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FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

(Mark One)

For the quarterly period ended September 30, 2004

OR

For the transition period from              to             

Commission File Number 0-13716

NORTH PITTSBURGH SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

4008 Gibsonia Road, Gibsonia, Pennsylvania 15044-9311

(Address of principal executive offices)

(Zip Code)

724.443.9600

(Registrant’s telephone number, including area code)

No Change

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

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

The number of shares of the registrant’s Common Stock (par value $.15625 per share) outstanding as of October 31, 2004 was 15,005,000.

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PART I

FINANCIAL INFORMATION

Report of Independent Registered Public Accounting Firm

The Board of Directors

North Pittsburgh Systems, Inc.:

We have reviewed the condensed consolidated balance sheet of North Pittsburgh Systems, Inc. and subsidiaries as of September 30, 2004, the related condensed consolidated statements of income for the three-month and nine-month periods ended September 30, 2004 and 2003, and the related condensed consolidated statements of cash flows for the nine-month periods ended September 30, 2004 and 2003. These condensed consolidated financial statements are the responsibility of the Company’s management.

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

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

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of North Pittsburgh Systems, Inc. and subsidiaries as of December 31, 2003 and the related consolidated statements of income, shareholders’ equity and comprehensive income, and cash flows for the year then ended (not presented herein); and in our report dated February 20, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2003 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/    KPMG LLP

Pittsburgh, Pennsylvania

October 26, 2004

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PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Income (Unaudited)

(Amounts in Thousands – Except Per Share Data)

See accompanying notes to unaudited condensed consolidated financial statements.

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NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Amounts in Thousands)

(Continued)

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NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Amounts in Thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

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NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)

(Amounts in Thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

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NORTH PITTSBURGH SYSTEMS, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)

(Amounts in Thousands)

(1) Basis of Presentation and Consolidation

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

Certain amounts in the Company’s 2003 condensed consolidated financial statements have been reclassified to conform with the presentation of its 2004 condensed consolidated financial statements.

(2) Comprehensive Income

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

(3) Postretirement Benefits

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

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

Eligible retirees of North Pittsburgh are provided healthcare and life insurance benefits under an unfunded plan until the retiree reaches 65 years of age. The costs associated with these benefits are summarized in the second table that follows.

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Components of Net Periodic Benefit Cost:

The following tables summarize the components of our net periodic benefit cost:

North Pittsburgh also has a nonqualified supplemental pension plan covering former and current employees, which provides for incremental pension payments to the extent that income tax regulations limit the amount payable from North Pittsburgh’s qualified defined benefit plan. Pension expense for the supplemental plan for the three-month periods ended September 30, 2004 and 2003 was $55 and $41, respectively, and pension expense for the nine-month periods ended September 30, 2004 and 2003 was $165 and $121, respectively.

Employer Contributions:

The Company previously disclosed in its financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2003 (2003 Form 10-K), that it expected to make discretionary contributions totaling $2,500 to its qualified pension plan in 2004. Due to an elective additional tax-deductible contribution of $2,000 made in 2003, no minimum contribution is required for the pension plan in 2004. However, the Company made tax-deductible discretionary contributions of $1,154 and $1,346 in January and April of 2004, respectively.

Contributions for the other postretirement benefit plans are made on a pay-as-you-go basis, with total contributions of $481 having been made during the nine-month period ended September 30, 2004. The $481 of contributions for the nine-month period ended September 30, 2004 were in line with the expected annual contributions of $641 disclosed in the Company’s 2003 Form 10-K.

(4) Transactions with Related Parties

Since 1998, we have had an agreement to obtain certain data processing functions from a third party processor (Processor), which is a member of the Armstrong Group of Companies (the Armstrong Group). We are related to the Armstrong Group by a common shareholder and director. Payments to the Processor under this agreement were $2,127 and $2,894 for the nine-month periods ended September 30, 2004 and 2003, respectively. Also, we paid $168 and $135, respectively, in those same periods to the law firm of a member of the Board of Directors for various legal services. As of September 30, 2004, we had amounts outstanding of $176 and $31 to the Processor and such law firm, respectively.

In addition, in the ordinary course of business, we both provide and receive telecommunication transport services from Boulevard Communications, LLP (Boulevard), a competitive access provider jointly owned by us and a company in the Armstrong Group. Total

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revenues recognized from providing services to Boulevard were approximately $19 for both nine-month periods, and total expenses incurred from receiving services from Boulevard were approximately $146 and $225, for the nine-month periods ended September 30, 2004 and 2003, respectively. We also provide, in the ordinary course of business, telecommunication and transport services to other member companies of the Armstrong Group, with total revenues recognized of approximately $90 and $133, for those same periods, respectively. The amounts outstanding from and/or due to Boulevard and the companies in the Armstrong Group were negligible as of September 30, 2004.

(5) Workforce Reduction

During the second quarter of 2003, the Company instituted a workforce reduction program at its North Pittsburgh subsidiary. That program consisted of both layoffs and early retirement incentives. The Company recorded $1,076 and $66 in severance charges related to the workforce reduction program during the second and third quarters of 2003, respectively.

Because of the workforce reduction program, the Company also recorded curtailment charges and completed a re-measurement of its obligations under its defined benefit pension plan and postretirement healthcare plan. Curtailment charges totaling $1,583 were recorded in the second quarter of 2003. Both the $1,142 in severance charges and $1,583 in curtailment charges were recorded in the “Network and other operating expenses” line item on the Company’s Condensed Consolidated Statements of Income.

(6) Recent Accounting Pronouncements

In June of 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, “Accounting for Asset Retirement Obligations”. The Company adopted this pronouncement on January 1, 2003. SFAS No. 143 requires that we record the fair value of an asset retirement obligation as a liability in the period in which we incur a legal obligation associated with the retirement of tangible long-lived assets resulting from the acquisition, construction, development, and/or normal use of the assets. We would also record a corresponding asset that is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation will be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. The adoption of SFAS No. 143 did not have a material effect on our consolidated financial statements.

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

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PART I

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

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

Cautionary Language Concerning Forward-Looking Statements

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

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

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

We also refer you to the section titled “Factors Affecting Our Prospects” under Item 1 of our 2003 Form 10-K for additional discussions concerning items which pose risks and uncertainties that could affect our future results.

Overview

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

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

In addition to our core businesses described above, we also derive a portion of our net income and cash flow from our limited partner interests in three wireless partnerships, all of which

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are majority owned and operated by Verizon Wireless. These partnerships, which have their origin in the 1980s with the allocation by the Federal Communications Commission (FCC) of B licenses, cover territories, which overlap the majority of our ILEC and edge-out markets.

General Description of Our Company and Business

The Registrant, organized May 31, 1985, is a holding company and has no operating function. Its predecessor, North Pittsburgh, a telephone public utility incorporated in 1906, became a wholly owned subsidiary of the Registrant on May 31, 1985. Penn Telecom became a wholly owned subsidiary of the Registrant on January 30, 1988. Prior to this date, Penn Telecom was a wholly owned subsidiary of North Pittsburgh. Penn Telecom is certificated as a Competitive Access Provider (CAP), a CLEC and an Interexchange Carrier (IXC) and has entered into these businesses. Pinnatech, a wholly owned subsidiary of the Registrant, formed in 1995, principally provides Internet and broadband related services. The Registrant, North Pittsburgh, Penn Telecom and Pinnatech operate under the provisions of the Pennsylvania Business Corporation Law.

North Pittsburgh Telephone Company

North Pittsburgh, our ILEC, was founded in 1906 and operates in an approximate 285 square mile territory in Western Pennsylvania, which includes portions of Allegheny, Armstrong, Butler and Westmoreland Counties. We provide service to approximately 72,900 business and residential access lines in our ILEC territory. Over the past decade, our ILEC territory has experienced very robust population growth due to the continued expansion of suburban communities into our serving area, with the southernmost point of our territory being only 12 miles from the City of Pittsburgh. According to the census covering the past decade, the population in our ILEC service territory grew 14.3% from 1990 to 2000. Although no formal census has been published since 2000, business and new home growth has remained robust in our territory over the last several years and census estimates, which are published on a yearly basis, continue to show population growth.

We operate a 100% digital switching network, comprised of nine central offices and 93 CSAs. The core of the network consists of two main host switches, a Nortel DMS 500 and a Nortel DMS 100. The majority of the CSAs were built over the past seven years, during which we completed an extensive network modernization plan. The current CSA architecture, in which nearly all loop lengths are kept to 12,000 feet or less, has enabled us to offer digital subscriber line (DSL) service over 99% of our access lines. In addition, we have deployed fiber extensively throughout the network, resulting in a 100% Synchronous Optical Network (SONET) that supports all of the inter-office and host-remote links as well as the majority of business parks within our ILEC serving area. We believe that our network is built for the future, in which our ability to satisfy the growing customer demand for broadband and multi-megabit services will be a key critical success factor.

Penn Telecom

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

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

Our sales strategy in our edge-out markets has been to focus on small to mid-sized business customers (defined as 5 to 500 lines), educational institutions and healthcare facilities, offering local and long distance voice services as well as DSL. Our fiber-based network, comprised of multiple rings, enables us to compete against Verizon and other CAPs to offer high capacity special access circuits (from DS-1s up to OC-48s) to IXCs, ISPs and even other CLECs. As of

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September 30, 2004, Penn Telecom served 37,295 dial tone access lines and 21,422 access line equivalents¹, for a grand total of 58,717 equivalent access lines².

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

Pinnatech

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

For a more complete understanding of our business, industry, principal services rendered, properties and other interests, we suggest you read our 2003 Form 10-K. There have been no significant changes in the mode of conducting business or the properties owned by the Company or its subsidiaries since the filing of that Form 10-K report. Current updates to the regulatory environment under which our subsidiaries operate can be found below in the “Regulatory Matters” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Industry Dynamics

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

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

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

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

Regulation and Competition

The telecommunications industry was greatly impacted by the passage of the Telecommunications Act of 1996 (the 1996 Act), which was the legislative instrument that opened the industry to significantly greater competition. The degree and pace at which markets have been experiencing competition have varied, with most of the original regulatory barriers to entry having been removed in the markets served by the country’s largest local exchange carriers, also referred to as the Regional Bell Operating Companies (RBOCs). Smaller rural companies, such as our ILEC, North Pittsburgh, were given regulatory relief in the form of exemptions and temporary

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suspensions from many of the competitive portions of the 1996 Act in order to allow state regulators sufficient time to examine the public policy implications of allowing competition in rural areas, and if deemed in the public interest, allowing smaller companies to gradually prepare for competition and to restructure rates. Although we still maintain in our ILEC territory some of the regulatory protections against non-facilities based competition, we expect that over time these protections will be reduced and/or entirely eliminated.

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

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

Highlights and Outlook

Revenues for the nine-month period ended September 30, 2004 increased $3,368, or 4.3%, over the prior year comparable period. The majority of this growth was attributable to our ability to continue to effectively penetrate our edge-out markets as well as expand our broadband service offerings. The revenue growth rate of 4.3%, though, was lower than the full year 2003 revenue growth rate of 11.2% due mostly to several intercarrier compensation rate decreases experienced over the last twelve months. A revision in the percent local use (PLU) factor used to settle traffic between Verizon and Penn Telecom in September of 2003, the continued phase down of Penn Telecom’s interstate access rates in conjunction with the FCC’s Access Charge Reform Order and decreases in access and transit rates charged for wireless traffic have been the main contributing factors to the curtailment of the revenue growth rate.

Total operating expenses for the nine-month period ended September 30, 2004 decreased $1,583 from the prior year comparable period, which included $2,725 in charges associated with a workforce reduction program. Excluding those charges, other operating expenses increased $1,142, or 1.9%, in the first nine months of 2004 over the comparable prior year period. The lower percentage growth in operating expenses in contrast to operating revenues reflected our continued efforts to contain costs. The first nine months of 2004 were impacted positively by decreases in the cost of contracted operational support system (OSS) services pursuant to a new agreement executed in the third quarter of 2003 as well as by our ability to greatly moderate the annual growth rate in overall labor costs (inclusive of current and postretirement benefits). Labor costs increased at an approximate 4% rate for the nine-month period ended September 30, 2004 over the prior year comparable period, in contrast to double-digit percentage increases in these costs experienced in the past several years.

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

Our cost structure is heavily weighted towards labor and depreciation. As such, there is not a great deal of direct correlation between our revenues and our largest operating expenses. Percentage increases in our labor costs have outpaced our revenue growth over the past several years, primarily driven by increases in healthcare costs and postretirement benefit expenses. We have taken steps to address some of these issues, including the workforce reduction program implemented in 2003 and using our excess cash reserves to make additional contributions into the defined benefit pension plan. The benefits of taking these steps were evident in the results of operations for the first nine months of 2004. Our ability to contain the growth in overall labor costs to 4% in comparison to the first nine months of 2003 allowed for the majority of the increase in revenues to flow through into operating margin.

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

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Our financial condition and balance sheet have continually improved over the last several years through prudent investment strategies and strong cash flows generated from operating activities. Unlike many telecommunication companies that have substantially leveraged their businesses, we have a greater amount of cash on hand ($36,156) than our total debt outstanding ($25,453). Our financial condition gives us the ability to invest in new products and/or opportunities and the flexibility to continue to evaluate ways to create greater shareholder value, whether through our dividend policy, stock repurchases or other investment opportunities.

Results of Operations

The following discussion should be read in conjunction with our condensed consolidated financial statements, and the notes thereto, included in this quarterly report and with our audited financial statements, and the notes thereto, included in our 2003 Form 10-K.

Results of Operations for the Nine Months Ended September 30, 2004 and 2003

Net income for the nine-month period ended September 30, 2004 was $13,766, or $.92 per share, compared to net income of $9,813, or $.65 per share, for the comparable prior year period. The increase in net income was attributable to the following factors:

Operating Revenues

Total operating revenues increased $3,368, or 4.3%, in the nine-month period ended September 30, 2004 over the comparable period in 2003. This increase was the result of increases in local network services revenues of $1,678 (8.9%), long distance and access services revenues of $805 (1.7%), directory advertising, billing and other services revenues of $77 (8.1%) and other operating revenues of $953 (12.4%), offset partially by a decrease in telecommunication equipment sales of $145 (8.8%).

Increases in local network services revenues of $1,678, or 8.9%, were primarily attributable to the following factors:

The increase in long distance and access services revenues of $805, or 1.7%, was primarily attributable to the following factors:

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The decrease in access revenues of $527, or 2%, is in contrast to the growth rate in access revenues of 12% experienced for full year 2003. Excluding the impact of the rate re-balancings (which merely shifted revenues from one financial statement line item to another) and prior year final intercarrier settlement adjustments, access revenues from all other sources increased at a 2% rate over the prior year nine-month period. The decrease in the growth rate from 2003 was mostly attributable to reductions in effective intercarrier compensation rates, the most significant of which was a revision made between Verizon and Penn Telecom in September of 2003 in the PLU factor used to settle traffic between the companies. At that time, the PLU factor change resulted in an approximate $250 per month decrease in intrastate access revenues recognized. Secondly, in conjunction with the FCC’s Access Charge Reform Order, Penn Telecom’s interstate access rates have been phased down over a three-year period that began in 2001. The final decrease, which adjusted Penn Telecom’s rates to mirror the incumbents’ rates, was effective June 20, 2004 and resulted in an approximate $40 per month decrease in access revenues. Although Penn Telecom’s access line growth of 12,783, or 52%, from the prior year period resulted in an increase in end user interstate access charges and contributed to an approximate 35% increase in minutes of use (MOUs) on the network, the decreases in the effective intercarrier compensation rates described above mitigated the aggregate access revenue increase for Penn Telecom for the nine-month period ended September 30, 2004 to $242, or 5%.

Reductions in wireless intercarrier compensation rates also negatively impacted the 2004 year to date growth rate. The Company experienced a $100 decrease in access revenues from wireless carriers for the nine-month period ended September 30, 2004 over the prior year comparable period despite a 23% increase in billable MOUs. In comparison, revenues from wireless traffic increased approximately $540 for full year 2003.

The increase in directory advertising, billing and other services revenues of $77 was mostly attributable to the prior year first quarter including an approximate $120 reduction in revenues recorded in anticipation of a lower settlement for the 2002 directory book than originally estimated. The positive increase in directory advertising revenues was partially offset by a $46 decrease in carrier billing and collection revenues as the volumes of services and calls billed on behalf of other carriers have continued to decrease.

The increase in other operating revenues of $953, or 12.4%, was primarily due to growth in DSL revenues of approximately $856 as combined DSL lines (both wholesale and retail) sold increased from 9,333 as of September 30, 2003 to 11,590 as of September 30, 2004.

The decrease in telecommunication equipment sales of $145 was mostly due to a decrease in new equipment sales. Correspondingly, telecommunication equipment expenses decreased by $115.

Operating Expenses and Net Operating Income

Total operating expenses decreased $1,583, or 2.6%, in the nine-month period ended September 30, 2004 over the comparable period in 2003. The change was the result of decreases in network and other operating expenses of $1,157 (2.7%), depreciation and amortization expenses of $170 (1.2%), state and local taxes of $141 (4.8%) and telecommunications equipment expenses of $115 (9.9%).

The decrease in network and other operating expenses of $1,157, or 2.7%, was primarily due to the prior year including $2,725 in charges recorded in association with a workforce reduction program at our North Pittsburgh subsidiary. Excluding those charges, other operating expenses in this category increased $1,568, or 3.9%, for the first nine months of 2004 over the comparable prior year period, mostly due to increases in direct costs associated with the growth in access lines and access line equivalents. Such direct costs include the fees paid for leasing

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unbundled network elements in the portions of our edge-out markets that we do not provision over our own facilities and fees paid to terminate the increased local, toll and Internet traffic generated by our growing customer base. The 3.9% increase in costs, though, was historically low in comparison to the growth rates experienced in the past several years, due to the impact of the following items:

The decrease in consolidated depreciation and amortization expenses of $170, or 1.2%, was the result of the capitalized costs and license fees, which were incurred with the conversion to a Year 2000 compliant OSS approximately five years ago, becoming fully depreciated in December of 2003. This resulted in an approximate $810 decrease in depreciation for that set of assets. Otherwise, depreciation expense for all other assets increased approximately $640 as the depreciable asset base (gross property, plant and equipment) grew 4.6% over the twelve-month period ended September 30, 2004.

The decrease in state and local taxes of $141, or 4.8%, was attributable mostly to nominal decreases in payroll taxes and gross receipts tax expense.

Overall, the increase in total operating revenues of $3,368 coupled with the decrease in total operating expenses of $1,583, resulted in a $4,951, or 31.0%, increase in net operating income for the nine-month period ended September 30, 2004 over the comparable prior year period.

Other Items

Interest expense decreased for the nine-month period ended September 30, 2004 by $178 due to the continued scheduled pay-down of our Federal Financing Bank (FFB) notes and capital lease obligation.

Equity income of affiliated companies increased $1,523 in the nine-month period ended September 30, 2004 over the comparable prior year period due mainly to a $1,553 increase in the amount of income generated from the Company’s limited partner interest in three wireless partnerships. These partnerships, all of which are majority owned and operated by Verizon Wireless, have continued to show strong growth in the number of customers and operating results. In addition, we are benefiting from a reduction in switching costs which became effective in 2004.

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

Results of Operations for the Three Months Ended September 30, 2004 and 2003

Fluctuations in revenue and expenses for the three-month period ended September 30, 2004, as compared to the same quarterly period in 2003, were generally attributable to the same reasons discussed in the nine-month comparison above, with the exception of the following:

Long distance and access services revenues decreased $241, or 1.5%, for the three-month period ended September 30, 2004 as compared to the same quarterly period in 2003, in contrast to a nine-month year to date increase of $805, or 1.7%. The intercarrier compensation rate decreases described above in the nine-month analysis had a more profound impact on the quarter over quarter results as the majority of the decreases in the wireless intercarrier compensation rates

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were effective June 1, 2004, and the final phase down of Penn Telecom’s interstate access rates was effective June 20, 2004. As such, the third quarter of 2004 was the first three-month period to experience the full impact of those rate decreases. In addition, North Pittsburgh had an approximate $180 decrease on a quarter over quarter basis in interstate access revenues recognized through the National Exchange Carrier Association (NECA). The NECA average schedule settlement formulas, which were effective with the fiscal 2004 tariff filing and cover the period July 1, 2004 through June 30, 2005, decreased approximately 4%. As the effective date of the tariff filing was July 1, 2004, the third quarter was the first period in 2004 to experience the impact of the tariff decrease. Interstate access revenues for the year to date period are actually slightly higher than 2003, because the tariff rates in effect for the first six months of 2004 were approximately 4% higher than those for the corresponding six-month period in 2003.

With respect to the revenues North Pittsburgh recognizes through the NECA pooling process and the interstate tariffs that NECA files on behalf of the pooling participants, there exists the risk that revenues recognized since July 1, 2004 may be subject to adjustment. On July 1, 2004, the Pricing Policy Division of the FCC’s Wireline Competition Bureau released an Order that suspended for one day and set for investigation the NECA fiscal 2004 tariff. The investigation is still ongoing, with NECA and the petitioners providing the support documentation requested by the FCC. The Company is unable to predict the ultimate outcome of this investigation and the possible impact, if any, on revenues that have been recognized since July 1, 2004 as well as prospective revenues.

Directory advertising, billing and other services revenues decreased $46, or 12.5%, for the three-month period ended September 30, 2004 as compared to the same quarterly period in 2003, in contrast to a nine-month year to date increase of $77, or 8.1%. As previously discussed, the year to date increase was mostly a result of the prior year first quarter including an approximate $120 reduction in revenues recorded in anticipation of a lower settlement for the 2002 directory book than originally estimated. Absent that item, which was unique to the first quarter comparisons, year over year revenues have decreased slightly as a result of lower carrier billing and collection revenues.

Telecommunication equipment sales decreased $217, or 35.5%, for the three-month period ended September 30, 2004 as compared to the same quarterly period in 2003, in contrast to a nine-month year to date decrease of $145, or 8.8%. The higher rate of decrease for the current quarterly period as compared to the year to date period was a result of a more dramatic decrease in both new equipment sales and post-sale support revenues. As the majority of our revenue from this category is non-recurring in nature, quarter over quarter comparisons can be impacted by the timing of when some of our larger installations occur. Correspondingly, telecommunication equipment expenses decreased $155, or 37.2%, in the third quarter of 2004 over the prior year third quarter, in contrast to a nine-month year to date decrease of $115, or 9.9%.

Network and other operating expenses increased $533, or 3.9%, for the three-month period ended September 30, 2004 as compared to the same quarterly period in 2003, in contrast to a nine-month year to date decrease of $1,157, or 2.7%. The increase in expenses for the third quarter of 2004 as compared to the year to date decrease was due to the fact that $2,659 of the total $2,725 in workforce reduction charges were recorded in the second quarter of 2003.

Equity income of affiliated companies increased $1,066, or 186.7%, for the three-month period ended September 30, 2004 as compared to the same quarterly period in 2003, in contrast to a nine-month year to date increase of $1,523, or 66.7%. The larger percentage increase for the third quarterly period of 2004 as compared to the year to date period was partially due to the fact that the favorable reduction in switching expense, as previously described, became effective with the partnership results that we reported for the second quarter of 2004. In addition, the prior year third quarter results for the Pennsylvania RSA 6 (I) partnership were negatively impacted by conversion costs incurred with the transition of the majority partnership interest from Alltel Communications to Verizon Wireless. Also, the prior year first quarter results for the Pennsylvania RSA 6 (II) partnership were positively impacted by several non-recurring items.

Liquidity and Capital Resources

Cash and temporary investments were $36,156 at September 30, 2004 as compared to $32,026 at December 31, 2003. The increase was a result of operating cash flows exceeding investment and financing requirements. Cash flows from operations were $22,672 for the nine-month period ended September 30, 2004, a $2,646 increase from the comparable prior year period. Cash flows from operations were positively impacted by an increase in net income during the current year to date period as well as by the fact that the prior year period included $1,076 in pre-tax ($629 in after tax) cash severance and early retirement incentives. In addition, contributions

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into the Company’s defined benefit pension plan were $491 lower in the first nine months of 2004 than the prior year period. The above positive impacts on cash flows from operations were partially offset by timing influences on income tax payments, which reduced cash flows from operations by approximately $600 for the nine-month period ended September 30, 2004 versus the prior year comparable period.

Cash flows used for investing activities were $7,479 for the nine-month period ended September 30, 2004, a $1,410 increase from the comparable prior year period. The increase was primarily the result of a $2,521 increase in capital additions, as the first nine months of 2004 included investments in equipment for our next generation of DSL products (including a 3 Megabit offering), investments in network equipment for our planned VoIP product as well as an increase in purchases for fleet vehicles. This was partially offset by a $1,136 increase in net proceeds received from our wireless partnerships.

We expended $11,063 during the nine-month period ended September 30, 2004 for financing activities, which included cash dividends and the scheduled repayments of debt and capital lease obligations. The amount is $356 higher than the prior year period, mostly as a result of a $300 increase in dividends paid pursuant to the Company raising by $.01 per share the dividend it declared payable during the second and third quarters of 2004.

Temporary excess funds were invested in short-term cash equivalents with maturity dates scheduled to coincide with tax payment due dates, debt principal payments, dividend payment dates and other predictable cash needs. We expect to continue the investment of such excess funds throughout the remainder of 2004 and for 2005, which should enable us to meet all short-term obligations.

Working capital levels at September 30, 2004 increased $4,600 from December 31, 2003, mostly due to the continued generation of cash flows from operations, which contributed to a $4,130 increase in cash and temporary investments (as discussed above).

The decrease in long-term debt was a result of scheduled principal repayments of $2,314 during the nine-month period ended September 30, 2004. We funded 100% of our year-to-date 2004 expenditures for property and equipment from operations cash flows and cash reserves. Therefore, no additional advances were requested from our available debt facilities. In 1996, North Pittsburgh was granted approval for a loan from the FFB guaranteed by the Rural Utilities Service (RUS) in the maximum principal amount of $75,000. The total amount outstanding at September 30, 2004 to the FFB under this loan was $25,453, with all advances having a maturity date of December 31, 2012. The unadvanced amount of this facility as of September 30, 2004 was $34,764. North Pittsburgh can draw against this facility through June 30, 2012 for qualified capital expenditure projects, as defined in the loan agreement, to furnish and improve telephone service in rural areas. As of September 30, 2004, North Pittsburgh had approximately $3,813 of qualified capital expenditures that were eligible to be drawn against this facility.

The notes payable to the FFB are secured by a supplemental Mortgage Agreement executed by North Pittsburgh, which provides that substantially all of the assets of North Pittsburgh, which approximate a net book value of $101,320, are subject to a lien or a security interest. Such agreement contains restrictions regarding dividends and other distributions by North Pittsburgh. Under these restrictions, unless certain working capital levels, net worth levels and interest expense ratios are maintained, North Pittsburgh is not permitted to pay dividends on its capital stock (other than in shares of capital stock), or make any other distributions to its shareholder, or purchase, redeem or retire any of its capital stock or make any investment in affiliated companies. As a result of these restrictions, approximately $11,661 of North Pittsburgh’s retained earnings was available for dividends and other distributions to the Registrant as of September 30, 2004. Taking into consideration the North Pittsburgh restrictions, approximately $49,451 of our consolidated retained earnings was available for dividends and other distributions to our shareholders as of September 30, 2004.

North Pittsburgh also has available through June of 2009 a $10,000 line of credit with the Rural Telephone Finance Cooperative at a rate of prime plus 1 ¹/2%. No borrowings have been taken against the line of credit.

Consolidated capital expenditure commitments for the purchase and installation of new equipment at September 30, 2004 amounted to approximately $1,287, with such amount being part of our 2004 capital expenditure program, which is projected to aggregate in the range of $13,000 to $14,000. The Company had made expenditures of $10,655 in association with this construction program through September 30, 2004. We expect our 2005 capital expenditure program to be similar in size to our 2004 program.

We expect cash flows provided by operating activities and cash reserves over the next twelve months to be sufficient to service long-term debt and capital lease obligations, to pay dividends and to finance all capital projects. We expect to continue to have the necessary cash flows from operations and cash reserves to internally finance 100% of our projected capital expenditures. However, due to the low cost financing available through the RUS for qualified North Pittsburgh capital expenditures, we may request advancements from the RUS facility in the future.

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We refer you to our Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our 2003 Form 10-K for a disclosure and discussion of our aggregate contractual obligations and purchase commitments as of December 31, 2003. There were no material changes in the specified contractual obligations and purchase commitments during the nine-month period ended September 30, 2004. Scheduled payments of $2,314, $1,194 and approximately $215 were made to reduce the outstanding long-term debt, capital lease and operating lease obligations, respectively, during the first nine months of 2004.

Critical Accounting Policies

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

Revenue Recognition

Revenues are recognized when local network, long distance, and access services are provided. Local service, intrastate long distance and intrastate access service revenues are subject to the jurisdiction of the Pennsylvania Public Utility Commission (PA PUC). Interstate long distance and interstate access service revenues are subject to the jurisdiction of the FCC. Revenues from equipment sales are recorded after equipment has been installed and accepted by the customer. Directory advertising revenues are recognized ratably over the 12-month period related to the directory publication.

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

However, as noted in the Results of Operations for the Three Months Ended September 30, 2004 and 2003 section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations, the current tariff which serves as the basis for the revenue recognition of the NECA pool is currently under investigation. On July 1, 2004, the Pricing Policy Division of the FCC’s Wireline Competition Bureau released an Order that suspended for one day and set for investigation the NECA fiscal 2004 tariff. The investigation is still ongoing, with NECA and the petitioners providing the support documentation requested by the FCC. There therefore exists the risk that revenues recognized since July 1, 2004 may be subject to adjustment pursuant to the ultimate outcome of this investigation. The Company is unable to predict the ultimate outcome of this investigation and the possible impact, if any, on revenues that have been recognized since July 1, 2004 as well as prospective revenues.

Impairment of Long-Lived Assets

Based upon the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, we review assets for impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. A determination of impairment (if any) is made based on estimates of future undiscounted cash flows. We adopted SFAS No. 144 effective January 1, 2002. We have determined, based on our reviews, that there had been no impairment to the carrying value of such assets in 2003 or for the nine-month period ended September 30, 2004.

Valuation of Accounts Receivable

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

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Income Taxes

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

Pension and Other Postretirement Benefits

We calculate the costs of providing retiree benefits under the provisions of SFAS No. 87 and SFAS No. 106. The key assumptions used in making these calculations are disclosed in Note 6 to our consolidated financial statements included in our 2003 Form 10-K. The most significant of these assumptions are the discount rate used to value the future obligation, expected return on plan assets and health care cost trend rates. We select discount rates commensurate with current market interest rates on high-quality, fixed-rate debt securities. The expected return on assets is based on our current view of the long-term returns on assets held by the plan, which is influenced by the historical performance of plan assets, asset allocation and other third-party studies. The medical cost trend rate is based on our actual medical claims and future projections of medical cost trends.

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

Regulatory Matters

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

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

North Pittsburgh’s wireline operations are considered Rural under the 1996 Act and are exempt from certain of the foregoing obligations unless, in response to a bona fide request for interconnection, the PA PUC removes that exemption. More specifically, pursuant to the rural exemption provision of Section 251(f)(1) of the 1996 Act, North Pittsburgh is currently exempted from offering collocation, UNEs, wholesale discounts and certain other requirements of the 1996 Act which originally pertained to non-rural ILECs. The rural exemption does not, however, prevent facilities based competition in North Pittsburgh’s service area. In addition, on January 15, 2003, the PA PUC denied the request of North Pittsburgh and other rural carriers in the state of Pennsylvania for an extension of a temporary suspension of Sections 251(b) and (c) of the 1996 Act which North Pittsburgh and the other rural carriers had held since July 10, 1997. There are two main implications of the denial of extension of the temporary suspension to North Pittsburgh. First, North Pittsburgh is now open to the potential removal of its rural exemption if a prospective competitor successfully petitions the PA PUC for its removal. However, the PA PUC may grant such a removal only if it finds that the competitor’s proposal is not unduly economically burdensome to North Pittsburgh, is technically feasible and is consistent with the universal service provisions of the 1996 Act. In addition, the burden of proof in such a proceeding rests with the competitor. Second, North Pittsburgh became subject to implementing Local Number Portability (LNP) within six months of receipt of a bona fide request from a CLEC.

In March of 2003, North Pittsburgh did receive a request from a CLEC to negotiate an interconnection agreement. Accompanying the request for interconnection by the CLEC was a request for LNP. As a result of that request, North Pittsburgh implemented LNP capability in November of 2003. North Pittsburgh is still in negotiations with the requesting CLEC with regard to a final interconnection agreement.

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The North Pittsburgh implementation of LNP capability coincided with the FCC’s ordered deadline for certain ILECs, including North Pittsburgh, to implement wireline to wireless LNP by November 24, 2003. On January 19, 2004, the FCC extended the November 24, 2003 deadline until May 24, 2004 for certain rural local exchange carriers. However, because North Pittsburgh was already LNP capable, this extension did not apply to North Pittsburgh. The FCC’s Order regarding wireline to wireless LNP has been challenged in court, and the eventual outcome of that court challenge is unknown. Until such time as the court may overturn the FCC’s Order or remand the issue to the FCC, the requirement of wireline to wireless LNP is applicable to North Pittsburgh and Penn Telecom. Under the current rules, wireline to wireless LNP may cause both North Pittsburgh and Penn Telecom to experience some loss of customers and the associated revenues, as customers will be able to migrate from wireline service to wireless service and still retain their current telephone numbers.

The provision of interstate toll and access services by North Pittsburgh and Penn Telecom is subject to the regulatory scrutiny of the FCC. Terms, conditions and rates for interstate toll and access services are filed in interstate tariffs for review and approval by the FCC. However, since August 1, 2001, the FCC has not required non-dominant interstate toll providers, including Penn Telecom, to file tariffs for their interstate toll services. Penn Telecom now informs its toll customers of the rates, terms and conditions through written notice. The provision of intrastate toll and access services is subject to regulatory scrutiny by the PA PUC. Terms, conditions and rates for intrastate toll and access services are filed in intrastate tariffs for PA PUC review and approval.

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

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

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

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

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

In February of 2002, the FCC issued a NPRM regarding the possible classification of wireline broadband Internet access as an information service rather than a telecommunications service. Should the FCC adopt this proposed rule, it may cause network based broadband offerings such as DSL services to be more lightly regulated by the FCC. In the NPRM, the FCC also asked whether it should extend Universal Service Fund (USF) requirements to not only facilities based wireline Broadband Internet Service Providers (BISPs) but also wireless, cable TV and satellite BISPs. Should the FCC extend a USF contribution requirement to all BISPs, North Pittsburgh, Penn Telecom and Pinnatech would be affected. Because the outcome of this proceeding is unknown at this time, we are unable to determine the effect such action may have on our operations and revenues.

In February of 2002, the FCC also issued a Further Notice of Proposed Rulemaking (FNPRM) regarding the possible reformation of the system for assessing and recovering USF monies. In that proceeding, the FCC has asked for comment on whether it should assess carrier contributions based on the number and capacity of connections that contributing carriers provide to customers, rather than on the current method, which is based on the interstate revenues they earn. Should the FCC reform the current system for assessing and recovering USF monies, North Pittsburgh, Penn Telecom and Pinnatech would be affected by the change. Because the outcome of this proposal is unknown at this time, we are unable to determine the effect such action may have on our operations and revenues.

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On February 20, 2003, the FCC issued its decision regarding the Triennial Review of the 1996 Act. The decision dealt with several issues that may affect North Pittsburgh and Penn Telecom. In that decision, the FCC eliminated unbundling requirements for ILECs in regard to broadband services provided over fiber facilities but continued to require unbundled access to mass-market narrowband loops. In addition, ILECs are not required to unbundle packet switching services. The FCC further found that the high frequency portion of the loop, also referred to as line sharing, is no longer required to be provided as a UNE and that UNE requirement will therefore be phased out over three years. Additionally, the FCC found that ILECs will no longer have to offer the local switching UNE to CLECs for business customers served by high-capacity loops. The states had 90 days to rebut this finding. For mass market customers served by narrowband loops, the FCC set out specific criteria that states shall apply to determine if switching should no longer be available as an UNE. Upon a state ruling eliminating switching as an UNE for mass market customers, the FCC set forth a three-year period for carriers to transition off Unbundled Network Element Platform (UNE-P), which is a service that bundles UNE switching with other UNEs such as UNE loop to provide the entire local service platform. The FCC Order explaining the decision was released August 21, 2003.

The PA PUC, on October 3, 2003, entered an Order that initiated two proceedings to implement the requirements set forth in the FCC’s Triennial Review Order (TRO) in a manner specific to Pennsylvania. The first proceeding investigated whether the PA PUC should request a waiver from the FCC in regard to the elimination of the requirement that ILECs provide CLECs with the local switching UNE for customers served by high-capacity loops. This proceeding has closed with the PA PUC concluding that the proceeding did not apply to incumbents such as North Pittsburgh that have a rural exemption and that a FCC waiver should not be requested. Verizon, however, remained obligated under a separate State Order to continue to provide access to its local switching UNE. The second PA PUC proceeding dealing with the continued ILEC provision of the local switching UNE to CLECs for mass-market customers remains pending.

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

On June 30, 2004, a group of CLECs including AT&T and several state regulatory parties filed petitions at the U. S. Supreme Court seeking to reverse the federal appeals court decision. On October 12, 2004, the Supreme Court announced it would not hear the appeal.

Concurrently, on August 20, 2004, the FCC released an Order and NPRM that detailed the interim UNE rules. These interim rules included a six-month freeze of the current UNE rates. The RBOCs and the United States Telephone Association asked the U. S. Court of Appeals for the DC Circuit to grant a mandamus petition ordering the FCC to comply with the Appeals Court’s earlier decision. On October 7, 2004, the Court issued an order stating they will not consider the petition until January 2005. It is expected that the FCC will adopt the permanent rules in response to the Court’s decision sometime before the end of 2004 and before the Court acts on the mandamus petition.

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

With regard to UNE-P, we had approximately 2,700, or 7%, of our CLEC dial tone access lines served utilizing UNE-P as of September 30, 2004. Should changes occur in the current UNE-P environment, either in terms of restricting availability or revising pricing methodologies to allow for price increases, our margins realized for these lines may decrease and/or our future effectiveness in geographically expanding our customer base may be partially hampered.

In addition, with respect to the FCC’s ongoing review, certain RBOCs have posed questions concerning their requirements regarding the unbundling of high-capacity loops at Total Element Long Run Incremental Cost (TELRIC) rates. Although it is our current understanding that this issue

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concerning high-capacity loop pricing was not part of the original TRO review, and therefore not an addressable matter in the current review by the FCC, some RBOCs have been very aggressive in pro-actively extending unilateral interpretations of the U. S. Court of Appeals decision onto this matter. Any changes in the pricing methodology that migrates high-capacity loops from TELRIC to special access rates could have a material adverse effect on our CLEC business.

Effective January 22, 2001, under a statutory framework referred to as Chapter 30, North Pittsburgh moved from rate-of-return regulation in the intrastate jurisdiction to an alternative form of regulation, which is a price cap plan. Under North Pittsburgh’s price cap plan, rates for non-competitive intrastate services are allowed to increase based on an index that measures economy-wide price increases less a productivity offset. There is no limitation on earnings under this plan. The terms of the plan also allow North Pittsburgh to rebalance rates once each year to allow North Pittsburgh to gradually realign its intrastate rate structure on a more rational cost and market basis in order to meet future competition. In addition, as competition develops in the future, North Pittsburgh may file with the PA PUC to declare certain services competitive and thereby be freed from all rate regulation for those services. In return for approval of the alternative form of regulation, North Pittsburgh has committed to continue to upgrade its network in the future to ensure that all its customers will have access to broadband services. On April 30, 2003, North Pittsburgh filed its annual Price Stability Mechanism (PSM) compliance filing under its approved price cap plan. While the application of the PSM formula in the plan normally would have required North Pittsburgh to reduce some rates for non-competitive services, resulting in an annual revenue decrease of approximately $160, North Pittsburgh has identified that a reduction in intercarrier compensation rates charged to a wireless provider, which was not included in the original 2003 PSM, could be included in a revised 2003 PSM filing pursuant to the terms of its Chapter 30 plan. The revised PSM filing would eliminate the need to reduce rates. North Pittsburgh entered into negotiations with various parties that had intervened with the original 2003 PSM filing and, on July 22, 2004, filed a Joint Request with the PA PUC for settlement that resolved the outstanding issues. As part of the settlement, North Pittsburgh also agreed not to increase rates for local service for business and residential customers until July 1, 2005 to further recover the revenues lost as a result of the reduction in intercarrier compensation. The PA PUC on October 24, 2004 issued a Tentative Order approving the Joint Request for Settlement with only one minor modification regarding the number of custom calling features that Lifeline-eligible customers may purchase. Parties to the Settlement have agreed to the PA PUC proposed modifications and the Order is now final.

The Chapter 30 legislation, which enables North Pittsburgh to operate under an alternative price-cap form of regulation, expired due to legislative sunset provisions on December 31, 2003. However, the PA PUC on January 22, 2004 issued a Statement of Policy concluding that under the current Public Utility Code, the approved Chapter 30 alternative plans of regulation for all ILECs operating in Pennsylvania would remain in effect and would be fully enforceable in all respects upon the ILECs after the sunset date of December 31, 2003. Competing versions of new proposed legislation reauthorizing and revising the Chapter 30 regulations have been introduced in both the Pennsylvania House and Senate. Legislative action reauthorizing Chapter 30, with some revisions, is possible by the end of 2004. Because the outcome of this legislative initiative is unknown at this time, we are unable to determine the effect that any new legislation reauthorizing Chapter 30 will have on our operations and revenues.

It is our understanding that North Pittsburgh will remain under its current Chapter 30 plan until such time as the PA PUC orders changes in the plan or the legislature enacts new Chapter 30 legislation.

Recent Accounting Pronouncements

In June of 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”. The Company adopted this pronouncement on January 1, 2003. SFAS No. 143 requires that we record the fair value of an asset retirement obligation as a liability in the period in which we incur a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development, and/or normal use of the assets. We would also record a corresponding asset that is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation will be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. The adoption of SFAS No. 143 did not have a material effect on our consolidated financial statements.

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

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PART I

Item 3. Quantitative And Qualitative Disclosures About Market Risk

There have been no material changes in reported market risks faced by the Company since the end of the preceding fiscal year on December 31, 2003.

Item 4. Controls and Procedures

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

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

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PART II

OTHER INFORMATION

Item 6. Exhibits

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SIGNATURES

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

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