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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to
Commission file number 0-11174
WARWICK VALLEY TELEPHONE COMPANY
----------------------------------
(Exact name of registrant as specified in its charter)
New York 14-1160510
------------------------------ ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
47 Main Street, Warwick, New York 10990 .
------------------------------------------- -----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (845) 986-8080
Former name, former address and former fiscal year, if changed since last
report.
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO [ ]
Indicate by check mark whether registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: 5,401,780 Common Shares,
$.01 par value, outstanding at November 2, 2004.
INDEX TO FORM 10Q
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of September 30, 2004
and December 31, 2003 3
Consolidated Statements of Income for the three and nine months ended September 30, 2004 4
and 2003, as restated
Consolidated Statements of Cash Flows for the nine months ended September 30, 2004
and 2003, as restated 5
Notes to Consolidated Financial Statements 6-13
Item. 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 13-19
Item. 3 Quantitative and Qualitative Disclosures about Market Risk 19
Item. 4 Controls and Procedures 19
PART II - OTHER INFORMATION
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 21-26
-2-
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
WARWICK VALLEY TELEPHONE COMPANY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
($ in thousands except share amounts)
SEPTEMBER 30, DECEMBER 31,
2004 2003
----------- -----------
ASSETS
Current assets:
Cash and cash eqivalents $ 13,742 $ 5,717
Accounts receivable - net of reserve for uncollectibles - $144 and $508 respectively 3,710 3,420
Other accounts receivable 102 273
Materials and supplies 1,241 1,153
Prepaid expenses 837 681
Deferred income taxes 413 495
----------- -----------
Total Current Assets $ 20,045 $ 11,739
----------- -----------
Property, plant and equipment, net 41,260 41,322
Unamortized debt issuance costs 106 115
Intangible asset - pension 744 744
Other deferred charges 613 510
Investments 4,644 5,303
----------- -----------
TOTAL ASSETS $ 67,412 $ 59,733
=========== ===========
LIABILITIES
Current Liabilities:
Accounts payable $ 604 $ 1,559
Current maturities of long term debt 1,139 223
Advance billing and payments 269 247
Customer deposits 114 135
Accrued taxes 889 506
Pension and post retirement benefit obligations 584 1,139
Accrued access billing 835 694
Other accrued expenses 946 1,252
----------- -----------
Total Current Liabilities $ 5,380 $ 5,755
----------- -----------
Long-term debt 11,010 6,926
Deferred income taxes 4,705 4,119
Other liabilities and deferred credits 567 536
Pension and post retirement benefit obligations 4,984 4,511
----------- -----------
TOTAL LIABILITIES $ 26,646 $ 21,847
----------- -----------
Shareholders' Equity
Preferred Shares - $100 par value; authorized and issued shares 5,000;
$0.01 par value authorized and unissued shares 10,000,000; $ 500 $ 500
Common stock - $0.01 par value; authorized shares 10,000,000 60 60
issued 5,985,463 as of September 30, 2004 and 5,984,883 as of December 31, 2003
Treasury stock - $0.01 par value, 583,683 Common Shares as of September 30, 2004 (3,598) (3,598)
and December 31, 2003
Additional paid in capital 3,486 3,473
Accumulated other comprehensive income (765) (765)
Retained earnings 41,083 38,216
----------- -----------
Total Shareholders' Equity $ 40,766 $ 37,886
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 67,412 $ 59,733
=========== ===========
Please see accompanying notes, which are an intergral part of the consolidated
financial statements.
-3-
WARWICK VALLEY TELEPHONE COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
($in thousands except per share amounts)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Restated) (Restated)
Operating Revenues:
Local network service $ 1,050 $ 1,025 $ 3,075 $ 3,062
Network access service 2,237 2,467 6,463 7,137
Long distance services 928 969 2,900 2,846
Directory advertising 362 353 1,088 1,061
Online services 1,740 1,689 5,180 4,932
Other services and sales 706 869 2,242 2,572
----------- ----------- ----------- -----------
Total operating revenues 7,023 7,372 20,948 21,610
----------- ----------- ----------- -----------
Operating Expenses:
Plant specific 1,172 1,407 3,257 3,549
Plant non-specific:
Depreciation & amortization 1,291 1,248 3,961 3,649
Other 835 684 2,368 2,025
Customer operations 1,109 1,110 3,435 3,206
Corporate operations 1,269 994 3,826 3,323
Cost of services and sales 459 476 1,451 1,856
Property, revenue and payroll taxes 413 350 1,185 1,066
----------- ----------- ----------- -----------
Total operating expenses 6,548 6,269 19,483 18,674
----------- ----------- ----------- -----------
OPERATING INCOME 475 1,103 1,465 2,936
Other Income (Expense)
Interest income (expense), net of capitalized interest (77) (114) (214) (331)
Income from equity method investments 2,757 2,456 7,791 6,604
Other income (expense) 36 (42) 58 (44)
----------- ----------- ----------- -----------
Total other income (expense) - net 2,716 2,300 7,635 6,229
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 3,191 3,403 9,100 9,165
Income Taxes 1,039 1,154 3,081 3,104
----------- ----------- ----------- -----------
NET INCOME 2,152 2,249 6,019 6,061
Preferred Dividends 6 6 19 19
----------- ----------- ----------- -----------
INCOME APPLICABLE TO COMMON STOCK $ 2,146 $ 2,243 $ 6,000 $ 6,042
=========== =========== =========== ===========
Basic & Diluted Earnings per Share of
Outstanding Common Stock $ 0.40 $ 0.41 $ 1.11 $ 1.12
=========== =========== =========== ===========
Weighted Average Shares of Common Stock
Outstanding 5,401,780 5,401,409 5,401,404 5,400,753
=========== =========== =========== ===========
Please see accompanying notes, which are an intergral part of the consolidated
financial statements.
-4-
WARWICK VALLEY TELEPHONE COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
($in thousands except per share amounts)
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
2004 2003
-------- -------
(Restated)
CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 6,019 $ 6,061
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,961 3,649
Deferred income tax and investment tax credit 668 294
Interest charged to construction (6) (38)
Income from equity investments (7,791) (6,604)
Change in assets and liabilities:
(Increase) Decrease in accounts receivable (290) (1,428)
(Increase) Decrease in other accounts receivable 171 338
(Increase) Decrease in materials and supplies (88) (69)
(Increase) Decrease in prepaid expenses (156) (385)
(Increase) Decrease in deferred charges (103) (406)
Increase (Decrease) in accounts payable (955) 418
Increase (Decrease) in customers' deposits (21) 1
Increase (Decrease) in advance billing and payment 22 20
Increase (Decrease) in accrued taxes 383 211
Increase (Decrease) in pension & post retirement benefits obligations (83) 1,087
Increase (Decrease) in accrued access billing 141 170
Increase (Decrease) in other accrued expenses (275) (191)
-------- -------
Net cash provided by operating activities 1,597 3,128
-------- -------
CASH FLOW FROM INVESTING ACTIVITIES:
Capital expenditures (3,890) (3,561)
Interest charged to construction 6 38
Distribution from partnership 8,925 8,250
Investment contributions (475) 0
-------- -------
Net cash provided by investing activities 4,566 4,727
-------- -------
CASH FLOW FROM FINANCING ACTIVITIES:
Increase (Decrease) in notes payable 0 (5,000)
Proceeds from issuance of long term debt 5,000 3,149
Unamoritzed debt issuance 0 (114)
Dividends(Common) (3,133) (2,777)
Dividends(Preferred) (19) (19)
Sale of common stock 14 48
-------- -------
Net cash provided by (used in) financing activities 1,862 (4,713)
-------- -------
Increase (Decrease) in cash and cash equivalents 8,025 3,142
Cash and cash equivalents at beginning of year 5,717 1,641
-------- -------
Cash and cash equivalents at end of year $ 13,742 $ 4,783
======== =======
Please see accompanying notes, which are an intergral part of the consolidated
financial statements.
-5-
WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands except per share amounts
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Warwick Valley Telephone Company (the "Company") provides communications
services to customers in the Towns of Warwick, Goshen, and Wallkill, New York
and the Townships of Vernon and West Milford, New Jersey. Its services include
providing local, toll telephone service to residential and business customers,
access and billing and collection services to interexchange carriers, Internet
access and Video service.
BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial
statements of the Company and its subsidiaries have been prepared in accordance
with generally accepted accounting principles in the United States of America
for interim financial information and with the instructions to Form 10-Q.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of the Company's management, all adjustments consisting only of
normal recurring adjustments considered necessary for fair presentation have
been included. Operating results for the three and nine month periods ended
September 30, 2004 are not necessarily indicative of the results that may be
expected for the entire year.
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All material intercompany transactions and
balances have been eliminated in the consolidated financial statements.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and any
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reported period. Actual results could differ from those estimates. The interim
condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto included in the
Company's latest annual report on Form 10-K, as amended.
RECLASSIFICATIONS
Certain amounts previously reported for prior periods have been
reclassified to conform to the current year presentation in the accompanying
consolidated financial statements. Such reclassifications had no effect on the
results of operations or shareholders' equity as previously recorded.
NOTE 2: RESTATEMENT
On December 4, 1998, the New York Public Service Commission ("NYPSC")
issued Cases 94-C-0095 and 28425 ("Order"), which required the Company to reduce
traffic sensitive access charges to inter-exchange carriers. This Order was
effective from January 1, 1999 to present and consequently had no impact on
periods prior to that date. The Company has determined that it did not reduce
traffic sensitive charges to inter-exchange carriers during the period January
1, 1999 to March 31, 2004, as stipulated by the Order. As a result, the Company
recorded additional revenues from inter-exchange carriers in the amount equal to
the incremental difference between the rate charged and the rate that would
comply with the Order. Accordingly, the Company has restated its financial
statements for all prior periods affected as the cumulative impact for periods
prior to June 30, 2004 would have been material if recorded in the second
quarter of 2004. The Company has restated the prior periods to reduce revenue,
accrue interest, and record the related tax impact. The Company has filed an
amendment to the Company's 2003 Annual Report on Form 10-K reflecting the impact
of this restatement. The following tables present the impact of the restatement.
The NYPSC has not made a final determination regarding the amount of the
Company's obligation and whether the Company will be required to make a refund,
the way any refund would be calculated or of the amount or timing of any
payments. Therefore, the ultimate amount of repayment may differ from the
current liability and such difference, if any, would be reflected in earnings in
the period of settlement.
-6-
WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands except per share amounts
The impact of the restatement on the consolidated statement of income for the
three months and nine months ended September 30, 2003 was as follows:
Three months ended September 30, 2003 Nine months ended September 30, 2003
------------------------------------- ------------------------------------
As Previously As Previously
Reported As Restated Reported As Restated
--------------- --------------- --------------- ---------------
Operating revenues $ 7,420 $ 7,372 $ 21,756 $ 21,610
Operating income $ 1,151 $ 1,103 $ 3,082 $ 2,936
Interest expense $ (105) $ (114) $ (306) $ (331)
Total other income (expense) $ 2,308 $ 2,300 $ 6,254 $ 6,229
Income before income taxes $ 3,459 $ 3,403 $ 9,336 $ 9,165
Income taxes $ 1,173 $ 1,154 $ 3,165 $ 3,104
Net income $ 2,286 $ 2,249 $ 6,171 $ 6,061
Basic & diluted earnings per share $ 0.42 $ 0.41 $ 1.13 $ 1.12
The impact of the restatement on the consolidated statement of cash flows for
the nine months ended September 30, 2003 was as follows:
Nine months ended September 30, 2003
------------------------------------
As Previously
Reported As Restated
----------------- -----------------
Net income $ 6,171 $ 6,061
Deferred income taxes $ 353 $ 294
Increase in accrued access billing $ - $ 170
NOTE 3: IMPACT OF RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
The Company adopted FASB Interpretation No. 46 "Consolidation of Variable
Interest Entities" ("FIN 46") in 2003. FIN 46, which is an interpretation of ARB
No. 51, "Consolidated Financial Statements", addresses the consolidation of
investments made by a business enterprise, structured in a way that, although
the enterprise may have less than a majority interest in the voting rights, the
investment exhibits other characteristics making the enterprise the primary
beneficiary of the investment, absorbing the majority of the losses, receiving
the majority of the expected residual returns, and thereby requiring
consolidation by the business enterprise. As of September 30, 2004, FIN 46 did
not significantly impact the Company's operating results or financial position.
The Company will continue to monitor the impact of FIN 46 on an ongoing basis.
Effective January 1, 2003, the Company adopted SFAS No. 143, "Accounting
for Asset Retirement Obligations" ("SFAS No. 143"). SFAS No. 143 addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs.
The Company's rates are regulated by the Federal Communications Commission
("FCC"), NYPSC, and New Jersey Board of Public Utilities ("NJBPU"); therefore,
the Company reflects the effects of the rate making actions of these regulatory
bodies in its financial statements. On December 20, 2003, the FCC notified
carriers by order that it would not adopt SFAS No. 143 since the FCC concluded
that SFAS No.143 conflicted with the FCC's current accounting rules that require
telephone companies to accrue for asset retirement obligations through
prescribed depreciation rates.
-7-
WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands except per share amounts
The Company has concluded that it did not have an asset retirement
obligation as defined by SFAS No.143, as of September 30, 2004 or December 31,
2003. The Company historically recorded cost of removals through depreciation
rates and accumulated depreciation. In conjunction with the adoption of SFAS
No.143, the Company has reclassified $563 and $505 as of September 30, 2004 and
December 31, 2003, respectively, from accumulated depreciation to a regulatory
liability for the cost of removal that the Company has recorded through its
historical depreciation rates.
NOTE 4: EARNINGS PER SHARE
Basic and diluted earnings per share are based on the weighted average
number of actual shares outstanding of 5,401,780 and 5,401,409; 5,401,404 and
5,400,753 for the three and nine month periods ended September 30, 2004 and
2003, respectively. Share amounts have been restated for the three-for-one stock
split (see Note 11).
The Company did not have any common stock equivalents as of September 30,
2004 and 2003.
NOTE 5: COMPREHENSIVE INCOME
Comprehensive income is equivalent to net income for the three and nine
month periods ended September 30, 2004 and 2003.
NOTE 6: SEGMENT INFORMATION
The Company's segments are strategic business units that offer different
products and services and are managed as telephone and online services. The
Company evaluates segment performance based upon factors such as revenue growth,
expense containment, market share and operating income.
The telephone segment provides landline telecommunications services,
including local, network access, long distance services and messaging, and sells
customer premise equipment, private business exchange equipment and yellow and
white pages advertising and electronic publishing.
The online segment provides high speed and dial up Internet services, help
desk operations, and Video over VDSL.
Segment balance sheet information as of September 30, 2004 and December
31, 2003 is set forth below:
September 30, December 31,
2004 2003
------------- -------------
Assets
Telephone $ 72,921 $ 62,825
Online 10,643 9,883
Elimination (16,152) (12,975)
------------- -------------
Total assets $ 67,412 $ 59,733
============= =============
-8-
WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands except per share amounts
Segment income statement information for the nine months ended September 30,
2004 and 2003 (restated) is set forth below:
2004 2003
-------- --------
Revenues
Telephone $ 17,334 $ 18,116
Online 5,180 4,932
Eliminations (1,566) (1,438)
-------- --------
Total revenues $ 20,948 $ 21,610
Operating income
Telephone 1,709 3,095
Online (244) (159)
-------- --------
Total operating income $ 1,465 $ 2,936
Interest expense and income (214) (331)
Income from equity method investments 7,791 6,604
Other income (expense) 58 (44)
-------- --------
Income before taxes $ 9,100 $ 9,165
======== ========
Segment income statement information for the three months ended September 30,
2004 and 2003 (restated) is set forth below:
2004 2003
-------- --------
Revenues
Telephone $ 5,802 $ 6,154
Online 1,740 1,689
Eliminations (519) (471)
-------- --------
Total revenues $ 7,023 $ 7,372
Operating income
Telephone 613 1,177
Online (138) (74)
-------- --------
Total operating income $ 475 $ 1,103
Interest expense and income (77) (114)
Income from equity method investments 2,757 2,456
Other income (expense) 36 (42)
-------- --------
Income before taxes $ 3,191 $ 3,403
======== ========
-9-
WARWICK VALLEY TELEPH6ONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands except per share amounts
NOTE 7: MATERIAL AND SUPPLIES
Material and supplies are carried at average cost except that specific
costs are used in the case of large individual items. As of September 30, 2004
and December 31, 2003, the material and supplies inventory consisted of the
following:
2004 2003
-------- --------
Inventory for outside plant $ 282 $ 231
Inventory for inside plant 697 472
Inventory for online plant 82 90
Inventory of video equipment 31 283
Inventory of equipment held for sale or lease 149 77
-------- --------
$ 1,241 $ 1,153
======== ========
NOTE 8: PROPERTY, PLANT AND EQUIPMENT
Plant in service, at cost, consisted of the following as of September 30,
2004 and December 31, 2003:
2004 2003
-------- --------
Land, buildings, furniture and other support equipment $ 7,527 $ 7,518
Network and communications plant 29,426 27,273
Telephone plant 24,564 23,747
Online plant 9,729 9,513
-------- --------
Plant in service $ 71,246 $ 68,051
Plant under construction 2,030 1,467
-------- --------
73,276 69,518
Less: Accumulated depreciation 32,016 28,196
-------- --------
Property, plant and equipment, net $ 41,260 $ 41,322
======== ========
NOTE 9: INVESTMENTS
The Company is a limited partner in Orange County-Poughkeepsie Limited
Partnership ("O-P") and has a 7.5% investment interest which is accounted for
under the equity method of accounting. The majority owner and general partner is
Verizon Wireless of the East L.P. The following summarizes O-P's income
statement for the nine months ended September 30:
(Unaudited)
2004 2003
---------- ----------
Net sales $ 122,486 $ 107,617
Cellular service cost 11,697 13,288
Operating expenses 5,610 4,647
---------- ----------
Net operating income 105,179 89,682
Other income 717 1,145
---------- ----------
Net income $ 105,896 $ 90,827
========== ==========
-10-
WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands except per share amounts
The following summarizes O-P's income statement for the three months ended
September 30:
(Unaudited)
2004 2003
-------- --------
Net sales $ 42,852 $ 39,643
Cellular service cost 3,886 4,483
Operating expenses 1,904 1,901
-------- --------
Net operating income 37,062 33,259
Other income 248 231
-------- --------
Net income $ 37,310 $ 33,490
======== ========
The Company also owns 17% of Zefcom, LLC, d.b.a. Telispire, a consortium
of small telephone companies that resells Sprint PCS under private label. Prior
to the fourth quarter of 2003, this investment had historically been recorded on
the cost method of accounting. Zefcom formed an Executive Operating Committee
(the "Operating Committee") consisting of representatives from three of the
investors in Zefcom. The Operating Committee's responsibilities are to assist
management, as necessary, in relations with consultants and prospective
investors and in matters of finance.
The Company's Chief Executive Officer was elected to this committee in
August 2003. Accordingly the Company, through its representation of this
Operating Committee began exerting significant influence on the financial and
operating decisions of Zefcom in the fourth quarter of 2003. As a result of this
change, the Company changed its accounting for the Zefcom investment from the
cost method to the equity method of accounting. In August 2004, the Company's
Chief Financial Officer was elected to this committee replacing the Chief
Executive Officer, thereafter, in October 2004 the Company's Business and
Planning Director replaced the Chief Financial Officer in that role.
In accordance with generally accepted accounting principles, the Company
has adjusted its prior period financial results to record its 17% investment in
Zefcom as if it had been accounted for under the equity method of accounting.
The Company's share of Zefcom's losses has been reflected in "Other Income" in
the Income Statement for the three and nine month periods ended September 30,
2004 and 2003. The impact to net income for the nine month period ended
September 30, 2003 was a decrease of $108. Earnings per share also decreased by
$0.01.
In March 2004, the Company made an initial capital contribution of $238 in
cash to Empire State Independent Fiber Network, LLC ("EsiNet"). The Company
committed to contribute a total of $950 in four payments over the succeeding
twelve months in connection with the Company's 25% interest in the venture. Two
of these payments have already been made. The remaining payments of
approximately $238 each are scheduled for, December 1, 2004 and April 1, 2005,
respectively. EsiNet's operations are anticipated to begin during the first half
of 2005.
In October 2004, the Company completed the sale of all its interest in
DataNet Communications Group for approximately $4,500 (see Note 12).
NOTE 10: PENSION AND POST RETIREMENT OBLIGATIONS
The components of net periodic cost for the three months ended September
30 are as follows:
Post Retirement
Pension Benefits Benefits
2004 2003 2004 2003
------ ------ ------ ------
Service Cost $ 63 $ 105 $ 47 $ 40
Interest Cost 203 216 77 69
Expected Return On Plan Assets (162) (153) (30) (21)
Amortization Of Prior Service Cost 22 32 8 8
Amortization Of Net (Gain) Loss 35 35 52 45
Special Termination Benefits 0 169 0 0
------ ------ ------ ------
Net Periodic Benefit Cost $ 161 $ 404 $ 154 $ 141
====== ====== ====== ======
-11-
WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands except per share amounts
The components of net periodic cost for the nine months ended September 30
are as follows:
Post Retirement
Pension Benefits Benefits
2004 2003 2004 2003
-------- -------- -------- --------
Service Cost $ 189 $ 315 $ 141 $ 121
Interest Cost 609 647 231 208
Expected Return On Plan Assets (487) (459) (90) (64)
Amortization Of Prior Service Cost 66 95 24 24
Amortization Of Net (Gain) Loss 106 106 157 134
Special Termination Benefits 0 506 0 0
-------- -------- -------- --------
Net Periodic Benefit Cost $ 483 $ 1,210 $ 463 $ 423
======== ======== ======== ========
The Company has previously disclosed in its financial statements for the
year ended December 31, 2003 that it expected to contribute $918 to its pension
plan and $222 to its post retirement plan, respectively in 2004. During the nine
months ended September 30, 2004, the Company has contributed $445 to its pension
plan and $111 to its post retirement plan.
In December 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the "Act") was signed into law. The Act introduces a
prescription drug benefit under Medicare ("Medicare Part D") as well as a
federal subsidy to sponsors of retiree health care benefit plans that provide a
benefit that is at least actuarially equivalent to Medicare Part D. The Company
is impacted by the Act since it sponsors a postretirement health care plan that
provides prescription drug benefits
In May 2004, the Financial Accounting Standards Board released FASB Staff
Position No. FAS 106-2, "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003 ("FSP
106-2"). FSP 106-2 states that if a company concludes that its single-employer
defined benefit postretirement health care plan provides a drug benefit that is
actuarially equivalent to the Medicare Part D benefit, the employer should
recognize the subsidy in the measurement of the accumulated postretirement
benefit obligation (APBO) under FAS 106, and should account for this reduction
in the APBO as an actuarial gain. If an employer amends its plan to achieve
actuarially equivalent drug benefits, therefore making the employer eligible for
the subsidy, the employer is required to consider the combined effect that the
amendment and the subsidy have on the APBO. If the combined effect is a decrease
in the APBO, the net reduction is accounted for as an actuarial gain. If the
combined effect is an increase in the APBO, the net increase is accounted for as
a plan amendment.
The provisions of FSP 106-2 are effective for the first interim or annual
period beginning after June 15, 2004 for all public companies. If the effects of
FSP 106-2, including the subsidy, changes in participation rates, and changes in
per capita claims costs, lead the employer to conclude that the enactment of FSP
106-2 was not a "significant event" for its plan, the effects should be
incorporated in the valuation performed at the next measurement date required by
FAS 106. Because clarifying regulations providing a firm definition of
actuarial equivalence have not yet been issued, the Company is unable to
determine whether the prescription drug benefits provided under its plans are
actuarially equivalent to Medicare Part D benefits, and the Company has not
recorded any impact of the Act for this group. Until the Company is able to
make a determination as to actuarial equivalence, measures of the accumulated
postretirement benefit obligation and net periodic postretirement benefit cost
will not include any effect of the subsidy. Although not expected to be
significant, the Company expects to reflect the other effect of the Act (e.g.,
participation rates, healthcare cost trend rates, etc.) on postretirement
benefit costs and obligations at the Company's next measurement date.
NOTE 11: SHAREHOLDERS' EQUITY
The Company has 10,000,000 authorized Common Shares at $0.01 Par value;
5,000 authorized Preferred Shares at $100 par value; and 10,000,000 authorized
Preferred Shares at $0.01 par value.
On April 25, 2003, the Company announced a three-for-one stock split of
the Company's Common Shares. Approval for the stock split was received from both
the New York State Public Service Commission and the New Jersey Board of Public
Utilities on October 6, 2003, and the additional shares resulting from the split
were made available on October 13, 2003. Also, a par value of one cent per share
was established for the Common Shares. As a result, earnings-per-share amounts
for the three and nine month periods ended September 30, 2003 have been restated
to reflect the stock split.
-12-
WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands except per share amounts
NOTE 12: SUBSEQUENT EVENT
On October 28, 2004 the Company completed the sale of all of its shares in
DataNet Communications Group, Inc. (also known as Hudson Valley DataNet),
("DataNet") to DCG Acquisition, LLC, an affiliate of Quadrangle Capital
Partners, LP (together with its affiliated funds, "Quadrangle") for
approximately $4,500. The Company received $3,600 in cash. In addition, $900
will be retained in escrow on the Company's behalf until May 1, 2005 (or later
with respect to any amount relating to claims pending) to secure certain
indemnification obligations of DataNet under an agreement between DataNet, DCG
Acquisition LLC, John Galanti and Quadrangle, pursuant to Quadrangle's
acquisition of a controlling interest in DataNet. The amounts held in escrow and
not required for payment of indemnification obligations will be paid over to the
Company with interest when the escrow is terminated. The Company's original
investment in DataNet was $1,000. Accordingly the Company expects to realize a
pre-tax gain of approximately $3,500, less any amounts withheld to pay for
indemnification obligations, as noted above.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company operates in the communications services industry and provides
telephone, directory advertising services, Internet, Video and other services to
its customers. The Company's basic business strategy is directed towards
retaining as much of the traditional telecommunications business as possible,
while using its existing network to develop and grow its Internet, data and
entertainment products. The information below reflects all of these factors and
efforts.
You should read this discussion in conjunction with the consolidated
financial statements and the accompanying notes. The presentation of dollar
amounts in this discussion is in thousands.
RESTATEMENT:
On December 4, 1998, the New York Public Service Commission ("NYPSC")
issued Cases 94-C-0095 and 28425 ("Order"), which required the Company to reduce
traffic sensitive access charges to inter-exchange carriers. This Order was
effective from January 1, 1999 to present and consequently had no impact on
periods prior to that date. The Company has determined that it did not reduce
traffic sensitive charges to inter-exchange carriers during the period January
1, 1999 to March 31, 2004, as stipulated by the Order. As a result, the Company
recorded additional revenues from inter-exchange carriers in the amount equal to
the incremental difference between the rate charged and the rate that would
comply with the Order. Accordingly, the Company has restated its financial
statements for all prior periods affected as the cumulative impact for periods
prior to June 30, 2004 would have been material if recorded in the second
quarter of 2004. The Company has restated the prior periods to reduce revenue,
accrue interest, and record the related tax impact. The Company has filed an
amendment to the Company's 2003 Annual Report on Form 10-K reflecting the impact
of this restatement. The following tables present the impact of the restatement.
The NYPSC has not made a final determination regarding the amount of the
Company's obligation and whether the Company will be required to make a refund,
the way any refund would be calculated or of the amount or timing of any
payments. Therefore, the ultimate amount of repayment may differ from the
current liability and such difference, if any, would be reflected in earnings in
the period of settlement.
-13-
Three months ended September 30, 2003 Nine months ended September 30, 2003
------------------------------------- ------------------------------------
As Previously As Previously
Reported As Restated Reported As Restated
------------- ------------- ------------- -------------
Operating revenues $ 7,420 $ 7,372 $ 21,756 $ 21,610
Operating income $ 1,151 $ 1,103 $ 3,082 $ 2,936
Interest expense $ (105) $ (114) $ (306) $ (331)
Total other income (expense) $ 2,308 $ 2,300 $ 6,254 $ 6,229
Income before income taxes $ 3,459 $ 3,403 $ 9,336 $ 9,165
Income taxes $ 1,173 $ 1,154 $ 3,165 $ 3,104
Net income $ 2,286 $ 2,249 $ 6,171 $ 6,061
Basic & diluted earnings per share $ 0.42 $ 0.41 $ 1.13 $ 1.12
The impact of the restatement on the consolidated statement of cash flows for
the nine months ended September 30, 2003 was as follows:
Nine months ended September 30, 2003
------------------------------------
As Previously
Reported As Restated
------------ ------------
Net income $ 6,171 $ 6,061
Deferred income taxes $ 353 $ 294
Increase in accrued access billing $ - $ 170
SALE OF INVESTMENT:
On October 28, 2004 the Company completed the sale of all its shares in
DataNet for $4,500. The Company's original investment in DataNet was $1,000. The
expected gain on the sale of this transaction will be reflected in the Company's
fourth quarter 2004 operating results.
OVERVIEW: RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004
AND 2003 - (in thousands)
OPERATING REVENUES
Operating revenues decreased by $349 (or 5%) for the three-month period
ended September 30, 2004. This decrease was due primarily to a reduction in
network access revenues of $230 (or 9%) which resulted largely from lower local
switching support revenues received from the Universal Service Administration
Corporation ("USF"), and rate reductions attributable to the implementation of
the aforementioned Order described above under Restatement. Long Distance
service revenues decreased $41 (or 4%) for the three month period ended
September 30, 2004 due to the continued decline in interstate interLATA call
volume following customer trends towards wireless communications. Online service
revenues increased $51 (or 3%) due primarily to increases of $160 (or 28%) in
DSL revenues and $136 (or 58%) in Video revenues, resulting from the continued
expansion of our customer base for these products. These increases were offset
by a decrease of $249 (or 28%) in dial up services due to customers primarily
outside of our service territory migrating to other high speed Internet
connections. A decrease of $163 (or 19%) in other services and sales revenues
was the result of lower rates that were mandated by the FCC for reciprocal
compensation and an overall decrease in sale of other non-regulated ancillary
services. Local service revenues were flat as access line losses were offset by
increased sales of additional calling features to existing customers. Directory
advertising sales were also flat reflecting the continued market trend towards
slow growth in the demand for directory ad pages.
OPERATING EXPENSES
Total operating expenses increased $279 (or 4%) for the three month period
ended September 30, 2004. An increase in depreciation and amortization expense
of $43 (or 3%) reflects ongoing plant upgrades to accommodate the growing DSL
business as well as the cost of the Video equipment installed to expand the
number of Video service subscribers. Other plant non-specific expenses increased
$151 (or 22%) due primarily to Video content costs for our growing Video
subscriber base. Corporate operations expenses increased $275 (or 28%) mainly
due to professional and consulting fees associated with Sarbanes-Oxley Act
Section 404 compliance. Partially offsetting these increases were lower plant
specific expenses of $235 (or 17%) due primarily to lower trunkline costs.
-14-
OTHER INCOME (EXPENSE)
Other income (expense) increased by $416 (or 18%) for the three month
period ended September 30, 2004 from $2,300 in the corresponding period of 2003
due primarily to an increase in income from O-P. The partnership's earnings
increased 11% over the comparable period last year. Continuing strong O-P call
volume remains the primary factor behind the increase.
Interest expense (net) decreased by $37 (or 32%) for the three month
period ended September 30, 2004 from $114 in the corresponding period of 2003
due to lower interest rates from the debt refinancing in February 2003.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 -
(in thousands)
OPERATING REVENUES
Operating revenues decreased by $662 (or 3%) to $20,948 for the nine-month
period ended September 30, 2004. This decrease was due primarily to a decrease
in network access revenues of $674 (or 9%) which resulted largely from lower
local switching support revenues received from the Universal Service
Administration Corporation, and rate reductions attributable to the
implementation of the aforementioned Order described above under Restatement.
Long distance service revenues increased $54 (or 2%) due primarily to an
increase in revenues from wireless carriers. Online service revenues increased
$248 (or 5%) due primarily to increases of $524 (or 33%) in DSL revenues and
$516 (or 98%) in Video revenues, resulting from the continued expansion of our
customer base for these products. These increases were offset by a decrease of
$827 (or 29%) in dialup services due to the migration of customers (primarily
outside of our service territory) to other high speed Internet connections. A
decrease of $330 (or 13%) in other services and sales revenue was the result of
lower rates that were mandated by the FCC for reciprocal compensation and
overall decreases in the sale of other non-regulated ancillary services. Local
service revenues were flat as access line losses were offset by increased sales
of additional calling features to existing customers. Directory advertising
sales were also flat reflecting the continued market trend towards slow growth
in the demand for directory ad pages.
OPERATING EXPENSES
Total operating expenses increased $809 (or 4%) for the nine month period
ended September 30, 2004. The increase in depreciation and amortization expense
of $312 (or 9%) reflects ongoing plant upgrades to accommodate the growing DSL
business as well as the cost of the Video equipment to service the expanding
number of Video service subscribers. Other plant non-specific expenses increased
$343 (or 17%) due primarily to Video content costs for our growing Video
subscriber base. Customer operations expenses increased $229 (or 7%) due to
higher labor costs resulting from additions to sales and computer support.
Corporate operations increased $503 (or 15%) primarily as the result of
increased professional fees and consulting fees associated with Sarbanes-Oxley
Section 404 compliance. The decrease of $292 (or 8%) in plant specific expenses,
and $405 (or 22%) in cost of services and sales was due primarily to lower trunk
line costs for voice and Internet services with interconnection companies in
2004.
OTHER INCOME (EXPENSE)
Other income (expense) increased by $1,406 (or 23%) for the nine month
period ended September 30, 2004 from $6,229 in the corresponding period of 2003
due primarily to an increase in income from O-P. The partnership's earnings
increased 17% over the comparable period last year. Continuing strong O-P call
volume remains the primary factor behind the increase.
Interest expense (net) decreased by $117 (or 35%) for the nine month
period ended September 30, 2004 from $331 in the corresponding period of 2003
due to lower interest rates from debt refinancing in February 2003.
INVESTMENT IN ZEFCOM
The Company has a 17% ownership interest in Zefcom, LLC ("Zefcom"). This
investment had historically been recorded on the cost method of accounting.
Zefcom formed an Executive Operating Committee consisting of representatives
from three of the investors in Zefcom. The Operating Committee's
responsibilities are to assist management as necessary in relations with
consultants and prospective investors, and in matters of finance.
The Company's Chief Executive Officer was elected to this committee in
August 2003. Accordingly the Company, through its representation of this
Operating Committee began exerting significant influence on the financial and
operating decisions of Zefcom in the fourth quarter of 2003. As a result of this
change, the Company changed its accounting for the Zefcom investment from the
cost method to the equity method of accounting. In August 2004, the Company's
Chief Financial Officer was elected to this committee replacing the Chief
Executive Officer thereafter in October 2004 the Company's Business and
Planning Director replaced the Chief Financial Officer in that role.
-15-
In accordance with generally accepted accounting principles, the Company
has adjusted its prior period financial results to record its 17% investment in
Zefcom as if it had been accounted for under the equity method of accounting.
The Company's percentage of Zefcom's losses have been reflected in the "Other
Income" in the Income Statement for the three and nine month periods ended
September 30, 2004 and 2003. The impact to net income for the three and nine
month periods ended September 30, 2003 was a loss of $42 and $108, respectively.
Earnings per share for 2003 also decreased by $0.01 and $0.01, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company had $13,742 of cash and cash equivalents available at
September 30, 2004. The Company has a $4,000 line of credit with a bank, of
which the entire amount remained unused at September 30, 2004. Interest is at a
variable rate and borrowings are on a demand basis without restrictions. In
addition the Company had an $18,475 unsecured term credit facility with CoBank,
ACB at a variable rate (approximately 3.5% for the period January 1, through
September 30, 2004) which expired on September 30, 2004. The Company had
utilized $12,000 of the CoBank, ACB term credit as of September 30, 2004.
Beginning in October 2004 the Company is required to make principal payments on
outstanding debt for 32 consecutive quarters. The Company's first principal
payment was made on October 20, 2004.
CASH FROM OPERATING ACTIVITIES
During 2004 the Company's primary source of funds continues to be cash
generated from operations (augmented by distributions from O-P as described
below). For the nine month period ended September 30, 2004, net cash from
operating activities was less than our capital expenditures due to the Company's
continuing growth of the Video business. Cash from operating activities
decreased $1,531 as compared to the corresponding period in 2003 mainly due to
the timing of cash receipts from customers and payments to vendors.
CASH FROM INVESTING ACTIVITIES
Capital expenditures totaled $3,890 during the nine month period ended
September 30, 2004 as compared to $3,561 for the corresponding period of 2003,
reflecting a leveling off of investment required for the rollout of the Video
business as it moves towards completion.
The Company's cash distribution from O-P for the Company's share of O-P's
earnings was $8,925 for the nine months ended September 30, 2004 versus $8,250
for the comparable period last year. Strong O-P call volume is the primary
factor for the increase.
In March 2004, the Company made a capital contribution of $238 to EsiNet.
An additional capital contribution of $238 was made on August 1, 2004. The
Company is committed to contribute a total of $950. The balance will be remitted
in two payments of approximately $238 each on December 1, 2004 and April 1,
2005, respectively.
CASH FROM FINANCING ACTIVITIES
Dividends declared by the Board of Directors of Warwick Valley Telephone
Company were $0.19 per share for the three month period ended September 30,
2004, compared to $0.16 for the corresponding period in 2003. The total
dividends paid for the nine months ended September 30, 2004 for common stock by
Warwick Valley Telephone Company were $3,133, compared to $2,777 for the same
period in 2003. In September 2004 the Company borrowed $5,000 under its loan
facility with CoBank to be used for future capital expenditures and strategic
acquisitions. Those funds were borrowed at that time because the commitment
period under the facility was expiring. The funds have been invested by CoBank
on the Company's behalf in short-term cash equivalents. In December 2003 the
Company borrowed $4,000 to repay secured mortgage notes that had reached
maturity. In February 2003, the Company used $3,149 of its unsecured credit
facility with CoBank to repay existing debt and pay costs associated with
closing the commitment with CoBank.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
The Company adopted FASB Interpretation No. 46 "Consolidation of Variable
Interest Entities" ("FIN 46") in 2003. FIN 46, which is an interpretation of ARB
No. 51, "Consolidated Financial Statements", addresses the consolidation of
investments made by a business enterprise, structured in a way that, although
the enterprise may have less than a majority interest in the voting rights, the
investment exhibits other characteristics making the enterprise the primary
beneficiary of the investment, absorbing the majority of the losses, receiving
the majority of the expected residual returns, and thereby requiring
consolidation by the business enterprise. As of September 30, 2004, FIN 46 did
not significantly impact the Company's operating results or financial position.
The Company will continue to monitor the impact of FIN 46 on an ongoing basis.
-16-
Effective January 1, 2003, the Company adopted SFAS No. 143, "Accounting
for Asset Retirement Obligations" ("SFAS No. 143"). SFAS No. 143 addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs.
The Company's rates are regulated by the Federal Communications Commission
("FCC"), NYPSC, and New Jersey Board of Public Utilities ("NJBPU"); therefore,
the Company reflects the effects of the rate making actions of these regulatory
bodies in its financial statements. On December 20, 2003, the FCC notified
carriers by order that it would not adopt SFAS No. 143 since the FCC concluded
that SFAS No.143 conflicted with the FCC's current accounting rules that require
telephone companies to accrue for asset retirement obligations through
prescribed depreciation rates.
The Company has concluded that it did not have an asset retirement
obligation as defined by SFAS No.143, as of September 30, 2004 or December 31,
2003. The Company historically recorded cost of removals through depreciation
rates and accumulated depreciation. In conjunction with the adoption of SFAS
No.143, the Company has reclassified $563 and $505 as of September 30, 2004 and
December 31, 2003, respectively, from accumulated depreciation to a regulatory
liability for the cost of removal that the Company has recorded through its
historical depreciation rates.
OTHER FACTORS:
COMPETITION
The Telecommunications Act of 1996 (the "Act") created a nationwide
structure in which competition is allowed and encouraged between local exchange
carriers, interexchange carriers, competitive access providers, cable TV
companies and other entities. The first markets of the Company that were
affected were those in which regional toll service is provided in both states.
Regional toll competition reduced the Company's revenues. The Company itself can
provide competitive local exchange telephone service outside its franchised
territory.
The Company currently provides access to the national and international
calling markets as well as intrastate calling markets through all interested
inter-exchange carriers, including the Company's wholly owned subsidiary Warwick
Valley Long Distance Company ("WVLD"). Equal access ("one-plus") service to all
toll carriers has been available to the Company's customers since August 1,
1991. Access to the remainder of the intrastate calling markets is provided by
the Company as well as other exchange carriers. WVLD, as an inter-exchange
carrier, competes against all such other carriers, including accelerating
wireless competition, providing full toll services to its customers at
discounted rates.
The Company's territory is surrounded by the territories of Verizon
Communications, Inc., Frontier - A Citizen's Communications Company and Sprint
Telephone, all of which offer residential and business telephone services and
equipment. There are also several competitive telephone companies located within
a 30-mile radius of Warwick, New York. Voice Over Internet Protocol ("VoIP")
providers are also beginning to offer limited service within the Company's local
service area. The Company is also working towards launching its own VoIP product
sometime in the first half of 2005. The Company's residential customers can
purchase telephone sets (including cellular sets) and equipment at other retail
outlets inside and outside the Company's territory and not affiliated with the
Company.
The Company is currently competing with Frontier - A Citizen's
Communications Company - in the Middletown, New York area as well as with Sprint
United Telephone in the Vernon, New Jersey area for local service through access
lines. The Company is reviewing plans to provide limited service in other
surrounding areas in both New York and New Jersey. There can be no assurances
that the Company will effect any such additional plans, or that other companies
will not begin providing competitive local exchange telephone service in the
Company's franchise territory. Cablevision has launched a VoIP product in the
New York Metro area that also includes their West Milford, New Jersey franchise
area. West Milford Township in New Jersey includes Upper Greenwood Lake, which
is part of the Company's existing local service area.
Online competes both on the basis of service and price. There are numerous
competitors throughout Online's market area whose services are available to
customers. During the third quarter of 2004 the Company's DSL product,
Ultralink, increased its penetration level to 31.3% of establishments passed.
Conversely, the number of customers for Online's dial-up product decreased
11.56% due to the migration of customers to high speed Internet provided by the
Company and by the competition. Switches to competing service providers occurred
primarily outside of our service territory. Whether customer and pricing levels
can be maintained depends, in part, on the actions of existing competitors, the
possible entry into the market of new competitors, the rate of technological
change and the level of demand for services.
Our Video product was launched in April of 2002 and is competing against
entrenched cable companies including Service Electric Company ("SEC"),
Cablevision and satellite TV companies such as Direct TV and Dish Network.
On November 10, 2003 the FCC issued an order requiring intermodal
portability (wireline to wireless) in the top one hundred Metropolitan Service
Areas ("MSA") by November 23, 2004 where the requesting wireless carrier's
"coverage area" overlaps that of the local exchange carrier. The Company did
provide intermodal Local Number Portability ("LNP") by May 24, 2004. LNP may
-17-
assist a competitor in obtaining our customers because customers can keep their
current telephone number, even when they switch their telephone service from the
Company to another carrier. As of September 30, 2004, LNP had not posed a
significant competitive risk within the Company's service territory.
REGULATION
The Company's New York telephone service operations are subject to the
jurisdiction of the NYPSC, and the Company's New Jersey telephone service
operations to the jurisdiction of the NJBPU. These two bodies have regulatory
authority over the Company with respect to rates, facilities, services, reports,
issuance of securities and other matters such as corporate restructuring. As a
result, the Company's ability to respond quickly to changing market conditions
or to implement a new business organization can be limited by the necessity of
obtaining regulatory reviews or responding to interrogatories, all of which can
slow down or even prevent a desired transaction or change. Interstate toll and
access services are subject to the jurisdiction of the FCC. The Company receives
reimbursement from carriers in the form of charges for providing carriers access
to and from the Company's local network. Video operations are also under the
jurisdiction of the NYPSC, the NJBPU, and the FCC as well as the municipalities
where the Company provides services.
In the Company's two New Jersey exchanges, intrastate toll revenues are
retained by toll carriers, of which the Company is one. The associated access
charges are retained by the Company. Revenues resulting from traffic between the
Company, Verizon and Sprint are reconciled through charges payable to each
company for terminating traffic.
In addition to charging for access to and from the Company's local
network, the Company bills and collects charges for most interstate and
intrastate toll messages carried on its facilities. Interstate billing and
collection services provided by the Company are not regulated. They are provided
under contract by the Company. Intrastate billing and collection remain partly
regulated in New York and fully regulated in New Jersey. The regulated services
are provided under tariff. Some carriers provide their own billing and
collection services.
The Company has filed a petition with the NYPSC seeking approval to
reorganize its corporate structure in order to create a holding company that
would separate its regulated local exchange operations from its deregulated
operations. Under this reorganization plan, corporate management and
administrative functions would remain at Warwick Valley Telephone Company,
proposed to be renamed WVT Communications Inc., which would become the
unregulated holding company of a regulated local exchange subsidiary (proposed
to be named Warwick Valley Telephone Company) and other, unregulated
subsidiaries. Before the Company may complete this proposed reorganization plan,
it must first obtain the approval of the NYPSC, the NJBPU and its shareholders.
The Company is actively pursuing the resolution of this petition before the two
public service commissions.
The FCC has pending decisions regarding the USF and inter-carrier
compensation issues. Whether the USF can be sustained and whether VoIP providers
will be required to participate in funding Rural Carriers will affect and
influence decisions to invest in new facilities. The FCC is expected to act on
these issues in 2004.
As discussed in previous filings, the Company's investment in O-P has over
the years been increasing in value to such an extent that it could raise an
issue as to whether the Company is required to register as an "investment
company" under the Investment Company Act of 1940. That question arises if the
fair value of all of the Company's so-called "investment securities" exceeds
forty percent of the fair value of the Company's total assets. At a meeting near
the end of September 2004, the Company's Board of Directors determined that the
fair value of the Company's investment securities (principally, its investment
in O-P) now slightly exceeds that threshold. However, because of, among other
things, the nature of its business as a telephone company and the fact that
slightly less than seventy-five percent of its operating revenues are derived
from sources other than O-P, the Company does not believe that it is required to
register as an investment company.
CAUTIONARY LANGUAGE CONCERNING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-Q, including, without
limitation, statements containing the words "believes," "anticipates,"
"intends," "expects" and words of similar import, constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Such forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of the Company or industry results to be materially different
from any future results, performance or achievements expressed or implied by
such forward-looking statements. Such factors include, among others the
following: general economic and business conditions, both nationally and in the
geographic regions in which the Company operates; industry capacity; demographic
changes; existing governmental regulations and changes in or the failure to
comply with, governmental regulations; legislative proposals relating to the
businesses in which the Company operates; competition; technological changes;
and the loss of any significant ability to attract and retain qualified
personnel. Given these uncertainties, current and prospective investors should
be cautioned in their reliance on such forward-looking statements. The Company
disclaims any obligations to update any such factors or to publicly announce the
results of any revision to any of the forward-looking statements contained
herein to reflect future events or developments.
-18-
SECTION 404 OF THE SARBANES-OXLEY ACT OF 2002
As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the
Securities and Exchange Commission adopted rules requiring public companies to
include a report of management on the Company's internal control over financial
reporting in their annual reports on Form 10-K. This report is required to
contain an assessment by management of the effectiveness of the Company's
internal controls over financial reporting. In addition, the public accounting
firm auditing a public company's financial statements must also attest to and
report on management's assessment of the effectiveness of the Company's internal
controls over financial reporting as well as the operating effectiveness of the
Company's internal controls. While the Company is expending significant
resources in developing the necessary documentation and testing procedures
required by Section 404, there is a significant risk that the Company will not
comply with all of the requirements imposed by Section 404. If the Company fails
to have an effectively designed and operating system of internal control, it
will be unable to comply with the requirements of Section 404 in a timely
manner. If the Company is unable to complete its assessment as to the adequacy
of its internal control over financial reporting as of December 31, 2004 as
required by Section 404 of the Sarbanes-Oxley Act of 2002, or if such assessment
is completed and material weaknesses are identified and reported, its external
auditors may either disclaim an opinion as it relates to management's assessment
of the effectiveness of its internal control or may issue an adverse opinion on
the effectiveness of the Company's internal controls. This may impact the
reliability of our internal controls over financial reporting.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not hold or issue derivative instruments for any
purposes or other financial instruments for trading purposes. The
Company's only assets exposed to market risk are its interest bearing bank
accounts, into which the Company deposits its excess operating funds on a
daily basis and the $5,000 of recently borrowed funds which CoBank has
deposited in an interest bearing account on the Company's behalf. The
Company has the option of choosing the following rate options from CoBank:
Weekly Quoted Variable Rate, Long-Term Fixed Quote and a Libor Option. The
Company does not believe that its exposure to interest rate risk is
material.
ITEM 4. CONTROLS AND PROCEDURES
1. Evaluation of Disclosure Controls and Procedures
The Company's management, including the Company's Chief Executive
Officer and Principal Accounting Officer conducted an evaluation as
of September 30, 2004 regarding the effectiveness of the Company's
disclosure controls and procedures (as defined in Rule 13a-15(e) and
Rule 15d-15(e)). Based on that evaluation, the Chief Executive
Officer and Principal Accounting Officer concluded that, except for
the material weaknesses in internal controls noted below, the
disclosure controls and procedures were effective in ensuring that
all material information required to be disclosed in the reports the
Company files and submits under the Securities and Exchange Act of
1934 has been made known to them on a timely basis and that such
information has been properly recorded, processed, summarized and
reported, as required.
The Company's management has also commenced and is in the process of
completing its evaluation of its internal controls under Section 404
of the Sarbanes-Oxley Act of 2002, as discussed below.
2. Changes in Internal Controls
There have been no significant changes in the Company's internal
controls over financial reporting during the third quarter of 2004
that materially affected, or are reasonably likely to materially
affect, the Company's internal controls over financial reporting.
3. Sarbanes-Oxley Section 404 Compliance
Section 404 of the Sarbanes-Oxley Act of 2002 (the "Act") will
require the Company to include an internal control report from
management in its Annual Report on Form 10-K for the year ended
December 31, 2004 and in subsequent Annual Reports thereafter. The
internal control report must include the following: (1) a statement
of management's responsibility for establishing and maintaining
adequate internal controls over financial reporting, (2) a statement
identifying the framework used by management to conduct the required
evaluation of the effectiveness of the Company's internal controls
over financial reporting, (3) management's assessment of the
effectiveness of the Company's internal controls over financial
reporting as of December 31, 2004, including a statement as to
whether or not internal controls over financial reporting are
effective, and (4) a statement that the Company's independent
auditors have issued an attestation report on management's
assessment of internal controls over financial reporting.
Management acknowledges its responsibility for establishing and
maintaining internal controls over financial reporting and seeks to
continually improve those controls. In addition, in order to achieve
compliance with Section 404 of the Act within the required
timeframe, the Company has been conducting a process to document and
evaluate its internal controls over financial reporting in 2004. In
this regard, the Company has dedicated internal resources, engaged
outside consultants and adopted a detailed work plan to: (1) assess
and document the adequacy of internal controls over financial
reporting; (2) take steps to improve control processes where
required; (3) validate through testing that controls are functioning
as documented; and (4) implement a continuous reporting and
improvement process for internal controls over financial reporting.
The Company believes its process for
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documenting, evaluating and monitoring its internal control over financial
reporting is consistent with the objectives of Section 404 of the Act.
During the third quarter of 2004, the Company commenced testing of its
internal controls. The Company's documentation and testing to date have
identified certain internal control deficiencies in the documentation,
design and effectiveness of internal controls over financial reporting
that the Company is in the process of remediating, several of which have
been identified as material weaknesses. As a result, the Company has
concluded that the following internal control deficiencies constituted
material weaknesses: deficiencies related to a lack of segregation of
duties; deficiencies related to manually intensive processes; and
deficiencies related to lack of formal review or reconciliations.
Given the risks inherent in the design and operation of internal controls
over financial reporting, the Company can provide no assurance as to its
or its independent auditor's conclusions at December 31, 2004 with respect
to the effectiveness of its internal controls over financial reporting.
It should be noted that any system of controls, however well designed and
operated, can provide only reasonable, and not absolute, assurance that
the objectives of the control system are met. In addition, the design of
any control system is based in part upon certain assumptions about the
likelihood of future events. Because of these and other inherent
limitations of control systems, there can be no assurance that any design
will succeed in achieving its stated goals under all potential future
conditions.
The Company, having identified these internal control weaknesses, is
developing a remediation program that will begin to correct these
deficiencies throughout the balance of 2004 and on into 2005. The Company
is allocating the necessary resources and manpower to this task, as well
as working towards adding additional resources and manpower where needed.
PART II - OTHER INFORMATION
ITEM 5. OTHER INFORMATION
SHAREHOLDERS IN 401(K) PLAN
As of September 30, 2004 3.0% of the Company's outstanding Common Shares
were held by employees in the Company's 401(k) plan. These percentages fluctuate
quarterly.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits -
31.1 Chief Executive Officer Certification
31.2 Principal Accounting Officer Certification
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by
Herbert Gareiss, Jr.-principal executive officer.
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by
Kevin J. Kerr -principal accounting officer.
b) Reports on Form 8-K -
On April 7, 2004, the Company issued a press release announcing that
it will bring advanced broadband communications services to 54
cities and surrounding communities in rural New York by
participating with a team of 13 telecommunications firms to organize
the Empire State Independent Fiber Network LLC.
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On April 30, 2004 Lynn Pike, then the President of Warwick Valley
Telephone Company ("the Company"), discussed certain aspects of the
Company's business at its Annual Shareholders Meeting.
On June 25, 2004, the Board of Directors accepted the resignation of
Mr. M. Lynn Pike as President, CEO, and Director of Warwick Valley
Telephone Company and designated Mr. Herbert Gareiss, Jr. a Director
and Vice President, as acting President, also effective June 25,
2004, while it conducted a search for Mr. Pike's successor.
On July 21, 2004, the Board of Directors appointed Mr. Herbert
Gareiss, Jr. the Company's President and CEO. Mr. Gareiss, who
joined the Company in 1980, had previously been designated acting
President on June 25, 2004. Mr. Gareiss has been a Director of the
Company since 1998 and will retain his Board membership. The Board
of Directors also named Zigmund C. Nowicki Jr., Director of
Information Technology and Human Resources, as Corporate Secretary
to replace Mr. Gareiss in that position.
On August 16, 2004 Warwick Valley Telephone Company (the "Company")
gave notice that Form 12b-25 was filed on August 10, 2004 with the
Securities and Exchange Commission ("SEC"), informing the SEC of the
late filing of its Quarterly Report on Form 10-Q for the period
ended June 30, 2004.
On August 18, 2004, the Company stated that it had been delayed in
filing its Quarterly Report on Form 10-Q for the period ended June
30, 2004. The Company also stated that it expected to file its
Quarterly Report no later than August 25, 2004.
On September 3, 2004 the Company announced its agreement to sell it
shares in DataNet Communications Group, Inc. (Hudson Valley
DataNet).
On September 20, 2004 Mr. Philip A. Grybas, Chief Financial Officer
of the Company submitted his resignation to the company's Board of
Directors to take a position with SureWest Communications,
Roseville, California.
On November 1, 2004 the Company announced the closing of the sale of
all its shares in DataNet Communications Group, Inc.
On November 9, 2004, the Company mailed an informational newsletter
to keep shareholders informed about developments within the Company
as well as the strategies for growing our business and the state of
the telecommunications industry in general.
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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.
Warwick Valley Telephone Company
Registrant
Date 11/12/04 /s/Herbert Gareiss, Jr.
Herbert Gareiss, Jr., President
(Chief Executive Officer)
Date 11/12/04 /s/Kevin J. Kerr
Kevin J. Kerr, Controller
(Principal Accounting Officer)
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