Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2003

Commission File No. 0-11053

Commonwealth Telephone Enterprises, Inc.

(Exact name of registrant as specified in its charter)

100 CTE Drive, Dallas, Pennsylvania 18612-9774

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number including area code: 570-631-2700

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $1.00 per share

(Title of Class)

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.    x  Yes        ¨  No

Indicate by check mark whether the registrant is an accelerated filer (as defined in rule 12b-2 of the Act).    x  Yes        ¨  No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

Number of shares of the Registrant’s Stock ($1.00 par value) outstanding at February 27, 2004:

22,309,441 Common Stock

Aggregate market value of Registrant’s voting stock held by non-affiliates at June 30, 2003 computed by reference to the closing price as reported by NASDAQ for Common Stock ($43.94 per share) and to the closing price as reported by NASDAQ for Class B Common Stock ($47.87 per share), is as follows:

$1,002,881,915 Common Stock

The market value is based on the value of the Common Stock and Class B Common Stock that was outstanding on June 30, 2003. The Class B Common Stock is no longer outstanding as a result of the recapitalization that was completed on September 3, 2003. See the discussion of the recapitalization transaction in Part II Item 5.

Documents Incorporated by Reference

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC.

TABLE OF CONTENTS TO FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003

“CTE,” “the Company,” “we,” “us” and “our” refer to Commonwealth Telephone Enterprises, Inc.

“Our RLEC” and “CT” refer to Commonwealth Telephone Company, a rural incumbent local exchange carrier and a subsidiary of Commonwealth Telephone Enterprises, Inc.

The segment “CT” includes the results of our RLEC; Commonwealth Long Distance Company (“CLD”), a long-distance reseller; and the portion of Jack Flash^® (“Jack Flash”), our broadband data service that uses digital subscriber line (“DSL”) technology to offer high-speed Internet access and digital connectivity solutions, that is in CT’s territory.

“Our CLEC,” “RLEC ‘edge-out’ ” and “CTSI” refer to CTSI, LLC, a competitive local exchange carrier and a subsidiary of Commonwealth Telephone Company.

“Expansion markets” refers to those CTSI markets from which the Company made a decision to exit in December 2000, as further described in this document.

2

Table of Contents

PART I

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act and we intend that such forward-looking statements be subject to these safe harbors. These statements are generally accompanied by words such as “intend,” “anticipate,” “believe,” “estimate,” “expect” or similar statements. Our forward-looking statements involve risks and uncertainties that could significantly affect expected results in the future differently than expressed in any forward-looking statements we have made. These risks and uncertainties include, but are not limited to:

Additional factors that could cause or contribute to such differences are set forth in the section entitled “Risk Factors” and are discussed elsewhere in this report. Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of the assumptions could prove inaccurate; and therefore, we cannot provide any assurance that the results contemplated in such forward-looking statements will be realized. The inclusion of this forward-looking information should not be regarded as a representation by us or any other person that the future events, plans or expectations that we contemplate will be achieved. Furthermore, past performance in operations and share price are not necessarily predictive of future performance.

Item 1. Business

General

We are a telecommunications company providing telephony and related services in Pennsylvania markets as a rural incumbent local exchange carrier, or RLEC. We also operate as a competitive local exchange carrier, or CLEC, in three regional Pennsylvania markets that border CT’s markets, which we refer to as our RLEC “edge-out” markets. CT is the nation’s seventh largest non-Bell incumbent local exchange carrier, serving over 338,400 switched access lines as of December 31, 2003. CTSI served over 138,600 competitive switched access lines as of December 31, 2003. For the years ended December 31, 2003 and 2002, we had consolidated revenues of $335.7 million and $318.6 million, respectively.

Recently, we revised our segments to provide management with a more comprehensive financial view of our key businesses and promote better alignment of strategies and objectives. The CT segment includes the results of our RLEC and also now includes the results of Commonwealth Long Distance Company (“CLD”), a long-distance reseller and substantially all of Jack Flash^® (“Jack Flash”), our broadband data service that uses digital subscriber line (“DSL”) technology to offer high-speed Internet access and digital connectivity solutions, which is in CT’s territory. The results of these businesses were previously included in our “Other” business segment. We have recast the financial data and discussions of prior periods in this annual report to make them comparable to the current period’s presentation.

CT, founded in 1897, operates in a rural, approximately 5,000 square mile territory with a population of approximately 450,000 people, and a line density of approximately 68 access lines per square mile. Approximately three quarters of CT’s switched access lines serve residential customers. CT generated revenues of $223.8 million and $208.0 million, and operating income of $97.2 million and $86.6 million for the years ended December 31, 2003 and 2002, respectively. CT ranks among the industry leaders in switched access line growth and penetration of residential additional lines, primarily as a result of a successful campaign to market additional lines. From 1995 to 2003, CT’s penetration of residential additional lines grew from 3% to 39%, while its number of switched access lines grew at a compound annual growth rate of 5.1%, resulting in growth of its overall revenues at a compound annual growth rate of 6.5%.

3

Table of Contents

CTSI formally began operating in our “edge-out” markets in 1997 and currently provides a full array of competitive voice and data telecommunications services mainly to business customers. CTSI serves the three regional Pennsylvania “edge-out” markets of Wilkes-Barre/Scranton/Hazleton, Harrisburg and Lancaster/Reading/York. Late in 2002, we announced the extension of our RLEC “edge-out” business operations into select areas of Pennsylvania’s Lehigh Valley. We view this opportunity as an extension of our current activities, rather than the establishment of a fourth regional market. In the “edge-out” markets, CTSI generated revenues of $85.3 million and $84.0 million and operating income of $9.0 million and $10.7 million for the years ended December 31, 2003 and 2002, respectively. Beginning in 1998, CTSI expanded beyond its original three “edge-out” markets into five additional expansion markets. At the end of 2000, however, we developed an exit strategy for these expansion markets in order to refocus our attention on our three original “edge-out” markets. This strategy has allowed us to increase our operating income and to significantly reduce our capital needs. We recorded a restructuring charge of $99.7 million, or $64.8 million after-tax, in the fourth quarter of 2000 in connection with this strategy, and we completed our withdrawal from these markets by June 30, 2001.

We also own and operate other telecommunications-related support businesses that all operate in the deregulated segments of the telecommunications industry and that support the operations of our two primary operating companies. These businesses are epix^® Internet Services, one of the northeast’s largest rural Internet service providers with approximately 35,400 dial-up Internet access subscribers as of December 31, 2003; and Commonwealth Communications, a provider of telecommunications equipment and facilities management services. Our “Other” business segment also includes our corporate entity.

A web site featuring current information regarding Commonwealth Telephone Enterprises, Inc., can be found on the Internet at www.ct-enterprises.com. However, the information on our web site is not part of this annual report. Our periodic reports are available on our web site as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission.

Business Strategy

We strive to grow our revenues, control our expenses and deploy our capital in a manner that maximizes our operating income. In order to achieve this goal, we have formulated the following business strategy:

Continue to Market CT’s Switched Access Lines

CT continues to market additional lines to residential and business customers in its territory. Its number of switched access lines grew by 0.2% in the year ended December 31, 2003. Our rate of business line growth was 2.7% for the year ended December 31, 2003. CT’s residential lines declined primarily as additional lines are disconnected from customers switching to DSL and other high-speed products and non-wireline providers.

Leverage CT’s Brand, Reputation and Expertise to Further Penetrate CTSI’s Markets

In the CTSI markets, we seek to increase our penetration rate by targeting business customers who have traditionally been underserved by Verizon and by offering competitive service packages that compare favorably to those being offered by Verizon. We believe our strong Commonwealth Telephone brand, reputation and expertise provide us with important competitive advantages in these markets and will allow us to continue to gain new customers and increase our market share at a low marginal operating cost.

Increase Sales of Data Products and Services

We intend to capitalize on an increasing demand for business and residential data services, including demand for high bandwidth connectivity, in all of the markets we serve. We offer dial-up Internet access through epix^® Internet Services and digital subscriber line, or DSL, broadband services through Jack Flash^®. We believe there is additional opportunity to increase sales of our data services at a low marginal operating cost in all of the markets in which we operate.

Increase Penetration of Enhanced Services

CT offers an array of enhanced services such as caller identification, voice mail and custom calling services such as call-forwarding, call waiting and three-way calling. These services generally produce higher margins than basic telephone service. We believe these enhanced services provide a source of revenue and operating income growth potential as our penetration rates for enhanced services are currently below industry averages. Our RLEC’s network is 100% digitally-switched and all upgrades to provide these additional services to our

4

Table of Contents

entire customer base have been substantially completed. We have increased our efforts to market enhanced services to our customers and believe we can achieve higher penetration rates that are more in line with industry averages.

Continue to Provide Superior Service and Customer Care

We intend to continue to capitalize on our support and other back office systems to provide superior service and customer care. Our RLEC has already achieved the lowest level of “justified complaints,” as defined by the Pennsylvania Public Utility Commission (“PUC”), among Pennsylvania’s largest local exchange carriers in eight of the past nine years for which ratings are available, including the last six years for which ratings are available. In our CTSI markets, we currently provide personalized customer care through customer account managers who service business customers, and through our centralized call center which operates 24 hours a day, 7 days a week to support our business and residential customers. By building on our strong service record, we plan to further differentiate ourselves from our competitors.

Selectively Pursue Strategic Acquisitions

To continue the growth of our business, we will seek to selectively acquire companies that offer a strategic fit with our existing businesses. This may include companies that could help us deepen our industry focus, further penetrate or broaden our target areas, increase the breadth of services we offer or strengthen our marketing efforts.

Risk Factors

Risks related to regulation of the telecommunications industry

The telecommunications industry is subject to extensive regulation at the federal, state and local levels. The costs of complying with this regulation, delays or failures to receive required regulatory approvals, or the enactment of new, adverse regulatory requirements may have a material adverse effect upon our business. The risks presented by the regulatory environment we face include the following:

The amounts we can charge for most of our services are subject to regulatory restrictions. Our financial results have been adversely affected by recent reductions in access rates and may be further adversely affected by future regulatory decisions.

Approximately 12.9% and 13.7% of our consolidated revenues for the years ended December 31, 2003 and 2002, respectively, were from local service fees paid by customers of our RLEC. These fees, and other charges imposed by our RLEC for in-state services, are subject to a long-term alternative regulation plan approved by the Pennsylvania Public Utility Commission (“PUC”). Under this plan, our RLEC can change its in-state rates, in the aggregate, only at an annual rate equal to the overall rate of inflation minus two percentage points or for events deemed outside of our RLEC’s control that result in reduced revenues or increased expenses. These increases may not be sufficient to cover increases in our costs. Indeed, in periods of low inflation (as experienced in 2002), this formula may require rate reductions, although our RLEC can “bank” these reductions, currently at approximately $1.6 million, for up to four years to offset against future inflation-based increases. Moreover, it is possible that the applicable regulations could be changed in the future to impose even greater restrictions on our ability to raise rates for local service.

Additionally, approximately 45.1% and 45.8% of our consolidated revenues for the years ended December 31, 2003 and 2002, respectively, came from charges paid to us by other carriers for services CT and CTSI provided in originating and terminating intrastate and interstate toll calls, and for services CTSI provided in terminating local calls received from other telephone companies. The payments we receive for these services are regulated by the Federal Communications Commission (“FCC”) and the Pennsylvania PUC. The amounts charged by both CT and CTSI have been reduced by recent regulatory decisions.

Beginning in June 2001, new FCC rules substantially reduced the per-minute rates CTSI can charge to long-distance companies for interstate access. Revenues from these access charges represented approximately 0.8% and 1.3% of our consolidated revenues for the years ended December 31, 2003 and 2002, respectively. Upon full

5

Table of Contents

phase-in after three years, these rules will result in a reduction in CTSI’s interstate access rates to a level equal to the rates charged by Verizon in the areas where CTSI operates, which we expect will be approximately $0.0042 per minute.

Also beginning in June 2001, other FCC rules substantially reduced the amounts CTSI can charge other telephone companies, known as reciprocal compensation charges, for local telephone calls that terminate to an Internet Service Provider, or ISP. The total reciprocal compensation recorded by CTSI represented approximately 1.0% and 1.2% of our consolidated revenues for the years ended December 31, 2003 and 2002, respectively. Of these amounts, local reciprocal compensation associated with ISP traffic was approximately 0.9% and 1.1% of our consolidated revenues for the years ended December 31, 2003 and 2002, respectively. The FCC rate ceilings will result in continued reductions in the revenues CTSI receives from interstate access charges and reciprocal compensation. The FCC rules do not affect the rates CTSI collects on calls that terminate to customers who are not ISPs, although these rates are subject to review by the Pennsylvania PUC and may be changed in the future.

We cannot predict whether any additional FCC or Pennsylvania PUC rules will be passed that will result in further reductions in the revenues we receive, although the FCC is currently considering proposals that could significantly change the interstate access charge system. Additionally, these agencies’ current rules may change as a result of judicial review or policy changes at the agencies.

If any of the favorable regulatory provisions from which CT currently benefits were to be modified or terminated, we could experience higher costs and lower revenues.

Because of its status as a rural telephone company under the Telecommunications Act of 1996, or the Act, CT is not currently required to comply with that Act’s provisions requiring an incumbent carrier to unbundle its network, provide colocation, provide resale discounts, provide interconnection at rates based on forward-looking incremental costs or other items. If this limitation were to change, more competitors could enter our RLEC markets than we currently expect. We could also incur additional administrative and regulatory expenses as a result of such newly imposed requirements. The Pennsylvania PUC has authority under the Act to terminate CT’s rural exemption if it receives a request to do so from another telecommunications carrier. To date, no other carrier has made such a request to the Pennsylvania PUC, but we cannot assure you that CT’s rural exemption will remain in effect indefinitely.

Additionally, since 1997, CT has operated under rate regulations for in-state services that permit increased returns arising from improved productivity to accrue to equity owners. We believe that this regulatory arrangement is more favorable to us than traditional rate of return regulation, which requires productivity gains to be passed on to ratepayers. The regulations also include other provisions, such as rate adjustments, that may protect us against events deemed outside of our control. The Pennsylvania PUC has asserted continuing jurisdiction over these alternative regulatory arrangements and we therefore cannot assure you that it will allow full or partial recovery of reduced revenues or increased expenses in the future. In addition, the legislation under which the Pennsylvania PUC approved our current form of regulation expired December 31, 2003, and we cannot assure you that it will be renewed. All of these regulations are subject to change and/or termination which could result in reduced revenues for CT.

Furthermore, CT currently receives its interstate access revenues pursuant to average cost schedules established by the National Exchange Carrier Association (“NECA”). Should CT lose its average schedule status, or if NECA should make changes in its cost schedules, we could incur a significant loss of interstate access revenue.

Loss of our access to network elements from incumbent telephone companies or an increase in the prices we must pay for those elements would adversely affect CTSI’s business.

Approximately half of CTSI’s customers are served, at least in part, by network elements leased primarily from Verizon. CTSI’s business, therefore, depends in large part on our ability to provide service to our customers by leasing various elements of the incumbent telephone company’s network to provide local service. The Act and FCC and state commission rulings under the Act require incumbent telephone companies to lease us the necessary network elements. If these rules are changed by the FCC or state commissions or are struck down by the courts, our ability to provide service in a cost-effective manner could be adversely affected. For example, the

6

Table of Contents

FCC could remove one or more of the necessary elements that the incumbent telephone company is required to provide to us, or permit substantial increases in the amounts the incumbent company can charge CTSI. If incumbent telephone companies were no longer to be required to provide unbundled network elements on favorable terms, CTSI’s operating margins would be reduced and it might not be able to compete effectively.

Effective October 2, 2003, the FCC adopted substantial changes to its rules governing access to unbundled network elements. The new rules generally preserve unbundled access to most voice-grade local loops, which are the type of facility most frequently used by CTSI. On March 2, 2004, however, the U.S. Court of Appeals vacated and remanded substantial parts of these new rules for further consideration by the FCC, which could result in additional changes affecting CTSI’s access to network elements. In addition, the FCC has announced that it is considering changes to its rules governing pricing of these network elements, which could result in increases to CTSI’s costs. We cannot predict how future decisions by the agency or the courts could affect CTSI’s business.

Regulatory requirements could delay or prevent our ability to take actions we consider beneficial to our business.

Pennsylvania law requires us to secure consent from the Pennsylvania PUC prior to issuing capital stock, incurring long-term debt or selling or otherwise disposing of material utility assets. Both the FCC and the Public Utility Commission must review any transaction that results in a “change of control” of a regulated entity or of a holding company of a regulated entity. The approval process for these transactions can be lengthy and could restrict our ability to offer services, set prices, obtain financing or take other steps that we may believe to be in our best interest.

Risks related to the competitive nature of the telecommunications industry

The telecommunications industry is highly competitive. We face actual or potential competition from many existing and emerging companies, including other incumbent and competitive local telephone companies, long-distance carriers and resellers, wireless telephone companies, Internet service providers, satellite companies and cable companies. We may not be able to successfully anticipate and respond to various competitive factors affecting the industry, including regulatory changes that may affect our competitors and us differently, new technologies and services that may be introduced, changes in consumer preferences, demographic trends and discount pricing strategies by competitors. The risks to our business from this competition include the following:

Verizon, as the incumbent local carrier in CTSI’s markets, has competitive advantages over us which adversely affect our operating margins.

As the incumbent carrier in CTSI’s markets, Verizon enjoys competitive advantages, including its wireline connection to virtually all of our customers and potential customers, its established brand name and its substantial financial resources. As a competitive local carrier, we are effectively required to discount our services to win potential customers, and to pay substantial amounts to Verizon to lease elements of its networks. These factors result in lower operating margins for CTSI, and make us especially vulnerable to any discount pricing policies that Verizon may adopt to exploit its lower-cost structure and greater financial resources. Additionally, Verizon is now able to offer in-region long-distance services to its Pennsylvania customers, which allows it to offer attractive service packages to its customers in the markets we serve. This may result in a further competitive disadvantage in CTSI’s markets.

We face intense competition in our markets for long-distance, Internet access and other ancillary services that are important to our business and to our growth strategy.

An important part of our business strategy is to sell additional services to local customers in both the CT and CTSI markets. The markets for these ancillary services, however, are extremely competitive, and in some cases, are dominated by companies far larger than our own with lower costs and greater name recognition and technical and financial resources, than ours. Our competitors for these services include, in addition to Verizon, long-distance companies like AT&T, MCI and Sprint, and, in the Internet service provider business, Time Warner and discounted service providers. To compete against these established companies, we expect to have to offer both lower prices and superior service to our customers, and we may not be able to do so on profitable terms. If we are

7

Table of Contents

unable to maintain a competitive offering of long-distance, Internet access and other ancillary services, we may also lose local customers who prefer to obtain a package of services from one telecommunications provider.

Technological developments could increase our costs and cause a decline in demand for our services.

The telecommunications industry is subject to rapid and significant changes in technology. If we do not replace or upgrade technology and equipment that becomes obsolete, we will be unable to compete effectively because we will not be able to meet the needs or expectations of our customers. Additionally, replacing or upgrading our infrastructure in the future could result in significant capital expenditures.

Our wireline telecommunications services also are in competition or potential competition with numerous alternative technologies, including, in particular, wireless communications. The wireless telecommunications industry is experiencing significant technological change. Wireless carriers are improving the capacity and quality of digital wireless technology, and are also expected to continue to reduce the prices for their services. These developments could reduce customer demand for our services and the prices that we will be able to charge for these services, particularly in CTSI’s markets where a number of wireless providers are established competitors and in certain areas of CT’s territory. We believe that future technological developments are likely to result in further improvements in wireless telecommunications services, as well as in other telecommunications technologies, and are likely to result in increased competition for our various businesses.

Voice over Internet Protocol, also known as VoIP, is an emerging technological trend that could cause a decrease in demand for our traditional telephone services, including the demand for additional lines. VoIP is gaining ground among business users who have found that Internet telephone systems can cut costs and improve efficiency. It is also possible for residential users to use VoIP as a replacement for a traditional telephone line (for example, by obtaining Internet access over a cable television system). We cannot predict which of many possible future technologies, products or services will be important to maintain our competitive position or what expenditures will be required to develop and provide these technologies, products or services.

Many of our competitors have superior resources which may place us at a cost and price disadvantage.

Many of our current and potential competitors have market presence, engineering, technical and marketing capabilities and financial, personnel and other resources substantially greater than ours. These competitors may be able to develop and expand their communications and network infrastructures more quickly, adapt more swiftly to new or emerging technologies and changes in customer requirements, take advantage of acquisition and other opportunities more readily and devote greater resources to the marketing and selling of their products and services than we can. Additionally, the greater brand name recognition of some competitors, such as Verizon, requires us to price CTSI’s services at lower levels in order to win business. Finally, the cost advantages of some competitors may give them the ability to reduce their prices for an extended period of time if they so choose.

Other business risks

A substantial portion of CTSI’s revenues are derived from Internet service providers, or ISPs. A decline in these ISP customers or their customer base could negatively impact our financial results.

CTSI derives a substantial portion of its revenues from ISPs. We expect that this reliance will continue in the foreseeable future. ISPs represented approximately 23.2% and 24.7% of CTSI’s revenues for the years ended December 31, 2003 and 2002, respectively. This percent will decrease in the future as a result of our approximately $700,000 per month reduction in revenue from our revised PLU factor with Verizon. These high-margin revenues include services provided directly to ISPs, including local dial tone and transport-type (cap-type) services, and indirect services such as reciprocal compensation, and trunking from Verizon as a result of Verizon’s customers calling these ISPs. Industry-wide trends towards declining usage of dial-up Internet access may threaten the profitability or viability of our ISP customers. If we lose a significant number of these customers that are providing dial-up Internet services, or if a significant portion of these customers are unable to pay amounts owed to us, our financial results would be negatively impacted.

Changes in the jurisdictional mix of CTSI’s traffic with Verizon will materially adversely affect its results.

CTSI’s revenues from access charges and reciprocal compensation are affected by the mix of traffic delivered to it by other carriers for termination to CTSI’s customers. Verizon has notified CTSI of a reduction in

8

Table of Contents

the proportion of its delivered traffic that will be subject to intrastate access charges, and a corresponding increase in the proportion that will be subject to reciprocal compensation rates. Because the reciprocal compensation rates are significantly lower than intrastate access charges, this change in traffic mix reduced CTSI’s revenues by approximately $700,000 per month during the last two months of 2003 and will continue to materially effect its revenues going forward.

Demand for some of our services may be adversely affected by a downturn in the U.S. economy.

Demand for some of our services may be adversely affected by the downturn in the U.S. economy. As a result, we may experience lower than expected revenues for some of our businesses going forward. If current general economic conditions worsen, the revenues, cash flow and earnings of our company as a whole could be adversely affected.

Our future rate of growth in switched access lines will likely be lower than our historical growth rates and this decline may adversely affect our results.

Our business strategy depends in part on the continued growth of our switched access line base. The rate of growth has declined as the rate of additional line penetration in CT’s markets has matured. Additionally, the FCC adopted an order that required CT to increase our monthly per-line charges to local subscribers in 2002. Other regulatory actions could result in further increases in CT’s monthly per-line charges, which may discourage customers from purchasing additional lines. To the extent that the rate of growth continues to decline or becomes negative, our ability to generate additional revenues from this source, which has been very important to our results in recent years, will decrease.

Our growth strategy will require us to invest significant capital in services that may not achieve the desired returns.

We plan to continue to invest capital into services such as digital subscriber line, or DSL. This business is highly competitive (primarily cable modem), and we cannot assure you that we will be able to achieve the returns on investment that we expect. Additionally, even if we are successful in our efforts to develop this new business, its operating results and margins will likely be lower than those of our core lines of business. Moreover, we expect that any success we experience in selling DSL service will, to some extent, be offset by reduced demand for additional lines, which can be rendered redundant by DSL.

Any disruption in our services could potentially expose us to a loss of customers or claims for damages.

Because our services are critical to many of our customers’ businesses, any significant interruption in our services could result in a loss of customers or claims by our customers for indirect or consequential damages. Although the standard terms and conditions of our tariffs and customer contracts disclaim our liability for any such damages, a customer could still bring a lawsuit against us claiming lost profits or other consequential damages as the result of a service interruption or other web site or application problems that the customer may ascribe to us. We cannot assure you that a court would enforce any limitations on our liability. In such cases we could be liable for substantial damage awards.

We depend on third parties, over whom we have no control, to deliver our services.

Because of the interconnected nature of the telecommunications industry, we depend heavily on other local telephone companies, long-distance carriers and numerous other third parties to deliver our services. CTSI is particularly dependent on cooperation from Verizon in order to provide local service to a portion of its customers, about half of whom are not completely physically served by our network. We do not have a long-term agreement with Verizon to provide us with the network connections we need, and the terms of our relationship with Verizon are subject to change as the result of regulatory agency and court decisions. In addition, we are dependent on easements, franchises and licenses from various private parties such as established telephone companies and other utilities, railroads, long-distance companies, state highway authorities, local governments and transit authorities, for access to aerial pole space, underground conduits and other rights-of-way in order to construct and operate our networks. The failure to maintain the necessary third party arrangements on acceptable terms would have an adverse effect on our ability to conduct our business.

9

Table of Contents

If future acquisitions or business combinations are not successful, we could suffer an adverse effect on our business and results of operations.

From time to time we consider acquisitions of other businesses, some of which could be material to us. To the extent that we make any acquisitions in the future, we may issue common stock that would dilute the ownership of our stockholders, incur debt, assume liabilities or incur large and possibly immediate write-offs. Acquisition transactions require a significant commitment of resources and are accompanied by a number of risks, including:

We cannot be sure that we will succeed in addressing these risks or any other problems encountered in connection with potential business combinations and acquisitions.

As a holding company, we will require dividends from subsidiaries to meet our cash requirements.

We are a holding company whose principal assets are the shares of capital stock of our subsidiaries. With the exception of some revenues we generate as a result of our holding company’s merger with Commonwealth Communications, we do not generate any significant operating revenues of our own. Consequently, we depend on dividends, advances and payments from our subsidiaries (primarily CT) to fund our activities and meet our cash needs, including our debt service requirements. Our subsidiaries are separate and distinct legal entities. The ability of our subsidiaries to pay dividends or make other payments or advances to us will depend on their operating results and will be subject to contractual restrictions, various business considerations and to applicable laws and regulations. Accordingly, we cannot assure you that our subsidiaries will be able to, or be permitted to, make distributions to enable us to make payments in respect of our indebtedness.

The restrictive terms imposed by our indebtedness may prevent us from achieving some of our business objectives.

CT’s CoBank indebtedness contains various covenants that limit its ability to engage in the following activities:

Our ability to comply with these covenants can be affected by events beyond our control. A breach of any of these covenants could also result in a default even if we are able to pay our debt. A default under these covenants or covenants under other financing arrangements we enter into could result in the acceleration of required payments or the inability to receive financing in the future.

Risks relating to our common stock

Our governing documents and applicable laws and regulations may discourage a takeover attempt.

Provisions contained in our articles of incorporation and by-laws, Pennsylvania law and industry regulations could make it difficult for a third party to acquire us, even if doing so might be beneficial to our shareholders. For example, our certificate of incorporation and by-laws impose various procedural and other requirements that

10

Table of Contents

could make it difficult for shareholders to effect certain corporate actions. In addition, federal and Pennsylvania regulations regarding changes of control in our business are very restrictive. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock and may have the effect of delaying or preventing a change in control that you deem beneficial to you.

Risks related to our Board of Directors’ Composition

Four of our directors are also on the Board of Directors of Level 3 Communications, Inc.

Level 3 is a global communications and information services company. In 2004, Level 3 announced that it had privately negotiated a sale of its remaining shares of our common stock and no longer holds any equity ownership in our company. These four directors, who also serve on the Board of Directors of Level 3, as with all the directors, have influence over our corporate and management policies, including potential mergers or acquisitions, asset sales and other significant corporate transactions. Our Chairman, Walter Scott, Jr., is also the Chairman of Level 3.

Five of our Directors also serve on the Board of Directors of RCN Corporation.

Five of our directors also serve on the Board of Directors of RCN. Also, Level 3 owns approximately 22% of the outstanding equity securities of RCN. We have existing relationships with RCN. These relationships are arms-length business transactions. RCN has recently announced it may reorganize under Chapter 11.

CT Operations

Our RLEC, CT, offers local, toll, network access and enhanced services in a rural, mountainous market located primarily in the eastern third of Pennsylvania.

Network Strategy

CT utilizes a technologically-advanced, fiber-rich network that is based on digital-switching, Sonet transport and host/remote (TR 303 Standards Based) architecture. It was the first telephone company to deploy fiber optics in a toll application and was one of the first local exchange carriers in the nation to deploy a network of all digitally-switched central offices. CT operates its own Signaling System 7, STP based network, which provides automated monitoring and routing of telephone calls. Throughout its market, CT has 12 digital host switches and about 500 remote switches. All of the trunks between the hosts and the majority of host-to-remote wire center links are connected with fiber optic cable. Connection to our customers, or the “last mile,” is provided over our RLEC’s copper outside plant. Our network architecture provides for short loop lengths in our copper plant, which allows CT to aggregate customer lines at the remotes for transport, and concentrates costly network intelligence in a small number of host offices. CT currently uses an asynchronous transfer mode (“ATM”) network to support its network of over 11,000 DSL lines in its territory. Additionally, our RLEC operates a network control center, which monitors network performance 24 hours a day, 7 days a week and allows us to maintain high network performance standards.

Customer Service

CT has long been recognized as a customer service leader in Pennsylvania. Each year the Pennsylvania Public Utility Commission issues a study that measures the customer service results of the state’s six largest local exchange service providers which includes Alltel, MCI Local, Verizon Pennsylvania (formerly Bell Atlantic), Verizon North, Inc. (formerly GTE North, Inc.) and Sprint (formerly United). CT has achieved the lowest level of “justified complaints,” as defined by the Pennsylvania Public Utility Commission, among Pennsylvania’s largest local exchange carriers in eight of the past nine years for which ratings are available, including the last six years for which ratings are available.

Regulatory Environment

CT is subject to regulation by the Pennsylvania Public Utility Commission, or PUC, for intrastate ratemaking purposes, which includes rates for basic local services, intraLATA toll services and access services for the origination and termination of in-state long-distance calls. In 1997, CT entered into an alternative

11

Table of Contents

regulatory framework with the PUC for all of its intrastate operations under which it agreed to meet certain broadband service delivery parameters in exchange for a price cap formula, rather than rate of return regulations, which had linked CT’s prices directly to its book costs. As a result of the alternative regulatory framework, CT’s profits are not directly limited by the PUC as they were under the former rate of return system of regulation. Instead, CT received the flexibility to increase local rates annually based on inflation less 2 percentage points, so that increased returns arising from improved productivity and efficiency in excess of 2% per annum accrue to the equity owners of CT. CT can also seek to rebalance rates periodically between various intrastate service categories, such as toll and access. If inflation is less than 2% in a given year, however, as it has been in recent years, CT may be required to reduce its rates. These decreases can be “banked” for up to four years and offset against any increases that would be allowed under the plan during those years. Additionally, CT has the ability to request relief on a dollar-for-dollar basis for certain events deemed outside of its control that result in reduced revenues or increased expenses. This may include changes in revenues that may result from portions of interstate access charge reform.

CT’s alternative regulatory plan was approved by the PUC under a provision of law that expired on December 31, 2003, and has not (to date) been extended or re-enacted by the Pennsylvania General Assembly. CT believes that its plan remains valid because it was approved under the law in effect at the time of approval, but this is an unresolved area of the law and we can give no assurances as to the continued effectiveness of the plan.

The PUC must also approve any issuance of stock, incurrence of long-term debt or acquisition or sale of material utility assets by CT. In addition, the PUC must approve any change in control of either CT or its holding company. The PUC defines a “change in control” as either an acquisition or disposition of the largest single voting interest in a company, if that interest exceeds 20%. In addition, the Federal Communications Commission, or FCC, must also approve any sale or “transfer of control” of CT or of its holding company.

CT is subject to the jurisdiction of the FCC with respect to interstate rates, services, access charges and other matters, including the prescription of a uniform system of accounts. Interstate services, for the purpose of determining FCC jurisdiction, are communications that originate in one state and terminate in another state or a foreign country, including the use of CT’s local telephone network for the origination or termination of such communications. Settlements for CT’s interstate services, consisting primarily of carrier common line settlements and access charges for interstate toll calls, which accounted for approximately 33.7% of our RLEC’s 2003 revenues, are regulated by the FCC based on “average schedule” formulas that are designed to approximate the interstate jurisdictional costs of telephone companies based on statistical data rather than actual costs. These average schedule formulas are subject to periodic revision by the FCC and changes in the formulas, or removal of CT from them, could result in a significant revenue loss. However, removal of our RLEC from these formulas is specifically listed in its Pennsylvania alternative regulation plan as an event outside of its control that would justify an offsetting rate adjustment. The FCC also has an open rulemaking proceeding in which it is considering major changes to its rules governing interstate access charges and other forms of inter-carrier compensation. We are unable to predict how any FCC action in this proceeding may affect CT’s revenues. CT also receives funding from the federal Universal Service Fund, under rules established by the FCC. Changes in the universal service funding mechanism could affect CT’s revenues.

During 2002 and 2003, CT revised its rate structure to implement recent FCC rulings regarding interstate access charges and the universal service support system for rate of return rural incumbent local exchange carriers. The changes included a substantial reduction in usage-based access charges to long-distance companies, an increase in monthly subscriber line charges to local service customers and the creation of a universal funding mechanism funded by all telecommunications carriers. In addition to the above modifications, the FCC has also released a Notice of Proposed Rulemaking under which it will investigate the possibility of allowing telephone companies such as CT to convert to a form of incentive regulation similar in some respects to its existing alternative regulation plan in Pennsylvania. We are unable to predict the outcome of this proposed rulemaking at this time.

Competitive Environment

With the exception of competition from intraLATA toll providers and attractive calling packages offered by several non-wireline providers in certain areas of our territory, our RLEC has faced very limited competition to date since the Telecommunications Act was passed in 1996. Part of the reason for this is that CT maintains a

12

Table of Contents

rural exemption from the provisions of the Telecommunications Act, including, but not necessarily limited to, unbundling, colocation and rate discounts, for all of its access lines in Pennsylvania. The rural exemption does not preclude competitors from providing telephone services within our RLEC’s service area entirely over their own facilities. However, it requires prospective competitors who seek resale discounts, colocation, TELRIC pricing and unbundled network elements to go through a formal review by the Pennsylvania PUC before receiving approval. The PUC may grant such approval only if it finds that the competitor’s proposal is not unduly economically burdensome, is technically feasible and is consistent with the universal service provisions of the Telecommunications Act. CT has recently received limited requests for network interconnection for the exchange of traffic between its network and the networks of other facilities-based telecommunications providers and has negotiated agreements with several carriers for such limited interconnection. A variety of other factors contribute to our RLEC’s relative insulation from competition. These factors include its service territory’s high-cost of facilities-based entry due to low population density, the lack of concentration of any large business customers (as its top 10 business customers account for less than 5% of its revenues), its low basic service rates, its customer service record and level of customer satisfaction and its favorable regulatory environment. While competition from wireless providers is present in our markets, it is mitigated due to the low population density, rural nature and mountainous topography of our markets. We also face competition from national ISPs such as Time Warner and from cable providers offering a cable modem product.

Jack Flash^®

In the second half of 1999, we began offering our DSL service under the trade name Jack Flash^®. We offer this service through our own facilities, or “on-net,” in the majority of CT’s territory and on an “on-net” and an “off-net” basis in selected areas of CTSI’s markets. As of December 31, 2003, most of our installed DSL lines are in CT’s territory.

CLD

Since 1990, Commonwealth Long Distance Company has conducted the business of providing long-distance telephone services. Commonwealth Long Distance provides long-distance services to CT’s customers. CLD purchases long-distance minutes on a wholesale basis from a third-party provider.

CTSI Operations

We offer competitive local, toll, network access, long-distance, enhanced services, broadband data services and high-speed Internet access services in three regional “edge-out” markets, which encompass cities and surrounding areas that have total populations between 250,000 and 500,000 people, as well as a significant concentration of business and industry. The geographic area represented by these three markets is roughly one- third the size of CT’s service territory, or about 1,750 square miles, with a population of approximately 1.4 million and approximately 600 access lines per square mile.

Late in 2002, CTSI announced the extension of its existing business operations into select areas of Pennsylvania’s Lehigh Valley. We view this opportunity as an extension of our Central market (Lancaster/Reading/York), rather than the establishment of a fourth regional market.

Beginning in 1998, we had expanded beyond our original three “edge-out” markets and into five expansion markets located in Pennsylvania, New York, Ohio and West Virginia. In December 2000, we announced that we were exiting these expansion markets to redirect our focus on our “edge-out” markets. The expansion markets accounted for approximately 20% of our CLEC’s competitive lines and approximately 20% of our CLEC’s revenues. The redirection of CTSI’s strategy to focus on our original three “edge-out” markets is allowing us to increase our operating income and to significantly reduce our capital needs. We completed our withdrawal from these markets by June 30, 2001.

Network Strategy

CTSI’s network strategy is to own the majority of the key elements of the local exchange network. These elements include the host switches, the remote switches and the facilities connecting the host switches to the remote switches, including both the fiber optic cable and the transport electronics. In addition, where

13

Table of Contents

economically viable, CTSI builds copper distribution facilities between the remote switch and customer premises. Our network strategy allows us to provide high quality and reliable service, reduce customer churn and generate attractive margins. CTSI builds, owns and operates digitally switched, fiber intensive networks that are DSL-qualified in each of its three regional edge-out markets. As of December 31, 2003, CTSI had approximately 98% of its access lines connected to its own switches and approximately 52% of its access lines completely on its own network.

Customer Service

CTSI strives to provide its customers with exceptional service and uses the same customer care procedures that have proven successful for our 107 year-old RLEC. We operate a customer service center, which takes calls 24 hours a day, 7 days a week, to handle all customer complaints and problems. We are also proficient in the other unique customer service aspects of operating in a CLEC environment and have developed an efficient provisioning interface with the incumbent local exchange carrier. Because we own and operate a significant portion of our own network elements, we do not depend heavily on the incumbent local exchange carrier for provisioning and maintenance resolution.

Sales Organization

We utilize direct sales channels to target potential business and residential customers. Our direct channels include sales teams based in local offices, which are exclusively focused on selling to potential business customers with more than five lines. Each team consists of customer account managers and specialists that focus on retaining and growing accounts after the initial sale. In addition, our inside sales team is focused on residential and business customers with fewer than five lines.

Regulatory Environment

The Pennsylvania PUC exercises jurisdiction over CTSI’s intrastate telephone services, including basic local exchange service, intrastate access services and intraLATA toll services. Under the PUC’s current practices, CTSI’s rates and services are generally subject to much less regulatory scrutiny than those of our RLEC, or those of the dominant local telephone company in its markets (i.e. Verizon). Additionally, municipalities and other local government agencies may regulate limited aspects of CTSI’s business, such as its use of rights-of-way.

At the federal level, the FCC has jurisdiction over interstate services, including access charges as well as long-distance services. CTSI’s rates, terms and conditions of service are filed with the FCC in tariffs and are subject to the FCC’s complaint jurisdiction. The FCC has established rules limiting the rates CTSI and other competitive local exchange carriers can charge for origination and termination of long-distance calls (switched access), and for termination of local calls to Internet service providers (ISP traffic). In both cases, the rates prescribed by the FCC are significantly lower than the rates CTSI was charging prior to the adoption of the new rules in 2001.

The Telecommunications Act of 1996 gives CTSI rights to interconnect its network with Verizon, to exchange traffic with Verizon and to obtain unbundled access to elements of Verizon’s network at regulated rates based on Verizon’s forward-looking costs, which may include a reasonable profit. Under this law, Verizon and CTSI may negotiate the prices and other terms and conditions of these arrangements, but in the event of an impasse, the Pennsylvania PUC has authority to arbitrate any disputes. Future rulings by the Pennsylvania PUC, or changes in the FCC rules under which the Pennsylvania PUC resolves these issues, may have a material effect on CTSI’s costs and profitability.

CTSI purchases access to various network elements from Verizon under FCC rules that require the Pennsylvania PUC to determine rates for these elements based upon forward-looking incremental costs. Effective October 2, 2003, the FCC adopted significant changes to its rules requiring incumbent carriers like Verizon to offer unbundled access to network elements to competing carriers like CTSI. Our preliminary analysis indicates that the rules are not likely to have a material impact on CTSI’s use of unbundled voice-grade loops, which is the network element CTSI uses most extensively. On March 2, 2004, however, the U.S. Court of Appeals vacated and remanded substantial parts of these rules to the FCC for further consideration, which could result in additional changes to the rules. Our preliminary analysis of this recent ruling is that it will not likely have a material effect on CTSI’s costs and profitability. In a separate proceeding, the FCC is also considering possible changes to its rules for pricing these elements.

14

Table of Contents

The prices, terms and conditions of CTSI’s access to Verizon’s network may change as the result of ongoing and future legislative, court and regulatory activities. We cannot offer any assurance that CTSI will continue to be able to obtain this access on favorable terms.

Competitive Environment

CTSI competes principally with the services offered by the incumbent local exchange carrier, Verizon. Incumbent local exchange carriers such as Verizon have relationships with their customers, have the potential to subsidize services from their regulated service revenues and benefit from certain favorable state and federal regulations. Verizon is larger and has greater financial resources than CTSI. In light of the passage of the Telecommunications Act and concessions by some of the regional Bell companies, federal and state regulatory initiatives may provide increased business opportunities to CLECs, but incumbent carriers may obtain increased pricing flexibility for their services as competition increases. If, in the future, incumbent carriers are permitted by regulators to lower their rates substantially, engage in significant volume and term discount pricing practices for their customers or charge CLECs significantly higher fees for interconnection to the incumbent carriers’ networks, CTSI’s competitive position would be adversely affected.

Since late 2001, Verizon has been able to offer long-distance services in conjunction with its local telephone services in Pennsylvania. CTSI also offers packages of local and long-distance services. Verizon may be able to compete more effectively against CTSI now that it is able to offer all of the same services.

CTSI also faces, and will continue to face, competition from other current and potential future market entrants, including other CLECs, long-distance companies, cable television companies, electric utilities, microwave carriers, wireless telecommunications providers, Internet service providers and private networks built by large end users. The edge-out markets served by CTSI are served by one or more other CLECs including XO Communications, Telcove, Choice One Communications and others. We expect competition from CLECs and other companies to continue in the future.

Other Operations

Commonwealth Communications

Commonwealth Communications provides telecommunications equipment and technical services, and designs, installs and manages telephone systems for businesses, hospitals and universities located primarily in Pennsylvania. Commonwealth Communications also undertakes premises distribution systems projects and cabling projects primarily for hospitals and educational institutions.

epix^® Internet Services

epix^®, founded in 1994, is our Internet service provider. epix^® primarily provides dial-up Internet access at a flat rate for residential users and also provides dedicated access for business users and associated services such as web page hosting and design. epix^® provides a competitive Internet product to CT and CTSI and other customers, along with network support, technical support and customer service to Jack Flash^®, our DSL product. epix^® had approximately 35,400 dial-up subscribers as of December 31, 2003.

Relationship among CTE and RCN

Transitional Services and Agreements

Until December 2002, the Company had a month-to-month long-distance resale agreement with RCN as well as a management service agreement. The management service agreement was the result of the distribution of shares of CTE’s (then called C-TEC Corporation) wholly-owned subsidiary, RCN Corporation, to C-TEC shareholders. RCN agreed to provide or cause to be provided to CTE certain specified services (management services) for a transitional period after the distribution. The total fee for 2003, 2002 and 2001 was approximately $0, $1.2 million and $1.2 million, respectively. The transitional services remaining in 2001 and 2002 were primarily management services from the Office of the Chairman. In December 2002, we completed a purchase of properties from RCN based on fair market value, totaling approximately $2.0 million.

Miscellaneous

Four of our directors are also directors of Level 3. These four directors, as with all the directors, have influence over our corporate and management policies, including potential mergers or acquisitions, asset sales

15

Table of Contents

and other significant corporate transactions. In 2002, with the oversight and recommendation of an independent committee of the Board of Directors, we entered into two registration rights agreements with Level 3 relating to the common shares and class B shares Level 3 beneficially owned. During 2002, Level 3 sold all of the common shares it beneficially owned in two underwritten offerings pursuant to these agreements.

On April 24, 2003, we entered into a Recapitalization Agreement (the “Recapitalization Agreement”) with Level 3 and Eldorado Equity Holdings, Level 3’s indirect, wholly-owned subsidiary. Under the terms of the Recapitalization Agreement, we agreed to amend our existing charter to: (i) reclassify and convert each outstanding share of CTE Class B Common Stock into 1.09 shares of CTE Common Stock; and (ii) eliminate from the existing charter the CTE Class B Common Stock, and all provisions related thereto, and certain miscellaneous inoperative provisions. Level 3 agreed, pursuant to the terms of the Recapitalization Agreement, to vote its shares in favor of the reclassification and the related charter amendments. At the Annual Meeting on September 3, 2003, shareholders approved the proposal to reclassify and convert each outstanding share of CTE Class B Common Stock into 1.09 shares of CTE Common Stock. CTE now has only one class of common stock, with each outstanding share having one vote in corporate governance matters. As a result of the reclassification, Level 3’s ownership was reduced to approximately 4.6% of the outstanding CTE Common Stock and correspondingly approximately 4.6% of the voting power.

On January 21, 2004, Level 3 announced that it had privately negotiated a sale of its remaining 1,108,596 shares of CTE Common Stock to an institutional investor. In connection with this transaction, certain registration rights were assigned by Level 3 to the purchaser.

Our Chairman, Walter Scott, Jr., is also the Chairman of Level 3. Also, Level 3 owns approximately 22% of the outstanding equity securities of RCN. Five of our directors also serve on the Board of Directors of RCN. See also “Risk Factors” included in this report.

Employees

We employed a total of 1,204 employees as of December 31, 2003. Approximately 36% of our employees are covered under collective bargaining agreements. On January 27, 2003, Commonwealth Telephone Company bargaining employees ratified a new labor contract with the Communications Workers of America that will remain in effect until November 30, 2005. Also, in August 2002, Commonwealth Communications bargaining employees ratified a new labor contract with the Communications Workers of America that will remain in effect until June 29, 2005.

Item 2. Properties

Our property consists principally of central office equipment, telephone lines, telephone instruments and related equipment and land and buildings related to telephone operations. This plant and equipment is maintained in good operating condition for CT and CTSI operations. The properties of CT are subject to mortgage liens held by CoBank, ACB. We own substantially all of our central office buildings, administrative buildings, warehouses and storage facilities. All of the telephone lines are located either on private or public property. Locations on private land are governed by easements or other arrangements. We are not aware of any environmental liabilities which would have a material impact on our financial position or results of operations.

Item 3. Legal Proceedings

In the normal course of business, there are various legal proceedings outstanding, including both commercial and regulatory litigation. We do not believe these proceedings will have a material adverse effect on our results of operations or financial condition. Additionally, there are no other legal matters pending that we expect to have a material impact on our financial condition or results of operations.

Item 4. Submission of Matters to a Vote of Security Holders

None

16

Table of Contents

EXECUTIVE OFFICERS OF THE REGISTRANT

17

Table of Contents

EXECUTIVE OFFICERS OF THE REGISTRANT—(Continued)

18

Table of Contents

EXECUTIVE OFFICERS OF THE REGISTRANT—(Continued)

19

Table of Contents

PART II

Item 5. Market for Registrant’s Common Equity and Related Shareholder Matters

Our Common Stock is traded on the NASDAQ National Market (Symbol: CTCO).

There were approximately 1,728 holders of the Company’s Common Stock on February 27, 2004, based on the records of our transfer agent. Other information required under Item 5 of Part II is set forth in Management’s Discussion and Analysis of Financial Condition and Results of Operations included on pages F-1 to F-22 of this report and Notes to Consolidated Financial Statements included on pages F-29 to F-51 of this report.

On April 24, 2003, we entered into a Recapitalization Agreement (the “Recapitalization Agreement”) with Level 3 Communications, Inc. (“Level 3”) and Eldorado Equity Holdings, Level 3’s indirect, wholly-owned subsidiary. Under the terms of the Recapitalization Agreement, we agreed to amend our existing charter to: (i) reclassify and convert each outstanding share of CTE Class B Common Stock into 1.09 shares of CTE Common Stock; and (ii) eliminate from the existing charter the CTE Class B Common Stock, and all provisions related thereto, and certain miscellaneous inoperative provisions. Level 3 agreed, pursuant to the terms of the Recapitalization Agreement, to vote its shares in favor of the reclassification and the related charter amendments. On September 3, 2003, at the Annual Meeting, shareholders approved the proposal to reclassify and convert each outstanding share of CTE Class B Common Stock into 1.09 shares of CTE Common Stock. CTE now has only one class of common stock, with each share having one vote in corporate governance matters. As a result of the reclassification, Level 3’s ownership was reduced to approximately 4.6% of the outstanding CTE Common Stock and correspondingly 4.6% of the voting power. Subsequently, on January 21, 2004, Level 3 announced the sale of all of its remaining CTE Common Stock.

In connection with the Recapitalization, the class B common shares held as Treasury stock were retired and the shares are no longer authorized.

In July of 2003, we sold $300 million principal amount of 3.25% convertible notes due July 15, 2023, unless earlier redeemed, repurchased or converted.

The notes were issued by us and sold through Morgan Stanley & Co. Inc., Legg Mason Wood Walker Inc. and Wachovia Securities in transactions exempt from the registration requirements of the Securities Act to “qualified institutional buyers” pursuant to Rule 144A.

Interest is 3.25% per annum on the principal amount, payable semi-annually in arrears in cash on January 15 and July 15 of each year, beginning January 15, 2004. In addition, we will pay contingent interest for any six-month period from January 15 to July 14 and from July 15 to January 14, with the initial six-month period commencing July 15, 2008, if the trading price of the notes for each of the five trading days immediately preceding the first day of the applicable six-month period equals 120% or more of the principal amount of the notes. During any interest period when contingent interest shall be payable, the contingent interest payable per note will equal 0.25% of the average trading price of a note during the five trading days immediately preceding the first day of the applicable six-month interest period.

Holders may convert their notes into shares of our common stock at an initial conversion rate of 17.5439 shares per $1,000 principal amount of notes, representing an initial conversion price of approximately $57.00, subject to adjustment, prior to the close of business on the final maturity date under any of the following circumstances:

20

Table of Contents

We may redeem any of the notes beginning July 18, 2008, by giving holders at least 30 days’ notice. We may redeem the notes either in whole or in part at a cash redemption price of 100% of their principal amount, plus accrued and unpaid interest, including contingent interest, if any, and additional interest, if any, to, but excluding, the redemption date.

If a designated event occurs prior to maturity, holders may require us to repurchase all or part of their notes at a cash repurchase price equal to 100% of their principal amount, plus accrued and unpaid interest, including contingent interest, if any, and additional interest, if any, to, but excluding, the repurchase date.

Holders may require us to repurchase all or part of their notes on July 15 of 2008, 2013 and 2018 at a cash repurchase price equal to 100% of their principal amount, plus accrued and unpaid interest, including contingent interest, if any, and additional interest, if any, to, but excluding, the repurchase date.

On November 7, 2003, in connection with a registration rights agreement relating to the notes, we filed a resale shelf registration statement on Form S-1 with the Securities and Exchange Commission.

Item 5. (c) Purchases of Equity Securities by the Issuer and Affiliated Purchasers

Effective November 13, 2003, our Board of Directors authorized a Stock Repurchase Program of up to $100 million of CTE’s common stock. On February 9, 2004, our Board of Directors increased the size of the total stock repurchase program to up to $150 million of CTE Common Stock. No time limit has been set for the completion of the Stock Repurchase Program. The purchases have and will be made in open market, negotiated or block transactions. The transactions will be executed at CTE’s discretion, based on ongoing assessments of our capital needs, and the market value of CTE Common Stock. Repurchased shares have and will be placed in Treasury and may be used for our employee benefit plans or for other general corporate purposes. The table below provides information regarding purchases of CTE Common Stock made by us during the fourth quarter of the fiscal year covered by this report:

Notes

The $100 million Stock Repurchase Program was announced on November 13, 2003; the $50 million addition to the program was announced on February 10, 2004. The Stock Repurchase Program has no expiration date. We had no other stock repurchase plan or program expire during the period covered by the table. Also, no plans or programs were terminated prior to expiration. All purchases were made in accordance with the safe harbor in Rule 10b-18 under the Securities Exchange Act of 1934.

Item 6. Selected Financial Data

Information required under Item 6 of Part II is included on page F-23 of this report.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Information required under Item 7 of Part II is included on pages F-1 to F-22 of this report.

21

Table of Contents

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Information required under Item 7A of Part II is included on page F-15 of this report. Additional information is contained in Note 14 “Off Balance Sheet Risk and Concentration of Credit Risk” of the Consolidated Financial Statements included on page F-49 of this report.

Item 8. Financial Statements and Supplementary Data

The Consolidated Financial Statements and supplementary data required under Item 8 of Part II are included on pages F-24 to F-51 of this report.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

During the two years preceding December 31, 2003, there has been neither a change of accountants of the Registrant nor any disagreement on any matter of accounting principles, practices or financial statement disclosures.

Item 9A. Controls and Procedures

The management of Commonwealth Telephone Enterprises, Inc. (“the Company”), under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Accounting Officer, conducted an evaluation of the Company’s “disclosure controls and procedures” (as defined in Exchange Act Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Accounting Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

There was no significant change in the Company’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 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.

P ART III

Item 10. Directors and Executive Officers of the Registrant

The information required under Item 10 of Part III with respect to the Directors of the Registrant is set forth in the definitive proxy statement relating to the Registrant’s Annual Meeting of Shareholders to be filed by the Registrant with the Commission pursuant to Section 14(a) of the Securities Exchange Act of 1934 (the “1934 Act”) and is hereby specifically incorporated herein by reference thereto.

The information required under Item 10 of Part III with respect to the executive officers of the Registrant is set forth at the end of Part I hereof.

The full text of our Code of Ethical Conduct is published on our web site at www.ct-enterprises.com. We intend to disclose future amendments to our Code of Ethical Conduct, and waivers of its provisions granted to executive officers and directors, on our web site within five business days following the date of such amendment or waiver.

Item 11. Executive Compensation

The information required under Item 11 of Part III is set forth in the definitive proxy statement relating to the Registrant’s Annual Meeting of Shareholders to be filed by the Registrant with the Commission pursuant to Section 14(a) of the 1934 Act, and is hereby specifically incorporated herein by reference thereto.

22

Table of Contents

Item 12. Security Ownership of Certain Beneficial Owners and Management

The information required under Item 12 of Part III is included in the definitive proxy statement relating to the Registrant’s Annual Meeting of Shareholders to be filed by the Registrant with the Commission pursuant to Section 14(a) of the 1934 Act, and is hereby specifically incorporated herein by reference thereto.

Item 13. Certain Relationships and Related Transactions

The information required under Item 13 of Part III is included in the definitive proxy statement relating to the Registrant’s Annual Meeting of Shareholders to be filed by the Registrant with the Commission pursuant to Section 14(a) of the 1934 Act, and is hereby specifically incorporated herein by reference thereto.

Item 14. Principal Accountant Fees and Services

The information required under Item 14 of Part III is included in the definitive proxy statement relating to the Registrant’s Annual Meeting of Shareholders to be filed by the Registrant with the Commission pursuant to Section 14(a) of the 1934 Act, and is hereby specifically incorporated herein by reference thereto.

PART IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

Item 15. (a)(1) Financial Statements

Management’s Discussion and Analysis of Financial Condition and Results of Operations (Unaudited)

Selected Financial Data (Unaudited)

Consolidated Statements of Operations for Years Ended December 31, 2003, 2002 and 2001

Consolidated Balance Sheets—December 31, 2003 and 2002

Consolidated Statements of Cash Flows for Years Ended December 31, 2003, 2002 and 2001

Consolidated Statements of Changes in Common Shareholders’ Equity for Years Ended December 31, 2003, 2002 and 2001

Notes to Consolidated Financial Statements

Report of Independent Auditors

Item 15. (a) (2) Fi nancial Statement Schedules

Description

Condensed Financial Information of the Registrant for Years Ended December 31, 2003, 2002 and 2001 (Schedule I)

Valuation and Qualifying Accounts and Reserves for Years Ended December 31, 2003, 2002 and 2001 (Schedule II)

All other financial statement schedules not listed have been omitted since the required information is included in the Consolidated Financial Statements or the Notes thereto, or is not applicable or required.

23

Table of Contents

Item 15. (a)(3) Exhibits

Exhibits marked with an asterisk are filed herewith. The remaining exhibits have been filed with the Commission and are incorporated herein by reference.

(2) Plan of acquisition, reorganization, arrangement, liquidation or succession

2.1 Distribution agreement among C-TEC Corporation, RCN Corporation and Cable Michigan, Inc. is incorporated herein by reference to Exhibit 2.1 to Amendment No. 2 to Form 10/A of RCN Corporation dated September 15, 1997, (Commission File No. 0-22825).

2.2 Articles of Merger between C-TEC Corporation and Commonwealth Communications, Inc. dated September 29, 1997 is incorporated herein by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1997, (Commission File No. 0-11053).

2.3 Limited Liability Company Operating Agreement of CTSI, LLC dated June 30, 2001 is incorporated herein by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001, (Commission File No. 0-11053).

2.4 Agreement and Plan of Merger between CTSI, Inc. and CTSI, LLC dated June 22, 2001 is incorporated herein by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001, (Commission File No. 0-11053).

2.5 Limited Liability Company Operating Agreement of CTE Telecom, LLC dated December 2, 2002 is incorporated herein by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, (Commission File No. 0-11053).

2.6 Agreement and Plan of Merger between Commonwealth Long Distance Company and CTE Telecom, LLC dated December 31, 2002 is incorporated herein by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, (Commission File No. 0-11053).

2.7 Agreement and Plan of Merger between epix^® Internet Services, Inc. and CTE Telecom, LLC dated December 31, 2002 is incorporated herein by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, (Commission File No. 0-11053).

2.8 Recapitalization Agreement dated April 24, 2003, by and among Commonwealth Telephone Enterprises, Inc., Level 3 Communications, Inc. and Eldorado Equity Holdings, Inc. is incorporated herein by reference to Exhibit 2.1 to the Company’s Report on Form 8-K as filed with the Commission on April 25, 2003, (Commission File No. 0-11053).

(3) Articles of Incorporation and By-laws

3.1 Amended and Restated Articles of Incorporation dated September 3, 2003 is herein incorporated by reference to Exhibit 3.12 to the Company’s Form S-1 Registration Statement as filed with the Commission on November 7, 2003, Registration No. 333-10325.

3.2 By-laws of Registrant, as amended and restated as of December 3, 2003 are incorporated herein by reference to Exhibit 3.1 to the Company’s Report on Form 8-K as filed with the Commission on December 3, 2003, (Commission File No. 0-11053).

(4) Instruments Defining the Rights of Security Holders, Including Indentures

4.1 Loan Agreement dated as of March 29, 1994, made by and between Commonwealth Telephone Company and the National Bank for Cooperatives is incorporated herein by reference to the Company’s Report on Form 10-Q for the quarter ended March 31, 1994, (Commission File No. 0-11053).

4.2 Line of Credit Agreement dated as of September 30, 1999 by and between Commonwealth Telephone Company as borrower and the CoBank, ACB is incorporated herein by reference to Exhibit 4(b) to the Company’s Report on Form 10-Q for the quarter ended September 30, 1999, (Commission File No. 0-11053).

4.3 Line of Credit Amendment dated as of September 15, 2000 by and between Commonwealth Telephone Company as borrower and the CoBank, ACB is incorporated herein by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000, (Commission File No. 0-11053).

24

Table of Contents

4.4 Amended and Restated Line of Credit Agreement dated April 6, 2001 by and between Commonwealth Telephone Company as borrower and the CoBank, ACB is incorporated herein by reference to Exhibit 4 to the Company’s Report on Form 10-Q for the quarter ended March 31, 2001, (Commission File No. 0-11053).

4.5 Second Amended and Restated Line of Credit Agreement dated June 4, 2002 by and between Commonwealth Telephone Company as borrower and the CoBank, ACB is incorporated herein by reference to Exhibit 4(a) to the Company’s Report on Form 10-Q for the quarter ended June 30, 2002, (Commission File No. 0-11053).

4.6 Letter Agreement dated March 13, 2003 to amend the Loan Agreement dated as of March 29, 1994 and the Second Amended and Restated Line of Credit Agreement dated as of June 4, 2002 between Commonwealth Telephone Company and CoBank, ACB is incorporated herein by reference to Exhibit 4(a) to the Company’s Report on Form 10-Q for the quarter ended March 31, 2003, (Commission File No. 0-11053).

4.7 Agreements Regarding Amendments to Loan Documents dated June 2, 2003 by and between Commonwealth Telephone Company as borrower and CoBank, ACB is incorporated herein by reference to Exhibit 4.1 to the Company’s Report on Form 10-Q for the quarter ended June 30, 2003, (Commission File No. 0-11053).

4.8 Indenture for 3¼% Convertible Notes due 2023 dated July 18, 2003 between Commonwealth Telephone Enterprises, Inc. and the Bank of New York, as Trustee is incorporated herein to Exhibit 4.10 to the Company’s Form S-1 Registration Statement as filed with the Commission on November 7, 2003, Registration No. 333-10325.

4.9 Form of 3¼% Convertible Notes due 2023 is incorporated herein to Exhibit 4.10 to the Company’s Form S-1 Registration Statement as filed with the Commission on November 7, 2003, Registration No. 333-10325.

4.10 Registration Rights Agreement dated July 18, 2003 by and among Commonwealth Telephone Enterprises, Inc. and Morgan Stanley & Co. Incorporated, Legg Mason Wood Walker, Incorporated and Wachovia Capital Markets, LLC, as Initial Purchasers is incorporated herein by reference to Exhibit 4.11 to the Company’s Form S-1 Registration Statement as filed with the Commission on November 7, 2003, Registration No. 333-10325.

(10) Material Contracts

10.1 C-TEC Corporation, 1994 Stock Option Plan is incorporated herein by reference to the Company’s Report on Form 10-Q for the quarter ended March 31, 1994, (Commission File No. 0-11053).

10.2 C-TEC Corporation, Common-Wealth Builder Employee Savings Plan is incorporated herein by reference to Exhibit 28(b) to Form S-8 Registration Statements (as amended) of Registrant filed with the Commission, Registration No. 2-98306 and 33-13066.

10.3 C-TEC Corporation 1994 Stock Option Plan, as amended, is incorporated herein by reference to Form S-8 Registration Statement of Registrant filed with the Commission, Registration No. 33-64563.

10.4 C-TEC Corporation Executive Stock Purchase Plan is incorporated herein by reference to Form S-8 Registration Statement of Registrant filed with the Commission, Registration No. 33-64677.

10.5 Registration Rights Agreement dated October 23, 1998 among Registrant, Walter Scott, Jr., James Q. Crowe and David C. McCourt is incorporated herein by reference to Exhibit 10.1 to the Company’s Form 8-K dated October 28, 1998, (Commission File No. 0-11053).

10.6 1997 Non-Management Directors’ Stock Compensation Plan effective February 12, 1997, as amended is incorporated herein by reference to Exhibit 10 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998, (Commission File No. 0-11053).

10.7 Commonwealth Telephone Enterprises, Inc. Executive Stock Purchase Plan as amended and restated, effective December 21, 1998 is incorporated herein by reference to Exhibit 99.1 to the Company’s Report on Form 10-Q for the quarter ended September 30, 1999, (Commission File No. 0-11053).

25

Table of Contents

10.8 1997 Non-Management Directors’ Stock Compensation Plan effective February 12, 1997, as amended and restated, is incorporated herein by reference to Exhibit 10(a) to the Company’s Report on Form 10-Q for the quarter ended March 31, 2000, (Commission File No. 0-11053).

10.9 Registration Rights Agreement dated February 7, 2002, between Registrant and Level 3 Communications, Inc. is incorporated herein by reference to Exhibit 10.13 of Form S-3 Registration Statement of Registrant filed with the Commission, Registration No. 333-82366.

10.10 Consulting Agreement dated March 1, 2002, by and between CTE Services, Inc. and James DePolo d/b/a Westminster Marketing Associates is incorporated herein by reference to Exhibit 10(n) to the Company’s Report on Form 10-K for the year ended December 31, 2001, (Commission File No. 0-11053).

10.11 Amendment No. 1 effective May 15, 2002, to the CTE Equity Incentive Plan (formerly known as the CTEC Corporation 1996 Equity Incentive Plan) is incorporated herein by reference to Exhibit 10(a) to the Company’s Report on Form 10-Q for the quarter ended June 30, 2002, (Commission File No. 0-11053).

10.12 Commonwealth Telephone Enterprises, Inc. Bonus Plan is incorporated herein by reference to Exhibit 10(b) to the Company’s Report on Form 10-Q for the quarter ended June 30, 2002, (Commission File No. 0-11053).

10.13 Commonwealth Telephone Enterprises, Inc. Executive Stock Purchase Plan as amended and restated, effective September 5, 2002 is incorporated herein by reference to Exhibit 10(a) to the Company’s Report on Form 10-Q for the quarter ended September 30, 2002, (Commission File No. 0-11053).

10.14 Shelf Registration Agreement dated as of November 12, 2002 among Registrant, Level 3 Communications, Inc. and Eldorado Equity Holdings, Inc. is incorporated herein by reference to Exhibit 10.1 of Form S-3 Registration Statement of Registrant filed with the Commission, Registration No. 333-101127.

10.15 Amendment No. 1 to the Registration Rights Agreement dated April 23, 2003, by and among Commonwealth Telephone Enterprises, Inc., Level 3 Communications, Inc. and Eldorado Equity Holdings, Inc. is incorporated herein by reference to Exhibit 10.1 to the Company’s Report on Form 8-K as filed with the Commission on April 25, 2003, (Commission File No. 0-11053).

* (21) Subsidiaries of the Registrant

* (23) Consent of Independent Accountants

* (24) Powers of Attorney

* (31.1) Rule 13a-14(a) Certification of Chief Executive Officer

* (31.2) Rule 13a-14(a) Certification of Chief Accounting Officer

* (32) Section 1350 Certifications

   (99) Additional Exhibits

(a) Undertakings to be incorporated by reference into Form S-8 Registration Statement Nos. 2-98305, 33-5723, 2-98306 and 33-13066 are incorporated herein by reference to Exhibit 28(a) to the Company’s Annual Report on Form 10-K for the year ended December 31, 1987, (Commission File No. 0-11053).

Item 15. (b) Reports on Form 8-K

On December 3, 2003, the Company filed a report on Item 5 of Form 8-K to disclose the amendment and restatement of the By-laws of the Registrant.

26

Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

Date: March 15, 2004

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

27

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act and we intend that such forward-looking statements be subject to these safe harbors. These statements are generally accompanied by words such as “intend,” “anticipate,” “believe,” “estimate,” “expect” or similar statements. Our forward-looking statements involve risks and uncertainties that could significantly affect expected results in the future differently than expressed in any forward-looking statements we have made. These risks and uncertainties include, but are not limited to:

Additional factors that could cause or contribute to such differences are set forth in the section entitled “Risk Factors” and are discussed elsewhere in this report. Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, we cannot provide any assurance that the results contemplated in such forward-looking statements will be realized. The inclusion of this forward-looking information should not be regarded as a representation by us or any other person that the future events, plans or expectations that we contemplate will be achieved. Furthermore, past performance in operations and share price is not necessarily predictive of future performance.

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto:

Overview

History

We began operations as Commonwealth Telephone in 1897 with the construction of a telephone line between two rural farms in Pennsylvania. In 1928, a prominent Pennsylvania family acquired Commonwealth Telephone and continued to grow the company through acquisition and internal growth. The company went public in 1952, but the family continued to hold a controlling stake. In the 1980’s, the company expanded beyond wireline telephone into cable, cellular, paging and other telecommunications-related services through acquisition and business development. In 1986, the controlling family implemented a dual class voting structure in order to strengthen its control, with the common stock having one vote per share and class B common stock having 15 votes per share. In 1993, the controlling family sold its ownership interest to a subsidiary of Peter Kiewit Sons’, which has since become Level 3 Communications, Inc. (“Level 3”). In 1997, Commonwealth Telephone implemented a spin-off of certain operations into two new public companies, a bundled telecommunications provider (RCN Corporation) and a cable television operator (Cable Michigan, Inc.). At the conclusion of the spin-off, we became the public company that currently exists as Commonwealth Telephone Enterprises, Inc. (“CTE,” “the Company,” “we,” “us” or “our”). In April and December of 2002, Level 3 sold approximately 9,000,000 shares of our common stock in two registered offerings, which resulted in a reduction of its voting power in our company from approximately 48% of the voting power of our equity securities to approximately 29%. In September 2003, we completed a transaction pursuant to which each outstanding share of our Class B Common Stock was converted into 1.09 shares of our Common Stock (the “Recapitalization Transaction”). Following the Recapitalization Transaction, the 1,017,061 shares of our Class B Common Stock that Level 3 beneficially owned prior to the Recapitalization Transaction, representing approximately 29% of the voting power of our equity securities, were converted into 1,108,596 shares of our Common Stock, representing approximately 4.6% of the voting power of our equity securities. In January 2004, Level 3 announced that it had closed a privately-negotiated sale of its remaining 1,108,596 shares of our Common Stock to an institutional investor.

F-1

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

Management’s Overview

2003 Highlights

CTE continued to produce solid consolidated financial results in 2003. Sales increased 5.4% in 2003 to $335,722 and operating income increased 7.0% to $103,381. The increase in sales is due in part to CT’s favorable federal and state regulatory environments and in part to continued growth at CTSI, our RLEC “edge-out.” The increase in operating income is due to increased revenues and continued efforts of cost control across all of our operations.

Late in 2002, CTSI extended into the Lehigh Valley area of Pennsylvania. Lehigh Valley’s capital network is significantly deployed and we are focused on how we can most effectively increase sales and customer connections in this market extension.

At our Annual Meeting in September, our shareholders approved the proposal to reclassify and convert each outstanding share of CTE Class B Common Stock, which had super voting rights, into 1.09 shares of CTE Common Stock. This action reduced Level 3’s voting interest, simplified our capital structure and increased our market float.

In July of 2003, we took advantage of a favorable market and sold $300,000 of 3.25% convertible notes due in 2023. The success of the offering illustrated the market’s confidence in our company’s long-term prospects, goals and strategies.

In November of 2003, taking advantage of our strong cash position and a relatively weak stock price, and based on management’s recommendation, our Board of Directors authorized a Stock Repurchase Program of up to $100 million of CTE Common Stock, which was recently increased to $150 million.

Other uses of the proceeds from our debt offering include working capital, capital expenditures and other general corporate purposes including potential acquisitions and new product offerings. Our approach to acquisitions has been, and will continue to be “prudent and disciplined.” Acquisitions are inherently risky, and it is our belief that we should focus on what we do best and pursue opportunities that make sense both strategically and economically, and are in the best interests of our shareholders.

In addition, while we do not presently intend to pay cash dividends on our common stock, we may decide to pay dividends in the future. The payment of any cash dividends will be at the discretion of our Board of Directors and will be based on a number of factors including the dividend taxation level.

In January of 2004, Level 3 sold its remaining shares of CTE Common Stock to a an institutional investor, eliminating the “overhang” associated with Level 3’s publicly stated desire to monetize its investment in CTE.

In order to promote better alignment of strategies and objectives among sales, marketing and regulatory, we recently revised our segments. See the discussion below.

2003 Challenges and 2004 Expectations

We faced many challenges in 2003 that will continue into the future. Wireless substitution is accelerating and Voice over IP is evolving. In addition, there are industry-wide trends toward declining usage of dial-up Internet access and wireline long-distance services, generally.

The legislative and regulatory landscape continues to be a challenging one. Chapter 30, which governs CT’s alternative form of regulation has expired; and currently, no action has been taken by the Pennsylvania legislature to renew the law. FCC-mandated interstate access rate reductions reduced CTSI’s revenues in 2003 and will reduce interstate revenues even further in 2004.

F-2

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

Also, a substantial portion of CTSI’s revenues are derived directly and indirectly from ISPs. Consolidation within the ISP industry, bankruptcy or a major network reconfiguration could negatively impact CTSI’s results.

Despite these items, our operations generate a significant amount of cash flow. Our strategic plan is designed to insure that we identify and capitalize on changing consumer preferences, market trends and technological developments. CT is actively bundling voice and data products to provide our customers with convenient, attractive packages in order to minimize churn to cable modem and wireless. Both CT and CTSI are exploring alliances and partnerships with other providers in order to expand our product offerings and to capitalize on our strong sales experience, technologically-advanced network, loyal customer base and high-speed capacity.

Segments

Our two primary operations are Commonwealth Telephone Company (“CT”), which is a rural incumbent local exchange carrier (“RLEC”), and CTSI, LLC (“CTSI”), which we refer to as our RLEC “edge-out” operations, and is a competitive local exchange carrier (“CLEC”). Recently, we revised our segments to provide management with a more comprehensive financial view of our key businesses and promote better alignment of strategies and objectives. Prior years’ segment information has been recast to conform to the new presentation. The CT segment now includes the results of Commonwealth Long Distance Company (“CLD”), a long-distance reseller; and the portion of Jack Flash^® (“Jack Flash”), our broadband data service that uses digital subscriber line (“DSL”) technology to offer high-speed Internet access and digital connectivity solutions, that is in CT’s territory. The results of these operations were previously included in our “Other” segment. The CTSI segment did not change. CTSI’s revenue is derived primarily from access, local service, competitive access, Internet access from dedicated and Jack Flash DSL, local long-distance (intraLATA toll) and long-distance service revenue. Our “Other” segment is comprised of telecommunications-related businesses that all operate in the deregulated segments of the telecommunications industry and support the operations of our two primary operating companies. These support businesses are epix^® Internet Services (“epix”), a rural Internet service provider; and Commonwealth Communications (“CC”), a provider of telecommunications equipment and facilities management services. “Other” also includes our corporate entity.

As of December 31, 2003, CT served over 338,400 switched access lines. In 1997, we formally launched our facilities-based CLEC, CTSI. CTSI operates in three “edge-out” regional Pennsylvania markets that border CT’s markets and that, we believe, offer attractive market demographics, such as higher population density and a higher concentration of businesses. In late 2002, we extended our operations into select areas of Pennsylvania’s Lehigh Valley. We view this as an extension of our current Central market (Lancaster/Reading/York), rather than the establishment of a fourth regional market. CTSI served over 138,600 switched access lines as of December 31, 2003, which were mainly business customers.

Beginning in 1998, CTSI expanded beyond its original three “edge-out” markets into five additional expansion markets in Pennsylvania, New York, Ohio and West Virginia. At the end of 2000, we developed an exit strategy for these “expansion” markets in order to refocus our attention on our three original “edge-out” markets. This strategy has allowed us to grow our operating income and significantly reduced our capital needs. We completed our withdrawal from these markets by June 30, 2001.

Revenue

CT’s revenue is derived primarily from access, local service, enhanced services, local long-distance (intraLATA toll), long-distance service revenue and Jack Flash DSL. Access revenue consists primarily of charges paid by long-distance companies for access to our network in connection with the completion of long-distance telephone calls. Local service revenue consists of charges for local exchange telephone services, including monthly tariffs for basic local service. Enhanced services revenue is derived from service for special calling features, such as Caller ID and Call Waiting. Local long-distance and long-distance revenues consist of charges for such services paid by CT’s customers. Jack Flash DSL revenue consists of charges for high-speed Internet access and digital connectivity solutions provided to CT’s customers.

F-3

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

CTSI’s revenue is derived primarily from access, local service, competitive access, Internet access from dedicated and Jack Flash DSL, local long-distance (intraLATA toll) and long-distance service revenue. Access revenue consists primarily of charges paid by long-distance companies and other non-CLEC customers for access to our network in connection with the completion of long-distance telephone and local calls and the delivery of other services. Access revenue also includes recurring trunking revenue and reciprocal compensation. Local service revenue consists of charges for local exchange telephone services, including monthly recurring charges for basic services and special calling features. Competitive access revenue consists of charges for point-to-point connections. Internet access revenue consists of charges for dedicated Internet access provided to CTSI’s customers. Jack Flash DSL revenue consists of charges for high-speed Internet access and digital connectivity solutions provided to CTSI’s customers. Long-distance revenue consists of charges for long-distance service paid by CTSI’s customers.

Our “Other” business segment includes the revenue from epix and Commonwealth Communications. epix revenue for this segment consists of dial-up Internet access revenue. Commonwealth Communications generates revenue primarily from telecommunications projects, including installation of telephone systems for business customers, cabling projects and telecommunications systems design.

Operating Costs

Our operating costs and expenses for each of our segments primarily include access charges and other direct costs of sales, payroll and related benefits, selling and advertising, software and information system services and general and administrative expenses. These costs have increased over time as we have grown our operations and revenues. We expect these costs to continue to increase as our revenue growth continues, but generally at a slower rate than revenue growth. CTSI also incurs additional costs related to leased local loop charges associated with providing last mile access, circuit rentals, engineering costs, colocation expense, terminating access for local calls and long-distance expense. CLD also incurs long-distance expense associated with purchasing long-distance minutes on a wholesale basis from a third party provider. CC also incurs expenses primarily related to equipment and materials used in the course of the installation and provisioning of service.

Capital Expenditures

We incur capital expenditures associated with access line growth, expenditures for upgrading existing facilities and costs related to the provisioning of DSL services in CT and CTSI territories. Capital expenditures associated with access line growth, comprising a significant portion of our overall capital spending, are success-based and therefore result in incremental revenue.

F-4

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

Selected Segment Data

Data Tables

We have included certain segment financial data in the tables below. Operating income (loss) is the primary measure used by our management to assess the performance of each segment.

2003 vs 2002

For the year ended December 31, 2003, our consolidated sales increased $17,167 or 5.4% and were $335,722 and $318,555 for the years ended December 31, 2003 and 2002, respectively. Higher sales at CT of $15,849 and CTSI of $1,330 contributed to the increase. Other sales declined by $12. Operating expenses increased $10,381 from an increase in consolidated costs and expenses of $8,689 primarily due to increased pension cost and an operating tax settlement recorded in 2002 that did not recur in 2003, higher depreciation expense of $2,921, a lower positive settlement in 2003 associated with our 2000 restructuring charge, partially offset by charges in 2002 of $2,333 associated with the Voluntary Retirement Program that did not recur in 2003 and the elimination of management fees as a result of the management services agreement with RCN, which

F-5

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

were $1,200 in 2002. Operating income increased $6,786 as a result of the increase in sales, offset by the increases in operating expenses discussed above. Consolidated net income was $72,865 or $3.07 per diluted share for the year ended December 31, 2003, including a cumulative effect accounting adjustment of $13,230 or $0.55 per diluted share from the adoption of SFAS No. 143, “Accounting for Asset Retirement Obligations.” Net income was $57,124 or $2.42 per diluted share for the year ended December 31, 2002. Contributing to the increase in net income is the increase in operating income and the cumulative effect accounting adjustment, partially offset by an increase in interest expense due to the sale of convertible notes in July 2003.

CT

CT’s sales were $223,827 and $207,978 for the years ended December 31, 2003 and 2002, respectively. The sales increase of $15,849 or 7.6% is primarily due to higher access revenue, recovery of a portion of WorldCom receivables previously written-off and increased enhanced services revenue, partially offset by lower toll revenues. Installed access lines increased 613 or 0.2%; CT’s sale of business lines contributed to this access line growth. CT’s residential lines declined as additional lines were disconnected from customers switching to DSL and other high-speed products and non-wireline providers.

Interstate access revenue increased $8,084 resulting from an increase in the National Exchange Carrier Association (“NECA”) average schedule formulas, growth in access lines, an increase in special access circuits and an increase in minutes of use. State access revenue increased $2,438 primarily as a result of an increase in minutes of use. In addition, enhanced service revenue increased $718 primarily from Caller ID and certain other enhanced services sales. In the third quarter of 2003, a third party vendor assumed our WorldCom receivables resulting in a recovery of $965 of amounts previously written-off. Local service revenue decreased $273 primarily due to the one-time surcharge refund and a revision in the way CT treats state tax surcharges, partially offset by increases in access lines and a regulatory rate increase of $0.21 in May 2002 for substantially all dial-tone lines, based on a Gross Domestic Product Price Index (GDPPI) rate increase. IntraLATA toll and long-distance revenues decreased $358 primarily as a result of lower market share due to attractive calling packages offered by several non-wireline providers in certain areas of CT’s territory, a trend we expect to continue, partially offset by a new low-rate long-distance product offering. Jack Flash sales increased $1,476 due to an increase in subscribers.

CT’s costs and expenses, excluding depreciation, amortization, management fees, restructuring charges (reversals) and Voluntary Retirement Program (“costs and expenses”) were $79,730 and $74,614 for the years ended December 31, 2003 and 2002, respectively. Costs and expenses increased $5,116 or 6.9% due to a favorable operating tax settlement of $2,589 recorded in the fourth quarter of 2002 that did not recur in 2003 and also due to the new long-distance product offering. Costs and expenses of Jack Flash increased due to an increase in network support costs and an increase in DSL sales. Costs and expenses also increased as a result of higher local terminating expense, higher snow removal costs, higher utility costs, additional costs to maintain our properties and higher data base dip charges due to growth in Caller ID revenues. These increases were partially offset by lower payroll costs due to the realignment of our management staff that occurred late in the fourth quarter of 2002 and lower advertising costs.

Other operating expenses increased $193 or 0.4% for the year ended December 31, 2003. The increase was due to an increase in depreciation and amortization expense of $1,517 or 3.3% to $46,944 as a result of higher depreciable plant from capital expenditures in 2002 and 2003. This increase was partially offset by the elimination of management fees of $1,324.

CT’s operating income increased $10,540 or 12.2% to $97,153 for the year ended December 31, 2003. The increase was a result of the items discussed above.

CTSI

CTSI’s sales were $85,336 and $84,006 for the years ended December 31, 2003 and 2002, respectively. This increase of $1,330 primarily represents an increase in local service, primarily from an increase in installed access

F-6

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

lines; and increases in long-distance, customer point-to-point circuit revenues and Internet access from dedicated and DSL. At December 31, 2003, CTSI had 138,667 installed access lines as compared to 126,649 at December 31, 2002, an increase of 12,018 or 9.5%. CTSI’s net line additions were lower versus the recent past due to a loss of access lines in the fourth quarter of 2003 in connection with the reconfiguration of a key business customer’s network. The increase in point-to-point circuit revenue is due to Internet and cellular providers using our circuits to allow their networks to tie into the switched network system. Also contributing to the increase in revenue was an increase in Internet Service Provider, or ISP traffic. For the year ended December 31, 2003, CTSI recorded $12,258 or 14.4% of its revenues from compensation revenue associated with ISP traffic, as compared to $11,961 or 14.2% for the same period in 2002.

CTSI derives a substantial portion of its revenues from ISPs. We expect that this reliance will continue in the foreseeable future. ISPs represented approximately 23.2% and 24.7% of CTSI’s revenues for the years ended December 31, 2003 and 2002, respectively. This percentage will decrease in the future as a result of our approximately $700 per month reduction in revenue from our revised percent of local usage (PLU) factor with Verizon. These high-margin revenues include services provided directly to the ISP including local and cap-type services and indirect services including reciprocal compensation and trunking from Verizon as a result of Verizon’s customers calling these ISPs. Industry-wide trends toward declining usage of dial-up Internet access may threaten the profitability or viability of our ISP customers. If we lose a significant number of these customers that are providing Internet services, or if a significant portion of these customers are unable to pay amounts owed to us, our financial results could be negatively impacted.

The increases in revenue were partially offset by the continued reduction in access revenue resulting from a modification to certain transport billings related to access trunking by approximately $1,200 per quarter that began in the third quarter of 2002. This modification is a result of a dispute between CTSI and Verizon regarding billing for these transport trunking facilities. In February 2004, Verizon filed a Petition for Resolution of a Dispute with the Pennsylvania PUC, seeking a refund and/or credits for approximately $7.9 million in facilities charges that CTSI billed to Verizon over a two-year period. CTSI has answered Verizon’s complaint, denying all liability, and asking the Pennsylvania PUC to render a decision in favor of CTSI.

Revenues are also reduced by the continued implementation of the Federal Communications Commission’s (“FCC”) mandated interstate access rate reduction. The FCC rate ceilings will result in continued reductions in the revenues CTSI receives from interstate access charges and reciprocal compensation. In addition, industry-wide trends toward declining usage of dial-up Internet access and of long-distance services generally, may have a negative impact on these revenues. CTSI’s revenues from access charges and reciprocal compensation are also affected by the mix of traffic delivered to it by other carriers for termination to CTSI customers. Verizon has recently notified CTSI of a reduction in the proportion of its delivered traffic that will be subject to intrastate access charges, and a corresponding increase in the proportion that will be subject to reciprocal compensation rates based on a revised PLU factor. Because the reciprocal compensation rates are much lower than access charges, this change in traffic mix negatively affected CTSI’s revenues by approximately $700 per month, beginning in November 2003.

Costs and expenses were $55,610 and $53,983 for the years ended December 31, 2003 and 2002, respectively. The increase of $1,627 is primarily due to additional circuit rental expense, leased local loop charges and increased costs related to Internet revenue growth, partially offset by reduced bad debt and advertising expenses.

Other operating expenses increased $3,743 or 24.4% for the year ended December 31, 2003 primarily as a result of a lower positive settlement of $2,304 in 2003 associated with our 2000 restructuring charge. Depreciation and amortization expense increased $1,835 or 9.7% to $20,748 as a result of higher depreciable plant from capital expenditures in 2002 and 2003, primarily associated with increased installed access lines. This increase was partially offset by the elimination of management fees of $396.

F-7

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

CTSI’s operating income decreased $4,040 or 27.6% to $10,614 for the year ended December 31, 2003. The decrease was a result of the items discussed above.

Other

Other sales were $26,559 and $26,571 for the years ended December 31, 2003 and 2002, respectively. The decrease of $12 is due to a decrease in epix sales, offset by an increase in CC sales.

epix sales decreased $1,063 or 8.7% due to a decrease in dial-up subscribers as customers move to DSL and other high-speed products. CC sales increased $1,051 or 7.3% primarily due to an increase in new business systems sales. The operating results of CC are subject to fluctuations due to its less predictable revenue streams, market conditions and the effect of competition on margins.

Costs and expenses were $27,500 and $25,554 for the years ended December 31, 2003 and 2002, respectively. Expenses at the corporate entity increased primarily due to increased pension expense from a decline in pension assets in 2002. This increase was partially offset by reduced costs and expenses at epix of $1,435 primarily as a result of a decrease in subscribers, lower rent expense, a reduction in headcount and lower toll charges. CC costs and expenses were $12,969 and $13,144 for the years ended December 31, 2003 and 2002, respectively. Costs and expenses decreased $175. This change was due to a favorable settlement of an outstanding project dispute and a reduction in headcount, partially offset by an increase in costs of $790 due to the increase in sales.

Other operating expenses decreased $2,244 or 39.4% for the year ended December 31, 2003. The decrease was primarily the result of a $2,333 charge in 2002 associated with the Voluntary Retirement Program described below that did not recur in 2003. Depreciation and amortization expense decreased $431 or 11.1% to $3,445. This decrease was partially offset by an increase of $520 attributable to the elimination of management fees allocations.

The operating loss in Other was ($4,386) for the year ended December 31, 2003 as compared to ($4,672) for the year ended December 31, 2002. The change was a result of the items discussed above.

Restructuring Charges (Reversals)

In December 2000, we announced that we would exit CTSI’s five expansion markets (suburban Philadelphia, PA; Binghamton, NY; Syracuse, NY; Charleston/Huntington, WV; and Youngstown, OH) launched over the preceding two years. Related to this strategy, we recorded an estimated restructuring charge of $99,713 (pre-tax) and $64,813 (after-tax), or ($2.79) (after-tax) per common share (including effects of anti-dilutive options). At December 31, 2003, we carry a liability of $812 relating primarily to an estimated customer claim relating to the assignment of customers to another CLEC. See Note 4 to the Consolidated Financial Statements for additional information.

Voluntary Retirement Program

On December 12, 2001, we initiated a Voluntary Retirement Program (“VRP”). The program was offered to certain eligible employees across all of our operations. The VRP was largely funded from pension assets, and therefore, nearly 80% of the cost was non-cash to the Company. In the fourth quarter of 2001, we recorded a charge of $5,388 ($3,502 after-tax) of which $4,120 represented non-cash charges related to pension enhancement, social security supplements and vacation benefits. Other VRP program costs of $1,268 related to medical insurance and other program expenses. Since the deadline related to this program extended into 2002, and because only a portion of the eligible employees had made a decision to accept this program prior to year-end 2001, $2,333 ($1,423 after-tax) was recorded in the first quarter of 2002. The VRP costs of $2,333 represent $1,805 of non-cash charges related primarily to pension enhancement, social security supplements and vacation benefits. Other VRP program costs of $528 related to medical insurance and other program expenses. See Note 10 to the Consolidated Financial Statements for additional information.

F-8

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

Interest Expense

Interest expense includes interest on our convertible notes, CT’s mortgage note payable to CoBank, ACB (formerly National Bank for Cooperatives) (“CoBank”), interest on revolving credit facilities and amortization of debt issuance costs. We used interest rate swaps on $70,000 of floating rate debt to hedge against interest rate exposure. Interest expense was $13,560 for the year ended December 31, 2003 as compared to $10,483 for the year ended December 31, 2002. The increase of $3,077 is primarily a result of our issuance of convertible notes in July 2003.

Income Taxes

Our effective tax rates were 37.2% and 37.2% for the years ended December 31, 2003 and 2002, respectively. In 2002, we received a non-recurring beneficial impact due to the tax law change that increased the amount of net operating losses allowed to be carried forward for state tax purposes. In December 2002, we reorganized our legal entity structure to allow the Pennsylvania state taxable losses of CLD and epix to be offset against state taxable income of CT, a benefit we realized in 2003. We anticipate our 2004 effective tax rate to be approximately 38%. For an analysis of the change in income taxes, see Note 11 to the Consolidated Financial Statements.

2002 vs 2001

For the year ended December 31, 2002, our consolidated sales increased 3.9% to $318,555. Higher sales at CT of $9,396 and CTSI of $5,382 contributed to the increase, but were partially offset by a decline in Other sales of $2,837. Operating income increased $19,834 primarily as a result of the increase in consolidated sales and lower costs in providing these sales, a decrease in costs due to our exit from the CTSI expansion markets and lower charges in 2002 in connection with the Voluntary Retirement Program that was initiated in December 2001. This increase in operating income was partially offset by an increase in depreciation expense of $3,634 and a lower positive settlement in 2002 associated with our 2000 restructuring charge. Net income increased by $13,992 in 2002 primarily due to the increase in operating income and a decrease in interest expense of $7,865, partially offset by an increase in income taxes of $12,958. Net income was $57,124 or $2.42 per diluted share and $43,132 or $1.84 per diluted share for the years ended December 31, 2002 and 2001, respectively.

CT

CT’s sales were $207,978 and $198,582 for the years ended December 31, 2002 and 2001, respectively. The sales increase of $9,396 or 4.7% is primarily due to higher access revenues and an increase in local service and enhanced services revenues. This increase in revenue is offset by lower intraLATA toll revenues and a charge from the write-off of WorldCom receivables of $2,000 that was recorded as contra-revenue. The increase in revenue is attributable to an increase in installed access lines of 7,183 or 2.2%. The increase in our RLEC’s access lines is due to a 5.5% growth in the number of business lines installed. The continued marketing of residential additional lines resulted in an increase in residential additional line penetration from 39.4% in 2001 to 40.4% in 2002.

Interstate access revenue increased $6,134 resulting from an increase in the NECA average schedule formulas, growth in access lines, an increase in special access circuits and an increase in minutes of use. State access revenue increased $4,266 primarily as a result of an increase in minutes and access line growth. Local service revenue increased $1,591 as a result of an increase in access lines and a GDPPI rate increase of $0.21 for substantially all dial-tone lines in May 2002. In addition, enhanced service revenue increased $1,348 primarily from Caller ID and certain other custom calling features. Jack Flash sales increased $1,488 due to an increase in subscribers. IntraLATA toll and long-distance revenues decreased $3,115 primarily as a result of lower market share due to customers selecting alternate lower cost service providers and attractive calling packages offered by several non-wireline providers in certain areas of CT’s territory.

F-9

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

CT’s costs and expenses, excluding depreciation, amortization, management fees, restructuring charges (reversals) and Voluntary Retirement Program (“costs and expenses”) were $74,614 and $78,048 for the years ended December 31, 2002 and 2001, respectively. CT’s costs and expenses decreased $3,434 or 4.4% due to a decrease in long-distance costs from the decrease in long-distance sales; a favorable operating tax settlement of $2,589 recorded in the fourth quarter of 2002; lower advertising costs and other costs to roll out Jack Flash; reductions in Pennsylvania capital stock tax due to certain tax incentives offered by the state of Pennsylvania aimed at attracting business into certain areas of qualifying cities in the state; and savings due to the Voluntary Retirement Program. These reductions were partially offset by increased payroll costs resulting from annual salary increases and performance-based incentives and higher expenses for higher data base dip charges due to the growth in Caller ID revenues.

Other operating expenses increased $3,234 or 7.4% for the year ended December 31, 2002. The increase was due to an increase in depreciation and amortization expense as a result of higher depreciable plant from capital expenditures in 2001 and 2002.

CT’s operating income increased $9,596 or 12.5% to $86,613 for the year ended December 31, 2002. The increase was a result of the items discussed above.

CTSI

CTSI’s sales were $84,006 (edge-out $84,006; expansion $0) and $78,624 (edge-out $73,061; expansion $5,563) for the years ended December 31, 2002 and 2001, respectively. This increase of $5,382 (edge-out $10,945; expansion ($5,563)) in sales represents an increase in local service, access and customer point-to-point circuit revenues. This increase included a reduction in access revenue resulting from a modification to certain transport billings related to access trunking. This modification is a result of a dispute between CTSI and Verizon regarding billing for these transport trunking facilities. The increase in revenue is in part a result of an increase in installed access lines. For the year ended December 31, 2002, CTSI had 126,649 installed access lines as compared to 112,396 at December 31, 2001, an increase of 14,253 or 12.7%. Also contributing to the increase in revenue was an increase in ISP traffic. For the year ended December 31, 2002, CTSI recorded $11,961 or 14.2% of its edge-out market revenues from compensation revenue associated with ISP traffic, as compared to $10,242 or 14.0% for the same period of 2001. Internet and cellular providers using our circuits to allow their networks to tie into the switched network system contributed to an increase of $2,722 in point-to-point circuit revenue.

Costs and expenses were $53,983 (edge-out $53,983; expansion $0) and $61,476 (edge-out $53,263; expansion $8,213) for the years ended December 31, 2002 and 2001, respectively. The decrease of $7,493 (edge-out $720; expansion ($8,213)) is primarily due to the decline in the expenses of the expansion markets due to our exit from those markets. The increase in costs in the edge-out markets is due to additional circuit rental expense, higher management information systems charges and increased payroll costs resulting from annual salary increases and performance-based incentives. These higher expenses were substantially offset by reduced bad debt expense due to improved collection efforts and a reduction in terminating access charges from independent local exchange carriers.

Other operating expenses increased $7,398 or 92.8% for the year ended December 31, 2002 primarily as a result of a lower positive settlement of $5,347 in 2002 associated with our 2000 restructuring charge. Depreciation and amortization expense increased $2,051 or 12.2% to $18,913 as a result of higher depreciable plant from capital expenditures in 2001 and 2002, primarily associated with increased installed access lines.

CTSI’s operating income increased $5,477 or 59.7% to $14,654 for the year ended December 31, 2002. The increase was a result of the items discussed above.

F-10

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

Other

Other sales were $26,571 and $29,408 for the years ended December 31, 2002 and 2001, respectively. The decrease of $2,837 or 9.6% is due to a decrease in both CC and epix sales.

CC sales decreased $1,792 or 11.1% primarily due to a decrease in business systems upgrade sales and non-recurring Premises Distribution Systems cabling sales. epix sales decreased $1,045 or 7.9% versus 2001 due to a decrease in dial-up subscribers.

Costs and expenses were $25,554 and $28,446 for the years ended December 31, 2002 and 2001, respectively. CC costs and expenses were $13,144 and $15,016 for the years ended December 31, 2002 and 2001, respectively. The decrease of $1,872 is the result of decreased costs associated with a decrease in sales. epix costs and expenses decreased $1,417 due to lower transport costs, a reduction in headcount and reduced bad debt expense due to improved collection efforts.

Other operating expenses decreased $4,706 or 45.3% for the year ended December 31, 2002. The decrease was primarily the result of a lower charge of $3,055 in 2002 associated with the Voluntary Retirement Program described below. Depreciation and amortization expense decreased $1,651 or 29.9% to $3,876.

The operating loss in Other was ($4,672) for the year ended December 31, 2002 as compared to ($9,433) for the year ended December 31, 2001. The change was a result of the items discussed above.

Restructuring Charges (Reversals)

In December 2000, we initiated an exit strategy for CTSI to reduce its network expansion plan from a total of eight markets to three markets. This strategy was aimed at focusing on the three “edge-out” markets adjacent to CT’s rural footprint. These edge-out markets encompass the Wilkes-Barre/Scranton/Hazleton, Harrisburg and Lancaster/Reading/York, PA markets. Related to this strategy, we recorded an estimated restructuring charge of $99,713 (pre-tax) and $64,813 (after-tax), or ($2.79) (after-tax) per common share (including effects of anti-dilutive options). CTSI had completed its withdrawal from the five non-“edge-out” expansion markets (suburban Philadelphia, PA; Binghamton, NY; Syracuse, NY; Charleston/Huntington, WV; and Youngstown, OH) by June 30, 2001. At December 31, 2002, we carried a liability of $2,029. See Note 4 to the Consolidated Financial Statements for additional information.

Voluntary Retirement Program

On December 12, 2001, we initiated a Voluntary Retirement Program (“VRP”). The program was offered to certain eligible employees across all of our operations. The VRP was largely funded from pension assets, and therefore, nearly 80% of the cost was non-cash to the Company. In the fourth quarter of 2001, we recorded a charge of $5,388 ($3,502 after-tax) of which $4,120 represented non-cash charges related to pension enhancement, social security supplements and vacation benefits. Other VRP program costs of $1,268 related to medical insurance and other program expenses. Since the deadline related to this program extended into 2002, and because only a portion of the eligible employees had made a decision to accept this program prior to year-end 2001, $2,333 ($1,423 after-tax) was recorded in the first quarter of 2002. The VRP costs of $2,333 represent $1,805 of non-cash charges related primarily to pension enhancement, social security supplements and vacation benefits. Other VRP program costs of $528 related to medical insurance and other program expenses. See Note 10 to the Consolidated Financial Statements for additional information.

Interest Expense

Interest expense includes interest on CT’s mortgage note payable to CoBank, interest on CTE’s revolving credit facilities and amortization of debt issuance costs. We used interest rate swaps of $90,000 on floating rate

F-11

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

debt to hedge against interest rate exposure. Interest expense was $10,483 for the year ended December 31, 2002 as compared to $18,348 for the year ended December 31, 2001. The decrease of $7,865 is primarily due to lower average debt outstanding and lower interest rates on variable rate debt not subject to interest rate swaps. Interest expense on CT’s mortgage note payable to CoBank decreased as a result of scheduled principal payments. The decrease is also due to the recording in the fourth quarter 2002 of interest from an operating tax settlement of $1,518.

Income Taxes

Our effective tax rates were 37.2% and 32.6% for the years ended December 31, 2002 and 2001, respectively. In 2002, we received a one-time beneficial impact from tax law changes in Pennsylvania for net operating loss (“NOL”) carryforwards. Our lower 2001 effective rate was due to tax benefits of approximately $7.3 million recorded as a result of tax strategies implemented during 2001. These strategies included allowing the state of Pennsylvania tax losses of CTSI to be offset against state of Pennsylvania taxable income of CT. Also, CT has taken advantage of certain tax incentives offered by the state of Pennsylvania aimed at attracting business into certain areas of qualifying cities in the state. In addition, the 2001 effective tax rate reflects the utilization of deferred tax assets that were not realizable prior to the implementation of these strategies. We received continued savings from these tax strategies in 2002. For an analysis of the change in income taxes, see Note 11 to the Consolidated Financial Statements.

Liquidity and Capital Resources

On July 18, 2003, we sold $300,000 of 3.25% convertible notes due 2023. The net proceeds from this offering, in addition to cash generated from operations, are being and will be used for working capital, capital expenditures and other general corporate purposes. In addition, other uses of cash may include potential acquisitions, new product offerings, debt retirement and common stock repurchases. While we do not presently intend to pay cash dividends on our common stock, we may decide to pay such dividends in the future. The payment of any cash dividends in the future will be at the discretion of our Board of Directors. The declaration of any cash dividend and the amount thereof will depend on a number of factors, including our financial condition, capital requirements, funds from operations, the dividend taxation level, our stock price, future business prospects and such other factors as our Board of Directors may deem relevant. Additionally, other indebtedness we incur may place significant restrictions on our ability to pay dividends. On July 2, 2003 we repaid in full all amounts outstanding on the $240,000 revolving credit facility, which totaled $5,000, and terminated this facility and all commitments thereunder on July 17, 2003.

We announced a $100 million Stock Repurchase Program on November 13, 2003 and a $50 million addition to the program on February 10, 2004. The Stock Repurchase Program has no expiration date. As of December 31, 2003, we had repurchased 1,179,200 shares with an average purchase price of $36.776. As of February 29, 2004, we had repurchased 1,709,310 shares with an average purchase price of $37.055, and total dollars traded of approximately $63.3 million.

F-12

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

We have the following financing arrangements in place:

Cash and temporary cash investments were $336,035 at December 31, 2003, as compared to $34,935 at December 31, 2002. For purposes of reporting cash flows, we consider all highly liquid investments with an original maturity of three months or less to be temporary cash investments. Temporary cash investments are investments in high quality, diversified money market mutual funds. We monitor fund performance of money market mutual funds available to us on a quarterly basis to maximize returns and insure investment quality. Our working capital ratio was 2.56 to 1 at December 31, 2003, as compared to .75 to 1 at December 31, 2002. The net increase is due to the proceeds from the convertible notes, increased liquidity provided by operations and reductions in capital spending.

For the year ended December 31, 2003, our net cash provided by operating activities was $150,275 comprised of net income of $72,865, non-cash depreciation and amortization of $71,137 and other non-cash items and working capital changes of $6,273. Net cash used in investing activities of $43,736 consisted primarily of additions to property, plant and equipment of $47,372. Net cash provided by financing activities of $194,561 consisted primarily of proceeds from the issuance of long-term debt of $300,000, partially offset by the net redemption of debt of $56,788 and stock repurchases of $43,367.

We maintain a credit agreement with CoBank at interest rates which are based on a number of floating and fixed rate options. Principal and interest are payable monthly. This agreement contains restrictive covenants, which, among other things, require the maintenance of a specified debt to cash flow ratio. As of December 31, 2003, the weighted average interest rate was 6.79% on borrowings of $29,521. To take advantage of our favorable cash position, on September 3, 2003 we paid $18,625 on our mortgage note payable to CoBank.

An amended revolving line of credit agreement with CoBank was entered into in June 2003, that extended the availability of credit to June 2004. The aggregate amount outstanding on this commitment was $65,000 at December 31, 2003 and 2002. This agreement contains restrictive covenants which, among other things, requires the maintenance of a specific debt to cash flow ratio at CT. We may refinance this line of credit when it becomes due in June 2004.

We expect to have adequate resources to meet our currently foreseeable obligations and development plans for our CTSI markets and customer demand for additional capacity and service. In addition to cash generated from operations, sources of funding for any additional capital requirements or acquisitions may include financing from public offerings or private placements of equity and/or debt securities and bank loans. There can be no assurance that additional financing will be available to us or, if available, that it can be obtained on a timely basis and on acceptable terms. Failure to obtain such financing could result in the delay or curtailment of our development plans and expenditures.

F-13

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

On April 2, 2002, we completed a 4,898,000-share secondary offering of our common stock. In December 2002, a 4,741,326-share secondary offering of our common stock was also completed. All of these shares were offered by a subsidiary of Level 3 Communications, Inc. As such, we did not receive any proceeds from the sale of shares in these offerings.

On April 24, 2003, we entered into a Recapitalization Agreement (the “Recapitalization Agreement”) with Level 3 Communications, Inc. (“Level 3”) and Eldorado Equity Holdings, Level 3’s indirect, wholly-owned subsidiary. Under the terms of the Recapitalization Agreement, we agreed to amend our existing charter to: (i) reclassify and convert each outstanding share of CTE Class B Common Stock into 1.09 shares of CTE Common Stock; and (ii) eliminate from the existing charter the CTE Class B Common Stock, and all provisions related thereto, and certain miscellaneous inoperative provisions. Level 3 agreed, pursuant to the terms of the Recapitalization Agreement, to vote its shares in favor of the reclassification and the related charter amendments. At the Annual Meeting on September 3, 2003, shareholders approved the proposal to reclassify and convert each outstanding share of CTE Class B Common Stock into 1.09 shares of CTE Common Stock. CTE now has only one class of common stock, with each outstanding share having one vote in corporate governance matters. As a result of the reclassification, Level 3’s ownership was reduced to approximately 4.6% of the outstanding CTE Common Stock and correspondingly approximately 4.6% of the voting power.

On January 21, 2004, Level 3 announced that it had privately-negotiated a sale of its remaining 1,108,596 shares of CTE Common Stock to an institutional investor. In connection with this transaction, certain registration rights were assigned by Level 3 to the purchaser.

Off Balance Sheet Arrangements, Contractual Obligations and Commitments

We have contractual obligations and commercial commitments made in the ordinary course of business. The commercial obligations, financings and commitments made by us are customary transactions, similar to those of other comparable telecommunications providers.

The tables set forth below contain information with regard to disclosures about contractual obligations and commercial commitments. These disclosures are also included in the Notes to the Consolidated Financial Statements and cross referenced in the tables below.

The following table discloses aggregate information about our contractual obligations as of December 31, 2003, and the periods in which payments are due:

As of December 31, 2003 we have no letters of credit or other financial guarantees outstanding.

F-14

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

The following table discloses aggregate information about our derivative instruments, the source of fair value of these instruments and their maturities:

Quantitative and Qualitative Disclosures about Market Risk

We are exposed to interest rate risk primarily through our borrowing activities. There is inherent rollover risk for borrowings as they mature and are renewed at current market rates. The extent of this risk is not quantifiable or predictable because of the variability of future interest rates and our future financing requirements.

We measure the fair value of the convertible debt based upon current market prices or by obtaining quotes from dealers. The fair value of bank debt is estimated using discounted cash flow calculations. The table that follows summarizes the fair values of our fixed and variable rate debt. The table also provides a sensitivity analysis of the estimated fair values of these financial instruments assuming 100-basis-point upward and downward shifts in the weighted average interest rate.

We manage our interest rate risk through a combination of variable and fixed rate debt instruments at varying maturities and by using interest rate swaps. In the second quarter of 2001, we entered into additional interest rate swap agreements totaling $55,000 in order to maintain a targeted mix of floating and fixed rate debt. Hedges 1 and 2 totaling $25,000 matured in the second quarter 2002, and were not renewed. Additionally, Hedge 5 in the amount of $15,000 matured in the third quarter 2002, and was not renewed. Hedge 7 matured in May 2003, and was not renewed.

The table below provides information about our interest rate swaps. Notional amounts are used to calculate the contractual payments to be exchanged under the contract. The estimated fair value amounts have been provided to us by the financial institutions with which we have swap contracts using consistent valuation methodologies.

F-15

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

Critical Accounting Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Certain estimates require more subjectivity or judgment than others. We review the critical accounting estimates, judgments and degrees of subjectivity inherent in these estimates with the Company’s Audit Committee. These critical accounting estimates are:

F-16

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

Related and Like Parties

On April 2, 2002, we completed a 4,898,000-share secondary offering of our common stock. In December 2002, a 4,741,326-share secondary offering of our common stock was also completed. All of these shares were offered by a subsidiary of Level 3 Communications, Inc. As such, we did not receive any proceeds from the sale of shares in these offerings.

On April 24, 2003, we entered into a Recapitalization Agreement (the “Recapitalization Agreement”) with Level 3 Communications, Inc. (“Level 3”) and Eldorado Equity Holdings, Level 3’s indirect, wholly-owned subsidiary. Under the terms of the Recapitalization Agreement, we agreed to amend our existing charter to: (i) reclassify and convert each outstanding share of CTE Class B Common Stock into 1.09 shares of CTE Common Stock; and (ii) eliminate from the existing charter the CTE Class B Common Stock, and all provisions related thereto, and certain miscellaneous inoperative provisions. Level 3 agreed, pursuant to the terms of the Recapitalization Agreement, to vote its shares in favor of the reclassification and the related charter amendments. At the Annual Meeting on September 3, 2003, shareholders approved the proposal to reclassify and convert each outstanding share of CTE Class B Common Stock into 1.09 shares of CTE Common Stock. CTE now has only one class of common stock, with each outstanding share having one vote in corporate governance matters. As a result of the reclassification, Level 3’s ownership was reduced to approximately 4.6% of the outstanding CTE Common Stock and correspondingly approximately 4.6% of the voting power.

On January 21, 2004, Level 3 announced that it had privately-negotiated a sale of its remaining 1,108,596 shares of CTE Common Stock to an institutional investor. In connection with this transaction, certain registration rights were assigned by Level 3 to the purchaser.

Four of our directors are also directors of Level 3. Our Chairman, Walter Scott, Jr., is also the Chairman of Level 3. We have entered into a month-to-month agreement with Level 3 to provide Internet backbone and colocation services.

We have existing relationships with RCN Corporation (“RCN”), which is an affiliate of Level 3. Also, Level 3 owns approximately 22% of the outstanding equity securities of RCN. On April 23, 2003, Michael Adams and Timothy Stoklosa resigned from our Board of Directors. Both were officers of RCN. Presently, five of our directors also serve on the Board of Directors of RCN. Late in 2002, we terminated a month-to-month long-distance resale agreement and a management service agreement with RCN. Our existing relationships with RCN are arms-length business transactions. RCN has recently announced it may reorganize under Chapter 11.

Recent Accounting Pronouncements

The FASB issued Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities,” in January 2003 and amended the Interpretation in December 2003. FIN 46 requires an investor with a majority of the

F-17

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

variable interests in a variable interest entity (VIE) to consolidate the entity, and also requires majority and significant variable interest investors to provide certain disclosures. A VIE is an entity in which the voting equity investors do not have a controlling financial interest or the equity investment at risk is insufficient to finance the entity’s activities without receiving additional financial support from the other parties. Development-stage entities that have sufficient equity invested to finance the activities they are currently engaged in and entities that are businesses, as defined in the Interpretation, are not considered VIEs. We have completed a review of our Yellow Book, USA, L.P. Partnership activities and have determined that the entity does not qualify as a VIE under the Interpretation.

Legislative and Regulatory Developments

Commonwealth Telephone Company

Prices for CT’s (our RLEC) local and in-state long-distance services are regulated by the Pennsylvania Public Utility Commission (“PUC”). These prices are currently set under an alternative regulation plan, which the PUC approved in 1997. Under this plan, among other things, CT is protected by an exogenous events provision that recognizes and accounts for any state/federal regulatory, legislative changes or other unique changes in the telephone industry that affect revenues or expenses, thereby allowing CT to adjust rates to compensate for changes in revenues and/or expenses due to such exogenous events.

The state law authorizing this alternative form of regulation for CT and other incumbent local exchange carriers, or LECs, in Pennsylvania expired on December 31, 2003. The Pennsylvania legislature to date has not taken action to extend the PUC’s power to maintain alternative regulation, but is considering legislation to reinstate this power. Representatives of CT have been actively involved in the legislative process, both individually and through our membership in various industry organizations, to renew the legislation. We believe that CT’s alternative regulation plan remains valid, because it was approved by the PUC under the law that was in effect at the time of approval, but this is an unsettled area of the law. At this time we are unable to predict the outcome of these developments or their potential effect on our results of operations or financial condition.

In 2003, CT filed a petition with the PUC seeking an exogenous event adjustment for revenues lost due to the bankruptcies of two large interexchange carriers in 2002. If approved, this adjustment would have allowed CT to avoid a rate reduction that was required due to the low rate of inflation during the most recent plan year. In response, government agencies that represent ratepayer interests challenged CT’s surcharge treatment of certain state taxes. CT negotiated a settlement with the agencies under which no exogenous adjustment was allowed, but CT is permitted to defer rate reductions otherwise required under its alternative regulation plan for up to four years and offset them against future increases (if any); the settlement also provides for a limited one-time surcharge refund and a revision in the way CT treats state tax surcharges in the future. The PUC approved the settlement in August 2003. Pursuant to the settlement, CT issued refunds to customers of approximately $1.24 million, but will defer, for up to 4 years, annual rate reductions currently at approximately $1.6 million, and may be able to offset these deferred reductions against future rate increases to which it might otherwise be entitled.

On July 10, 2003, the PUC issued an order addressing intrastate access reform and Universal Service Funding (“USF”) reform for independent local exchange carriers in Pennsylvania. The order provides for continuation of intrastate USF funding to CT until completion of a future rulemaking proceeding by the PUC, which must be commenced no later than December 31, 2004, but which may not be completed until much later. The order also requires CT to reduce the access rates it charges to other carriers which originate or terminate intrastate long-distance calls to CT’s customers, in two phases, a mandatory first phase in 2003 and an optional second phase in 2004. These reductions are to be matched by revenue neutral increases in rates charged to CT’s basic telephone customers. Although there will be no direct impact on CT’s revenues because of this revenue neutral mechanism, the increases in monthly per-line rates may reduce demand among CT’s customers for additional lines and other services.

F-18

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

Settlements for our RLEC’s interstate services (consisting primarily of carrier common line settlements and access charges for interstate toll calls), which currently account for approximately 33.7% of its telephone service revenues, are regulated by the Federal Communications Commission (“FCC”) based on the “average schedule” formulas proposed by the National Exchange Carrier Association (“NECA”). Removal of CT from the NECA average schedules could result in a significant revenue loss for CT. However, such a development is specifically listed as an exogenous event under CT’s alternative regulation plan. Monies paid to CT by NECA come from pools that are funded by all NECA companies via subscriber line charges to customers, access charges to interexchange carriers (“IXCs”) and Universal Service Funding. During the Fund’s fiscal year ending June 30, 2004, CT is entitled to receive approximately $14 million in high-cost support (Interstate Common Line Support (ICLS) and Long-Term Support (LTS)) via NECA, which is equivalent to approximately $3.46 per line per month. Changes in the Universal Service Fund formulas could have a material effect on CT’s revenues. On February 12, 2004, the FCC announced that it will amend its rules concerning Long-Term Support, which is one category of Universal Service Funding that CT currently receives; however, the FCC stated that these changes will not affect current funding levels.

The FCC is considering adopting proposed rules that would allow telephone companies such as CT to convert to a form of incentive regulation similar in some respects to CT’s existing alternative regulation plan in Pennsylvania. We are unable to predict the timing or outcome of this proposed rulemaking at this time.

Since 2001, the FCC has been considering proposed changes to its rules to unify several existing systems of inter-carrier compensation (intrastate access, interstate access, reciprocal compensation, EAS settlements, etc.) into a single coherent structure. The FCC has taken no action on these proposals to date, but may reactivate this proceeding in the near future. Various industry groups are currently developing proposals in anticipation of FCC action, and CTE has been active in efforts underway through its industry association, the United States Telecom Association (USTA). The FCC has expressed a tentative preference for moving to a “bill and keep” regime, whereby carriers would exchange traffic with one another without payment of compensation, but may also consider alternative approaches. Since CT currently derives a significant portion of its revenues from inter-carrier compensation, changes in these rules may have material effects on our revenues and earnings. However, any FCC ruling is likely to address the concerns of rural carriers like CT such as the ability to raise other rates to offset reductions in inter-carrier compensation, a transition period, and/or increased Universal Service Funding. Until the FCC adopts a specific proposal, it is impossible to predict how changes in this area may affect CT.

CT, CTSI and CLD are required to make contributions to the federal Universal Service Fund, based on their end-user revenues for interstate and international telecommunications services. Each of these companies currently passes through the cost of these contributions to its end-user customers, either as a surcharge or as part of the price of its services. The FCC made relatively modest changes to the contribution formulas in 2002. The FCC is currently considering further changes to its Universal Service Fund regulations that, if adopted, would alter the basis upon which Universal Service Fund contributions are determined and the means by which such contributions may be recovered from customers. The FCC has not yet acted on these proposals and it is not clear whether the FCC will adopt any of these proposals. Based on the foregoing, the application and effect of the Universal Service Fund requirements (and comparable state contribution requirements) on the telecommunications industry cannot be definitively ascertained at this time.

In April 2003, NPCR, Inc. d/b/a Nextel Partners (“Nextel”), a wireless telecommunications provider, petitioned the FCC to designate Nextel as an Eligible Telecommunications Carrier (“ETC”) in many areas of Pennsylvania, including all of CT’s service territory. Under the FCC’s rules implementing the Telecommunications Act of 1996, a competitive telecommunications provider that is designated as an ETC may receive the same per-line federal Universal Service Fund disbursements as an incumbent local exchange carrier (ILEC) receives, for services the competitor provides within that ILEC’s service territory. The Act specifies that in order to receive ETC authority in a territory served by a rural telephone company such as CT, the petitioner

F-19

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

must demonstrate that it can provide service throughout the rural company’s territory within a state and that its petition is in the public interest. Under current FCC rules, certification of Nextel would not affect the USF disbursements received by CT. However, in February 2004, a federal-state joint board recommended that the FCC adopt changes to its rules that could result in some reduction of USF disbursements to CT when customers choose to obtain their “primary” telecommunications service from a competing ETC. The FCC has until February 2005 to act upon this recommendation. CT and other rural companies in Pennsylvania have opposed Nextel’s petition on the grounds that Nextel has not satisfied the statutory standard for ETC certification. Wireless carriers have previously been designated as ETCs in other states, but Nextel is the first wireless carrier to seek ETC status in Pennsylvania. The FCC has not yet ruled on Nextel’s petition. We are unable to predict the outcome of these developments or their potential effect on our results of operations or financial condition.

Pursuant to the “rural exemption” provision of Section 251(f)(1) of the Telecommunications Act of 1996, CT is currently exempted from offering colocation, unbundled network elements (“UNEs”), wholesale discounts and other requirements of the Act that pertain to Regional Bell Operating Companies (“RBOCs”) and non-rural incumbent LECs. The rural exemption does not preclude competitors from providing telephone services within CT’s service area entirely over their own facilities. However, it requires prospective competitors who seek to interconnect with our network in order to resell services or lease unbundled network elements to go through a formal review by the Pennsylvania PUC before receiving approval. The Pennsylvania PUC may grant such approval only if it finds that the competitor’s proposal is not unduly economically burdensome, is technically feasible and is consistent with the Universal Service provisions of the Telecommunications Act. To date, no carrier has sought such a review by the Pennsylvania PUC.

However, the Act’s general requirement that telecommunications carriers interconnect networks for the exchange of traffic does apply to CT. CT has received several requests for network interconnection for the exchange of traffic between its network and the networks of other facilities-based telecommunications providers, and has entered into interconnection and reciprocal compensation agreements with several national wireless carriers providing for exchange of traffic between its network and theirs.

During 2002, the FCC directed wireless carriers to implement local number portability by November 24, 2003. On July 6, 2003, the U.S. Court of Appeals for the D.C. Circuit rejected further extensions and affirmed the November deadline for wireless local number portability. This program enables customers to keep their number when switching between carriers without regard to whether the carrier is a wireline or wireless service provider. During 2003, CT received requests from two wireless carriers seeking local number portability across much of its territory effective November 24, 2003, and has taken steps to comply with the FCC requirements. The implementation of wireless number portability could negatively impact our operations, as customers become able to transfer their residential or business telephone number to a wireless telephone.

During 1998, the FCC adopted an order that allows telecommunications carriers to recover over five years their carrier-specific costs of implementing local number portability, which allows customers to retain their local telephone numbers in the event they change local carriers. The order allows for such cost recovery in the form of a surcharge from customers to whom number portability is available. CT will seek to use this cost recovery mechanism to offset its costs of implementing number portability.

CTSI, LLC

CTSI’s prices are subject to regulation and review by the FCC and the PUC although, as a competitive provider, its rates are typically subject to much less scrutiny than those of CT, or those of Verizon which is the dominant local telephone service provider. CTSI’s costs are also affected by regulatory decisions, because CTSI relies in part on facilities and services purchased from incumbent telephone companies (primarily Verizon), including interconnection for the exchange of local traffic with other companies, in providing its services. CTSI has month-to-month interconnection agreements with Verizon and GTE.

F-20

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

Effective October 2, 2003, the FCC adopted significant changes to its rules requiring incumbent carriers like Verizon to offer unbundled access to network elements to competing carriers like CTSI. Under the new rules, Verizon will continue to be required to offer access to unbundled voice-grade loops, which is the network element that CTSI uses most frequently. However, Verizon will have the ability to petition the PUC in the future to restrict the availability of these loops in particular markets if it can demonstrate the presence of competitive alternatives. Verizon has not yet filed such a petition, but it has asked the PUC to restrict the availability of other network elements (including high-capacity loops and transport facilities) that CTSI does not rely on extensively. On March 2, 2004, however, the U.S. Court of Appeals vacated and remanded substantial parts of these rules to the FCC for further consideration, which could result in additional changes to the rules. Our preliminary analysis of this recent ruling is that it will not likely have a material effect on CTSI’s costs and profitability. Also, during 2003, the FCC gave notice of a proposed rulemaking in which it is considering changing the formula used by state commissions, including the Pennsylvania PUC, to determine rates for access to Verizon network elements and for interconnection to Verizon’s network. It is unknown at this time when the FCC will act on this proposal or what effects any changes in the rate formula will have on CTSI’s costs.

Under the Telecommunications Act of 1996, the Pennsylvania PUC has authority to arbitrate any disputes over the terms and conditions of interconnection between CTSI and Verizon, and the prices of various unbundled network elements CTSI purchases from Verizon. The PUC has taken a number of actions over the past several years affecting the prices for network elements, as well as the terms and conditions under which these elements are provided. The PUC operates within a framework of national rules adopted by the FCC governing network element unbundling. In 2003, the PUC approved changes in Verizon’s rates for unbundled local loops (that is, circuits connecting business and residential users’ premises to the Verizon central office). These rates, which are scheduled to become effective in March 2004, will result in a modest decrease in CTSI’s cost to obtain local loops in Verizon’s density cell 3 exchanges (where most CTSI customers are located), but an increase in the cost to serve customers in density cell 4. The PUC is continuing to consider a proposal by Verizon to average the rates for density cells 3 and 4, but has not yet taken any action on this proposal. Further decisions by the PUC and the FCC regarding these interconnection and unbundling obligations may have a material effect on CTSI’s costs and profitability.

On October 8, 2002, the Pennsylvania PUC entered an order initiating a generic investigation concerning the use of virtual NXX codes in Pennsylvania. Virtual NXX is the industry practice of assigning and populating NXX codes in exchanges where no physical LEC presence exists for the carrier responsible for the NXX code. The concern raised with virtual NXX involves carrier compensation and expense for calling activity terminated to these exchange codes. At this time we are unable to predict the outcome of this proceeding, or its possible effect on our results of operations or financial condition.

The FCC has adopted rules limiting the amounts that CTSI can charge other carriers for access to its network for originating and terminating interstate calls (access charges). Under these rules, carriers such as CTSI are currently permitted to charge interstate access rates no higher than $0.012 per minute; and, after June 2004, CTSI will be required to reduce its interstate access charges to levels no higher than those charged by Verizon (which we anticipate will be approximately $0.0042 per minute under the FCC’s rules for large incumbent carriers).

The FCC also has limited the right of competitive local carriers, such as CTSI, to collect reciprocal compensation on local telephone calls that terminate to ISPs. Under these rules, which took effect in June 2001, the amount of compensation payable to CTSI on calls to ISPs above a 3 to 1 ratio generally is limited to $0.0007 per minute. In addition, the total number of minutes for which CTSI can collect compensation at this rate is capped based on the number of minutes CTSI terminated in the first quarter 2001. On May 3, 2002, the U.S. Court of Appeals for the D.C. Circuit remanded the order in which the FCC adopted these rules, on the grounds that the FCC did not provide proper statutory authority for its order. The Court did not vacate the rules, however, and so the current compensation scheme will remain in effect pending the remand. To date, the FCC has taken no action in response to the Court’s remand.

F-21

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS—(Continued)

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)

CTSI derives a substantial portion of its revenues from ISPs. We expect that this reliance will continue in the foreseeable future. ISPs represented approximately 23.2% and 24.7% of CTSI’s revenues for the years ended December 31, 2003 and 2002, respectively. This percent will decrease in the future as a result of our approximately $700 per month reduction in revenue from our revised percent of local usage (PLU) factor with Verizon. These high-margin revenues include services provided directly to the ISP including local and cap-type services and indirect services including reciprocal compensation, and trunking from Verizon as a result of Verizon’s customers calling these ISPs. Industry-wide trends towards declining usage of dial-up Internet access may threaten the profitability or viability of our ISP customers. If we lose a significant number of these customers that are providing dial-up Internet services, or if a significant portion of these customers are unable to pay amounts owed to us, our financial results could be negatively impacted.

The FCC rate ceilings will result in continued reductions in the revenues CTSI receives from interstate access charges and reciprocal compensation. In addition, industry-wide trends towards declining usage of dial-up Internet access and of long-distance services generally, may have a negative impact on these revenues. CTSI’s revenues from access charges and reciprocal compensation are also affected by the mix of traffic delivered to it by other carriers for termination to CTSI customers. Verizon has recently notified CTSI of a reduction in the proportion of its delivered traffic that will be subject to intrastate access charges, and a corresponding increase in the proportion that will be subject to reciprocal compensation rates, due to a revised PLU factor. Because the reciprocal compensation rates are much lower than access charges, this change in traffic mix will have a material adverse affect on CTSI’s revenues of approximately $700 per month beginning November 2003. For the year ended December 31, 2003, CTSI recorded approximately $12,258 or 14.4% of its revenues from compensation revenue from ISP traffic. This compares to $11,961 or 14.2% for the same period in the previous year. Of these amounts, local reciprocal compensation associated with ISP traffic was $3,110 or 0.9% and $3,575 or 1.1% of our total consolidated revenues for the years ended December 31, 2003 and 2002, respectively. Revenues from interstate access charges represented approximately 0.8% and 1.3% of our consolidated revenues, for the years ended December 31, 2003 and 2002, respectively.

CTSI may also be affected by any changes in FCC rules governing inter-carrier compensation, as discussed above with respect to CT.

The PUC recently rejected a request made by Verizon to declare all services provided to business customers as qualifying for special individual case basis pricing arrangements. After Verizon asked the PUC to reconsider its decision, the PUC agreed to consider a more narrowly tailored proposal that would permit Verizon to offer the requested pricing arrangements only to small business customers in urban and suburban areas of Pennsylvania. It is unknown at this time whether the PUC will grant Verizon’s request.

CTSI has received several requests for network interconnection for the exchange of traffic between its network and the networks of other facilities-based telecommunications providers, and has entered into interconnection and reciprocal compensation agreements with several national wireless carriers providing for exchange of traffic between its network and theirs.

CTSI may also be affected by the introduction of wireless number portability in November 2003, for the same reasons discussed above with respect to CT. CTSI is permitted by applicable rules to recover the cost of implementing number portability from its end users.

In February 2004, Verizon Pennsylvania filed a complaint against CTSI with the Pennsylvania PUC, seeking a refund and/or credits for approximately $7.9 million in facilities charges that CTSI billed to Verizon over a two-year period. CTSI has answered Verizon’s complaint, denying all liability, and asking the Pennsylvania PUC to render a decision in favor of CTSI.

F-22

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

SELECTED FINANCIAL DATA

(Thousands of Dollars, Except Per Share Amounts)

(Unaudited)

For the Years Ended December 31,

F-23

Table of Contents

COMMONWEALTH TELEPHONE ENTERPRISES, INC., AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS