D&E COMMUNICATIONS INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2004

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

For the transition period from to

Commission File Number: 000-20709

D&E Communications, Inc.

(Exact name of registrant as specified in its charter)

PENNSYLVANIA

(State or other jurisdiction of

incorporation or organization)

I.R.S. Employer Identification Number: 23-2837108

Brossman Business Complex

124 East Main Street

P. O. Box 458

Ephrata, Pennsylvania 17522

(Address of principal executive offices)

Registrant’s Telephone Number: (717) 733-4101

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.


Class		Outstanding at October 29, 2004
Common Stock, par value $0.16 per share		14,254,617 Shares

D&E Communications, Inc. and Subsidiaries

Form 10-Q

TABLE OF CONTENTS


Item No.		Page
	PART I. FINANCIAL INFORMATION

1.	Financial Statements

	Consolidated Statements of Operations — For the three months and nine months ended September 30, 2004 and 2003	1

	Consolidated Balance Sheets — September 30, 2004 and December 31, 2003	2

	Consolidated Statements of Cash Flows — For the nine months ended September 30, 2004 and 2003	3

	Consolidated Statements of Shareholders’ Equity and Comprehensive Income (Loss) — For the nine months ended September 30, 2004 and 2003	4

	Notes to Consolidated Financial Statements	5

2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17

3.	Quantitative and Qualitative Disclosures about Market Risk	46

4.	Controls and Procedures	47

	PART II. OTHER INFORMATION

1.	Legal Proceedings	49

6.	Exhibits	49

	SIGNATURES	50

Form 10-Q Part I - Financial Information

Item 1. Financial Statements

D&E Communications, Inc. and Subsidiaries

Consolidated Statements of Operations

(in thousands, except per-share amounts)

(Unaudited)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
OPERATING REVENUES
Communication service revenues	$	39,877		$	39,764		$	120,261		$	117,596
Communication products sold		3,225			2,778			9,210			9,121
Other		590			489			2,121			1,686

Total operating revenues		43,692			43,031			131,592			128,403

OPERATING EXPENSES
Communication service expenses (exclusive of depreciation and amortization below)		17,033			15,822			48,884			45,250
Cost of communication products sold		2,547			1,979			7,372			6,995
Depreciation and amortization		9,724			9,645			29,343			28,772
Marketing and customer services		3,845			4,149			11,992			12,079
General and administrative services		6,083			6,138			19,336			18,339

Total operating expenses		39,232			37,733			116,927			111,435

Operating income		4,460			5,298			14,665			16,968

OTHER INCOME (EXPENSE)
Equity in net losses of affiliates		(576	)		(513	)		(1,426	)		(1,873	)
Interest expense		(3,456	)		(4,492	)		(10,947	)		(13,689	)
Loss on early extinguishment of debt		—			—			(4,841	)		—
Other, net		346			(6	)		1,339			922

Total other income (expense)		(3,686	)		(5,011	)		(15,875	)		(14,640	)

Income (loss) from continuing operations before income taxes and dividends on utility preferred stock		774			287			(1,210	)		2,328

INCOME TAXES AND DIVIDENDS ON UTILITY PREFERRED STOCK

Income taxes (benefit)		39			116			(955	)		859
Dividends on utility preferred stock		16			16			49			49

Total income taxes and dividends on utility preferred stock		55			132			(906	)		908

Income (loss) from continuing operations		719			155			(304	)		1,420

Discontinued operations:
Loss from operations of discontinued Paging business, net of income tax benefit of $27		—			—			—			(53	)

Income (loss) before cumulative effect of change in accounting principle		719			155			(304	)		1,367

Cumulative effect of change in accounting principle, net of income taxes of $177 (See Note 3)		—			—			—			260

NET INCOME (LOSS)	$	719		$	155		$	(304	)	$	1,627

Weighted average common shares outstanding (basic)		14,867			15,522			15,325			15,465
Weighted average common shares outstanding (diluted)		14,910			15,591			15,325			15,526

BASIC AND DILUTED EARNINGS (LOSS) PER COMMON SHARE
Income (loss) from continuing operations	$	0.05		$	0.01		$	(0.02	)	$	0.09
Income (loss) from discontinued operations		0.00			0.00			0.00			0.00
Cumulative effect of accounting change (See Note 3)		0.00			0.00			0.00			0.02

Net income (loss) per common share	$	0.05		$	0.01		$	(0.02	)	$	0.11

Dividends per common share	$	0.13		$	0.13		$	0.38		$	0.38

See notes to consolidated financial statements.

D&E Communications, Inc. and Subsidiaries

Consolidated Balance Sheets

(in thousands)

(Unaudited)


	September 30, 2004			December 31, 2003
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	6,399		$	12,446
Accounts receivable, net of reserves of $1,205 and $1,410		17,552			20,956
Inventories, lower of cost or market, at average cost		3,551			3,552
Prepaid expenses		6,082			8,914
Other		1,704			1,141

TOTAL CURRENT ASSETS		35,288			47,009

INVESTMENTS
Investments in and advances to affiliated companies		2,477			3,611

PROPERTY, PLANT AND EQUIPMENT
In service		327,175			320,720
Under construction		13,078			5,964

		340,253			326,684
Less accumulated depreciation		156,986			137,533

		183,267			189,151

OTHER ASSETS
Goodwill		149,045			149,127
Intangible assets, net of accumulated amortization		168,945			173,594
Other		8,392			11,756

		326,382			334,477

TOTAL ASSETS	$	547,414		$	574,248

LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
Long-term debt maturing within one year	$	9,125		$	11,001
Accounts payable and accrued liabilities		20,222			18,507
Accrued taxes		932			2,120
Accrued interest and dividends		1,749			1,949
Advance billings, customer deposits and other		7,406			10,323

TOTAL CURRENT LIABILITIES		39,434			43,900

LONG-TERM DEBT		221,000			222,765

OTHER LIABILITIES
Deferred income taxes		86,478			88,295
Other		16,422			17,248

		102,900			105,543

PREFERRED STOCK OF UTILITY SUBSIDIARY, Series A 4¹/2%, par value $100, cumulative, callable at par at the option of the Company, authorized 20 shares, outstanding 14 shares		1,446			1,446

COMMITMENTS
SHAREHOLDERS’ EQUITY
Common stock, par value $0.16, authorized shares 100,000 at September 30, 2004 and 30,000 at December 31, 2003		2,539			2,533
Outstanding shares: 14,254 at September 30, 2004 and 15,547 at December 31, 2003
Additional paid-in capital		160,091			159,515
Accumulated other comprehensive income (loss)		(4,107	)		(4,865	)
Retained earnings		42,728			48,693
Treasury stock at cost, 1,640 shares at September 30, 2004 and 307 shares at December 31, 2003		(18,617	)		(5,282	)

		182,634			200,594

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	547,414		$	574,248

See notes to consolidated financial statements.

D&E Communications, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)


	Nine Months Ended September 30,
	2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES OF CONTINUING OPERATIONS	$	34,824		$	32,109

CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures, net of proceeds from sales		(16,554	)		(14,139	)
Proceeds from Conestoga Wireless and Paging sales		—			10,176
Increase in investments and advances to affiliates		(446	)		(1,199	)
Decrease in investments and repayments from affiliates		154			189

Net Cash Used In Investing Activities from Continuing Operations		(16,846	)		(4,973	)

CASH FLOWS FROM FINANCING ACTIVITIES
Dividends on common stock		(5,425	)		(5,546	)
Payments on long-term debt		(213,640	)		(12,364	)
Proceeds from long-term debt financing		210,000			12,000
Payment of debt issuance costs		(1,971	)		—
Proceeds from issuance of common stock		346			951
Purchase of treasury stock		(13,335	)		—

Net Cash Used In Financing Activities from Continuing Operations		(24,025	)		(4,959	)

CASH PROVIDED BY (USED IN) CONTINUING OPERATIONS		(6,047	)		22,177

CASH USED IN DISCONTINUED OPERATIONS
Cash Used in Operating Activities of Discontinued Operations		—			(20,553	)

Net Cash Used In Discontinued Operations		—			(20,553	)

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(6,047	)		1,624

CASH AND CASH EQUIVALENTS
BEGINNING OF PERIOD		12,446			15,514

END OF PERIOD	$	6,399		$	17,138

See notes to consolidated financial statements.

D&E Communications, Inc. and Subsidiaries

Consolidated Statements of Shareholders’ Equity and Comprehensive Income (Loss)

For the nine months ended September 30, 2004 and 2003

(in thousands)

(Unaudited)


	2004						2003
	Shares			Amount			Shares			Amount
COMMON STOCK
Balance at beginning of year		15,854		$	2,533			15,721		$	2,512
Common stock issued for Employee Stock Purchase and Dividend Reinvestment Plans		40			6			49			8
Common stock issued for stock options exercised		—			—			72			11

Balance at September 30		15,894			2,539			15,842			2,531

ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year					159,515						158,101
Common stock issued for Employee Stock Purchase and Dividend Reinvestment Plans					576						642
Common stock issued for stock options exercised					—						549

Balance at September 30					160,091						159,292

ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Balance at beginning of year					(4,865	)					(7,071	)
Unrealized gain on investments, net of tax					—						470
Unrealized gain (loss) on interest rate swap agreements, net of tax					758						(261	)

Balance at September 30					(4,107	)					(6,862	)

RETAINED EARNINGS
Balance at beginning of year					48,693						52,343
Net income (loss)					(304	)					1,627
Dividends on common stock: $0.38 per share for each period					(5,661	)					(5,794	)

Balance at September 30					42,728						48,176

TREASURY STOCK
Balance at beginning of year		(307	)		(5,282	)		(307	)		(5,282	)
Treasury stock acquired		(1,333	)		(13,335	)		—			—

Balance at September 30		(1,640	)		(18,617	)		(307	)		(5,282	)

TOTAL SHAREHOLDERS’ EQUITY		14,254		$	182,634			15,535		$	197,855


	Three months ended September 30,						Nine months ended September 30,
	2004			2003			2004			2003
COMPREHENSIVE INCOME (LOSS)
Net income (loss)	$	719		$	155		$	(304	)	$	1,627
Unrealized gain on investments, net of income taxes of $0, $0, $0 and $284		—			6			—			470
Unrealized gain (loss) on interest rate swap agreements, net of income taxes of ($44), $314, $516 and ($179)		(62	)		459			758			(261	)

Total comprehensive income	$	657		$	620		$	454		$	1,836

See notes to consolidated financial statements.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 1. Notes to Consolidated Financial Statements

(Dollars in thousands, except per-share amounts)

(Unaudited)

1. Basis of Presentation

The accompanying consolidated financial statements include the accounts of D&E Communications, Inc. and its wholly-owned subsidiaries. D&E Communications, Inc., including its subsidiary companies, is defined and referred to herein as D&E or the Company.

The accompanying financial statements are unaudited and have been prepared pursuant to generally accepted accounting principles and the rules and regulations of the United States Securities and Exchange Commission (SEC). In the opinion of management, the financial statements include all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the Company’s results of operations, financial position and cash flows for the periods presented. 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 SEC rules and regulations. The use of generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. D&E believes that the disclosures made are adequate to make the information presented not misleading. These financial statements should be read in conjunction with D&E’s financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2003. Operating results for the three and nine-month periods ended September 30, 2004 are not necessarily indicative of the results for the year ended December 31, 2004.

2. Stock Compensation

The Company accounts for stock compensation under the intrinsic value method of APB Opinion 25, “Accounting for Stock Issued to Employees” and related interpretations. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 1. Notes to Consolidated Financial Statements

(Dollars in thousands, except per-share amounts)

(Unaudited)


	Three months ended September 30,						Nine months ended September 30,
	2004			2003			2004			2003
Net income (loss), as reported	$	719		$	155		$	(304	)	$	1,627
Add: stock-based employee compensation included in reported net income (loss), net of related tax		—			—			—			—
Deduct: total stock-based employee compensation expense determined under fair value-based method, net of related tax		(13	)		(13	)		(38	)		(38	)

Pro forma net income (loss)	$	706		$	142		$	(342	)	$	1,589

Basic and diluted income (loss) per share:
As reported	$	0.05		$	0.01		$	(0.02	)	$	0.11
Pro forma	$	0.05		$	0.01		$	(0.02	)	$	0.10

The fair value of options granted and options converted at the Conestoga acquisition of $7.20 is estimated using the Black-Scholes option price model with the following assumptions, which have not changed because no options were granted in 2003 or in the first nine months of 2004. Employee Stock Purchase Plan purchases were made each month at a 10% discount from market price with separate Black-Scholes assumptions.


	Option Plan		Stock Purchase Plan
Dividend yield	2.55	%	4.28	%
Expected life	5 years		0.16 years
Expected volatility	60.30	%	10.00	%
Risk Free interest rate	4.47	%	1.00	%

3. Accounting Changes and Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 143, “Accounting for Asset Retirement Obligations” (“SFAS No. 143”). This Statement establishes accounting practices relating to legal obligations associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development or normal operation of a long-lived asset. SFAS No. 143 requires that companies recognize the fair value of a liability for asset retirement obligations in the period in which the legal obligations are incurred and capitalize that amount as a part of the book value of the long-lived asset. That cost is then depreciated over the remaining life of the underlying long-lived asset. D&E adopted SFAS No. 143 effective January 1, 2003 and recorded an after-tax benefit of $260 as a cumulative effect accounting adjustment in the first quarter 2003. The adjustment represents the cumulative estimate of cost of removal charged to depreciation expense in earlier years.

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities — An Interpretation of Accounting Research Bulletin (ARB) No. 51” (“FIN 46”). This

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 1. Notes to Consolidated Financial Statements

(Dollars in thousands, except per-share amounts)

(Unaudited)

interpretation clarifies how to identify variable interest entities (“VIEs”) and how a company should assess its interests in a variable interest entity to decide whether to consolidate the entity. In December 2003, the FASB issued (“FIN 46-R”), a revision to FIN 46 which among other things, defers the effective date of implementation for certain entities until the first interim or annual reporting period ending after March 15, 2004.

D&E has one significant variable interest entity through its ownership interest in EuroTel, L.L.C. (“EuroTel”). D&E owns a one-third investment in EuroTel, a domestic corporate joint venture. EuroTel holds a 100% investment in PenneCom, B.V. (“PenneCom”), an international telecommunications holding company, and holds a 27.85% investment in Pilicka, a telecommunications company located in Poland. D&E has participated in this joint venture since January 1997. EuroTel, PenneCom and Pilicka are referred to herein as our European affiliates.

D&E’s participation in this joint venture has been to provide working capital for the development of Pilicka’s telephone business in Poland and to manage EuroTel’s investments. EuroTel has assets of approximately $2,500, with no annual operating revenue. D&E’s maximum exposure to loss from its involvement in EuroTel is approximately $1,600 for investments, advances and current accounts receivable.

Based on the accounting guidance of FIN 46-R, D&E has determined it is not the primary beneficiary of this entity. According to the guidance of FIN 46-R, consolidation of EuroTel is not required and thus there is no effect on the Company’s financial position, results of operations and cash flows.

On December 8, 2003, a new law was enacted, “the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (the Act), which provides a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D.

In May 2004, the FASB issued Staff Position No. FSP FAS 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“FSP 106-2”). FSP 106-2 provides guidance on accounting for the effects of the new Medicare prescription drug benefit available to employers whose prescription drug benefits are at least actuarially equivalent to the drug benefit provided under Medicare Part D. FSP 106-2 is effective as of the first interim or annual period beginning after June 15, 2004. Based upon the evaluation of information available to date, D&E has concluded that the prescription drug benefits provided by its postretirement health care plans are not actuarially equivalent to benefits available through Medicare Part D under the Act. Accordingly, the accumulated postretirement benefit obligation and the net periodic postretirement benefit cost reported in the financial statements and the accompanying notes do not reflect any effect of the federal subsidy provided by the Act.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 1. Notes to Consolidated Financial Statements

(Dollars in thousands, except per-share amounts)

(Unaudited)

4. Earnings per Share

Basic earnings per share amounts are based on income divided by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share amounts are based on income divided by the weighted average number of shares of common stock outstanding during the period after giving effect to dilutive common stock equivalents from assumed conversions of employee stock options. Options to purchase 55,104, 59,500, 221,358 and 70,104 shares for the three months and nine months ended September 30, 2004 and 2003, respectively, were not included in the computation of earnings per share assuming dilution because their effect on earnings per share would have been antidilutive. The following table shows how earnings per share were computed for the periods presented:


	Three months ended September 30,				Nine months ended September 30,
	2004		2003		2004			2003
Basic earnings (loss) per share computation
Income (loss) from continuing operations	$	719	$	155	$	(304	)	$	1,420
Income (loss) from discontinued operations		—		—		—			(53	)
Cumulative effect of accounting change		—		—		—			260

Net income (loss)	$	719	$	155	$	(304	)	$	1,627

Weighted average shares (thousands)		14,867		15,522		15,325			15,465

Basic earnings (loss) per share
Income (loss) from continuing operations	$	0.05	$	0.01	$	(0.02	)	$	0.09
Income (loss) from discontinued operations		0.00		0.00		0.00			0.00
Cumulative effect of accounting change		0.00		0.00		0.00			0.02

Net income (loss) per common share	$	0.05	$	0.01	$	(0.02	)	$	0.11

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 1. Notes to Consolidated Financial Statements

(Dollars in thousands, except per-share amounts)

(Unaudited)


	Three months ended September 30,				Nine months ended September 30,
	2004		2003		2004			2003
Diluted earnings (loss) per share computation
Income (loss) from continuing operations	$	719	$	155	$	(304	)	$	1,420
Income (loss) from discontinued operations		—		—		—			(53	)
Cumulative effect of accounting change		—		—		—			260

Net income (loss)	$	719	$	155	$	(304	)	$	1,627

Weighted average shares (thousands)		14,867		15,522		15,325			15,465
Plus incremental shares from assumed stock option exercises (thousands)		43		69		—			61

Adjusted weighted average shares (thousands)		14,910		15,591		15,325			15,526

Diluted earnings (loss) per share
Income (loss) from continuing operations	$	0.05	$	0.01	$	(0.02	)	$	0.09
Income (loss) from discontinued operations		0.00		0.00		0.00			0.00
Cumulative effect of accounting change		0.00		0.00		0.00			0.02

Net income (loss) per common share	$	0.05	$	0.01	$	(0.02	)	$	0.11

5. Intangible Assets

The intangible assets and related accumulated amortization recorded on the Company’s balance sheets are as follows:


	September 30, 2004			December 31, 2003
Indefinite-lived intangibles:
Franchises	$	104,800		$	104,800
FCC licenses		828			828
Finite-lived intangibles:
Customer relationships:
Gross carrying amount		75,700			75,700
Accumulated amortization		(12,865	)		(8,729	)
Trademarks and trade names:
Gross carrying amount		1,200			1,200
Accumulated amortization		(933	)		(633	)
Non-compete agreements:
Gross carrying amount		1,424			1,424
Accumulated amortization		(1,209	)		(996	)

Net intangible assets	$	168,945		$	173,594

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 1. Notes to Consolidated Financial Statements

(Dollars in thousands, except per-share amounts)

(Unaudited)

Aggregate amortization expense related to these intangible assets recorded for the three months ended September 30, 2004 and 2003 and the nine months ended September 30, 2004 and 2003, was $1,550, $1,550, $4,649 and $4,649, respectively.

The following table shows estimated amortization expense for each of the five years ended December 31:


Year	Amount
2004	$	6,198
2005		5,824
2006		5,513
2007		5,513
2008		5,513

Goodwill decreased $82 as a result of a reduction in a valuation allowance on deferred tax assets recognized in connection with the Conestoga acquisition.

6. Discontinued Operations

D&E Wireless

D&E owned a fifty percent partnership interest in PCS ONE. On April 1, 2002, D&E consummated the sale of PCS ONE.

During the three-month period ended March 31, 2003, D&E paid $20,500 in taxes related to gain on sale of PCS ONE which are included in cash used in operating activities of discontinued operations in the statement of cash flows.

Paging Services

During the third quarter of 2002, D&E committed to a plan to sell the assets of Conestoga Mobile Systems’ ($205) and D&E’s paging operations ($10). As such, the assets were reported as held for sale and the results of operations were reported in discontinued operations in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The assets were not depreciated while they were held for sale. In January 2003, we entered into an agreement to sell our paging operations’ assets for $215. The transaction closed for $171 on May 29, 2003. The final selling price was less than anticipated and resulted in a $29 net of tax asset impairment. This was caused by a smaller customer base on the date of sale than anticipated when the agreement was entered into. No liabilities were included as part of the sale.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 1. Notes to Consolidated Financial Statements

(Dollars in thousands, except per-share amounts)

(Unaudited)

Summarized income statement information for the discontinued operations of the paging services were as follows:


	Three months ended September 30,				Nine months ended September 30,
	2004		2003		2004		2003
Revenues	$	—	$	—	$	—	$	236
Expenses		—		—		—		316

Operating loss		—		—		—		(80	)
Income taxes (benefit)		—		—		—		(27	)

Loss from paging operations, net of income tax benefit	$	—	$	—	$	—	$	(53	)

7. Investments in Affiliated Companies

D&E owns a one-third investment in EuroTel, a domestic corporate joint venture. EuroTel holds a 100% investment in PenneCom, B.V. (PenneCom), an international telecommunications holding company, and also holds a 27.85% investment in Pilicka, a telecommunications company located in Poland. D&E also owns a 28.88% direct investment in Pilicka. D&E accounts for both its investment in EuroTel and its investment in Pilicka using the equity method of accounting.

In July 2002, EuroTel’s subsidiary, PenneCom, initiated a legal action against an investment bank and an individual, alleging violations of applicable law relating to the advice given by the investment bank and the individual to a prospective buyer not to close on the purchase of Pilicka. On June 28, 2004, the Second Circuit Court of Appeals rejected an order of the United States District Court for the Southern District of New York, which earlier had dismissed the case. Management of EuroTel continues to believe that, based on the advice of its legal counsel, the suit is meritorious. However, the ultimate outcome of the litigation cannot be determined and no amount has been recognized for possible collection of any claims in the litigation. Legal costs are expected to continue to be incurred on a contingency basis in pursuit of such litigation.

The summarized results of operations of EuroTel were as follows:


	Three months ended September 30,						Nine months ended September 30,
	2004			2003			2004			2003
Net sales	$	—		$	—		$	—		$	—
Net loss		(921	)		(798	)		(1,863	)		(2,676	)
D&E’s share of loss		(307	)		(266	)		(621	)		(892	)

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 1. Notes to Consolidated Financial Statements

(Dollars in thousands, except per-share amounts)

(Unaudited)

The summarized results of operations of Pilicka were as follows:


	Three months ended September 30,						Nine months ended September 30,
	2004			2003			2004			2003
Net sales	$	2,995		$	2,579		$	8,388		$	7,562
Net loss		(528	)		(450	)		(1,577	)		(2,188	)
D&E’s share of loss		(153	)		(130	)		(456	)		(632	)
Investment amortization		(116	)		(117	)		(349	)		(349	)
Total loss		(269	)		(247	)		(805	)		(981	)

8. Long-Term Debt

The following table sets forth the total long-term debt outstanding:


	Average Interest Rate		Maturity	September 30, 2004
Senior Secured Revolving Credit Facility	4.37	%	2011	$	10,000
Senior Secured Term Loan B	5.42	%	2011		147,314
Senior Secured Term Loan A	4.32	%	2011		37,811
Secured Term Loan	9.34	%	2014		20,000
Secured Term Loan	9.36	%	2014		15,000

					230,125
Less current maturities					9,125

Total long-term debt				$	221,000

On March 5, 2004, D&E completed a syndicated senior secured debt financing in the amount of $260,000 jointly arranged by CoBank, ACB and SunTrust Bank. The credit facilities are in the form of a $25,000 revolving line of credit, Term Loan A in the amount of $50,000, Term Loan B in the amount of $150,000, and the assumption of $35,000 of term indebtedness of a D&E subsidiary. The $200,000 of proceeds received related to the term loans of the new credit facilities were used to refinance our indebtedness under prior credit facilities and for general corporate purposes. D&E incurred a loss on the early extinguishment of debt of $4,841, consisting of a non-cash write-off of $4,628 of unamortized debt issuance costs of the previous credit facility and the expensing of $213 of debt issuance costs related to the new credit facility. D&E capitalized approximately $1,859 of debt issuance costs related to the new credit facility, which will be amortized into interest expense over the life of the new credit facility. On March 31, 2004, D&E began making quarterly scheduled payments of $1,625 on the new credit facility. In May 2004, D&E made a voluntary prepayment of $10,000 of which $8,439 and $1,561 was applied to Term Loan A and Term Loan B, respectively. On August 13, 2004 D&E borrowed $10,000 on the revolving credit facility to partially fund the acquisition of treasury stock. See Note 12.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 1. Notes to Consolidated Financial Statements

(Dollars in thousands, except per-share amounts)

(Unaudited)

On June 8, 2004, a capital lease obligation of $2,613 was eliminated in connection with the purchase of an office building previously held under a capital lease arrangement. The transaction did not impact the results of operations for the period.

9. Commitments and Contingencies

On May 24, 2002, pursuant to the merger agreement with Conestoga, D&E assumed Conestoga’s obligations under a Build-to-Suit agreement (“BTS”) with Mountain Union Telecom LLC (“Mountain Union”). The obligations related to the construction of 20 wireless tower sites for Conestoga’s wireless subsidiary, Conestoga Wireless Company (“CWC”). In November 2002, D&E entered into an asset purchase agreement (the “Asset Purchase Agreement”) with Keystone Wireless LLC (“Keystone Wireless”) for the sale of CWC. Although D&E sold the assets of this business, its obligations under the BTS were not assumed by Keystone Wireless. Under the BTS, D&E is obligated to work with Mountain Union to find and develop 20 wireless tower sites and, in the event its obligations under the BTS are not timely fulfilled, is obligated to pay a penalty to Mountain Union for nonperformance. Under the Asset Purchase Agreement, Keystone is obligated to enter into long-term operating leases for antenna space on up to 15 of the towers erected under the BTS, including the nine transferred to Keystone Wireless at the closing of the sale transaction. In 2003, D&E paid Mountain Union $700 for its BTS obligation due for seven wireless tower sites that definitely would not be constructed. In July 2004, D&E paid Mountain Union $200 for an additional two tower sites that would not be constructed. Under the terms of the Asset Purchase Agreement, Keystone is obligated to reimburse D&E for one-half of the penalties paid under the BTS, not to exceed $125. Because the underlying assets of CWC were sold under the Asset Purchase Agreement, D&E has considered any remaining obligations and potential penalties under the BTS a contingent liability. As of September 30, 2004, D&E has recorded $200 for its remaining commitment under the BTS as the potential cost or penalty for the two remaining sites. Zoning approval has been received for the two sites and we anticipate that construction will begin in the near future. Keystone Wireless has committed to lease space on both sites. Under the Asset Purchase Agreement, D&E is obligated to pay the cost of equipping one tower, using some of the equipment transferred to Keystone Wireless in the sale, and one-half of the cost, up to $62.5 for the second.

As part of the Company’s acquisition of Conestoga, D&E assumed a guarantee agreement with Mountain Union for the lease obligations on the wireless tower sites of Conestoga’s wireless subsidiary. When D&E entered into the Asset Purchase Agreement with Keystone Wireless, whereby Keystone Wireless was assigned the responsibility for the leases, Mountain Union declined to release D&E from its guarantee. In the event of a default by Keystone Wireless, D&E continues to guarantee the wireless tower site lease payments, which cover a 10-year period beginning on the commencement date of the lease of each tower. As such, the guarantee is a continuing guarantee provided on an individual tower site basis. The lease payments start at $1.5 per site per month, with provision for an increase of 4% per year. The maximum potential amount of undiscounted future payments that D&E could be required to make under the guarantee as of September 30, 2004 is $13,636. The majority of these tower site leases and our guarantee will expire between 2011 and 2013. As of September 30, 2004, D&E has recorded a liability for the lease guarantees of $3,200. D&E will recognize release from risk for the guarantee upon expiration or settlement of the guarantee.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 1. Notes to Consolidated Financial Statements

(Dollars in thousands, except per-share amounts)

(Unaudited)

10. Employee Benefit Plans

The costs for the Company’s pension plans and postretirement benefits other than pensions consisted of the following components:


	Pension Benefits						Postretirement Benefits
	Three months ended September 30,
	2004			2003			2004			2003
Components of Net Periodic Benefit Cost:
Service Cost	$	566		$	450		$	23		$	28
Interest Cost		881			728			44			55
Expected Return on plan assets		(868	)		(736	)		(7	)		(9	)
Amortization of initial net obligation		—			—			3			4
Amortization of prior service cost		(17	)		3			—			—
Amortization of net (gain) loss		256			153			11			17

Net periodic benefit cost	$	818		$	598		$	74		$	95


	Pension Benefits						Postretirement Benefits
	Nine months ended September 30,
	2004			2003			2004			2003
Components of Net Periodic Benefit Cost:
Service Cost	$	1,698		$	1,564		$	105		$	78
Interest Cost		2,643			2,514			208			153
Expected Return on plan assets		(2,604	)		(2,548	)		(33	)		(25	)
Amortization of initial net obligation		—			—			15			12
Amortization of prior service cost		(51	)		11			—			—
Amortization of net (gain) loss		768			525			53			47

Net periodic benefit cost	$	2,454		$	2,066		$	348		$	265

As of September 30, 2004, D&E contributed $2,163 to its defined benefit pension plans and has contributed $0 to its other postretirement benefit plan. The Company does not expect to make any additional contributions in 2004. D&E provides an opportunity for grandfathered retiring members of the Pension Plan for Employees of Buffalo Valley and the Pension Plan for Members of Local 1671, Conestoga Telephone & Telegraph Company, to purchase health care benefits under the Company’s fully-insured plan. Members of these Plans who elect to continue their coverage at retirement pay 100% of the applicable premiums. D&E also provides an opportunity for grandfathered retiring members of the Conestoga Telephone & Telegraph Company Pension Plan for non-union employees to purchase health care benefits under the Company’s fully-insured plan. The Company pays 50% of the premium for members of this Plan who elect to continue coverage at retirement. On July 21, 2004 the Company decided to discontinue offering these benefits to non-union grandfathered employees who will not be eligible to retire with these health benefits by June 30, 2005. As a result of this amendment to the postretirement plans, the Company’s accumulated postretirement benefit obligation decreased by approximately $1,310 and the postretirement benefits expense will decrease by $130 from August through December 2004.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 1. Notes to Consolidated Financial Statements

(Dollars in thousands, except per-share amounts)

(Unaudited)

11. Sales Tax

On July 15, 2004, D&E entered into a Stipulation for Judgment with the Commonwealth of Pennsylvania to settle a request for refund of sales taxes. On August 11, 2004, D&E received the refund, which amounted to $602 after deduction of legal fees. The refund was a reduction of general and administrative expenses of approximately $449 and interest income of approximately $153.

12. Treasury Stock

D&E entered into an agreement with Citizens Communications Company under which D&E purchased 1,333,500 shares of its common stock from Citizens, or approximately 8.56% of the outstanding shares of common stock of D&E. The negotiated repurchase also terminated a 1997 Stock Acquisition Agreement pursuant to which an affiliate of Citizens originally acquired 1,300,000 shares of D&E stock. Under that agreement, Citizens was required, among other things, to provide D&E with an opportunity to purchase the shares subject to the agreement prior to selling those shares generally. On August 13, 2004, D&E used cash on hand, plus $10,000 borrowed on its revolving credit facility, to fund the acquisition of treasury stock at a price of $10.00 per share.

13. Business Segment Data

Our segments, excluding the Paging segment, which is reported as a discontinued segment, are RLEC, CLEC, Internet Services and Systems Integration. In the fourth quarter of 2003, D&E moved responsibility for certain products to different segment managers. Certain amounts for prior years have been reclassified to conform to the current presentation. Conestoga Wireless revenue of $460 and an operating loss of $380 for the two weeks of operations in 2003 are included in Corporate, Other and Eliminations. The measure of profitability that management uses to evaluate performance of our business segments is operating income.

Financial results for D&E’s business segments are as follows:


	External Revenues				Intersegment Revenues						Operating Income (Loss)
	Three months ended September 30,				Three months ended September 30,						Three months ended September 30,
Segment	2004		2003		2004			2003			2004			2003
RLEC	$	24,691	$	26,698	$	2,406		$	1,853		$	6,426		$	8,214
CLEC		9,212		8,761		389			219			(837	)		(1,156	)
Internet Services		2,565		1,543		4			154			97			(167	)
Systems Integration		6,223		5,485		18			7			(1,096	)		(1,065	)
Corporate, Other and Eliminations		1,001		544		(2,817	)		(2,233	)		(130	)		(528	)

Total	$	43,692	$	43,031	$	—		$	—		$	4,460		$	5,298

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 1. Notes to Consolidated Financial Statements

(Dollars in thousands, except per-share amounts)

(Unaudited)


	External Revenues				Intersegment Revenues						Operating Income (Loss)
	Nine months ended September 30,				Nine months ended September 30,						Nine months ended September 30,
Segment	2004		2003		2004			2003			2004			2003
RLEC	$	75,846	$	78,904	$	7,069		$	5,886		$	21,200		$	24,784
CLEC		26,998		25,844		1,015			544			(2,468	)		(3,023	)
Internet Services		7,601		4,558		15			474			198			(185	)
Systems Integration		18,595		16,882		42			22			(3,416	)		(3,379	)
Corporate, Other and Eliminations		2,552		2,215		(8,141	)		(6,926	)		(849	)		(1,229	)

Total	$	131,592	$	128,403	$	—		$	—		$	14,665		$	16,968


	Segment Assets
Segment	September 30, 2004			December 31, 2003
RLEC	$	478,044		$	482,765
CLEC		63,691			64,415
Internet Services		3,164			3,086
Systems Integration		20,690			20,572
Corporate, Other and Eliminations		(18,175	)		3,410

Total	$	547,414		$	574,248

The following table shows a reconciliation of the results for the business segments to the applicable line items in the consolidated financial statements as follows:


	Three months ended September 30,						Nine months ended September 30,
	2004			2003			2004			2003
Operating income from reportable segments	$	4,590		$	5,826		$	15,514		$	18,197
Corporate, other and eliminations		(130	)		(528	)		(849	)		(1,229	)
Equity in net losses of affiliates		(576	)		(513	)		(1,426	)		(1,873	)
Interest expense		(3,456	)		(4,492	)		(10,947	)		(13,689	)
Loss on early extinguishment of debt		—			—			(4,841	)		—
Other, net		346			(6	)		1,339			922

Income (loss) from continuing operations before income taxes and dividends on utility preferred stock	$	774		$	287		$	(1,210	)	$	2,328

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

Overview

This Overview is intended to provide a context for the following Management’s Discussion and Analysis of Financial Condition and Results of Operation. Management’s Discussion and Analysis of Financial Condition and Results of Operation should be read in conjunction with our unaudited consolidated financial statements, including the notes thereto, included in this quarterly report on Form 10-Q, as well as our audited consolidated financial statements for the year ended December 31, 2003, as filed on Form 10-K with the SEC. We have attempted to identify the most important matters on which our management focuses in evaluating our financial condition and operating performance and the short-term and long-term opportunities, challenges and risks (including material trends and uncertainties) which we face. We also discuss the actions we are taking to address these opportunities, challenges and risks. The Overview is not intended as a summary of, or a substitute for review of, Management’s Discussion and Analysis of Financial Condition and Results of Operation. For comparative purposes, certain amounts have been reclassified to conform to the current-year presentation. The reclassifications had no impact on net income. Monetary amounts presented in the following discussion are in thousands, except per share amounts.

Business Segments

We operate as a rural local telephone company providing integrated communications services to residential and business customers in markets throughout the eastern half of Pennsylvania. We operate an incumbent rural local exchange carrier, or RLEC, in parts of Berks, Lancaster, Union and smaller portions of five other adjacent counties in Pennsylvania, and a competitive local telephone company, or CLEC, in the Lancaster, Harrisburg, Reading, Altoona, Pottstown, State College and Williamsport, Pennsylvania metropolitan areas, which we refer to as our “edge-out” markets. We offer our customers a comprehensive package of communications services including local and long distance telephone services, high speed data, Internet access and video services. We also provide business customers with integrated voice and data network solutions.

Our segments are RLEC, CLEC, Internet Services, and Systems Integration. The measure of profitability that management uses to evaluate performance of our business segments is operating income because individual segment managers are not responsible for such items as interest and taxes that are reported below operating income.

As of September 30, 2004, we served 140,243 RLEC access lines, 37,398 ⁽¹⁾ CLEC access lines, 12,071 dial-up Internet access subscribers, 10,008 digital subscriber lines (“DSL”) and 901 web hosting customers. For the quarter ended September 30, 2004, we generated total revenues of $43,692 and operating income of $4,460.

⁽¹⁾

The number of CLEC lines reported in this report has been adjusted cumulatively to include 110 lines as of December 31, 2003, 362 as of March 31, 2004, and 700 lines as of June 30, 2004 associated with one customer which were not included in our CLEC access line counts for the previous periods, beginning in the fourth quarter of 2003.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

Historically, we have derived a majority of our revenues from the regulated RLEC segment. The RLEC segment external revenues account for approximately 57% of the total third quarter 2004 consolidated revenues and substantially all of our operating income. The decrease in RLEC access lines experienced since 2002 is significant, as access lines have traditionally been monitored as an important measure of RLEC performance. Our total RLEC lines continued to decrease during the third quarter of 2004. The decreases have been primarily due to the fact that, customers have migrated second lines to broadband services, such as DSL. Additionally, customers transferring to wireless services decrease the demand for first and second lines. We believe the fact that we have succeeded in adding Internet service customers at a substantial rate over the past three years demonstrates that our customers are willing to pay for enhanced services. The opportunity to provide such services is an important component of our business plan.

Business Strategy

Our primary business objective is to be a leading, regional wireline-focused integrated communications service provider. To achieve this objective, we will continue to pursue the following goals:

•

We will continue to operate under a disciplined strategy to increase our market share in our edge-out markets by offering competitive communication service packages primarily to business customers. We will continue to leverage our modern network infrastructure, established reputation, extensive local knowledge and significant operating experience to attempt to gain new customers and increase our market share in our edge-out markets.

•

We will endeavor to be a single source provider of voice, video and data communications services to our business customers. We believe that the convergence and complexity of voice communications and data network technologies has increased the need for businesses to seek a single provider for all of their communications and data networking needs. Our systems integration business enhances our service offerings, and we believe bundling of video, DSL and voice is a key part of the strategy to grow revenue and strengthen customer relationships while providing increased value.

•

We will make efforts to further expand our market share of the Internet services market by meeting or exceeding the customer service and technical requirements of individual and business customers. While we intend to maintain our dial-up Internet access customer base, we also plan to leverage our success and further focus our sales and marketing efforts on selling our high speed data and related services.

•

We will offer a broad array of enhanced telephone services to our customers that improve our general customer experience, thereby helping to retain customers.

•

We will continue to make our commitment to customer service a top priority. Customer service, provided 24 hours a day, 7 days a week and 365 days a year, strengthens our relationships with our customers and enhances our competitive position.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

•

We will consider increasing the scale and scope of our business through acquisitions of companies, including other RLECs that strategically fit with our integrated communications strategy. Acquisition targets may include companies that deepen our industry focus, broaden service territories and increase the breadth of our services.

Business Risks

Our primary business risks include the external threat of increased competition in the telecommunications industry and the internal risk of our debt financing, which was primarily incurred in connection with the acquisition of Conestoga in 2002.

•

Risk of increased competition

It is basic policy of the Federal Communications Commission (“FCC”) and the Pennsylvania Public Utility Commission to encourage competition in the communications industry. The limited suspension that we held until January 2003 from certain interconnection requirements of the Telecommunications Act of 1996 (“TA-96”) has been discontinued. Since we did not receive additional extensions of this suspension, competitors are allowed to seek removal of our rural exemption for the purposes of entering our territory and using our services and facilities through interconnection agreements to provide competitive services.

The convergence of voice and data communication technologies is dramatically changing the communications industry. For several years, telephone and cable companies have been able to provide data transmission, with telephone companies having the advantage in voice and cable companies having the advantage in video. Technology may be eliminating those advantages. The further development of voice over Internet protocol (“VoIP”) is changing voice communication to a packet data transmission process. This enables cable companies, ISPs and new start-ups who need no facilities whatsoever, to compete with telephone companies for voice services and phone features like voicemail and unified communications. Furthermore, uncertainty in regulation of VoIP offerings at this time, places VoIP at a possible regulatory advantage over legacy telephone services. The FCC has ruled that VoIP services such as those offered by Pulver.com are not telecommunications services and should be subject to minimal regulation. In a related matter, however, the FCC has denied AT&T’s petition claiming that its service is an information service not subject to access charges. Additionally, the FCC has issued a Notice of Proposed Rulemaking to investigate the appropriate regulatory treatment of VoIP services. To maintain and grow our voice communication business, we are planning to introduce VoIP offerings into our marketplace. Our VoIP initiatives will drive converged services and networks to produce operational efficiencies. In certain markets, we are now able to offer video service over our fiber-copper network that competes with the video services offered by the cable companies.

Adding to the complexity of the competitive environment, wireless offerings in voice and data are becoming more capable and competitive; and technology has been developed that will enable electric power transmission lines to compete in the communications industry. In the future, service offerings of telephone, cable and electric power lines in voice, data and video may be similar, while wireless is a significant provider in voice and data. All of these developments will result in an even more highly competitive environment in which four types of companies are very likely to be in direct competition with each other in many locations. This development could cause telephone companies to lose their competitive edge in their territories and consequently result in significant inroads into their core telephone/voice business.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

In April 2004, the 9^th Circuit Court of Appeals refused to review its previous decision that cable modem service was in part a telecommunications service. In its previous decision, the 9^th Circuit determined that the FCC was wrong when it classified cable modem service as an information service. The 9^th Circuit granted a stay of its decision pending Supreme Court review. As telecommunications service providers, cable operators may have to make their networks available to other ISPs and also may have to contribute to the Universal Service Fund. This development could result in negative impacts on our cable TV operation.

The competitive threat posed by the convergence of technologies makes our commitment to customer service even more critical to the protection of our competitive position. We are a local company with local connections that can give individual personalized service. We are also able to provide an individual response to customer services needs. We feel that this responsiveness will be critical to our future operations. It may be a challenge to successfully convince both our business and residential customers to see us as their “preferred provider” of integrated communications services, particularly in light of the substantially greater resources of many of our competitors.

The foregoing opportunities and risks require management to attempt to balance several aspects of our business. Our relatively stable RLEC business segment provides cash flow both to pursue our business plan to evolve into a leading, regional wireline-focused integrated communications service provider and to provide a current return on investment to our shareholders in the form of the dividend that we have historically paid. However, since our resources are limited and the manner in which the communications industry will develop is uncertain, both in terms of technology and regulation, we will not be able to pursue every possible avenue of development and critical decisions will need to be made at various stages of our evolution as a company. These decisions can be made more difficult by our desire to balance our short-term goals of maintaining our RLEC business segment and dividend return and our long-term goal of providing voice, data and video services. Maintaining our dividend payout may be challenging due to the need to make continuing capital investments and restrictions under our financing facilities, both in the form of an annual limitation of $10,000 in dividends and the requirement to remain in compliance with financial covenants.

•

Risk of debt financing

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

We have recently refinanced our indebtedness. The effect of the refinancing was to lower the interest rates on our indebtedness, provide greater flexibility in our financial covenants and spread out the scheduled amortization of principal. The refinancing also lifts restrictions on the expansion of our CLEC edge-out market and eliminates the requirement of the prior loan agreement that excess cash flow be applied to prepayments of principal. This new structure, concluded to manage our balance sheet in order to better pursue our business plan, decreases the risks associated with our indebtedness. However, our indebtedness of approximately $230,125 as of September 30, 2004 could restrict our operations because:

•

We will use a substantial portion of our cash flow from operations to pay principal and interest on our indebtedness, which will reduce the funds available for working capital, capital expenditures, acquisitions and other general corporate purposes.

•

The level of indebtedness will make us more vulnerable to economic or industry downturns, and our debt service obligations increase our vulnerability to competitive pressures, as we may be more leveraged than many of our competitors.

Results of Operations

The following table is a summary of our operating results by segment for the three months ended September 30, 2004 and 2003. In the fourth quarter of 2003, D&E moved responsibility for certain products to different segment managers. Certain amounts for prior years have been reclassified to conform to the current presentation. The reclassifications had no impact on total operating income.


Three months ended	RLEC		CLEC			Internet Services			Systems Integration			Corporate, Other and Eliminations			Total Company
September 30, 2004
Revenues – External	$	24,691	$	9,212		$	2,565		$	6,223		$	1,001		$	43,692
Revenues – Intercompany		2,406		389			4			18			(2,817	)		—

Total Revenues		27,097		9,601			2,569			6,241			(1,816	)		43,692

Depreciation and Amortization		7,716		1,041			280			443			244			9,724
Other Operating Expenses		12,955		9,397			2,192			6,894			(1,930	)		29,508

Total Operating Expenses		20,671		10,438			2,472			7,337			(1,686	)		39,232

Operating Income (Loss)	$	6,426	$	(837	)	$	97		$	(1,096	)	$	(130	)	$	4,460

September 30, 2003
Revenues – External	$	26,698	$	8,761		$	1,543		$	5,485		$	544		$	43,031
Revenues – Intercompany		1,853		219			154			7			(2,233	)		—

Total Revenues		28,551		8,980			1,697			5,492			(1,689	)		43,031

Depreciation and Amortization		7,991		1,011			207			375			61			9,645
Other Operating Expenses		12,346		9,125			1,657			6,182			(1,222	)		28,088

Total Operating Expenses		20,337		10,136			1,864			6,557			(1,161	)		37,733

Operating Income (Loss)	$	8,214	$	(1,156	)	$	(167	)	$	(1,065	)	$	(528	)	$	5,298

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

The following table is a summary of our operating results by segment for the nine months ended September 30, 2004 and 2003. The 2003 Corporate, Other and Eliminations amounts include Conestoga Wireless revenue of $460 and a $380 operating loss for the two weeks before its sale in January 2003.


Nine months ended	RLEC		CLEC			Internet Services			Systems Integration			Corporate, Other and Eliminations			Total Company
September 30, 2004
Revenues – External	$	75,846	$	26,998		$	7,601		$	18,595		$	2,552		$	131,592
Revenues – Intercompany		7,069		1,015			15			42			(8,141	)		—

Total Revenues		82,915		28,013			7,616			18,637			(5,589	)		131,592

Depreciation and Amortization		23,258		3,168			784			1,428			705			29,343
Other Operating Expenses		38,457		27,313			6,634			20,625			(5,445	)		87,584

Total Operating Expenses		61,715		30,481			7,418			22,053			(4,740	)		116,927

Operating Income (Loss)	$	21,200	$	(2,468	)	$	198		$	(3,416	)	$	(849	)	$	14,665

September 30, 2003
Revenues – External	$	78,904	$	25,844		$	4,558		$	16,882		$	2,215		$	128,403
Revenues – Intercompany		5,886		544			474			22			(6,926	)		—

Total Revenues		84,790		26,388			5,032			16,904			(4,711	)		128,403

Depreciation and Amortization		23,716		2,980			608			1,215			253			28,772
Other Operating Expenses		36,290		26,431			4,609			19,068			(3,735	)		82,663

Total Operating Expenses		60,006		29,411			5,217			20,283			(3,482	)		111,435

Operating Income (Loss)	$	24,784	$	(3,023	)	$	(185	)	$	(3,379	)	$	(1,229	)	$	16,968

Consolidated Operations

Three months ended September 30, 2004 compared to three months ended September 30, 2003

Consolidated operating revenues from continuing operations increased $661, or 1.5%, to $43,692 for the quarter ended September 30, 2004, from $43,031 in the same period of 2003. The increase was primarily due to growth in sales of dedicated data circuits and leased facilities in our RLEC and CLEC segments of approximately $669 and increased directory revenue of $291 offset by a $462 decrease in long distance revenue.

Consolidated operating income from continuing operations decreased $838, to $4,460, for the third quarter of 2004, from $5,298 in the same period of 2003. Operating income as a percentage of revenue decreased to 10.2% in the third quarter of 2004 compared to 12.3% in the same period of 2003. The change was primarily attributable to cost increases, including wage and benefits costs of $1,007 and directory expense of $166, which more than offset the increased revenues described above. Employee costs were lower in the RLEC, but increased in all other segments. The video service trial we have been conducting, which is reported as part of the corporate and other amounts, also contributed to the decrease in operating profit.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

Other income and expense was a net expense of $3,686 in the third quarter of 2004 compared to a net expense of $5,011 in the same period of 2003. Our equity in the losses of our European affiliates increased to $576 in the third quarter of 2004 from $513 in the same period of 2003. Interest expense decreased to $3,456 in the third quarter of 2004, compared to $4,492 in the same period of 2003. Other, net was an income of $346 in 2004 compared to expense of $6 in 2003 primarily due to $167 of interest income received on a quarterly basis in 2004 from the note received from the sale of the assets of Conestoga Wireless and from $153 of interest income received with a sales tax refund.

Income taxes were $39 in the third quarter of 2004 compared to $116 in the same period of 2003. Income taxes were reduced in 2004 primarily due to tax benefits from state net operating losses and adjustments of our prior year tax provisions to the returns. Our net income was $719, or $0.05 per share, in the third quarter of 2004 compared to $155, or $0.01 per share, in the third quarter of 2003.

Nine months ended September 30, 2004 compared to nine months ended September 30, 2003

Consolidated operating revenues from continuing operations increased $3,189, or 2.5%, to $131,592 for the nine months ended September 30, 2004, from $128,403 in the same period of 2003. The increase was due to growth in sales of dedicated data circuits and leased facilities in our RLEC and CLEC segments of approximately $1,845, increased directory revenue of $1,039, and increased professional services revenue of approximately $1,282 in the Systems Integration segment. The sale of assets of Conestoga Wireless in January 2003, resulted in decreased revenue of $460 for the nine months of 2004 versus 2003.

Consolidated operating income from continuing operations decreased $2,303, to $14,665, for the first nine months of 2004, from $16,968 in the same period of 2003. Operating income as a percentage of revenue decreased to 11.1% in the first nine months of 2004 compared to 13.2% in the same period of 2003. The change was primarily attributable to cost increases, including wage and benefits costs of $2,494, directory expense of $857 and subcontracted labor of $985 in the Systems Integration segment, which more than offset the increased revenues described above. Employee costs were lower in the RLEC, but increased in all other segments. The video service trial we have been conducting, which is reported as part of corporate and other amounts, also contributed to the decrease in operating profit.

Other income and expense was a net expense of $15,875 in the first nine months of 2004 compared to a net expense of $14,640 in the same period of 2003. Our equity in the losses of our European affiliates decreased to $1,426 in the first nine months of 2004 from $1,873 in the same period of 2003. Interest expense decreased to $10,947 in the first nine months of 2004, compared to $13,689 in the same period of 2003. A $4,841 loss on early extinguishment of debt was incurred as a result of the refinancing of our long-term debt on March 5, 2004. This amount included a one-time non-cash charge of $4,628 from writing off deferred financing costs related to a May 2002 credit facility and $213 of one-time cash expense related to bank fees incurred to arrange the refinanced

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

credit facility which were not able to be capitalized. The remaining $2,760 of unamortized costs from the May 2002 credit facility, in addition to the debt issuance costs of $1,859 for the March 2004 refinanced credit facility were capitalized and will be amortized over the life of the new credit facility.

Income taxes were a benefit of $955 in the first nine months of 2004, compared to an expense of $859 in the same period of 2003, as a result of the current year tax loss, primarily due to refinancing costs, versus pretax income in the prior year, and as a result of tax benefits from state net operating losses and adjustments of our prior year tax provisions to the returns. Our net loss was $304, or $0.02 per share, in the first nine months of 2004, including the approximate $2,954, or $0.19 per share, after-tax loss on early extinguishment of debt, compared to a net income of $1,627, or $0.11 per share, in the first nine months of 2003, which included a $260, or $0.02 per share gain, on the cumulative effect of a change in accounting principle.

RLEC Segment Results


	Three months ended September 30,
	2004		2003		Change			% Change
Revenues:
Local Telephone Service	$	8,386	$	8,551	$	(165	)	(1.9	)
Network Access		13,240		14,102		(862	)	(6.1	)
Other		5,471		5,898		(427	)	(7.2	)

Total Revenues		27,097		28,551		(1,454	)	(5.1	)

Depreciation and Amortization		7,716		7,991		(275	)	(3.4	)
Other Operating Expenses		12,955		12,346		609		4.9

Total Operating Expenses		20,671		20,337		334		1.6

Operating Income	$	6,426	$	8,214	$	(1,788	)	(21.8	)

Access Lines at September 30		140,243		143,870		(3,627	)	(2.5	)

RLEC segment revenues decreased $1,454, or 5.1%, to $27,097 in the three months ended September 30, 2004, from $28,551 in the three months ended September 30, 2003. Local telephone service revenues decreased partially as a result of decreasing access lines, and network access revenues decreased from lower settlement rates, from decreased minutes of use and from a revision to our National Exchange Carrier Association (NECA) liability estimate. Both local and network access revenues were affected positively from growth in dedicated data circuits and leased facilities. Other revenue changes include an increase in directory advertising revenue offset by decreases in regional long distance toll service and equipment sales.

RLEC operating expenses increased $334, or 1.6%, to $20,671 in the third quarter of 2004, from $20,337 in the same period of the prior year. The increase is due mainly to increased contracted billing services, directory expense, repairs and maintenance and Universal Service Fund expenses, which were partially offset by decreases in depreciation, wages and benefits expenses.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)


	Nine months ended September 30,
	2004		2003		Change			% Change
Revenues:
Local Telephone Service	$	25,261	$	24,858	$	403		1.6
Network Access		41,204		42,282		(1,078	)	(2.5	)
Other		16,450		17,650		(1,200	)	(6.8	)

Total Revenues		82,915		84,790		(1,875	)	(2.2	)

Depreciation and Amortization		23,258		23,716		(458	)	(1.9	)
Other Operating Expenses		38,457		36,290		2,167		6.0

Total Operating Expenses		61,715		60,006		1,709		2.8

Operating Income	$	21,200	$	24,784	$	(3,584	)	(14.5	)

Access Lines at September 30		140,243		143,870		(3,627	)	(2.5	)

RLEC segment revenues decreased $1,875, or 2.2%, to $82,915 in the nine months ended September 30, 2004, from $84,790 in the nine months ended September 30, 2003. Local telephone service revenues increased and network access revenues decreased by a comparable amount as part of the rate rebalancing in July 2003. Additionally, revenue decreased due to the effect of certain decreased minutes of use and a revision to our National Exchange Carrier Association (NECA) liability estimate. Both local and network access revenues were affected positively from growth in dedicated data circuits and leased facilities. Other revenue changes include an increase in directory advertising revenue offset by decreases in regional long distance toll service and equipment sales.

RLEC operating expenses increased $1,709, or 2.8%, to $61,715 in the first nine months of 2004, from $60,006 in the same period of the prior year. The increase is due mainly to increased contracted billing services, directory expense, repair and maintenance and Universal Service Fund expenses, which were partially offset by decreases in depreciation expenses, wages and benefits. The uncollectible account expense was low in 2003 as a result of recovering $260 of WorldCom accounts receivable.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

CLEC Segment Results


	Three months ended September 30,
	2004			2003			Change			% Change
Revenues:
Local Telephone Service	$	3,093		$	2,553		$	540		21.2
Network Access		1,713			1,329			384		28.9
Long Distance		4,555			4,874			(319	)	(6.5	)
Other		240			224			16		7.1

Total Revenues		9,601			8,980			621		6.9

Depreciation and Amortization		1,041			1,011			30		3.0
Other Operating Expenses		9,397			9,125			272		3.0

Total Operating Expenses		10,438			10,136			302		3.0

Operating Loss	$	(837	)	$	(1,156	)	$	319		(27.6	)

Access Lines at September 30		37,398	⁽¹⁾		35,106			2,292		6.5

⁽¹⁾

CLEC segment revenues increased $621, or 6.9%, to $9,601 in the three months ended September 30, 2004, from $8,980 in the three months ended September 30, 2003. The increase was related to the addition of access lines for new customers and growth in dedicated data circuits, which increased local telephone service and network access revenues. Long distance revenues decreased approximately $319 due to rate reductions and decreased minutes of use.

Operating expenses for the CLEC segment increased $302, or 3.0%, to $10,438 in the third quarter of 2004, from $10,136 in the same period of 2003. Direct cost of operations increased primarily as a result of additional customers offset by decreases in network access expense. Continued increases in the number of access lines or customers are expected to improve operating efficiencies and improve operating results.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)


	Nine months ended September 30,
	2004			2003			Change			% Change
Revenues:
Local Telephone Service	$	8,549		$	7,128		$	1,421		19.9
Network Access		4,798			3,984			814		20.4
Long Distance		13,927			14,701			(774	)	(5.3	)
Other		739			575			164		28.5

Total Revenues		28,013			26,388			1,625		6.2

Depreciation and Amortization		3,168			2,980			188		6.3
Other Operating Expenses		27,313			26,431			882		3.3

Total Operating Expenses		30,481			29,411			1,070		3.6

Operating Loss	$	(2,468	)	$	(3,023	)	$	555		(18.4	)

Access Lines at September 30		37,398	⁽¹⁾		35,106			2,292		6.5

⁽¹⁾

CLEC segment revenues increased $1,625, or 6.2%, to $28,013 in the nine months ended September 30, 2004, from $26,388 in the nine months ended September 30, 2003. The increase was related to the addition of access lines for new customers and growth in dedicated data circuits, which increased local telephone service and network access revenues. Long distance revenues decreased approximately $774 due to rate reductions and decreased minutes of use.

Operating expenses for the CLEC segment increased $1,070, or 3.6%, to $30,481 in the first nine months of 2004, from $29,411 in the same period of 2003. Direct cost of operations increased primarily as a result of additional customers offset by decreases in network access expense. Continued increases in the number of access lines or customers are expected to improve operating efficiencies and improve operating results.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

Internet Services Segment Results


	Three months ended September 30,
	2004		2003			Change			% Change
Revenues	$	2,569	$	1,697		$	872		51.4

Depreciation and Amortization		280		207			73		35.3
Other Operating Expenses		2,192		1,657			535		32.3

Total Operating Expenses		2,472		1,864			608		32.6

Operating Income (Loss)	$	97	$	(167	)	$	264		158.1

Customers at June 30
DSL		10,008		6,734			3,274		48.6
Dial-up Access		12,071		12,855			(784	)	(6.1	)
Web-hosting Services		901		795			106		13.3

Internet Services segment revenues increased $872, or 51.4%, to $2,569 in the three months ended September 30, 2004, from $1,697 in the three months ended September 30, 2003. The increase resulted from additional DSL customers and web hosting subscribers. Additionally, effective October 2003, the Internet segment began selling DSL data transmission services in addition to DSL Internet connection services, which increased revenue by $702.

Operating expenses for the Internet Services segment increased $608, or 32.6%, to $2,472 in the third quarter of 2004, from $1,864 in the same period of 2003. The direct cost of operations increase includes $537 additional intercompany expense for wholesale DSL data transmission fees from the RLEC segment. Customer service expense growth of $75, or 16.1%, due to increased wage and benefit costs related in part to expanding customer service hours, was more than offset by other general and administrative expense reductions of $103, or 29.2%, largely from a decline in uncollectible receivables.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)


	Nine months ended September 30,
	2004		2003			Change			% Change
Revenues	$	7,616	$	5,032		$	2,584		51.4

Depreciation and Amortization		784		608			176		28.9
Other Operating Expenses		6,634		4,609			2,025		43.9

Total Operating Expenses		7,418		5,217			2,201		42.2

Operating Income (Loss)	$	198	$	(185	)	$	383		N/A

Customers at September 30
DSL		10,008		6,734			3,274		48.6
Dial-up Access		12,071		12,855			(784	)	(6.1	)
Web-hosting Services		901		795			106		13.3

Internet Services segment revenues increased $2,584, or 51.4%, to $7,616 in the nine months ended September 30, 2004, from $5,032 in the nine months ended September 30, 2003. The increase resulted from additional DSL customers and web hosting subscribers. Additionally, effective October 2003, the Internet segment began selling DSL data transmission services in addition to DSL Internet connection services, which increased revenue by $2,071.

Operating expenses for the Internet Services segment increased $2,201, or 42.2%, to $7,418 in the first nine months of 2004, from $5,217 in the same period of 2003. The direct cost of operations increase includes $1,536 additional intercompany expense for wholesale DSL data transmission fees from the RLEC segment. The customer service expense grew $434, or 33.5%, due to increased wage and benefit costs related in part to expanding customer service hours.

Systems Integration Segment Results


	Three months ended September 30,
	2004			2003			Change		% Change
Revenues	$	6,241		$	5,492		$	749	13.6

Depreciation and Amortization		443			375			68	18.1
Other Operating Expenses		6,894			6,182			712	11.5

Total Operating Expenses		7,337			6,557			780	11.9

Operating Loss	$	(1,096	)	$	(1,065	)	$	31	2.9

Systems Integration segment revenues increased $749, or 13.6%, to $6,241 in the three months ended September 30, 2004, from $5,492 in the three months ended September 30, 2003. The increase consisted of $408 in communication services revenue and $341 in telecommunications and computer equipment sales.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

Operating expenses for the Systems Integration segment increased $780, or 11.9%, to $7,337 in the third quarter 2004, from $6,557 in the same period of 2003. The major expense variance was an increase in wages and subcontractor services and to a lesser extent, an increase in material costs.


	Nine months ended September 30,
	2004			2003			Change			% Change
Revenues	$	18,637		$	16,904		$	1,733		10.3

Depreciation and Amortization		1,428			1,215			213		17.5
Other Operating Expenses		20,625			19,068			1,557		8.2

Total Operating Expenses		22,053			20,283			1,770		8.7

Operating Loss	$	(3,416	)	$	(3,379	)	$	(37	)	1.1

Systems Integration segment revenues increased $1,733, or 10.3%, to $18,637 in the nine months ended September 30, 2004, from $16,904 in the nine months ended September 30, 2003. The increase consisted of $1,273 in communication services revenue and $460 primarily from telecommunications equipment sales.

Operating expenses for the Systems Integration segment increased $1,770, or 8.7%, to $22,053 in the first nine months of 2004, from $20,283 in the same period of 2003. The major expense variance was an increase in wages and subcontractor services.

Financial Condition

Liquidity and Capital Resources

We have historically generated cash from our operating activities. Our overall capital resource strategy is to finance capital expenditures for new and existing lines of businesses with cash from operations. We anticipate any new acquisitions to be financed partly with operating cash and partly through external sources, such as bank borrowings and offerings of debt or equity securities. In May 2004, we made an additional principal payment of $10,000 on our term loans; however in August 2004, we borrowed $10,000 from our revolving credit facility to partially fund the purchase of 1,333,500 shares, or approximately 8.56% of D&E common stock from Citizens Communications.


	As of September 30,
	2004			2003
Net cash provided by (used in):
Cash flows from operating activities of continuing operations	$	34,824		$	32,109
Investing activities from continuing operations		(16,846	)		(4,973	)
Financing activities from continuing operations		(24,025	)		(4,959	)
Discontinued operations		—			(20,553	)

Net cash provided by operating activities of continuing operations was $34,824 in the nine months ended September 30, 2004, compared with $32,109 in the same period of 2003. Net cash provided by

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

operating activities of continuing operations in the nine months ended September 30, 2004 was primarily attributable to the net loss plus non-cash expenses for depreciation and amortization and early extinguishment of debt as well as a collection of an income tax receivable offset by a reduction in accounts payable. Net cash provided by operating activities of continuing operations in the nine months ended September 30, 2003 was primarily attributable to the net income plus non-cash expenses for depreciation and amortization as well as a reduction in accounts receivable.

Net cash used in investing activities was $16,846 in the nine months ended September 30, 2004, compared with a net cash of $4,973 used in the same period of 2003. On June 8, 2004, D&E purchased an office building in State College for $3,123 including closing costs, which was previously reported as a capital lease included in long-term debt. A capital lease obligation of $2,613 was eliminated and approximately $510 of the payment represents additional costs of land and building assets. Other capital additions in the first nine months of 2004 were primarily for information technology upgrades of approximately $5,773, including $1,543 related to the billing system conversion; communications network enhancements of approximately $6,829; and outside plant expansion totaling approximately $3,874. In 2003, the proceeds from the Conestoga Wireless and paging business sales of $10,176, were offset in part by the $14,139 of capital additions and $1,010 of net increase to investments and advances to affiliates.

Net cash used in financing activities was $24,025 in the nine months ended September 30, 2004, compared with $4,959 of net cash used in the same period of 2003. In the nine months of 2004, payment of dividends of $5,425 was a comparable use of funds in the prior year. The long-term debt refinancing on March 5, 2004 was the significant financing activity in the current year with proceeds of $200,000 of which $191,700 was used to repay the original loan and $1,971 to pay new debt issuance costs. Scheduled and voluntary repayments of long-term bank debt totaled $19,225 for the nine months of 2004. Additionally, the long-term capital lease obligations were reduced by $2,716 as a result of the capital lease payments and the eventual purchase of the office building and land. On March 14, 2003, we borrowed $12,000 to use along with cash from operations to pay $20,700 of federal taxes primarily related to the sale of our D&E wireless investment. On August 13, 2004 we borrowed $10,000 to partially fund the purchase of 1,333,500 treasury shares at $10.00 per share.

Discontinued operations had no cash effect in 2004 but used $20,553 of cash in 2003 primarily for paying the taxes due on the sale of PCS ONE in 2002.

Other

During the first nine months of 2004, we continued the trial of video services in Union County, Pennsylvania that was launched at the end of last year using the same DSL technology that we use for providing broadband access to customers throughout our territory. The combination of services in which we provide voice, video and high speed Internet access is known as a “triple play” bundle and is consistent with our objectives to be able to provide complete communications services to our customers. We are currently evaluating the triple play test phase and our ability to offer these services to effectively compete with cable television and wireless companies in the future. We are also working with Bucknell University on a unique video service where we use their data network to transmit video services to their students.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

D&E provides an opportunity for grandfathered retiring members of the Pension Plan for Employees of Buffalo Valley and the Pension Plan for Members of Local 1671, Conestoga Telephone & Telegraph Company, to purchase health care benefits under the Company’s fully-insured plan. Members of these Plans who elect to continue their coverage at retirement pay 100% of the applicable premiums. D&E also provides an opportunity for grandfathered retiring members of the Conestoga Telephone & Telegraph Company Pension Plan for non-union employees to purchase health care benefits under the Company’s fully-insured plan. The Company pays 50% of the premium for members of this Plan who elect to continue coverage at retirement. On July 21, 2004 the Company decided to discontinue offering these benefits for non-union grandfathered employees who will not be eligible to retire with these health benefits by June 30, 2005. As a result of this amendment to the postretirement plans, the Company’s accumulated postretirement benefit obligation decreased by approximately $1,310 and the annual postretirement benefits expense will decrease by $130 from August through December 2004 and are expected to decrease $300 in 2005 and later years.

D&E entered into an agreement with Citizens Communications Company under which D&E purchased from Citizens at a price of $10.00 per share, 1,333,500 shares of D&E’s common stock, approximately 8.56% of its outstanding shares. The negotiated repurchase also terminated a 1997 Stock Acquisition Agreement pursuant to which an affiliate of Citizens originally acquired 1,300,000 shares of D&E stock. Under that agreement, Citizens was required, among other things, to provide D&E with an opportunity to purchase the shares subject to the agreement prior to selling those shares generally. We borrowed $10,000 on our existing revolving credit facility, along with cash on hand, to fund the repurchase.

External Sources of Capital at September 30, 2004

On March 5, 2004, D&E completed a syndicated senior secured debt financing in the amount of $260,000 jointly arranged by CoBank, ACB and SunTrust Bank. The credit facilities are in the form of a $25,000 revolving line of credit, term loans in the amounts of $50,000 and $150,000, respectively, and the assumption of $35,000 of term indebtedness of a D&E subsidiary. The proceeds of the credit facilities were used to refinance indebtedness under prior credit facilities and for general corporate purposes. The facilities received ratings of BB- and Ba3 from Standard & Poor’s Ratings Services and Moody’s Investors Services, respectively. The effect of the refinancing was to lower the interest rates on our indebtedness, provide greater flexibility in the financial covenants and extend the amortization of principal. There is approximately $1,700 in annual cash interest savings under the new facilities. D&E incurred a one-time non-cash write-off of approximately $4,628 of unamortized debt issuance costs of the previous credit facility and capitalized approximately $1,859 and expensed $213 of costs related to the new credit facility.

As of September 30, 2004, our credit facility consists of Term Loan A (a $50,000 single draw 10-year senior term loan with a remaining balance of $37,811), Term Loan B (a $150,000 single draw 8.5-year senior term loan with a remaining balance of $147,314) and an 8.5-year senior reducing revolving credit facility, with a total availability of $25,000 ($15,000 remaining available since we

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

borrowed $10,000 on August 13, 2004) to fund capital expenditures, acquisitions, general corporate purposes and working capital needs. In connection with the Conestoga acquisition, we acquired their long-term loans of $35,000, which were transferred to D&E Communications under the same terms as part of the refinancing.

The Term Loan A requires interest payments with increasing quarterly principal payments, which began in the first quarter of 2004 and continue through the second quarter of 2011. The Term Loan B requires interest payments with small quarterly principal payments, which began in the first quarter of 2004 and continue through 2010 and four large quarterly payments in 2011. The revolving credit facility requires interest only payments until December 31, 2006 when the commitment will be reduced from $25,000 to $15,000 until the final required payment on June 30, 2011. Interest on both the term loans and the revolving credit facility is payable at the U.S. prime rate plus an applicable margin or at LIBOR rates plus an applicable margin based on our leverage ratio. A commitment fee of .50% must be paid on the unused portion of the revolving credit facility. The fixed interest rate loans of $35,000 transferred from Conestoga require interest only payments until the first quarter of 2005 and equal quarterly principal payments from the first quarter of 2005 through the fourth quarter of 2014.

The credit facility includes a number of significant covenants that impose restrictions on our business. These covenants include, among others, restrictions on additional indebtedness, mergers, acquisitions and the disposition of assets, sale and leaseback transactions and capital lease payments. In addition, we are required to comply with financial covenants with respect to the maximum leverage ratio, maximum indebtedness to total capitalization ratio, debt service coverage and fixed charge coverage. As of September 30, 2004, we had no other unsecured lines of credit. As of September 30, 2004, $15,000 of the revolving credit facility was available for borrowing without violating any of the covenants. Our ratio of total debt to total debt plus capital increased to 55.6% at September 30, 2004 from 53.6% at December 31, 2003 due to the impact of dividend payments and the treasury stock purchase reducing net equity.

Maturities of long-term debt as of September 30, 2004, under the March 5, 2004 credit facilities are as follows:


Year	March 5, 2004 Credit Facility
2004	$	6,500
2005		10,000
2006		10,000
2007		12,500
2008		12,500
Thereafter		178,625

The interest rates on the new loan facility depending on the leverage ratio are as follows:


Term Loan A		U.S. Prime plus 1.00% to 1.75% or LIBOR plus 2.00% to 2.75%
Term Loan B		U.S. Prime plus 1.50% to 1.75% or LIBOR plus 2.50% to 2.75%
Revolving Loan		U.S. Prime plus 1.00% to 1.75% or LIBOR plus 2.00% to 2.75%

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

As of September 30, 2004, we were in compliance with each of the financial covenant ratios in the new loan facility, which limits are as follows:


Total Leverage Ratio = Indebtedness divided by Cash Flow Declines to <2.75 after 1/1/2008		<4.25
Total Indebtedness to Total Capitalization Ratio		<60%
Debt Service Coverage = Cash Flow divided by Debt Service Pro forma last year Cash Flow/next year’s Debt Service		>1.75
Operating Cash Flow divided by Fixed Charges		>1.05

Cash Flow as used for covenant calculations is defined as “Operating Cash Flow” which means the sum of (i) net income or deficit, as the case may be (excluding extraordinary gains, extraordinary losses (including without limitation, any realization of the unamortized debt issuance cost from the Current Credit Agreement), the non-cash write up or write down of any asset), (ii) total interest expense (including non-cash interest), (iii) depreciation and amortization expense and other similar non-cash expenses, (iv) taxes, federal or state, imposed upon income and (v) non-cash employee and director compensation. For any period of calculation, Operating Cash Flow will be adjusted to give effect to any acquisition, sale or other disposition of any operation of business (or any portion thereof) during the period of calculation as if such acquisition, sale or other disposition occurred on the first day of such period of calculation. Further, the definition of fixed charges no longer includes dividend payments.

Commitments, Contingencies and Projected Uses of Capital

We believe that our most significant commitments, contingencies and projected uses of funds in 2004, other than for operations, include capital expenditures, the payment of quarterly common stock dividends, as and when declared by the board of directors, and other contractual obligations. On October 28, 2004, we declared a quarterly common stock dividend of $0.125 per share payable on December 15, 2004, to holders of record on December 1, 2004. We expect that this dividend will result in an aggregate payment of approximately $1,800. We believe that we have adequate internal and external resources available to meet ongoing operating requirements.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

constructed. In July 2004, D&E paid Mountain Union $200 for an additional two tower sites that would not be constructed. Under the terms of the Asset Purchase Agreement, Keystone is obligated to reimburse D&E for one-half of the penalties paid under the BTS, not to exceed $125. Because the underlying assets of CWC were sold under the Asset Purchase Agreement, D&E has considered any remaining obligations and potential penalties under the BTS a contingent liability. As of September 30, 2004, D&E has recorded $200 for its remaining commitment under the BTS as the potential cost or penalty for the two remaining sites. Zoning approval has been received for the two sites and we anticipate that construction will begin in the near future. Keystone Wireless has committed to lease space on both sites. Under the Asset Purchase Agreement, D&E is obligated to pay the cost of equipping one tower, using some of the equipment transferred to Keystone Wireless in the sale, and one-half of the cost, up to $62.5 for the second.

We hold a 33% interest in EuroTel and a 28.88% direct interest in Pilicka, both of which we account for under the equity method of accounting. Thus, neither the assets nor the liabilities of EuroTel or Pilicka are presented on a consolidated basis on our balance sheets. We have also committed to loan EuroTel, on an equal basis with the other investors in EuroTel, certain of its operating cash needs. In the nine months ended September 30, 2004, D&E made advances of $316 to EuroTel and we expect that our total 2004 advances will be less than $1,000 in the aggregate.

During 2003, we successfully won bids and paid $828 in the Federal Communications Commission auction for licenses in five geographic areas within our service territory. These licenses will enable us to provide wireless data services in Lancaster, Reading, Altoona, Williamsport and State College, Pennsylvania. A plan for implementing the use of these licenses is still under development.

Critical Accounting Policies

Our discussion and analysis of our results of operations and financial condition is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of the financial statements requires us to make estimates and judgments that affect the reported amounts. On an on-going basis, we evaluate our estimates, including those related to intangible assets, income taxes, revenues,

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

contingencies and impairment of long-lived assets. We base our estimates on historical experience and other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, as further described below.

We have identified the following critical accounting policies as those that are the most significant to our financial statement presentation and that require difficult, subjective and complex judgments.

Revenue Recognition

Revenue for all of our business segments is recorded when services are provided or products are delivered, when the price is fixed or determinable, persuasive evidence of an arrangement exists and the collectibility of the resulting receivable is reasonably assured. Our RLEC and CLEC pricing is subject to oversight by both state and federal regulatory commissions.

Such regulation also covers services, competition and other public policy issues. Different interpretations by regulatory bodies may result in adjustments in future periods to revenues derived from our RLEC and CLEC operations. We monitor these proceedings closely and make adjustments to revenue accordingly.

We receive a portion of our interstate access revenues in our RLEC segments from settlement pools in which we participate with other telephone companies through the National Exchange Carrier Association, Inc. (NECA). These pools were established at the direction of the FCC and are funded by interstate access service revenues, which the FCC regulates. Revenues earned through this pooling process are initially recognized based on estimates and are subject to adjustments that may either increase or decrease the amount of interstate access revenues. If the actual amounts that we receive from the settlement pools differ from the amounts that we have recorded as accounts receivables on our balance sheets, we are required to record the amount of such a reduction or increase as an adjustment to our earnings. During the first nine months of 2003 and 2004, we have not recorded significant adjustments to our revenues as a result of our participation in these pools.

Regulated Asset Depreciation

We use a composite group remaining life method and straight-line composite rates to depreciate the regulated property assets of our RLEC and CLEC segments. Under this method, when we replace or retire such assets, we deduct the net book value of these assets and charge it to accumulated depreciation. The effect of this accounting is to amortize any gains or losses on dispositions over the service lives of the remaining regulated telephone property assets rather than recognizing such gain or loss in the period of retirement.

In addition, use of the composite group remaining life method requires that we periodically revise our depreciation rates. Such revisions are based on asset retirement activity, and often require that we make related estimates and assumptions. If actual outcomes differ from our estimates and assumptions, we may be required to adjust depreciation and amortization expense, which could impact our earnings.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

Impairment of Long-Lived Assets

Long-lived assets, including our property, plant and equipment and our finite-lived intangibles, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable in accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Recoverability is assessed based on future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the undiscounted cash flows is less than the carrying value of the asset, an impairment loss is recognized. Any impairment loss, if indicated, would be measured as the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset. While we have never recorded a material impairment charge for long-lived assets, future events or changes in circumstances could result in a material charge to earnings.

Impairment of Goodwill and Indefinite-Lived Intangibles

Upon the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets,” on January 1, 2002, goodwill and indefinite-lived intangibles are no longer subject to amortization. Goodwill and indefinite-lived intangibles are subject to at least an annual assessment for impairment by comparing carrying value to fair value. There is a two-step process for goodwill. The first step is to identify a potential impairment by comparing the fair value of reporting units to their carrying value. If the results of the first step of the impairment testing indicate a potential impairment, the second step would be completed to measure the amount of any impairment loss. We continually evaluate whether events and circumstances have occurred that indicate the remaining balances of goodwill and indefinite-lived intangibles may not be recoverable. In evaluating impairment, we estimate the sum of the expected future cash flows derived from such goodwill and indefinite-lived intangibles. Such evaluations for impairment are significantly impacted by estimates of future revenues, costs and expenses, the market price of our stock and other factors. An impairment assessment was completed as of April 30, 2004 and 2003, and as a result, we have never recorded a material impairment charge for goodwill and indefinite-lived intangibles. Future events or changes in circumstances could result in a material charge to earnings.

Investment in Unconsolidated Affiliates

We have investments and advances to affiliated entities that are accounted for under the equity method of accounting. We periodically evaluate whether there have been declines in value in these investments, and if so, whether these declines are considered temporary or other-than-temporary. Other-than-temporary declines would be recognized as realized losses in earnings. Evidence of a loss in value includes, but is not limited to, our inability to recover the carrying amount of the investment or the inability of the investee to sustain an earnings capacity that would justify the carrying amount of the investment. The fair value of an investment that is less than its book value may indicate a loss in value of the investment. Our evaluations are based on many factors, including the duration and extent to which the fair value is less than carrying amount; the financial health of and business outlook for the investee, including industry performance, changes in technology, and operational and financing cash flow factors; and our intent and ability to hold the investment, including strategic factors.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

Retirement Benefits

Retirement benefits are a significant cost of doing business and represent obligations that will be settled in the future. Retirement benefit accounting is intended to reflect the recognition of future benefit costs over the employee’s approximate service period based on the terms of the plans and the investment and funding decisions made by a company. We record the costs of providing retirement benefits in accordance with SFAS No. 87 “Employers’ Accounting for Pensions”. In December 2003, we adopted SFAS No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits”, which provides expanded disclosures related to our employee benefit plans. Our estimates include assumptions regarding the discount rate to value the future obligation and the expected return on our plan assets. We use discount rates in line with current market interest rates on high quality fixed rate debt securities. Our return on assets is based on our current expectation of the long-term returns on assets held by the plan. Changes in these key assumptions can have a significant impact on the projected benefit obligations, funding requirements and periodic benefit costs that we incur.

Income Taxes

We file a consolidated federal income tax return. We have two categories of income taxes: current and deferred. Current taxes are those amounts we expect to pay when we file our tax returns. Since we must report some of our revenues and expenses differently for our financial statements than we do for income tax purposes, we record the tax effects of those differences as deferred tax assets and liabilities in our consolidated balance sheets. These deferred tax assets and liabilities are measured using the enacted tax rates that are currently in effect.

Management’s judgment is required in determining the provision for current income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against the net deferred tax assets. A valuation allowance is established for any deferred tax asset that we may not be able to use in the preparation and filing of our future tax returns. We have recorded a valuation allowance due to uncertainties related to the ability to utilize some of the deferred tax assets.

Recent Accounting Pronouncements

In May 2004, the FASB issued Staff Position No. FSP FAS 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

2003” (“FSP 106-2”). FSP 106-2 provides guidance on accounting for the effects of the new Medicare prescription drug benefit available to employers whose prescription drug benefits are at least actuarially equivalent to the drug benefit provided under Medicare Part D. FSP 106-2 is effective as of the first interim or annual period beginning after June 15, 2004. Based upon the evaluation of information available to date, D&E has concluded that the prescription drug benefits provided by its postretirement health care plans are not actuarially equivalent to benefits available through Medicare Part D under the Act. Accordingly, the accumulated postretirement benefit obligation and the net periodic postretirement benefit cost reported in the financial statements and the accompanying notes do not reflect any effect of the federal subsidy provided by the Act.

Forward-Looking Statements

This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements provide our current expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historical or current facts. These statements may relate to our financial condition, results of operations, plans, objectives, future performance and business. Often these statements include words such as “believes,” “expects,” “anticipates,” “estimates,” “intends,” “strategy,” “plan,” or similar words or expressions. In particular, statements express or implied, concerning future operating results, the ability to generate income or cash flows, or our capital resources or financing plans are forward-looking statements. These forward-looking statements involve certain risks and uncertainties. Our actual performance or achievements may differ materially from those contemplated by these forward-looking statements.

You should understand that various factors, in addition to those discussed in the section titled “Factors Affecting Our Prospects” and elsewhere in this document, could affect our future results and could cause results to differ materially from those expressed in these forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document. All subsequent written and oral forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements contained or referred to in this report. We do not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of this document or to reflect the occurrence of unanticipated events.

Factors Affecting Our Prospects

Our indebtedness could restrict our operations.

As of September 30, 2004, we had approximately $230,125 of total indebtedness, including current maturities. See “External Sources of Capital at September 30, 2004” above. This indebtedness could restrict our operations due to the following factors, among others:

•	we will use a substantial portion of our cash flow from operations to pay principal and interest on our indebtedness, which will reduce the funds available for working capital, capital expenditures, acquisitions and other general corporate purposes;

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

•	our indebtedness may limit our ability to obtain additional financing on satisfactory terms, if at all;

•	insufficient cash flow from operations may cause us to attempt to sell assets, restructure or refinance our debt, or seek additional equity capital, which we may be unable to do at all or on satisfactory terms;

•	our level of indebtedness may make us more vulnerable to economic or industry downturns;

•	we are restricted in paying dividends to our shareholders to a $10 million annual limit; and

•	our debt service obligations increase our vulnerabilities to competitive pressures, as we may be more leveraged than many of our competitors.

The convergence of voice and data communications technologies could eliminate our competitive advantages and may, in fact, put us at a competitive disadvantage.

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

with each other in many locations. This development could cause telephone companies to lose their competitive edge in their territories and consequently result in significant inroads into their core telephone/voice business.

In April 2004, the 9^th Circuit Court of Appeals refused to review its previous decision that cable modem service was in part a telecommunications service. In its previous decision, the 9^th Circuit determined that the FCC was wrong when it classified cable modem service as an information service. The 9^th Circuit granted a stay of its decision pending Supreme Court review. As telecommunications service providers, cable operators may have to make their networks available to other ISPs and also may have to contribute to the Universal Service fund. This development could result in negative impacts on our cable TV operation.

The agreements governing our indebtedness could restrict our operations and ability to make acquisitions.

The agreements governing our indebtedness contain covenants imposing financial and operating restrictions on our business. These restrictions may limit our ability to take advantage of potential business opportunities as they arise and adversely affect the conduct of our business. These covenants place restrictions on our ability and the ability of our subsidiaries to, among other things;

•	incur more indebtedness;

•	pay dividends, redeem or repurchase our stock or make other distributions;

•	make acquisitions or investments;

•	use assets as security in other transactions;

•	enter into transactions with affiliates;

•	merge or consolidate with others;

•	dispose of assets or use asset sale proceeds;

•	create liens on our assets; and

•	extend credit.

The communications industry is increasingly competitive, and this competition has resulted in pricing pressure on our service offerings. We may experience increased competitive pressures, which could have a negative effect on our revenues and earnings.

As an integrated communications provider, we face competition from:

•	competitive local exchange carriers, including TelCove, Commonwealth Telephone Enterprises, Choice One and XO Communications;

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

•	wireless service providers, including Cingular Wireless, Verizon Wireless, AT&T Wireless, Sprint PCS, Nextel and T-Mobile Wireless;

•	internet service providers, including AOL, EarthLink and MSN;

•	cable television companies, including Adelphia, Comcast, Pencor Services, Atlantic Broadband LLC and CATV Service, Inc.;

•	voice over Internet protocol (“VoIP”) providers, including Vonage, AT&T and Verizon;

•	providers of communications services, such as long distance services, including AT&T, Sprint, MCI and Verizon Communications;

•	systems integration providers, including Morefield, Williams, IntelliMark and Weidenhammer Systems Corp.; and

•	in the future could include electric power companies.

Many of our competitors are, or are affiliated with, major communications companies. These competitors have substantially greater financial and marketing resources and greater name recognition and more established relationships with a larger base of current and potential customers than we. Accordingly, it may be more difficult to compete against these large communications providers. In addition, we cannot assure you that we will be able to achieve or maintain adequate technology to remain competitive. Accordingly, it may be difficult to compete in any of our markets.

We may be exposed to potential risks resulting from new requirements under Section 404 of the Sarbanes-Oxley Act of 2002.

Beginning with our Annual Report on Form 10-K for the year ended December 31, 2004, Section 404 of the Sarbanes-Oxley Act requires that we evaluate and determine the effectiveness of our internal control over financial reporting in order to allow management to report on, and our independent auditors to attest to, such effectiveness. We have dedicated a significant amount of time and resources to ensuring compliance and also expect to incur additional expenses and diversion of management’s time as a result of performing the system and process evaluation, testing and remediation in order to comply with the management certification and auditor attestation requirements. We may encounter delays in implementing the requirements relating to internal controls; therefore, we cannot be certain about the timing of completion of our evaluation, testing and remediation actions or the impact that these activities will have on our operations.

We cannot provide any assurance that we will be able to complete our evaluation of our internal controls in time for us to successfully remediate any internal control deficiencies or that our independent registered public accounting firm can complete their assessment of our internal controls in a timely manner.

If, as of December 31, 2004, we identify and fail to remediate significant deficiencies and material weaknesses that lead us or our independent registered public accounting firm to be unable to reach a conclusion on our internal controls over financial reporting, or to conclude that our internal controls over financial reporting were not effective, there could be an adverse affect on our business.

We may be unable to successfully complete the conversion of the D&E and Conestoga billing systems into a single system, and such inability could have an adverse impact on our profitability.

The billing systems conversion of the D&E and Conestoga systems into a single platform is nearing completion. The conversion of the Conestoga data has been completed in October 2004 and the initial billing cycle began on November 1, 2004. Initial billing for other cycles will continue throughout the month of November. D&E has proactively notified the Conestoga customers of the changes related to bill format and does not anticipate any significant customer impact.

We have continuing involvement in the Conestoga wireless segment after its sale which may adversely affect the continuing operations of the business.

In connection with the acquisition of Conestoga, we committed to a plan to sell the assets of Conestoga’s wireless segment. The sale was completed on January 14, 2003. We have continuing involvement after the sale as a result of our continued guarantees on cell site leases and our responsibilities under a Build-to-Suit agreement. Payments required under the Build-to-Suit agreement

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

and payments, if any, that become due under the cell site guarantees could restrict our operations by reducing the funds available for working capital, capital expenditures, acquisitions and other general corporate purposes.

We may be unable to secure unbundled network elements at reasonable rates, or our CLEC growth may be delayed and the quality of service may decline.

In providing our CLEC service, we interconnect with and use other telephone companies’ networks to access certain of their customers. Therefore, we depend, in certain circumstances, upon the technology and capabilities of these other telephone companies, the quality and availability of other telephone companies’ facilities and other telephone companies’ maintenance of these facilities. We must also maintain efficient procedures for ordering, provisioning, maintaining and repairing facilities from these other telephone companies. We may not be able to obtain facilities and services of satisfactory quality from other telephone companies, or on satisfactory terms and conditions, in which case we may experience delays in the growth of our competitive local exchange carrier networks and the degradation of the quality of our service to customers.

We also provide digital subscriber line services. To provide unbundled DSL-capable lines that connect each end user to equipment, we rely on other telephone companies. TA-96 generally requires that charges for these unbundled network elements be cost-based and nondiscriminatory. Charges for DSL-capable lines and other unbundled network elements may vary based on rates proposed by other telephone companies and approved by state regulatory commissions. Increases in these rates could harm our CLEC business.

At its February 20, 2003 public meeting, the FCC voted on rules concerning ILECs’ obligations to make elements of their networks available on an unbundled basis to new entrants. The Order (“the TRO”) was published on August 21, 2003. According to the TRO, ILECs would not be obligated to give competitors unbundled access to broadband and fiber lines that the ILEC’s deploy in the future to provide broadband service. The FCC planned to limit the ILECs’ obligations to unbundle access to other elements of their systems, such as switches. The FCC established an impairment standard to determine whether ILECs must open elements of their systems to competitive providers. The standard is whether economic and operational impairment exists in a particular market necessitating the unbundling of elements of the ILECs’ systems for competitive providers. The state public utility commissions were tasked with conducting proceedings to apply the stated impairment standards to their specific markets. The PA PUC undertook its proceedings and was in the final decision stage when, on March 2, 2004, the United States Court of Appeals for the District of Columbia Circuit invalidated significant portions of the TRO. Most relevantly, the Appeals Court ruled that the FCC had delegated too much authority to the states and had not established sufficient bases for its order to unbundle mass market switches and transport facilities. Further, the Appeals Court affirmed the FCC’s decision not to require unbundling of hybrid loops, fiber-to-home loops and line sharing, but partially remanded the FCC’s rules on enhanced extended loops (“EELs”) used for provision of long distance service. The Court temporarily stayed its vacating of the rules until the later of 60 days or the denial of any petition for rehearing. The PA PUC has not yet stated its position as concerns the pending state proceedings under the original TRO and we are uncertain as to the outcome of this process. ILECs and CLECs may now turn to tariffs and/or market-based contract pricing to continue to purchase the

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 2. Management’s Discussion and Analysis of

Financial Condition and Results of Operations

(Dollar amounts are in thousands)

vacated unbundled elements for the immediate future. On July 22, 2004, the FCC voted to adopt interim network interconnection unbundling rules, which would be implemented only if the FCC could not adopt new permanent rules within a six month interim period. The FCC will also release a Notice of Proposed Rulemaking on permanent rules. Under the proposal, the wholesale rates currently offered to competitors would continue for a six month interim period. If permanent rules are not adopted during the six month interim period, RBOCs would be permitted to increase the rates they charge competitors for existing residential lines by $1.00 per month and for high-speed data lines serving existing small and midsized businesses by 15%. The rates charged for new customers could increase by six fold. These rates would remain in effect until the permanent rules are adopted. The increases mandated by the interim rules will increase the cost of doing business for all CLECs. If the permanent rules are based upon the interim rules, it could harm our CLEC business.

We are subject to a complex and uncertain regulatory environment that may require us to alter our business plans and face increased competition.

The United States communications industry is subject to federal, state and other regulations that are continually evolving. As new communications laws and regulations are issued, we may be required to modify our business plans or operations, and we may not be able to do so in a cost-effective manner. Federal and state regulatory trends toward a more competitive market place through reduced competitive entry standards are likely to have negative effects on our business and our ability to compete. In this regard, the regulatory environment governing ILEC operations has been and will likely continue to be very liberal in its approach to promoting competition and network access, which may increase the likelihood of new competitors offering similar services in our service areas. The introduction of new competitors could have a negative effect on our ILEC operating results yet at the same time present operating benefits to our CLEC business.

We no longer have a limited suspension from certain interconnection requirements of the Telecommunications Act of 1996. As a result, we may be subject to additional competition for telecommunications services.

Our RLEC services held a limited suspension until January 2003 from certain interconnection requirements of the TA-96. The suspension protected our RLEC markets by excluding us from requirements to allow competitors to have access to our customers by relying upon our services and facilities. Since we did not receive additional extensions of this suspension, competitors are allowed to seek removal of our rural exemption for the purposes of entering our territory and using our services and facilities through interconnection agreements to provide competitive services. The introduction of new competitors could result in the loss of customers and have a negative effect on our revenues and earnings.

The Systems Integration Segment could be affected by the overall economic climate.

The sale of equipment and services in the Systems Integration business is dependent upon the willingness of companies to invest in improvements in their information and communications systems. General economic conditions play a role in companies’ investment decisions that directly affect the potential sales of Systems Integration equipment and services.

Form 10-Q

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 3. Quantitative and Qualitative Disclosure

About Market Risks

(Dollar amounts are in thousands)

We are highly leveraged and, as a result, our cash flows and earnings are exposed to fluctuations in interest rates. Our debt obligations are U.S. dollar denominated. Our market risk, therefore, is the potential loss arising from adverse changes in interest rates and changes in our leverage ratio which may increase the margin added to the interest rate as provided in our loan agreement. There has been no significant change in the risk during 2004. As of September 30, 2004, and December 31, 2003 our debt can be categorized as follows:


	September 30, 2004		December 31, 2003
Fixed interest rates:
Secured Term Loans	$	35,000	$	35,000
Subject to interest rate fluctuations:
Senior Secured Revolving Credit Facility	$	10,000	$	29,550
Senior Secured Term Loans	$	185,125	$	166,500

As part of our loan covenant conditions, we have arranged interest rate protection on more than one-half of the total amount of senior indebtedness outstanding, with a weighted average life of at least 2 years. As of September 30, 2004, our bank debt is as follows:


	Principal		Average Rate		Fair Value
Rates fixed for two years through interest rate swaps	$	35,000	5.29	%	$	35,000
Rates fixed for three years through interest rate swaps	$	35,000	5.55	%	$	35,000
Rates fixed for four years through interest rate swaps	$	35,000	6.23	%	$	35,000
Fixed rate debt, rates fixed for twelve years	$	35,000	9.35	%	$	41,624

Total fixed rate debt	$	140,000	6.67	%	$	146,624
Variable rate debt	$	90,125	4.42	%	$	90,125

If interest rates rise above the rates of the variable debt, we could realize additional annual interest expense of $451 for each 50 basis points above the variable rates. If rates were to decline, we would realize less interest expense of approximately $451 annually for each 50 basis point decrease in rates.

The interest rate swaps were arranged to hedge against the effect of interest rate fluctuations. The swaps were arranged with three banks that participated in our senior indebtedness. Under these interest rate swap contracts, we agree to pay an amount equal to a specified fixed-rate of interest times a notional principal amount and to receive in turn an amount equal to a specified variable-rate of interest times the same notional amount. The notional amounts of the contracts are not exchanged. Net interest positions are settled quarterly.

Form 10-Q

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 3. Quantitative and Qualitative Disclosure

About Market Risks

(Dollar amounts are in thousands)


Terms of Swaps	Notional Amounts		Average Pay Rate		Average Received Rate		Fair Value of Liability
11/25/02 to 11/25/04	$	35,000	6.29	%	4.50	%	$	70
12/04/02 to 12/04/05	$	35,000	6.93	%	4.56	%	$	128
11/25/02 to 11/25/06	$	35,000	7.23	%	4.50	%	$	462

If interest rates rise above the rates fixed by these swaps, we could realize other comprehensive income of $525 for each 50 basis points above the fixed rates. If rates were to decline, we would realize other comprehensive expense of approximately $525 for each 50 basis point decrease in rates.

Our cash and cash equivalents consist of cash and highly liquid investments having initial maturities of three months or less. While these investments are subject to a degree of interest rate risk, it is not considered to be material.

Item 4. Controls and Procedures

As of September 30, 2004, the Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in Corporation reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Based upon that evaluation, the Corporation’s Chief Executive Officer and Chief Financial Officer have made certain changes to the design and operations of our disclosure controls and procedures that are more fully described below.

Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”) requires D&E to include a report regarding the effectiveness of its internal control over financial reporting, beginning with its Annual Report on Form 10-K for the year ending December 31, 2004. That report will include an assessment by D&E’s management on the design and operating effectiveness of its internal control over financial reporting as of the end of the fiscal year.

D&E has undertaken a comprehensive effort to assess its system of internal controls over financial reporting by using both internal resources and external consulting assistance. D&E has reviewed its internal controls over financial reporting to assess the effectiveness of internal controls over financial reporting. That review has shown that, while most controls function appropriately, some areas require additional work and improvement.

Certain internal control procedures have been remediated to improve their design and operating effectiveness. Enhancements have been made in areas such as in fixed asset controls, by conducting a physical inventory of fixed assets; in tax reporting procedures, by improving our monitoring controls; and in the implementation of accounting guidance, by adding an additional level of review.

Form 10-Q

D&E Communications, Inc. and Subsidiaries

Part I - Financial Information (continued)

Item 3. Quantitative and Qualitative Disclosure

About Market Risks

(Dollar amounts are in thousands)

During the quarterly review process for the period ended September 30, 2004, the Corporation’s Chief Executive Officer and Chief Accounting Officer identified errors that were the result of the misapplication of the accounting guidance EITF 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments” and EITF 98-14, “Debtor’s Accounting for the Changes in Line-of-Credit or Revolving Debt Arrangements” to a syndicated senior secured debt financing completed on March 5, 2004. The errors were immediately corrected and reported in amended Form 10-Q/A for the quarters ended March 31, 2004 and June 30, 2004. In light of the facts and circumstances relating to the restatement, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the restatement was reflective of a material weakness (as defined under standards established by the Public Company Accounting Oversight Board) in the Company’s disclosure controls. The material weakness was caused by an inadequate control over the review process of the implementation of accounting guidance to new transactions. The Company has subsequently implemented a policy that involves an additional level of review over the implementation of accounting guidance.

It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitation of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential conditions, regardless of how remote.

In October 2004, D&E has implemented the process to consolidate two of its existing billing systems into one billing program. This billing conversion will be completed in the fourth quarter, 2004. In connection with the billing system conversion process, we anticipate a significant change in the internal controls of the company as a result of consolidating the related internal control processes.

D&E Communications, Inc. and Subsidiaries

Part II - Other Information

Item 1. Legal Proceedings

In July 2002, EuroTel’s subsidiary, PenneCom, initiated a legal action in United States District Court for the Southern District of New York against an investment bank, and an individual, alleging violations of applicable law relating to the advice given by the investment bank and the individual to a prospective buyer not to close on the purchase of Pilicka. On June 28, 2004, the Second Circuit Court of Appeals rejected an order of the United States District Court for the Southern District of New York, which earlier had dismissed the case. Management of EuroTel continues to believe that, based on the advice of its legal counsel, the suit is meritorious. However, the ultimate outcome of the litigation cannot be determined and no amount has been recognized for possible collection of any claims in the litigation. Legal costs are expected to continue to be incurred in pursuit of such litigation.

We are involved in various legal proceedings arising in the ordinary course of our business. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on our consolidated financial condition or results of operations.

Item 6. Exhibits

(a) Exhibits:


Exhibit No.	Identification of Exhibit	Reference
31	Certification of the Chief Executive Officer and the Chief Financial Officer Required by Section 13a-15 of the Exchange Act	Filed herewith.

32	Certification of the Chief Executive Officer and the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed herewith.

D&E Communications, Inc. and Subsidiaries

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.


	D&E Communications, Inc.

Date: November 9, 2004

	By:	/s/ G. William Ruhl
		G. William Ruhl
		Chairman, President and
		Chief Executive Officer

Date: November 9, 2004

	By:	/s/ Thomas E. Morell
		Thomas E. Morell
		Senior Vice President,
		Chief Financial Officer and Treasurer