenues from custom calling features such as voicemail, caller ID, call waiting, etc.) increased $309, mostly as a result of the growth in access lines and the up-selling of these features in bundled packages.

• Local reciprocal compensation revenues increased $396 as we benefited from being able to bill for traffic above the growth cap set in the original FCC Order on Intercarrier Compensation for ISP-Bound Traffic pursuant to the forbearance granted by the FCC in October of 2004 in the Petition of Core Communications, Inc. Actual reciprocal compensation minutes of use (MOU) have decreased, however, by approximately 20% on a year over year basis due to the decline in data PRIs purchased by regional ISPs. Both the consolidation of our ISP customer base, which has led to the elimination of redundant and excess facilities, as well as the general decline in the dial-up Internet market have led to the decline in data PRIs and their associated MOUs. For year-to-date 2005 over 2004 comparative purposes, the benefit from being able to bill for traffic above the original growth cap pursuant to the aforementioned FCC action has outweighed the negative impact of the overall MOU decreases experienced. However, as future periods will no longer be impacted for comparative purposes by the limitations of the original growth cap, which applied only in earlier years, we would expect to experience a decline in reciprocal compensation revenues because of additional MOU decreases reasonably expected to occur in the future.

• Revenues from other local exchange circuits, such as ISDN BRI, frame relay and local private lines, have increased by $329. We have experienced growth in these circuits over the past twelve months, with one large school district in our CLEC edge-out territory alone ordering approximately 550 BRIs.

The increase in directory advertising, billing and other services revenues of $20 was not material.

The increase in other operating revenues of $732, or 8.5%, was partially due to the $596 growth in DSL and multi-megabit Ethernet revenues. Combined DSL lines (both wholesale and retail) sold increased from 11,590 as of September 30, 2004 to 13,687 as of September 30, 2005. Also, we introduced in 2004 a multi-megabit Ethernet product that can deliver speeds from 3 to 20 megabits, surpassing the existing top speed of our DSL product. Currently geared mostly for business applications, the multi-megabit Ethernet product experienced a growth of 215 circuits over the twelve-month period ended September 30, 2005. Revenues earned from other Internet related products and services, such as web development services, also increased over the prior year comparable period. In addition, aggregate revenue write-offs improved as the prior year nine-month period included write-offs for some ISPs while the current year nine-month period benefited from the recovery of a previously written-off carrier receivable.

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The decrease in long distance and access services revenues³ of $125, or 0.3%, was attributable to a number of factors:

• Access revenues decreased approximately $609, primarily due to:

- First, as described in the text above discussing local network service revenues, there was an approximate $1,080 reduction in North Pittsburgh’s intrastate access revenues in conjunction with the revenue neutral rate re-balancing that increased North Pittsburgh’s local residential and business rates and decreased its intrastate access rates.

- Second, as also discussed above, changes in NECA average schedule formulas used to determine North Pittsburgh’s interstate revenue requirement as well as some regulatory modifications and other events that have diminished North Pittsburgh’s ability to earn above the historical allowable rate of return have caused these interstate revenues to decrease approximately $600. The majority of this comparative revenue decrease occurred in the first half of 2005 as compared to the first half of 2004, however. NECA’s tariffs are effective on a July 1 through June 30 basis. The majority of the revenue decrease was due to the fact that the July 1, 2004 through June 30, 2005 average schedule formulas produced a decrease in North Pittsburgh’s realized interstate revenues from those amounts realized from the average schedule formulas associated with the July 1, 2003 through June 30, 2004 tariff. The new average schedule formulas, which are effective July 1, 2005 through June 30, 2006, should not produce a material change in North Pittsburgh’s realized interstate revenues, on a static basis, from the average schedule formulas in effect for the July 1, 2004 through June 30, 2005 period (static basis meaning keeping demand quantities the same; if demand quantities such as access lines and interstate MOUs decrease, North Pittsburgh’s ultimate revenue realized will also decrease).

- Third, in conjunction with the FCC’s Access Charge Reform Order, Penn Telecom’s interstate access rates have been phased down over a three-year period that began in 2001. The final phase down decrease, which adjusted Penn Telecom’s rates to mirror the incumbents’ rates, was effective June 20, 2004 and resulted in an approximate $40 per month decrease in access revenues. Although interstate access revenues for Penn Telecom will decline for full year 2005 over 2004, the majority of that comparative revenue decrease was concentrated in the first half of 2005 over the first half of 2004, because the revenue prior to June 20, 2004 was at the higher pre-final phase down rate. Penn Telecom’s interstate access revenues for the third quarter of 2005 actually increased a nominal $12 over the prior year third quarter due to the fact that the rates were comparatively the same while billable MOUs increased.

- Fourth, reductions in wireless intercarrier compensation rates contributed to a $284 decrease in access revenues received from wireless carriers, despite an increase in billable MOUs. We expect to see a decrease in access revenues from wireless carriers for full year 2005 over the full year 2004, also, due to the fact that the majority of the decreases in rates were effective in the beginning of the third quarter of 2004. Therefore, 2005 will reflect a full year of the reduced rates while the full year 2004 experienced the reduced rates for only the last six months. However, similar to the discussion in the preceding paragraph, the majority of that comparative revenue decrease was concentrated in the first half of 2005 over the first half of 2004. Revenues from wireless intercarrier compensation for the third quarter of 2005 actually increased $49 over the prior year third quarter due to the fact that the rates were comparatively the same and, as noted above, the billable MOUs increased.

- The above-mentioned factors were partially mitigated in the second quarter of 2005 by the positive impact of the settlement between North Pittsburgh and a carrier, resulting in a $1,604 increase in terminating access revenues realized over that amount which had been estimated and accrued over a multi-year period. Concurrent with the execution of the settlement agreement, North Pittsburgh also executed an interconnection agreement with the carrier. Based solely on a static analysis (that is, assuming constant MOUs, jurisdictional splits of traffic and access rates), we anticipate that North Pittsburgh’s revenues will benefit by approximately $200 on an annualized basis as a result of the difference between the final rates and terms of the interconnection agreement in comparison to those used historically in our estimates.

The $609 decrease in access revenues discussed above was partially offset by the following factors:

• Special access revenues increased approximately $385, mostly as a result of increases in the number of DS-1 and DS-3 circuits sold in our ILEC territory. In addition, an increase in trunking from wireless carriers and a network reconfiguration from an IXC also added to the revenue increase in this category.

³ The Company records and analyzes into three main components the elements that comprise the long distance and access services revenue category. The first category, access revenues, reflects mainly per MOU sensitive access charges, universal service revenues received by the Company and end-user interstate access line charges assessed on customer bills. The second category, special access, reflects the revenues received from high capacity circuits (primarily DS-1s, DS-3s and OC-3s) that are: 1) provided directly to end-user customers, in both the Company’s ILEC and CLEC territories; 2) provisioned to other telecommunication carriers for connection to their end-user customers; and 3) provisioned for inter-office trunking and transport and are billed under the special access tariff. The third category, toll, represents amounts billed to end-users for metro-area, intraLATA, interLATA and international toll.

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• Overall toll revenues increased $99. We have continued to be successful in bundling toll in our edge-out markets (in which the number of access lines grew by 4,304), with nearly a 78% subscription rate. Our ability to increase our customer base has been offset by continuing pricing pressures from the introduction of aggressively priced flat rate toll packages from other competitors and VoIP providers and intense pricing competition in the wireless market.

The decrease in telecommunication equipment sales of $323, or 21.4%, was primarily due to a $130 decrease in new equipment sales and a $180 decrease in post-sale support revenues. As noted above, these revenue sources for the most part are non-recurring in nature and are therefore subject to greater fluctuation on a comparable period basis. In addition, the long-term trend for these revenues has shown a decline over the last several years, mostly as a result of continuous price competition.

Operating Expenses and Net Operating Income

Total operating expenses increased $556, or 0.9%, in the nine-month period ended September 30, 2005 over the comparable period in 2004. The change was the result of an increase in network and other operating expenses of $194 (0.5%) and depreciation and amortization expenses of $628 (4.5%), offset partially by decreases in state and local taxes of $79 (2.8%) and telecommunications equipment expenses of $187 (17.8%).

The increase in network and other operating expenses of $194, or 0.5%, was mitigated significantly by the fact that the second quarter of 2005 contained the positive impact of the aforementioned settlement between North Pittsburgh and a carrier, resulting in a cumulative $800 reduction in traffic termination costs from the amount that was estimated and accrued over a multi-year period. As previously discussed, North Pittsburgh also concurrently executed an interconnection agreement with the carrier. However, the amount of traffic that North Pittsburgh terminates to the carrier has decreased approximately 70% over the past several years, and we therefore do not expect the final rates and terms of the interconnection agreement to have a material impact on our operating expenses on a going forward basis.

All other network and other operating expenses increased $994, or 2.3%, in the nine-month period ended September 30, 2005 over the prior year comparable period. This increase was mostly the result of:

• Increases in direct costs associated with the growth in access lines and access line equivalents. Such direct costs include the fees paid for leasing unbundled network elements in the portions of our edge-out markets that we do not provision over our own facilities and fees paid to terminate the increased local, toll and Internet traffic generated by our growing customer base.

• Increases in auditing and legal expenses of approximately $205 as a result of the continued increases in requirements imposed by rules and regulations promulgated by various market governing bodies, most notably the requirements imposed by the Sarbanes-Oxley Act of 2002 (SOX). We do not expect the full year 2005 increase in these expenses over the full year 2004 to be as high as reported for the nine-month period because a disproportionately higher amount of 2004’s auditing expense was booked in the fourth quarter of 2004, due mostly to the fact that the costs for the SOX Section 404 audit were higher than anticipated by ourselves, the industry and the regulators prior to that time. For 2005, auditing expenses are better known and have been more ratably accrued over the course of the year.

• Increases in combined labor and benefit expenses of approximately $430, or 2.1%, for the nine-month period ended September 30, 2005 over the comparable period in 2004. For full year 2004, such expenses increased 2.0% (the 2.0% figure for 2004 excludes the impact of $2,725 in charges associated with the workforce reduction in 2003, which impacted year over year comparable results). Payroll expense was up slightly as a result of the effects of the normal year over year wage increases. Current benefit expenses (mostly composed of medical insurance premiums) declined slightly, primarily due to decreases in medical insurance premiums at the Company’s North Pittsburgh subsidiary as a result of an increase in employee co-payments as well as more favorable experience ratings received for our 2005 premiums (2003 and 2004 premium increases were abnormally large due to an unusually high number of severe medical cases which negatively impacted the experience-rated portion of our insurance premiums). Aggregate postretirement benefit expenses, as addressed in more detail in Note 3 to the Condensed Consolidated Financial Statements included in this Form 10-Q, remained relatively constant, first nine months of 2005 over first nine months of 2004.

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The increase in depreciation and amortization expenses of $628, or 4.5%, was the result of the depreciable asset base (gross property, plant and equipment) increasing by 3.9% over the course of the past year. Furthermore, a higher ratio of new additions reflected data-centric equipment, which has shorter useful lives than the Company’s average depreciable base.

The decrease in state and local taxes of $79 was not material.

The decrease in telecommunication equipment expenses of $187, or 17.8%, was attributable to decreases in the direct costs of goods for equipment sales, as the associated revenues declined $323 from the prior year comparable period.

Overall, the increase in total operating revenues of $2,668, coupled with the increase in total operating expenses of $556, resulted in a $2,112, or 10.1%, increase in net operating income for the nine-month period ended September 30, 2005 over the comparable prior year period. As discussed above, the primary contributing factor to the increase in net operating income was the $2,404 result of North Pittsburgh’s settlement with a carrier. Net operating income from all other sources for the nine-month period ended September 30, 2005 declined $292, or 1.4%, over the comparable prior year period.

Other Items

Interest expense for the nine-month period ended September 30, 2005 decreased by $197 from the comparable prior year period, due to the continued scheduled pay-down of our Federal Financing Bank (FFB) notes and capital lease obligation.

Interest income during the nine-month period ended September 30, 2005 increased by $730 over the comparable prior year period, due to higher average invested cash balances as well as increases in the average interest rate received on our temporary investments. Our average interest rate earned on investments during the nine-month period ended September 30, 2005 was 2.85% as compared to 0.81% for the comparable nine-month period in 2004.

Equity income of affiliated companies increased $913 in the nine-month period ended September 30, 2005 over the comparable prior year period, due mainly to a $919 increase in the amount of income generated from the Company’s limited partner interests in three wireless partnerships. These partnerships, all of which are majority owned and operated by Verizon Wireless, have continued to show growth in their number of customers and operating results. We are also benefiting from a reduction in the partnerships’ switching costs that became effective with the partnerships’ results of operations recorded in our second quarter of 2004, which we estimate has contributed approximately $225 to the overall increase in equity income (the positive comparative impact was experienced primarily in the first quarter 2005 over first quarter 2004 results). While the earnings of the wireless partnerships have continued to improve during 2005, we have not experienced the same magnitude of improvement in our equity income of affiliated companies as seen in 2004 (a $2,537 increase for full year 2004). Although we will continue to benefit from the aforementioned reduction in switching costs, the incremental impact it had on 2004 earnings will most likely be non-repetitive in nature (that is, for 2005 comparison purposes, the last three quarters of 2004 would also have contained the lower switching costs).

The changes in sundry expense (net) were not material.

Three Months Ended September 30, 2005 and 2004

Fluctuations in revenue, operating expenses and other income (expenses) for the three-month period ended September 30, 2005, as compared to the same quarterly period in 2004, were generally attributable to the same reasons discussed above in the nine-month comparison with the exceptions of the following:

Long distance and access services revenues decreased $275, or 1.7%, for the three-month period ended September 30, 2005 as compared to the same quarterly period in 2004, in contrast to a nine-month year-to-date decrease of $125, or 0.3%. The larger percentage decrease for the third quarterly period of 2005 as compared to the nine-month period was due to the fact that the second quarter of 2005 contained the positive impact of the aforementioned settlement between North Pittsburgh and a carrier, resulting in a $1,604 increase in terminating access revenues realized over that amount which had been estimated and accrued over a multi-year period. Long distance and access services revenues from all other sources decreased $1,729, or 3.5%, for the nine-month year-to-date period, over the comparable prior year period. The smaller percentage decrease in these revenues experienced in the third quarter of 2005 as compared to the nine-month year-to-date period was mostly due to the fact that several of the access rate decreases, which occurred either at the end of the second quarter of 2004 or beginning of the third quarter of 2004 (and as described in more detail above in the nine-month analysis), primarily affected the comparative results for the first half of 2005 over the first half of 2004.

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Other operating revenues decreased $10, or 0.3%, for the three-month period ended September 30, 2005 as compared to the same quarterly period in 2004, in contrast to a nine-month year-to-date increase of $732, or 8.5%. The main factor for the decrease in revenues in the third quarter of 2005 over the prior year third quarter was that aggregate revenue write-offs increased $169 on a comparative basis. In contrast, aggregate revenue write-offs for the nine-month period ended September 30, 2005 decreased $137 from the comparable 2004 nine-month year-to-date period. Revenue write-offs associated with bankruptcies and the inability of customers to make full payments can fluctuate on a quarter over quarter basis based upon when the specific events occur. The first quarter of 2004 and third quarter of 2005 experienced the largest quarterly revenue write-offs for those respective year-to-date periods. In addition, the 2005 nine-month year-to-date period benefited from the recovery of a previously written-off carrier receivable in the second quarter of 2005. A second factor contributing to the variance in results experienced for the quarterly period as compared to the year-to-date period was that web development revenues were mostly flat on a third quarter over third quarter basis in contrast to increasing approximately $100 on a year-to-date basis. Web development revenues are mostly project driven and can fluctuate on a quarterly basis.

Network and other operating expenses increased $209, or 1.4%, for the three-month period ended September 30, 2005 as compared to the same quarterly period in 2004, in contrast to a nine-month year-to-date increase of $194, or 0.5%. The larger percentage increase for the third quarterly period of 2005 as compared to the year-to-date period was due to the fact that the second quarter of 2005 contained the positive impact of the aforementioned settlement between North Pittsburgh and a carrier, resulting in a cumulative $800 reduction in traffic termination costs from the amount that was estimated and accrued over a multi-year period. All other network and other operating expenses increased $994, or 2.3%, for the nine-month year-to-date period, over the comparable prior year period. The smaller percentage increase experienced in these expenses in the third quarter of 2005 as compared to the nine-month year-to-date period was primarily due to the fact that the third quarter of 2004 had unusually high installation expense associated with the cut-over of a very large school district (approximately 5,000 ALEs) in our CLEC edge-out market.

Equity income of affiliated companies increased $39, or 2.4%, for the three-month period ended September 30, 2005 as compared to the same quarterly period in 2004, in contrast to a nine-month year-to-date increase of $913, or 24.0%. The smaller percentage increase for the third quarterly period of 2005 as compared to the year-to-date period was due to several factors. First, as described earlier in our year-to-date analysis, we estimate that the reduction in the partnerships’ switching costs that became effective with the partnerships results of operations recorded in our second quarter of 2004 contributed approximately $225 to the overall increase in year-to-date equity income (the positive comparative impact was experienced primarily in the first quarter 2005 over first quarter 2004 results). Second, during the current year quarter, the Rural Service Area (RSA) 6 I and RSA 6 II partnerships had customer growth that outpaced that of Verizon Wireless as a whole. Overhead allocations to the partnerships for advertising, marketing and promotions are heavily weighted to gross customer additions. As such, these overhead costs, as well as the direct costs for commissions associated with the customer additions, have increased over the prior year third quarter. Although negatively impacting short-term results (as these upfront costs are usually greater than the normal margin made on a new customer in their first month or two of service), these customer additions will benefit the partnerships over the long-term. Finally, in the current year third quarter, the results of operations for the RSA 6 I partnership were negatively impacted by an increase in roaming expense from the prior year comparable quarter, mostly due to customer additions. However, roaming revenues, which are mostly revenues the partnership receives from other wireless carriers, including other Verizon partnerships and wholly owned markets, for providing network access to their customers who travel into the partnership’s territory and have little correlation to the customer base of the partnership, declined slightly.

Liquidity and Capital Resources

	September 30, 2005		December 31, 2004
Cash and temporary investments	$	49,270	$	42,569
Working capital	$	48,027	$	39,157
Long-term debt (including current maturities)	$	22,368	$	24,682

Cash and temporary investments were $49,270 at September 30, 2005 as compared to $42,569 at December 31, 2004. The increase was a result of operating cash flows exceeding investment and financing requirements. Cash flows from operations were $21,741 for the nine-month period ended September 30, 2005, a $931 decrease from the comparable prior year period. Cash flows from operations were positively impacted by the receipt of cash from the aforementioned North Pittsburgh settlement with a carrier. However, for comparative purposes, the 2004 nine-month period was positively impacted by the collection of an approximate $421 previously disputed receivable paid by a carrier in January of 2004. In addition, 2005 has been negatively impacted by the fact that depreciation expense for tax purposes has substantially decreased from the prior year, resulting in higher taxable income and therefore higher tax

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payments. The decrease in tax depreciation expense is partially a result of the reversal of temporary differences between book and tax depreciation. With the accelerated methods of depreciation available to be used for tax purposes, tax depreciation is usually greater than book depreciation in the early years of an asset’s life but less than book depreciation in the later years of an asset’s life. Many of the capital additions made in conjunction with our network modernization and CLEC build-out capital programs during the 1997-2001 period are now in the latter position. In addition, current year additions will not benefit from federal bonus depreciation, which was enacted after the economic downturn following September 11, 2001 and was applicable only to additions made before January 1, 2005. Cash flows from operations were negatively impacted also by the timing of working capital fluctuations, mostly as a result of the timing of when payables have come due.

Cash flows used for investing activities were $3,677 for the nine-month period ended September 30, 2005, a $3,802 decrease from the comparable prior year period. The decrease was primarily the result of a $2,946 decrease in expenditures for capital additions. We estimate that our full year 2005 capital expenditure program may be approximately $2,000 to $3,000 less than the prior year program, because 2004 included several large building renovations, expenditures for the majority of the core networking equipment for our VoIP product and expenditures for several software systems. Cash flows for investing activities were also positively impacted by an $831 increase in distributions received from our partnership investments.

We expended $11,363 during the nine-month period ended September 30, 2005 for financing activities, which included cash dividends and the scheduled repayments of debt and capital lease obligations. The amount was $300 higher than the prior year period due to a $300 increase in dividends paid.

Temporary excess funds were invested in short-term cash equivalents with maturity dates scheduled to coincide with tax payment due dates, debt principal payments, dividend payment dates and other predictable cash needs. We expect to continue the investment of such excess funds throughout 2005, which should enable us to meet all short-term obligations.

Working capital levels at September 30, 2005 increased $8,870 from December 31, 2004, mostly due to the continued generation of cash flows from operations, which contributed to the increase in cash and temporary investments (as discussed above).

The decrease in long-term debt was a result of scheduled principal repayments of $2,314 during the nine-month period ended September 30, 2005. We funded 100% of our year-to-date 2005 expenditures for property and equipment from operations cash flows and cash reserves. Therefore, no additional advances were requested from our available debt facilities. In 1996, North Pittsburgh was granted approval for a loan from the FFB guaranteed by the Rural Utilities Service (RUS) in the maximum principal amount of $75,000. The total amount outstanding at September 30, 2005 to the FFB under this loan was $22,368, with all advances having a maturity date of December 31, 2012. The unadvanced amount of this facility as of September 30, 2005 was $34,764. North Pittsburgh can draw against this facility through June 30, 2012 for qualified capital expenditure projects, as defined in the loan agreement, to furnish and improve telephone service in rural areas. As of September 30, 2005, North Pittsburgh had approximately $3,337 of qualified capital expenditures that were eligible to be drawn against this facility.

The notes payable to the FFB are secured by a supplemental Mortgage Agreement executed by North Pittsburgh, which provides that substantially all of the assets of North Pittsburgh, which approximate a net book value of $84,168, are subject to a lien or a security interest. Such agreement contains restrictions regarding dividends and other distributions by North Pittsburgh. Under these restrictions, unless certain working capital levels, net worth levels and interest expense ratios are maintained, North Pittsburgh is not permitted to pay dividends on its capital stock (other than in shares of capital stock), or make any other distributions to its shareholder, or purchase, redeem or retire any of its capital stock or make any investment in affiliated companies. As a result of these restrictions, approximately $4,673 of North Pittsburgh’s retained earnings was available for dividends and other distributions to the Registrant as of September 30, 2005. The Registrant has no restrictions on the amount of its retained earnings that are available for dividends and other distributions to its shareholders as of September 30, 2005. However, because of the aforementioned North Pittsburgh restrictions on dividends and distributions, the portion of our total cash and temporary investments available for dividends and other distributions to our shareholders as of September 30, 2005 was $39,594.

North Pittsburgh also has available through June of 2009 a $10,000 line of credit with the Rural Telephone Finance Cooperative at a rate of prime plus 1.5%. No borrowings have been taken against the line of credit and there are no commitment fees associated with it.

We expect cash flows provided by operating activities and cash reserves over the next twelve months to be sufficient to service long-term debt and capital lease obligations, to pay dividends and to finance all capital projects. We currently expect a capital expenditure program for 2005 in the range of $10,000 to $11,000, of which $7,709 has been expended through September 30, 2005. Although we have yet to complete our 2006 capital budgeting process, we would not

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expect at this time any material changes in the overall size of our capital expenditure program in 2006 from the levels expended during the last three years, which have ranged from approximately $10,500 to $13,500. We expect to continue to have the necessary cash flows from operations and cash reserves to internally finance 100% of our projected capital expenditures. However, due to the low cost financing available through the RUS for qualified North Pittsburgh capital expenditures, we may request advancements from the RUS facility in the future.

We refer you to our Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our 2004 Form 10-K for a disclosure and discussion of our aggregate contractual obligations and purchase commitments as of December 31, 2004. There were no material changes in the specified contractual obligations and purchase commitments during the nine-month period ended September 30, 2005, with the exception of a change in the commitment period for an operational support system that we had originally anticipated would be implemented in July of 2005. The contract is effective for a period of five years after the commencement of the processing of the first billing cycle, which we now estimate will take place in the first quarter of 2006. As such, we will not make in 2005 the $255 in estimated contractual payments originally anticipated to be due in the second half of 2005. Instead, we now expect the commitment period will be effective through the end of 2010, with an additional $255 in estimated contractual payments due in 2010.

During the first nine months of 2005, scheduled payments of approximately $3,279, $1,161, $257 and $1,531 were made to reduce outstanding long-term debt (principal and interest), capital lease, operating lease and operational support system obligations, respectively.

Critical Accounting Policies

Certain accounting policies are very important to the portrayal of our financial condition and results of operations and require management’s most subjective or complex judgments. These policies are as follows:

Revenue Recognition

Revenues are recognized when local network, long distance, and access services are provided. Local service, intrastate long distance and intrastate access service revenues are subject to the jurisdiction of the PA PUC. Interstate long distance and interstate access service revenues are subject to the jurisdiction of the FCC. Revenues from equipment sales are recorded after equipment has been installed and accepted by the customer. Directory advertising revenues are recognized ratably over the period related to the directory publication.

Our North Pittsburgh subsidiary receives a portion of its interstate access revenues from pooling arrangements in which it participates with other telephone companies. Such pools, which are administrated by NECA, are funded by access service charges regulated by the FCC. Revenues earned through these pooling arrangements, which are based on nationwide average costs of the pooling companies applied to certain projected demand quantities, are initially recorded based on estimates and are subject to adjustments that may either increase or decrease the final amount of interstate revenues realized for a given period. Management monitors the activity of the pools and establishes accruals, if deemed necessary, for estimated obligations to the pool. The calculations used to record these revenues are complex and involve a variety of estimates, and it is therefore possible that the ultimate amount realized from the pools could differ materially from our estimates, although historically we have not experienced significant out-of-period adjustments to our revenues as a result of participating in these pools.

Valuation of Accounts Receivable

We review accounts receivable to determine which are doubtful of collection. In making the determination of the appropriate allowance for doubtful accounts, we consider our accounts receivable aging schedules, history of write-offs, relationships with our customers and the overall credit worthiness of our customers.

Income Taxes

In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.

Pension and Other Postretirement Benefits

We calculate the costs of providing retiree benefits under the provisions of SFAS No. 87 and SFAS No. 106. The key assumptions used in making these calculations are disclosed in Note 6 to

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our consolidated financial statements included in our 2004 Form 10-K. The most significant of these assumptions are the discount rate used to value the future obligation, expected return on plan assets and health care cost trend rates. We select discount rates commensurate with current market interest rates on high-quality, fixed-rate debt securities. The expected return on assets is based on our current view of the long-term returns on assets held by the plan, which is influenced by the historical performance of plan assets, asset allocation and other third-party studies. The medical cost trend rate is based on our actual medical claims and projections of future medical cost trends.

The judgments used in making and applying the above described assumptions are based on our evaluation of the relevant facts and circumstances as of the date of the financial statements. Actual results may differ from those estimates.

Regulatory Environment

Both North Pittsburgh and Penn Telecom are subject to regulatory oversight by the PA PUC for intrastate services and the FCC for interstate services. The PA PUC and the FCC have broad powers of supervision and regulation over public utilities with respect to service and facilities, rates and charges, securities, the encumbering or disposition of public utility properties, accounting and various other matters.

Federal Regulatory Matters

The FCC regulates the rates, the system of financial accounts for reporting purposes, rules for interconnection with other carriers, universal service funding, certain aspects of service quality, the use of numbering resources, compliance with the Communications Assistance for Law Enforcement Act (CALEA), and other aspects related to North Pittsburgh’s and Penn Telecom’s provision of interstate services.

Interconnection Rules

In 1996, Congress passed the 1996 Act, which has the goal of opening the telecommunications industry to further competition for all services, including the local exchange market. The 1996 Act prohibits state legislative or regulatory restrictions or barriers to entry regarding the provision of local telephone service. It also requires most ILECs to interconnect with the networks of other telecommunications carriers, unbundle their services into network elements, offer their telecommunications services at wholesale rates in order to permit the resale of such services and allow other telecommunications carriers to locate equipment on their premises. Local exchange telephone carriers are also required to compensate each other for the transport and termination of calls. The FCC has issued a number of Rulemakings that continue to implement the requirements of the 1996 Act and are intended to facilitate the resale of services at wholesale rates and provide for local number portability (LNP), dialing parity, interconnection to any requesting carrier and access to network elements.

North Pittsburgh’s wireline operations are considered Rural under the 1996 Act and are exempt from certain of the foregoing obligations unless, in response to a bona fide request for interconnection, the PA PUC removes that exemption. More specifically, pursuant to the rural exemption provision of Section 251(f)(1) of the 1996 Act, North Pittsburgh is currently exempted from offering collocation, UNEs, wholesale discounts and certain other requirements of the 1996 Act which originally pertained to non-rural ILECs. However, upon a petition by a potential competitor, the PA PUC may grant the removal of North Pittsburgh’s rural exemption if it finds that the competitor’s proposal is not unduly economically burdensome to North Pittsburgh, is technically feasible and is consistent with the universal service provisions of the 1996 Act. The burden of proof in such a proceeding rests with the competitor. The rural exemption does not, however, prevent facilities-based competition in North Pittsburgh’s service area.

North Pittsburgh has received several requests from facilities-based CLECs to negotiate interconnection agreements and is now in the process of either negotiating or implementing those agreements.

Triennial Review Order and Related Matters

On February 20, 2003, the FCC issued its TRO regarding the 1996 Act. In that Order, the FCC eliminated unbundling requirements for ILECs in regard to broadband services provided over fiber facilities but continued to require unbundled access to mass-market narrowband loops. In addition, ILECs were not required to unbundle packet switching services. The FCC further found that the high frequency portion of the loop, also referred to as line sharing, was no longer required to be provided as a UNE and would therefore be phased out over three years. Other aspects of the original TRO filing, especially in regards to the rules pertaining to the availability of the local switching UNE (UNE-P), were later remanded back to the FCC.

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On March 2, 2004, the U. S. Court of Appeals for the District of Columbia issued a decision in response to a number of court appeals filed in regard to the FCC’s TRO. In that ruling, the court upheld the FCC’s rules in regard to their conclusion that ILECs need not unbundle broadband loops provided through the utilization of new technologies such as hybrid fiber/coaxial cable and fiber-to-the-home. Subsequent FCC orders have also relieved incumbents of the unbundling requirements for fiber-to-the-curb loops, where fiber is extended to within 500 feet of a customer premises. The court also agreed with the FCC that ILECs need not provide line sharing. However, the court vacated and remanded a number of FCC rules regarding the FCC’s finding that CLECs were impaired without access to certain network elements such as local switching. In addition, the court vacated the FCC’s decision to delegate to the state commissions determinations related to mass-market switching and dedicated transport elements.

On February 4, 2005, the FCC released its Order on Remand, setting forth the final rules regarding the unbundling obligations of the ILECs in response to the Appeals Court decision. The FCC’s revised UNE rules now state that CLECs are not impaired without unbundled access to the UNE-P combination comprised of Local Switching and UNE Loop, or Shared Transport Call Related Databases, or Signaling Networks used in connection with Local Switching.

In addition, the FCC found that CLECs are not impaired at certain Wire Center locations in regard to high bandwidth (DS-1 and DS-3) loops, dark fiber loops and interoffice transport facilities based on such criteria as the number of Business Lines and Fiber-Based collocators within the wire center.

The FCC also set forth regulations that establish a mandatory transition plan to facilitate the transition by CLECs from UNEs to alternative arrangements over either a twelve- or eighteen-month period depending on the UNE being eliminated. At the end of the transition plan, the CLEC must have alternative facilities of its own or an alternative arrangement with the ILEC under either a tariff or commercial agreement.

On February 10, 2005, Verizon Pennsylvania, Inc. notified Penn Telecom regarding Verizon’s implementation plan of the FCC Order on Remand. At the same time, Verizon also petitioned the PA PUC to institute an arbitration proceeding regarding amendments to interconnection agreements that it has with CLECs and cellular mobile radio service (CMRS) providers. While the FCC Remand Order was clear in regard to which unbundled elements are no longer required to be provided by ILECs, the definitions relating to the criteria for when a particular UNE is no longer required to be offered are still at issue and should be addressed in the arbitration proceeding.

On February 14, 2005, a number of parties filed a supplementary petition with the U.S. Court of Appeals for the District of Columbia, again seeking a writ of mandamus to compel the FCC to follow the Court’s previous directive in its earlier remand decision. Those parties filing the petition claim that the final FCC rules are still flawed and not in compliance with the Court’s decision. Action by the Court is still pending.

We believe that the outcome of the final FCC rules regarding the unbundling rules, if not overturned, will have no immediate impact on our ILEC operations, because we are not required to offer UNEs to competitors as long as we retain our rural exemption. In regard to our CLEC operations, because we do not currently utilize line sharing and utilize our own switching for business customers which are served by high-capacity loops, the elimination of these network elements will have no effect on our operations or revenues from our existing customer base.

With regard to the elimination of UNE-P, we currently provision 8% of our CLEC access lines (or 3% of our consolidated access lines) utilizing UNE-P. We have recently signed a three-year commercial agreement with Verizon that has set the terms of the pricing and provisioning of these lines. Although the costs for UNE-P will increase over time in connection with the terms of the agreement, our relatively low use of UNE-P and the ability to migrate some of the lines to alternative provisioning methodologies will limit the overall impact on our current cost structure. Based on our interpretation of the rules concerning access to unbundled high capacity loops, interoffice transport facilities and dark fiber, we believe we will experience moderate increases in the overall cost to provision such loops and facilities as a result of the FCC’s Order on Remand. We caution, however, that although the FCC’s Order on Remand defines impairment of such circuits based on a review of the number of business lines and fiber-based collocators in a serving wiring center, the practical definitions of what constitutes a business line or fiber-based collocator have yet to be decided.

The PA PUC, which has the authority to set rates and terms for interconnection between carriers within the guidelines ordered by the FCC, revised many of Verizon’s unbundled rates for loops as well as high capacity circuits effective October 2004. Although the revised rates reflect a mixture of both increases and decreases, based on the specific types of circuits and markets in which we operate, we have experienced an overall decrease in the average costs (on a per line basis) to provision our CLEC access lines located in Verizon markets as a result of the PA PUC action. Verizon challenged the PA PUC’s revisions to Verizon’s rates in Federal court. In August of 2005, the U.S. District Court for the Eastern District of Pennsylvania ruled in favor of the PA PUC,

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affirming the rates set for access to unbundled elements of Verizon’s network. The positive impact of the PA PUC revisions to Verizon’s rates have mitigated the negative impacts of the FCC’s Order on Remand, with slight decreases in the overall per line cost to provision access lines in our edge-out markets experienced in 2005.

Intercarrier Compensation and Universal Service

On February 10, 2005, the FCC issued a Further Notice of Proposed Rulemaking (FNPRM) in regard to the rules governing intercarrier compensation for the various types of traffic exchanged by telecommunications carriers. Under the current rules, rates charged for traffic vary by the type and/or the jurisdiction of the traffic. The FCC is considering replacing the current system of payments with a uniform regime where all types of traffic are compensated at a unitary rate. In that proceeding the FCC is seeking comment on seven comprehensive reform proposals that have been submitted to the FCC from industry participants and other interested parties. The FCC’s goal is to put in place an intercarrier compensation mechanism that encourages the development of efficient competition, that preserves universal service support which ensures affordable rates in rural and high cost areas, that is technologically and competitively neutral and that minimizes regulatory intervention and enforcement and relies on commercially negotiated contracts rather than rules and regulations. Both North Pittsburgh and Penn Telecom receive a large percentage of their revenues from intercarrier compensation payments, and the outcome of this proceeding therefore may have a large impact on their revenue streams. In addition, because universal service funding will be affected by any change in the current intercarrier compensation system, North Pittsburgh’s universal service funding from both the interstate and intrastate jurisdictions may be affected by the outcome of this proceeding.

On February 12, 2004, the FCC issued a Notice of Proposed Rulemaking (NPRM) in regard to examining the regulatory treatment of VoIP. While the FCC indicated its preference for minimal regulation, it also recognized the need to ensure that the provision of VoIP is consistent with social objectives including universal service, emergency 911, law enforcement access, consumer protection and disability access.

Prior to the FCC’s issuance of the NPRM regarding VoIP, several companies had petitioned the FCC for declaratory rulings that their specific service offerings, which utilize some component of Internet Protocol (IP), were exempt from access charges. One of these filings was made by AT&T and one was made by pulver.com.

The AT&T Petition asked the FCC for a declaratory ruling that AT&T’s Phone-to-Phone IP telephony service, which utilizes IP in the transport portion of the service, is exempt from access charges. On April 21, 2004, the FCC released an Order denying the AT&T Petition and affirming that access charges do apply to toll calls that originate or terminate on the Public Switched Telephone Network (PSTN) even if some portion of the call is transported utilizing IP.

In the pulver.com Order released on February 12, 2004, the FCC ruled that pulver.com’s Free World Dialup offering, which provides voice-calling services utilizing IP between two broadband connections to the Internet and which does not utilize the PSTN at either end, was exempt from access charges.

While these two FCC rulings have addressed the applicability of access charges in regard to specific services that utilize IP to provide voice or toll calling services, various questions regarding the full scope of regulations that will apply to VoIP services in general are still unresolved and will be addressed in the VoIP NPRM. The outcome of this NPRM proceeding will affect North Pittsburgh and Penn Telecom because: 1) VoIP services compete directly with the local and toll service offerings of North Pittsburgh and Penn Telecom, and 2) both North Pittsburgh and Penn Telecom receive a portion of their revenues from access charges, the applicability of which to various forms of IP traffic is being reviewed in the NPRM. As the outcome of this proceeding is unknown at this time, we are unable to determine the effect such action may have on our operations and revenues.

On December 20, 2003, Level 3 Communications, LLC filed with the FCC a petition requesting that the FCC forbear from applying switched access charges to IP calls that utilize the PSTN. On March 21, 2005, Level 3 Communications, LLC withdrew its petition; therefore, no action will be taken in regard to this matter at this time.

In February of 2002, the FCC also issued a FNPRM regarding the possible reformation of the system for assessing and recovering Universal Service Fund (USF) monies. In that proceeding, the FCC has asked for comment on whether it should assess carrier contributions based on the number and capacity of connections that contributing carriers provide to customers, rather than on the current method, which is based on the interstate revenues they earn. Because the outcome of this proposal is unknown at this time, we are unable to determine the effect such action may have on our operations and revenues.

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Other Federal Regulatory Matters

Since February 2002, the FCC has been considering the possible classification of wireline broadband Internet access as an information service rather than a telecommunications service. On June 27, 2005, the U.S. Supreme Court supported the 2002 FCC decision that said cable broadband Internet service was an information service and therefore free from most telephone rules, including the requirements to lease network access to competitors. In response to the Supreme Court ruling, on August 5, 2005, the FCC issued a press release stating that they had adopted an Order which determined that wireline broadband Internet access services are information services and will therefore now be regulated under Title I of the Act. The FCC also eliminated the requirement that wireline carriers offer the broadband transmission component of Internet access on a stand-alone basis to competitors. The Order does allow a wireline provider the flexibility to offer the transmission component on a common carrier basis, a non-common carrier basis, or some combination of both. The Order also requires a one-year transition period during which unaffiliated ISPs will be able to receive the separate transmission component on a grandfathered basis. In addition, the Order requires that facilities-based providers of broadband DSL transmission services continue to contribute to the federal USF based on current levels of reported revenues for those services for a 270-day period, or until the FCC adopts new USF contribution rules, whichever occurs earlier. The Order, which was released by the FCC on September 23, 2005, becomes effective on November 16, 2005. The Company is still reviewing the Order to determine the effect (if any) the Order will have on the provision of its broadband Internet access services and whether it will choose to offer the transmission component on a non-common carrier basis.

State Regulatory Matters

The PA PUC regulates the rates, the system of financial accounts for reporting purposes, certain aspects of service quality, billing procedures, universal service funding and other aspects related to North Pittsburgh’s and Penn Telecom’s provision of intrastate services. In addition, the PA PUC sets the rates and terms for interconnection between carriers within the guidelines ordered by the FCC.

Price Regulation

Effective January 22, 2001, under a statutory framework referred to as Chapter 30, North Pittsburgh moved from rate-of-return regulation in the intrastate jurisdiction to an alternative form of regulation, which was a price cap plan. Under North Pittsburgh’s price cap plan, rates for non-competitive intrastate services were allowed to increase based on an index that measures economy-wide price increases less a productivity offset. There were no limitations on earnings under this plan. The terms of the plan also allowed North Pittsburgh to rebalance rates once each year to allow North Pittsburgh to gradually realign its intrastate rate structure on a more rational cost and market basis in order to meet future competition. In addition and pursuant to competition developing, North Pittsburgh could file with the PA PUC to declare certain services competitive and thereby be freed from all rate regulation for those services. In return for approval of the alternative form of regulation, North Pittsburgh committed to continue to upgrade its network in the future to ensure that all its customers would have access to broadband services. The original Chapter 30 legislation expired due to legislative sunset provisions on December 31, 2003.

On November 30, 2004, Act 183 was signed into law in Pennsylvania. Act 183 implemented new Chapter 30 legislation, which continued many aspects of the former Chapter 30 provision (as described above) but also added some options for ILECs in regard to alternative regulation. Under the new Chapter 30, ILECs may commit to accelerate the deployment of broadband service capability to their entire service area and in exchange receive a reduction in, or elimination of, the productivity offset in their price index formula.

On February 25, 2005, North Pittsburgh filed an Amended Alternative Form of Regulation and Network Modernization Plan with the PA PUC pursuant to Act 183. In that filing, in addition to modifying its prior Chapter 30 Plan to comport with the new statute, North Pittsburgh committed to accelerate its deployment of a ubiquitous broadband network throughout its entire service area from the previous commitment date of December 31, 2015 to December 31, 2008. In return for making this commitment, North Pittsburgh will no longer be subject to a productivity offset when calculating the Price Stability Index component of its annual price stability mechanism filing. North Pittsburgh will also not have to contribute to certain new public policy funding obligations that were instituted as part of Act 183. On June 2, 2005, the PA PUC approved North Pittsburgh’s amended plan with no significant changes. We believe that, based on the substantial investment we have already made in our broadband network, the capital expenditures necessary to meet the accelerated commitment date should not necessitate any material increases to the broadband portion of North Pittsburgh’s capital expenditure program from recent levels.

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Other State Regulatory Matters

In addition to the PA PUC’s revision of Verizon’s unbundled rates previously discussed under the Triennial Review Order and Related Matters heading above, there is another recent PA PUC proceeding that could impact North Pittsburgh and Penn Telecom. On December 16, 2004, the PA PUC adopted an Order instituting an investigation regarding the intrastate access charges and intraLATA toll rates of rural carriers in Pennsylvania, and the effect on those charges and rates if the PA PUC were to reduce disbursements from the Pennsylvania USF to the rural carriers or if it were to broaden the base of contributors to include carriers that do not currently pay into the fund. The proceeding will also address the ramifications of recent changes to the Pennsylvania Public Utility Code set forth in Act 183 that affect access rate setting for both rural Local Exchange Carriers (LECs) and CLECs. Under the Act 183 changes to the Public Utility Code, the PA PUC may not require a LEC to reduce intrastate access rates except on a revenue neutral basis. The new statute also sets limits on a CLEC’s ability to charge intrastate access rates higher than the ILECs in the area in which they are offering service. The procedures regarding the PA PUC’s implementation of these rate setting limitations will be determined in this access charge and USF proceeding. This proceeding may affect both North Pittsburgh’s and Penn Telecom’s ability to set access charge rates. The proceeding also may affect the amount of funding that North Pittsburgh receives from the Pennsylvania USF and the amounts that North Pittsburgh and Penn Telecom contribute to that fund. A number of parties to the proceeding filed a petition asking that the PA PUC delay any action in regard to the Pennsylvania USF and intrastate access charges until such time as the FCC takes action in regard to intercarrier compensation issues. On August 11, 2005, the PA PUC adopted an Order, which was entered on August 30, 2005, in which it granted a stay of the investigative proceeding for a period not to exceed twelve months, unless further extended by the PA PUC, or until the FCC issues its ruling in its Unified Intercarrier Compensation proceeding, whichever occurs earlier. With the enactment of the stay, the outcome of this proceeding is unknown at this time, so we are unable to determine the impact the proceeding may have on the revenues of North Pittsburgh and Penn Telecom.

Recent Accounting Pronouncements

The FASB issued FIN 46, “Consolidation of Variable Interest Entities”, in January 2003 and amended the Interpretation in December 2003. A variable interest entity (VIE) is an entity in which its voting equity investors lack the characteristics of having a controlling financial interest or where the existing capital at risk is insufficient to permit the entity to finance its activities without receiving additional financial support from other parties. FIN 46 requires the consolidation of entities which are determined to be VIEs when the reporting company determines itself to be the primary beneficiary (the entity that will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s residual returns, or both). The amended Interpretation was effective for the first interim or annual reporting period ending after March 15, 2004, with the exception of special purpose entities for which the statement was effective for periods ending after December 15, 2003. We have completed a review of our partnership investments and have determined that those entities do not qualify as VIEs.

In May 2004, the FASB issued FASB Staff Position (FSP) No. FAS 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.” FSP 106-2 provides guidance on the accounting for the effects of the new Medicare prescription drug benefit available to employers who sponsor postretirement health care plans that provide a benefit that is at least actuarially equivalent to the drug benefit provided under Medicare Part D. FSP 106-2 was effective for the first interim reporting period beginning after June 15, 2004. The Company’s current accumulated projected benefit obligation and net periodic postretirement benefit cost do not reflect any amount associated with the federal subsidy provided by that Act. Medical coverage, including prescription drug benefits, provided by the North Pittsburgh postretirement benefit plan ceases when the retiree becomes Medicare eligible (currently age 65). The adoption of FSP 106-2 did not impact the Company’s consolidated financial statements.

In March 2005, the FASB issued FIN 47, “Accounting for Conditional Asset Retirement Obligations – an interpretation of FASB Statement No. 143”. FIN 47 clarifies that the term “conditional asset retirement obligation” as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligations,” refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. An entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. Any uncertainty about the amount and/or timing of future settlement should be factored into the measurement of the liability when sufficient information exists. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. We are currently evaluating the potential impact of this accounting interpretation on our results of operations and financial position.

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PART I

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in reported market risks faced by the Company since the end of the Company’s preceding fiscal year on December 31, 2004.

Item 4. Controls and Procedures

Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial and Accounting Officer, the Company evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q, and, based on their evaluation, the Chief Executive Officer and Chief Financial and Accounting Officer concluded that these disclosure controls and procedures are effective.

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II

OTHER INFORMATION

Item 6. Exhibits

(a) Exhibits Index for Quarterly Reports on Form 10-Q.

Exhibit No.	Subject	Applicability
(2)	Plan of acquisition, reorganization, arrangement, liquidation or succession	Not Applicable
(3)(i)	Articles of Incorporation	Provided in Quarterly Report on Form 10-Q for the quarter ended September 30, 2003 and Incorporated Herein by Reference
(3)(ii)	Amended and Restated By-Laws	Provided in Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 and Incorporated Herein by Reference
(4)	Instruments defining the rights of security holders including indentures
	(a)    Agreement of Reorganization and Plan of Merger	Provided in Registration of Securities of Certain Successor Issuers on Form 8-B filed on June 25, 1985 and Incorporated Herein by Reference
	(b)    Rights Agreement dated as of September 25, 2003	Provided as Exhibit 1 to the Registration of Certain Classes of Securities on Form 8-A filed on October 3, 2003 and Incorporated Herein by Reference
(10)	Material contracts
	(a)    Amended and Restated Executive Employment Agreement	Provided in Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 and Incorporated Herein by Reference.
	(b)    Executive Retention Payment Program Agreement	Provided in Annual Report on Form 10-K for the year ended December 31, 2003 and Incorporated Herein by Reference.
	(c)    Extension of Amended and Restated Executive Employment Agreement and Retention Payment Program	Provided in Annual Report on Form 10-K for the year ended December 31, 2003 and Incorporated Herein by Reference.
(11)	Statement re computation of per share earnings	Attached Hereto
(15)	Letter re unaudited interim financial information	Not Applicable
(18)	Letter re change in accounting principles	Not Applicable
(19)	Report furnished to securities holders	Not Applicable
(22)	Published report regarding matters submitted to vote of security holders	Not Applicable
(23)	Consents of experts and counsel	Not Applicable
(24)	Power of attorney	Not Applicable

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Exhibit No.	Subject	Applicability
(31(i).1)	Certification of President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Attached Hereto
(31(i).2)	Certification of Senior Vice President and Chief Financial and Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Attached Hereto
(32.1)	Certification of President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Attached Hereto
(32.2)	Certification of Senior Vice President and Chief Financial and Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Attached Hereto

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	NORTH PITTSBURGH SYSTEMS, INC.
	(Registrant)
Date: November 9, 2005	/s/ H. R. Brown
	H. R. Brown, President and Chief Executive Officer
Date: November 9, 2005	/s/ A. P. Kimble
	A. P. Kimble, Senior Vice President and
	Chief Financial and Accounting Officer

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