Warwick Valley Telephone Co. 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q


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

For the quarterly period ended September 30, 2005


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

For the transition period from to

Commission file number 0-11174

WARWICK VALLEY TELEPHONE COMPANY

(Exact name of registrant as specified in its charter)


New York		14-1160510

(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)


47 Main Street, Warwick, New York		10990

(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code (845) 986-8080

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 o No þ

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 5,351,780 Common Shares, $0.01 par value, outstanding at November 3, 2005.

WARWICK VALLEY TELEPHONE COMPANY

CONSOLIDATED BALANCE SHEETS
(Unaudited)
($ in thousands)


	September 30,			December 31,
	2005			2004
Assets
Current assets:
Cash and cash equivalents	$	15,942		$	16,809
Accounts receivable — net of reserve for uncollectibles — $154 and $148, respectively		2,739			3,317
Other accounts receivable		85			954
Materials and supplies		1,331			1,308
Prepaid income taxes		984			—
Prepaid expenses		693			599
Deferred income taxes		122			405

Total Current Assets	$	21,896		$	23,392


Property, plant and equipment, net		38,929			40,971
Unamortized debt issuance costs		93			103
Other deferred charges		834			889
Investments		4,694			3,411


Total Assets	$	66,446		$	68,766


Liabilities
Current Liabilities:
Accounts payable	$	582		$	813
Current maturities of long term debt		1,519			1,519
Advance billing and payments		274			255
Deferred income		—			889
Customer deposits		150			156
Accrued taxes		104			604
Pension and post retirement benefit obligations		715			1,429
Accrued access billing		—			827
Other accrued expenses		2,775			1,729

Total Current Liabilities	$	6,119		$	8,221


Long-term debt		9,112			10,251
Deferred income taxes		5,352			4,141
Other liabilities and deferred credits		623			607
Pension and postretirement benefit obligations		4,822			4,600


Total Liabilities	$	26,028		$	27,820


Shareholders’ Equity
Preferred Shares — $100 par value; authorized and issued shares 5,000; $0.01 par value authorized and unissued shares 10,000,000;	$	500		$	500
Common stock — $0.01 par value; authorized shares 10,000,000 issued 5,985,463 as of September 30, 2005 and December 31, 2004		60			60
Treasury stock — $0.01 par value, 633,683 Common Shares as of September 30, 2005 and 583,683 Shares as of December 31, 2004		(4,748	)		(3,598	)
Additional paid in capital		3,487			3,487
Accumulated other comprehensive (loss)		(1,328	)		(1,328	)
Retained earnings		42,447			41,825

Total Shareholders’ Equity	$	40,418		$	40,946


Total Liabilities and Shareholders’ Equity	$	66,446		$	68,766

Please see the accompanying notes, which are an integral part of the consolidated financial statements.

WARWICK VALLEY TELEPHONE COMPANY

CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
($ in thousands, except per share amounts)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2005			2004			2005			2004
Operating Revenues:
Local network service	$	995		$	1,050		$	2,949		$	3,075
Network access service		2,009			2,406			6,315			6,935
Long distance services		892			928			2,705			2,900
Directory advertising		358			362			1,059			1,088
Online services		1,680			1,740			5,097			5,180
Other services and sales		416			537			1,300			1,770


Total operating revenues		6,350			7,023			19,425			20,948


Operating Expenses:
Plant specific		1,184			1,172			3,472			3,257
Plant non-specific:
Depreciation and amortization		1,433			1,291			4,155			3,961
Other		890			835			2,566			2,368
Customer operations		1,123			1,109			3,269			3,435
Corporate operations		2,363			1,269			6,288			3,826
Cost of services and sales		328			459			1,167			1,451
Property, revenue and payroll taxes		342			413			1,096			1,185


Total operating expenses		7,663			6,548			22,013			19,483


Operating (loss) income		(1,313	)		475			(2,588	)		1,465

Other Income (Expense):
Interest income (expense), net of capitalized interest		(38	)		(77	)		(158	)		(214	)
Income from equity method investments, net		2,810			2,757			7,671			7,791
Gain on sale of investment		—			—			889			—
Other income (expense)		36			36			142			58


Total other income (expense) — net		2,808			2,716			8,544			7,635


Income before income taxes		1,495			3,191			5,956			9,100

Income Taxes		528			1,039			2,104			3,081


Net Income		967			2,152			3,852			6,019

Preferred Dividends		6			6			19			19


Income Applicable to Common Stock	$	961		$	2,146		$	3,833		$	6,000


Basic and Diluted Earnings per Share of Outstanding Common Stock	$	0.18		$	0.40		$	0.71		$	1.11


Weighted Average Shares of Common Stock Outstanding		5,351,780			5,401,780			5,362,586			5,401,404

Please see accompanying notes, which are an integral part of the consolidated financial statements.

WARWICK VALLEY TELEPHONE COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
($ in thousands)

FOR THE NINE MONTHS ENDED SEPTEMBER 30,


	2005			2004
				(Restated)
CASH FLOW FROM OPERATING ACTIVITIES:

Net income	$	3,852		$	6,019
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,155			3,961
Deferred income tax		1,494			668
Interest charged to construction		(8	)		(6	)
Income from equity investments, net of distributions		(1,045	)		1,134
Gain on sale of investment		(889	)		—

Change in assets and liabilities:
(Increase) Decrease in accounts receivable		578			(290	)
(Increase) Decrease in other accounts receivable		869			171
(Increase) Decrease in materials and supplies		(23	)		(88	)
(Increase) Decrease in prepaid income taxes		(984	)		—
(Increase) Decrease in prepaid expenses		(94	)		(156	)
(Increase) Decrease in deferred charges		55			(103	)
Increase (Decrease) in accounts payable		(231	)		(955	)
Increase (Decrease) in customers’ deposits		(6	)		(21	)
Increase (Decrease) in advance billing and payment		20			22
Increase (Decrease) in deferred income		(889	)		—
Increase (Decrease) in accrued taxes		(500	)		383
Increase (Decrease) in pension and post retirement benefits obligations		(492	)		(83	)
Increase (Decrease) in accrued access billing		(827	)		141
Increase (Decrease) in other accrued expenses		1,046			(306	)
Increase (Decrease) in other liabilities		16			31


Net cash provided by operating activities		6,097			10,522


CASH FLOW FROM INVESTING ACTIVITIES:
Capital expenditures		(2,104	)		(3,890	)
Interest charged to construction		8			6
Distribution from sale of investment		889			—
Investment contributions		(238	)		(475	)


Net cash used in investing activities		(1,445	)		(4,359	)


CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt		—			5,000
Proceeds from sale of common stock		—			14
Dividends(Common and Preferred)		(3,230	)		(3,152	)
Purchase of treasury stock		(1,150	)		—
Repayment of long term debt		(1,139	)		—


Net cash (used in) provided by financing activities		(5,519	)		1,862


(Decrease) increase in cash and cash equivalents		(867	)		8,025

Cash and cash equivalents at beginning of period		16,809			5,717


Cash and cash equivalents at end of period	$	15,942		$	13,742

Please see the accompanying notes, which are an integral part of the consolidated financial statements.

WARWICK VALLEY TELEPHONE COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands, except per share amounts

NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Warwick Valley Telephone Company (the “Company”) provides communications services to customers in the Towns of Warwick, Goshen, and Wallkill, New York and the Townships of Vernon and West Milford, New Jersey. Its services include providing local, toll telephone service to residential and business customers, access and billing and collection services to interexchange carriers, Internet access and Video service.

Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements of the Company and its subsidiaries have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of the Company’s management, all adjustments consisting only of normal recurring adjustments considered necessary for fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2005 are not necessarily indicative of the results that may be expected for the entire year.

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All material intercompany transactions and balances have been eliminated in the consolidated financial statements.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and any disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. The interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s latest Annual Report on Form 10-K.

Reclassifications

Certain amounts previously reported for prior periods have been reclassified to conform to the current year presentation in the accompanying consolidated financial statements. Such reclassifications had no effect on the results of operations or shareholders’ equity as previously recorded.

NOTE 2: RESTATEMENT

The Company has restated the Consolidated Statement of Cash Flows for the nine months ended September 30, 2004 to reclassify the cash distributions of earnings received from the Orange County-Poughkeepsie Limited Partnership (“O-P”), an investment accounted for under the equity method of accounting. These cash distributions were previously classified as investing activities. However, because the cash distributions of O-P represent a return on our investment in O-P, they should have been classified as operating activities. The restatement has resulted in cash distributions from O-P of $8,925 for the nine months ended September 30, 2004 being reclassified from “Cash Flows from Investing Activities” to “Cash Flows from Operating Activities” in the Consolidated Statement of Cash Flows. This restatement has no impact on the Company’s “Increase (Decrease) in cash and cash equivalents” in the Consolidated Statement of Cash Flows, revenues, expenses, net income, earnings per share in the Consolidated Statement of Net Income, or any Consolidated Balance Sheet items.

WARWICK VALLEY TELEPHONE COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands, except per share amounts

NOTE 3: IMPACT OF RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

In June 2004, the Financial Accounting Standards Board (the “FASB”) issued EITF Issue No. 03-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF Issue 03-1 establishes a common approach to evaluating other-than-temporary impairment to investments in an effort to reduce the ambiguity in impairment methodology found in APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock” and FASB No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, which has resulted in inconsistent application. In September 2004, the FASB issued FASB Staff Position EITF Issue 03-1-1, which deferred the effective date for the measurement and recognition guidance clarified in EITF Issue 03-1 indefinitely; however, the disclosure requirements remain effective for fiscal years ending after June 15, 2004. While the effective date for certain elements of EITF Issue 03-1 has been deferred, the adoption of EITF Issue 03-1 when finalized in its current form is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs-an amendment of ARB No. 43, Chapter 4.” SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage), and is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The standard requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this standard requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The adoption of SFAS No. 151 should not impact on the Company’s financial position, results of operations or cash flows.

In April 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). FIN 47 clarifies the term conditional asset retirement obligation as used in SFAS No. 143, “Accounting for Asset Retirement Obligations,” requiring companies to recognize a liability for the fair value of an asset retirement obligation that may be conditional on a future event if the fair value of the liability can be reasonably estimated. The Company does not expect that the adoption of FIN 47 will have a material impact on the Company’s financial position, results of operations or cash flows.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3.” The Statement applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company will adopt SFAS No. 154 January 1, 2006 and does not anticipate any material effect on its consolidated financial statements.

NOTE 4: EARNINGS PER SHARE

Basic and diluted earnings per share are based on the weighted average number of actual shares outstanding of 5,351,780 and 5,401,780 for the three months and 5,362,586 and 5,401,404 for the nine months ended September 30, 2005 and 2004, respectively.

The Company did not have any common stock equivalents as of September 30, 2005 and 2004.

NOTE 5: COMPREHENSIVE INCOME

Comprehensive income is equivalent to net income for the three and nine months ended September 30, 2005 and 2004.
The Company’s only component of accumulated comprehensive loss consists of minimum pension liability.

WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands, except per share amounts

NOTE 6: SEGMENT INFORMATION

The Company’s segments are strategic business units that offer different products and services and are managed as telephone and online services. The Company evaluates segment performance based upon factors such as revenue growth, expense containment, market share and operating income.

The telephone segment provides landline telecommunications services, including local, network access, long distance services and messaging, and sells customer premise equipment, private business exchange equipment and yellow and white pages advertising and electronic publishing.

The online segment provides high speed and dial up Internet services, help desk operations, and Video over VDSL.

Segment balance sheet information as of September 30, 2005 and December 31, 2004 is set forth below:


	September 30,			December 31,
	2005			2004

Assets
Telephone	$	71,718		$	74,338
Online		10,511			9,652
Elimination		(15,783	)		(15,224	)

Total assets	$	66,446		$	68,766

Segment cash flow information as of September 30, 2005 and 2004 is set forth below:


	September 30,		September 30,
	2005		2004

Capital expenditures
Telephone	$	1,578	$	2,654
Online		526		1,236

Total capital expenditures	$	2,104	$	3,890

WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands, except per share amounts

Segment income statement information for the nine months ended September 30, 2005 and 2004 is set forth below:


	2005			2004
Revenues
Telephone	$	15,728		$	17,334
Online		5,097			5,180
Eliminations		(1,400	)		(1,566	)

Total revenues	$	19,425		$	20,948

Deprecation and amortization
Telephone	$	2,826		$	2,867
Online		1,329			1,094

Total depreciation and amortization	$	4,155		$	3,961

Operating (Loss) Income
Telephone		(2,126	)		1,709
Online		(462	)		(244	)

Total operating (loss) income	$	(2,588	)	$	1,465

Interest expense and income		(158	)		(214	)
Income from equity method investments, net		7,671			7,791
Gain on sale of investment		889			—
Other income (expense)		142			58

Income before income taxes	$	5,956		$	9,100

Segment income statement information for the three months ended September 30, 2005 and 2004 are set forth below:


	2005			2004
Revenues
Telephone	$	5,138		$	5,802
Online		1,680			1,740
Eliminations		(468	)		(519	)

Total revenues	$	6,350		$	7,023

Deprecation and amortization
Telephone	$	925		$	944
Online		508			347

Total depreciation and amortization	$	1,433		$	1,291

Operating (Loss) Income
Telephone		(1,115	)		613
Online		(198	)		(138	)

Total operating (loss) income	$	(1,313	)	$	475

Interest expense and income		(38	)		(77	)
Income from equity method investments, net		2,810			2,757
Other income (expense)		36			36

Income before income taxes	$	1,495		$	3,191

WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands, except per share amounts

NOTE 7: MATERIAL AND SUPPLIES

Material and supplies are carried at average cost. As of September 30, 2005 and December 31, 2004, the material and supplies inventory consisted of the following:


	2005		2004

Inventory for outside plant	$	287	$	257
Inventory for inside plant		739		672
Inventory for online plant		68		80
Inventory of video equipment		66		130
Inventory of equipment held for sale or lease		171		169

	$	1,331	$	1,308

NOTE 8: PROPERTY, PLANT AND EQUIPMENT

Plant in service, at cost, consisted of the following as of September 30, 2005 and December 31, 2004:


	2005		2004

Land, buildings, furniture and other support equipment	$	8,107	$	7,925
Network and communications plant		31,038		30,699
Telephone plant		25,425		24,985
Online plant		10,535		10,252

Plant in service		75,105		73,861
Plant under construction		718		391

		75,823		74,252
Less: Accumulated depreciation		36,894		33,281

Property, plant and equipment, net	$	38,929	$	40,971

NOTE 9: INVESTMENTS

The Company is a limited partner in O-P and has a 7.5% investment interest which is accounted for under the equity method of accounting. The majority owner and general partner is Verizon Wireless of the East L.P.

The following summarizes O-P’s income statement for the nine months ended September 30:


	(Unaudited)
	2005		2004

Net sales	$	130,283	$	122,486
Cellular service cost		19,409		11,697
Operating expenses		4,831		5,610

Net operating income		106,043		105,179
Other income		489		717


Net income	$	106,532	$	105,896

WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands, except per share amounts

The following summarizes O-P’s income statement for the three months ended September 30:


	(Unaudited)
	2005		2004

Net sales	$	47,218	$	42,852
Cellular service cost		6,858		3,886
Operating expenses		1,728		1,904

Net operating income		38,632		37,062
Other income		163		248


Net income	$	38,795	$	37,310

The Company also owns 17% of Zefcom, LLC, d.b.a. Telispire, a consortium of small telephone companies that resells Sprint PCS under private label, which is accounted for under the equity method of accounting. The Company’s share of Zefcom’s losses has been reflected in “Income from equity investments, net” in the Income Statement for the three and nine months ended September 30, 2005 and 2004, respectively.

In March 2004, the Company made an initial capital contribution of $238 in cash to Empire State Independent Fiber Network, LLC (“EsiNet”). The Company committed to contribute a total of $950 in four payments over the succeeding twelve months in connection with the Company’s 25% interest in the venture. As of April 1, 2005, the Company had satisfied the entire commitment. EsiNet is currently in the process of building out its infrastructure. In the first quarter of 2005 the Company agreed to provide, if necessary, temporary bridge financing in the amount of $1,250, to be repaid within two years or upon the securing of permanent bank financing, if sooner. On March 31, 2005, this loan commitment expired without the Company’s having been required to extend the bridge loan. On June 22, 2005, EsiNet received a commitment from the Rural Telephone Finance Cooperative (“RTFC”) for a 10 year secured term loan in the amount of $6,750, subject to the delivery of satisfactory credit documentation to RTFC and to the satisfaction of all conditions precedent to closing. The Company’s share of EsiNet’s losses has been reflected in “Income from equity investments, net” in the Income Statement for the three months and nine months ended September 30, 2005.

The Company owned until October 2004 an 8.9% interest in DataNet. DataNet was formed in 2000 to build, market, and provide affordable, high speed, broadband fiber optic data communication services throughout New York State. In October 2004, the Company sold 100% of its interest in DataNet for $4,492. The Company received $3,603 in cash on the transaction date. The remainder of the sales price, $889, was held in an escrow account to provide funds available to satisfy any indemnification claim notices to DataNet subsequent to the transaction date until May 2005, at which time that amount, plus interest, was remitted in full to the Company. The Company was liable to indemnify the purchaser or any of its affiliates for any breach of a representation or warranty made by the Company or failure to perform any covenant or agreed upon action, pursuant to the Purchase Agreement.

NOTE 10: PENSION AND POST RETIREMENT OBLIGATIONS

The components of net periodic cost for the three months ended September 30 are as follows:


	Pension Benefits						Post Retirement Benefits
	2005			2004			2005			2004

Service Cost	$	—		$	63		$	53		$	47
Interest Cost		196			203			97			77
Expected Return On Plan Assets		(201	)		(162	)		(34	)		(30	)
Amortization Of Transition Asset		—			—			13			—
Amortization Of Prior Service Cost		—			22			(5	)		8
Amortization Of Net Loss		36			35			68			52


Net Periodic Benefit Cost	$	31		$	161		$	192		$	154

WARWICK VALLEY TELEPHONE COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Dollars in thousands, except per share amounts

The components of net periodic cost for the nine months ended September 30 are as follows:


	Pension Benefits						Post Retirement Benefits
	2005			2004			2005			2004

Service Cost	$	—		$	189		$	159		$	141
Interest Cost		589			609			288			231
Expected Return On Plan Assets		(603	)		(487	)		(102	)		(90	)
Amortization Of Transition Asset		—			—			39			—
Amortization Of Prior Service Cost		—			66			(15	)		24
Amortization Of Net Loss		105			106			204			157


Net Periodic Benefit Cost	$	91		$	483		$	573		$	463

The Company has previously disclosed in its financial statements for the year ended December 31, 2004 that it expected to contribute $1,208 to its pension plan and $222 to its post retirement plan, respectively in 2005. As of September 30, 2005, the Company has contributed $605 and $113, respectively. In August 2005, the Company also made a final required contribution of $438 for the Company Retirement Plan for Management Employees for the December 1, 2003 to November 30, 2004 plan year.

In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was signed into law. The Act introduces a prescription drug benefit under Medicare (“Medicare Part D”) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. The Company is impacted by the Act since it sponsors a postretirement health care plan that provides prescription drug benefits.

In May 2004, the Financial Accounting Standards Board released FASB Staff Position No. FAS 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“FSP 106-2”). FSP 106-2 states that if a company concludes that its single-employer defined benefit postretirement health care plan provides a drug benefit that is actuarially equivalent to the Medicare Part D benefit, the employer should recognize the subsidy in the measurement of the accumulated postretirement benefit obligation (APBO) under FAS 106, and should account for this reduction in the APBO as an actuarial gain. If an employer amends its plan to achieve actuarially equivalent drug benefits, therefore making the employer eligible for the subsidy, the employer is required to consider the combined effect that the amendment and the subsidy have on the APBO. If the combined effect is a decrease in the APBO, the net reduction is accounted for as an actuarial gain. If the combined effect is an increase in the APBO, the net increase is accounted for as a plan amendment.

The provisions of FSP 106-2 were effective for the first interim or annual period beginning after June 15, 2004 for all public companies. If the effects of FSP 106-2, including the subsidy, changes in participation rates, and changes in per capita claims costs, lead the employer to conclude that the enactment of FSP 106-2 was not a “significant event” for its plan, the effects should be incorporated in the valuation performed at the next measurement date required by FAS 106. Because clarifying regulations providing a firm definition of actuarial equivalence had not yet been issued, the Company was unable to determine whether the prescription drug benefits provided under its plans are actuarially equivalent to Medicare Part D benefits until the first quarter of 2005. Accordingly, the estimated annualized net periodic cost for Company post retirement benefits, as projected for the twelve months ended December 31, 2005 prior to adoption of the Act is $892, incorporating the provisions of the Act reduces this annualized cost to $770, resulting in a projected saving to the Company of $122 in 2005. The pro rata portion of this effect as it relates to the three and nine month periods ended September 30, 2005 is reflected in the valuation of net periodic cost present above.

NOTE 11: SHAREHOLDERS’ EQUITY

The Company has 10,000,000 authorized Common Shares at a par value of $0.01; 5,000 authorized Preferred Shares at a par value of $100; and 10,000,000 authorized Preferred Shares at a par value of $0.01.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Company operates in the communications services industry and provides telephone, directory advertising services, Internet, Video and other services to its customers. The Company’s basic business strategy is directed towards retaining as much of the traditional telecommunications business as possible, while using its existing network to develop and grow its Internet, data and entertainment products. The information below reflects all of these factors and efforts.

You should read this discussion in conjunction with the consolidated financial statements and the accompanying notes. The presentation of dollar amounts in this discussion is in thousands.

Restatement

The Company has restated the Consolidated Statement of Cash Flows for the nine months ended September 30, 2004 to reclassify the cash distributions of earnings received from the O-P, an investment accounted for under the equity method of accounting. These cash distributions were previously classified as investing activities. However, because the cash distributions of O-P represent a return on our investment in O-P, they should have been classified as operating activities. The restatement has resulted in cash distributions from O-P of $8,925 for the nine months ended September 30, 2004 being reclassified from “Cash Flows from Investing Activities” to “Cash Flows from Operating Activities” in the Consolidated Statement of Cash Flows. This restatement has no impact on the Company’s “Net increase in cash and cash equivalents” in the Consolidated Statement of Cash Flows, revenues, expenses, net income, earnings per share in the Consolidated Statement of Net Income, or any Consolidated Balance Sheet items.

Nasdaq Panel Review

The Company has received a letter from the Nasdaq Stock Market, Inc. stating that a Nasdaq panel will review the extensions of time that were granted to the Company by a Nasdaq hearing panel in connection with the delayed filings by the Company of its periodic reports. According to the letter, the hearing panel will provide information to the Nasdaq panel about its extension decisions near the end of November and the Company will have an opportunity to respond to or supplement that information in early December. The Company is unable to predict at this time what the results or consequences of this review will be. On November 3, 2005 the Nasdaq Stock Market removed the “E” that had been added to the trading symbol for the Company’s Common Shares because of the late filing of period reports. The trading symbol was restored to “WWVY” because the Company filed its Annual Report of Form 10-K and the two delayed Quarterly Reports on Form 10-Q for the first and second quarters of 2005. Management currently expects to file by November 15, 2005 an amendment to its Annual Report on Form 10-K for the year ended December 31, 2004 which will set forth the previously omitted opinion of its independent registered public accounting firm on the Company’s internal control over financial reporting as well as the final report of management on that matter.

Sale of Investment

Results of Operations for the three months ended September 30, 2005 and 2004 – (in thousands)

OPERATING REVENUES

Operating revenues decreased by $673 (or 10%) for the three-month period ended September 30, 2005. This decrease was due largely to a reduction in network access revenues of $397 (or 17%), which resulted mainly from lower local switching support revenues received from the Universal Service Fund (the “USF”) and a decline in intrastate and interstate switched access minutes. Long Distance network service revenues decreased $103 (or 25%) due to the continued decline in interstate interLATA call volume as a result of customer trends towards wireless communications. Partially offsetting the decline in Long Distance service revenues was an increase in subscribers to the Company’s long distance plan increasing Long Distance sales revenues by $67 (or 13%). Online service revenues decreased $60 (or 3%). Increases of $33 (or 4%) in DSL revenues and $86 (or 23%) in Video revenues, mainly due to the continued expansion of our customer base for these products, were offset by a decrease of $177 (or 28%) in dial up services due to customers primarily outside of our service territory migrating to other high speed Internet connections and a decline of $2 from Home Service Networking revenues. A decrease of $121 (or 23%) in other services and sales revenues was the result of lower rates that were mandated by the FCC for reciprocal compensation and an overall decrease in the sale of other non-regulated ancillary services. Local service revenues declined $55 (or 5%) due mainly to access line losses to a competitor who entered the market in the fourth quarter of 2004. Directory advertising sales declined $4 (or 1%), reflecting decreased demand from local, regional and national advertisers for directory ad pages.

OPERATING EXPENSES

Total operating expenses increased $1,115 (or 17%) for the three month period ended September 30, 2005. Plant specific expenses increased $12 (or 1%), due mainly to labor costs associated with repair and maintenance to outside plant structures offset by lower trunk line expenses due to cost saving initiatives. Depreciation and amortization expenses increased $142 (or 11%), due mainly to the cost associated with customer premise equipment installed in the homes of new Video subscribers. Other plant non-specific costs increased $55 (or 7%), due mainly to content costs associated with the Video product. Customer service expenses increased $14 (or 1%), due mainly to higher production costs associated with the directory, offset by lower salaries and benefits the result of headcount reductions. Corporate operations expenses increased $1,094 (or 86%), primarily because of professional and consulting fees associated with Sarbanes-Oxley Act Section 404 compliance and nonrecurring salary and benefit expenses associated with an executive who left the Company during the third quarter 2005. Partially offsetting these increases were decreases of $131 (or 29%) in Cost of services and sales as a result of lower trunk line costs, reflecting efficiencies generated from better management of capacity requirements and decreases of $71 (or 17%) in Property, revenue and payroll taxes due mainly to lower state taxes.

OTHER INCOME (Expense)

Other income (expense) increased $92 (or 3%) for the three month period ended September 30, 2005 from $2,716 in 2004 to $2,808 in 2005 due mainly to the Company’s share of O-P’s earnings, which increased 4% in comparison to 2004, partially offset by the Company’s share of losses from Zefcom and EsiNet. While O-P’s call volume remained high, the continued downward market pressure on pricing has had an adverse impact on the partnership’s profit margin.

Interest expense (net) decreased by $39 (or 51%) for the three month period ended September 30, 2005 from $77 in 2004 to $38 in 2005, as higher interest expense associated with increased borrowings and upward pressure on interest rates was offset by increased interest income generated from Company investments in interest bearing cash equivalents.

Results of Operations for the nine months ended September 30, 2005 and 2004 – (in thousands)

OPERATING REVENUES

Operating revenues decreased by $1,523 (or 7%) for the nine-month period ended September 30, 2005. This decrease was due largely to a reduction in network access revenues of $620 (or 9%), which resulted mainly from lower local switching support revenues received from the USF and a decline in intrastate and interstate switched access minutes. Long Distance network service revenues decreased $402 (or 28%) due to the continued decline in interstate interLATA call volume as a result of customer trends towards wireless communications. Partially offsetting the decline in Long Distance service revenues was an increase in subscribers to the Company’s long distance plan, increasing Long Distance sales revenues by $207 (or 14%). Online service revenues decreased $83 (or 2%). Increases of $161 (or 8%) in DSL revenues and $311 (or 30%) in Video revenues, due mainly to the continued expansion of our customer base for these products, along with revenues of $1 arising from the recent introduction of Home Networking Services, were offset by a decrease of $556 (or 27%) in dial up services due to customers primarily outside of our service territory migrating to other high speed Internet connections. A decrease of $470 (or 26%) in other services and sales revenues resulted from lower rates that were mandated by the FCC for reciprocal compensation and from an overall decrease in the sale of other non-regulated ancillary services. Local service revenues declined $126 (or 4%) due mainly to access line losses to a competitor who entered the market in the fourth quarter of 2004. Directory advertising sales declined $29 (or 3%) reflecting decreased demand from local, regional and national advertisers for directory ad pages.

OPERATING EXPENSES

Total operating expenses increased $2,530 (or 13%) for the nine month period ended September 30, 2005. Plant specific expenses increased $215 (or 7%), due mainly to labor costs associated with the repair and maintenance of outside plant structures and material purchases associated with the Video product. Depreciation and amortization expenses increased $194 (or 5%), due mainly to the costs associated with customer premise equipment installed in the homes of new Video subscribers. Other Plant non-specific expenses increased $198 (or 8%), due primarily to Video content costs to service the growing Video subscriber base. Corporate operations expenses increased $2,462 (or 64%), primarily because of professional and consulting fees associated with Sarbanes-Oxley Act Section 404 compliance and nonrecurring salary and benefit expenses associated with an executive who left the Company during the third quarter 2005. Partially offsetting these increases were decreases of $166 (or 5%) in Customer operations expenses due primarily to head count reductions, partially offset by higher production costs associated with the directory, decreases of $284 or (20%) in Cost of services and sales due mainly to lower trunk line costs, the result of efficiencies generated from better management of capacity, and decreases of $89 (or 8%) in Property, revenue and payroll taxes due mainly to lower state taxes.

OTHER INCOME (Expense)

Other income (expense) increased $909 (or 12%) for the nine month period ended September 30, 2005 from $7,635 in 2004 to $8,544 in 2005 due mainly to the $889 gain realized from the May 2005 release to the Company of funds that had been held in escrow as part of the terms of the sale of the Company’s investment in DataNet in October 2004. The gain was partially offset by the Company’s share of losses in Zefcom and EsiNet. The Company’s share of O-P’s earnings increased 1% in comparison to the prior year period. While O-P’s call volume remained high, downward market pressure on pricing has had an adverse impact on the partnership’s profit margin.

Interest expense (net) decreased by $56 (or 26%) for the nine month period ended September 30, 2005 from $214 in 2004 to $158 in 2005 as higher interest expense associated with increased borrowings and upward pressure on interest rates was offset by interest earned on the DataNet funds held in escrow and increased interest income generated from Company investments in interest bearing cash equivalents.

LIQUIDITY AND CAPITAL RESOURCES

The Company had $15,942 of cash and cash equivalents available at September 30, 2005. The Company has a $4,000 line of credit with a bank, of which the entire amount remained unused at September 30, 2005. Interest is at a variable rate and borrowings are on a demand basis without restrictions. In addition, the Company has an $18,475 unsecured credit facility with CoBank ACB at a variable rate, which approximated 5.2% for the nine months ended September 30, 2005. The Company could execute new borrowings under this credit facility until September 30, 2004. As of September 30, 2005 $10,631 in principal amount was outstanding under the CoBank, ACB term credit facility. In October 2004, the Company began making principal payments on the outstanding debt; the final payment is due July 20, 2012.

CASH FROM OPERATING ACTIVITIES

The Company’s primary source of funds continues to be cash generated from operations, including cash distributions from O-P. The Company’s cash distributions from O-P for the Company’s share of O-P earnings totaled $6,675 for the nine month period ended September 30, 2005 versus $8,925 for the comparable period last year. O-P’s cash distributions are made to the Company on a quarterly basis at the discretion of the general partner.

CASH FROM INVESTING ACTIVITIES

Capital expenditures totaled $2,104 during the nine month period ended September 30, 2005 as compared to $3,890 for the corresponding period of 2004, reflecting a slowdown in the expansion of the Video product while the Company studies the next generation of video technology, which will offer enhanced services such as video on demand and enable our products to reach additional customers. The Company expects to complete this study by the end of 2005 and be positioned to begin deployment in 2006.

In March 2004, the Company made an initial capital contribution of $238 to EsiNet. In April 2005, the Company made its final required capital contribution of $238, bringing its total investment in EsiNet to $950 and fulfilling its contractual funding obligation.

CASH FROM FINANCING ACTIVITIES

Dividends declared by the Board of Directors of Warwick Valley Telephone Company were $0.20 per share for the three month period ended September 30, 2005, compared to $0.19 for the corresponding period in 2004. The total dividends paid for the nine months ended September 30, 2005 for Common Shares were $3,211 compared to $3,133, for the same period in 2004. In March 2005, the Company purchased 50,000 Common Shares from a shareholder at $23 per share or $1,150. In September 2004, the Company borrowed $5,000 under its loan facility with CoBank to be used for future capital expenditures and strategic acquisitions. The borrowed funds have been invested by CoBank on the Company’s behalf in short-term cash equivalents.

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

OTHER FACTORS:

COMPETITION

The Telecommunications Act of 1996 (the “1996 Act”) created a nationwide structure in which competition is allowed and encouraged between local exchange carriers, interexchange carriers, competitive access providers, cable TV companies and other entities. The first markets of the Company that were affected were those in New York and New Jersey in which regional toll service is provided. Regional toll competition reduced the Company’s revenues. The Company itself can provide competitive local exchange telephone service, and has done so outside its franchised territory.

The Company currently provides access to the national and international calling markets as well as intrastate calling markets through all interested inter-exchange carriers, including WVLD. Access to the remainder of the intrastate calling markets is provided by the Company as well as other exchange carriers. WVLD, as an inter-exchange carrier, competes against all such other carriers, including cellular telephone providers and Internet-based service providers.

The Company’s territory is surrounded by the territories of Verizon Communications, Inc., Frontier — A Citizen’s Communications Company and Sprint-United Telephone, all of which offer residential and business telephone equipment. There are also several competitive telephone companies located within a 30-mile radius of Warwick, New York, and Voice over Internet Protocol (“VoIP”) providers are beginning to offer service in the Company’s franchised territory. The Company’s residential customers can purchase telephone sets (including cellular sets) and equipment at other retail outlets that are not affiliated with the Company, both inside and outside the Company’s territory.

The Company is currently competing for local service through access lines with Frontier — A Citizen’s Communications Company in the Middletown, New York area, as well as with Sprint-United Telephone in the Vernon, New Jersey area. The Company is reviewing plans to provide limited service in other surrounding areas in both New York and New Jersey. There can be no assurances that the Company will implement any such additional plans, or that other companies will not begin providing competitive local exchange telephone service in the Company’s franchise territory. Cablevision is currently rolling out VoIP in Bethpage, New York and has launched VoIP in New Jersey. In addition, in the second half of 2004, Cablevision began to compete with the Company in its historical footprint for its traditional access line customers by offering a triple play package of voice, video and data.

The present market environment requires that Online compete both on the basis of service and price. There are numerous competitors throughout Online’s market area whose services are available to customers. During the nine months ended September 30, 2005, UltraLink increased its market penetration level, increasing the number of subscribers by 4% while conversely, in the same time period, the number of customers for Online’s dial-up product decreased approximately 26% due to the migration of customers to high speed Internet provided not only by the Company itself but also by the competition, the latter primarily outside of our service territory. Whether customer and pricing levels can be maintained depends, in part, on the actions of existing competitors, the possible entry into the market of new competitors, the rate of technological change and the level of demand for voice, video and data services.

REGULATION

The Company’s New York telephone service operations are subject to the jurisdiction of the NYPSC, and the Company’s New Jersey telephone service operations to the jurisdiction of the NJBPU. These two bodies have regulatory authority over the Company’s local exchange operations with respect to rates, facilities, services, reports, issuance of securities and other matters such as corporate restructuring. As a result, the Company’s ability to respond quickly to changing market conditions or to implement a new business organization can be limited by the necessity of obtaining regulatory reviews or responding to interrogatories which can slow down or even prevent the desired transaction. Interstate toll and access services are subject to the jurisdiction of the FCC. The Company receives reimbursement from carriers in the form of charges for providing carriers access to and from the Company’s local network. Video operations are under the jurisdiction of the NYPSC, the NJBPU, and the FCC as well as the municipalities where the Company provides services.

The 1996 Act opened local telecommunications markets to competition, preempting state and local laws to the extent that they prevented competitive entry into a market. The 1996 Act allows states to retain the authority to preserve universal service, protect public safety and welfare, ensure quality of service, protect consumers and mediate and arbitrate disputes involving interconnection agreements between carriers. The 1996 Act generally requires local carriers to interconnect with other carriers, unbundle their services at wholesale rates, permit resale of their services, enable collocation of equipment, provide local number portability and dialing parity, provide access to poles, ducts, conduits and rights-of–way, and complete calls originating by competing carriers under termination agreements.

In 2003 the FCC issued an order which essentially kept in place the 1996 Act regulatory regime with respect to Unbundled Network Elements Platform (“UNEP”) competition, allowed authority for the states to implement UNEP competition and pricing and eliminated a previous requirement that ILECs share their high-speed lines with competitors. Although a Federal court reversed some parts of the FCC’s order, including the delegation to the states to implement UNEP competition and pricing, the line sharing provisions of the order were upheld. On February 4, 2005, the FCC released permanent rules governing UNEPs. Although it is expected that portions of these new rules will be appealed, the Company cannot predict the impact of any appeal. However, the Company believes that there will be minimal effect on its ILEC operations because the FCC’s impairment thresholds are at a level beyond the Company’s demographics and it does not currently have UNEP competition in its markets.

In the Company’s two New Jersey exchanges, intrastate toll revenues are retained by toll carriers, of which the Company is one. The associated access charges are retained by the Company. Revenues resulting from traffic between the Company, Verizon and Sprint are adjusted by charges payable to each company for terminating traffic.

In addition to charging for access to and from the Company’s local network, the Company bills and collects charges for most interstate and intrastate toll messages carried on its facilities. Interstate billing and collection services provided by the Company are not regulated. They are provided under contract by the Company. Intrastate billing and collection remain partly regulated in New York and fully regulated in New Jersey. The regulated services are provided under tariff. Some carriers provide their own billing and collection services.

The advent of VoIP services being provided by cable television and other companies has heightened the need for Federal and State regulators to determine whether VoIP is subject to the same regulatory and financial constraints as wire line telephone service. On November 9, 2004, the FCC issued an order in response to a petition from Vonage declaring that Vonage-style VoIP services were exempt from state telecommunications regulations. The FCC order applies to all VoIP offerings provided over broadband services. However, this order did not clarify whether or under what terms VoIP traffic may be subject to intercarrier compensation requirements; whether VoIP was subject to state tax or commercial business regulations; or whether VoIP providers had to comply with obligations related to 911 emergency calls, the Universal Service Fund (the “USF”) or the Communications Assistance Law Enforcement Act. The FCC is addressing these issues in its “IP-Enabled Services Proceedings”, which opened in February 2004. On June 3, 2005, the FCC issued an order establishing rules requiring VoIP service providers to incorporate 911 emergency call capabilities for their customers as a standard feature of their services, rather than an optional enhancement.

The FCC has decisions pending regarding the USF and inter-carrier compensation issues. The sustainability of the USF and the possible requirement that VoIP providers participate in funding rural carriers will affect and influence decisions to invest in new facilities. The same considerations apply to the continuation of inter-carrier compensation, or access charges, which is another element in the financial health of rural telephone companies. It was expected that the FCC would address issues involving inter-carrier compensation, the USF and internet telephony in 2005. On February 10, 2005, the FCC adopted a Further Notice of Proposed Rulemaking, addressing inter-carrier compensation. Proposed inter-carrier compensation changes, such as “bill and keep” (under which switched access charges and reciprocal compensation would be reduced or eliminated), could reduce the Company’s access revenues.

On June 29, 2005, the NYPSC issued an Order Instituting Proceeding and Inviting Comments in its Proceeding on Motion of the Commission on Issues Related to the Transition to Intermodal Competition in the Provision of Telephone Services (“Comp III”). Comp III seeks to address the state of competition, the impact competition is having on consumers and providers, and how these changes will, or should, impact the New York regulatory model. On August 15, 2005 the New York State Telephone Association (the“NYSTA”) on behalf of the Company and other New York State ILECs, filed its comments in regards to Comp III with the NYPSC. In making its case, the NYSTA asserted that, primarily driven by new technologies like VoIP and digital cable television voice services, intermodal competition has within a relatively short period of time created strong competitive alternatives to existing wireless and wire line services, and that ILECs need relief in the areas of consumer protection, mergers, sales and acquisitions, service quality reporting, complaint handling and flexible pricing.

The Company has filed a petition with the NYPSC seeking approval to reorganize its corporate structure in order to create a holding company that would separate its regulated local exchange operations from its deregulated operations. Under this reorganization plan, corporate management and administrative functions would remain at Warwick Valley Telephone Company, proposed to be renamed WVT Communications Inc., which would become the unregulated holding company of a regulated local exchange subsidiary (proposed to be named Warwick Valley Telephone Company) and other, unregulated subsidiaries. Before the Company may complete this proposed reorganization plan, it must first obtain the approval of the NYPSC, the NJBPU and its shareholders. The Company is actively pursuing the resolution of this petition before the two public service commissions.

Although O-P is an important component of the Company’s revenues and value, the Company continues to believe that the Company is primarily engaged in businesses other than investing, reinvesting, owning, holding or trading in securities and is therefore not required to register as an investment company under the Investment Company Act of 1940. However, changes in circumstances, for example in the valuations of its assets and businesses, including O-P, or its effectiveness in developing new services and businesses or maintaining existing activities, could result in the possibility that the Company might need to restructure its assets or activities in order to remain in compliance with the Investment Company Act of 1940.

RISK FACTORS

The following risk factors modify certain portions of the risk factors that were set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 (the “2004 Form 10-K”) and should be read in connection therewith.

The Company has completed its assessment of the design and operating effectiveness of our internal control over financial reporting, and has identified material weaknesses in its the internal control over financial reporting that may prevent the Company from being able to accurately report its financial results or prevent fraud. Such weaknesses could harm our business and operating results, the trading price of our stock and our access to capital.

Effective internal controls are necessary for us to provide reliable and accurate financial reports and prevent fraud. In addition, Section 404 under the Sarbanes-Oxley Act of 2002 required the Company to evaluate, and our independent registered public accounting firm attest to, the design and operating effectiveness of our internal control over financial reporting. If we cannot provide reliable and accurate financial reports and prevent fraud, our business and operating results could be harmed. In connection with the evaluation of its internal control over financial reporting, the Company identified material weaknesses, and may discover in the future, areas of its internal control that need improvement. Our efforts regarding internal controls are discussed in detail in the 2004 Form 10K under Item 9A, “Controls and Procedures.” We cannot be certain that any remedial measures we take will ensure that we design, implement, and maintain adequate controls over our financial processes and reporting in the future or will be sufficient to address and eliminate these material weaknesses. Remedying the material weaknesses that have been identified, and any additional deficiencies, significant deficiencies or material weaknesses that we or our independent registered public accounting firm may identify in the future, could require us to incur additional costs, divert management resources or make other changes. We have not yet remediated all the material weaknesses described in the 2004 Form 10-K under Item 9A, “Controls and Procedures.” If we do not remedy these material weaknesses, we will be required to report in our Quarterly Reports on Form 10-Q or in subsequent reports filed with the Securities and Exchange Commission that material weaknesses in our internal controls over financial reporting continue to exist. Any delay or failure to design and implement new or improved controls, or difficulties encountered in their implementation or operation, could harm our operating results, cause us to fail to meet our financial reporting obligations, or prevent us from providing reliable and accurate financial reports or avoiding or detecting fraud. Disclosure of our material weaknesses, any failure to remediate such material weaknesses in a timely fashion or having or maintaining ineffective internal controls could cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock and our access to capital.

If the Company is unable to file its financial statements, it could be delisted by Nasdaq and our stockholders could find it difficult to buy or sell our Common Shares.

Our Common Shares currently trade on Nasdaq. Nasdaq requires companies to fulfill specific requirements in order for their shares to continue to be listed, including the timely filing of reports with the Securities and Exchange Commission. Consequently, our securities may be considered for delisting if the Company fails to file annual and quarterly reports by the prescribed deadlines, fails to remediate documented material weaknesses in a timely manner or fails to develop and maintain effective controls and procedures. Any of the above could adversely affect Company’s stock price and subject the Company to sanctions by Nasdaq, or the Securities and Exchange Commission. If our Common Shares are not listed, it could be more difficult and expensive for investors to buy or sell them.

CAUTIONARY LANGUAGE CONCERNING FORWARD-LOOKING STATEMENTS

Certain statements contained in this Form 10-Q, including, without limitation, statements containing the words “believes,” “anticipates,” “intends,” “expects” and words of similar import, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company or industry results to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others the following: general economic and business conditions, both nationally and in the geographic regions in which the Company operates; industry capacity; demographic changes; existing governmental regulations and changes in or the failure to comply with, governmental regulations; legislative proposals relating to the businesses in which the Company operates; competition; technological changes; and the loss of any significant ability to attract and retain qualified personnel. Given these uncertainties, current and prospective investors should be cautioned in their reliance on such forward-looking statements. The Company disclaims any obligations to update any such factors or to publicly announce the results of any revision to any of the forward-looking statements contained herein to reflect future events or developments.

ITEM 3. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company does not hold or issue derivative instruments for any purposes or other financial instruments for trading purposes. The Company’s only assets exposed to market risk are its interest bearing bank accounts, into which the Company deposits its excess operating funds on a daily basis, the $5,000 of borrowed funds which CoBank has deposited in an interest bearing money market account on the Company’s behalf and a $3,500 certificate deposit currently held with our primary commercial banker. In regards to its CoBank loan, the Company has the option of choosing the following rate options: Weekly Quoted Variable Rate, Long-Term Fixed Quote and a Libor Option. The Company does not believe that its exposure to interest rate risk is material.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures

As of December 31, 2004, the management of the Company carried out an assessment under the supervision of and with the participation of our Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(b) and 15d-15(b). In the course of completing management’s assessment of the Company’s internal control over financial reporting, management has identified certain control deficiencies that are material weaknesses, as reported in the 2004 Form 10-K that was filed on September 30, 2005. As of the date of this assessment, the Chief Executive Officer and the Chief Financial Officer provisionally concluded that as a result of these material weaknesses, our disclosure controls and procedures were not effective as of December 31, 2004.

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The existence of one or more material weaknesses at December 31, 2004 precluded us from concluding that the Company’s internal control over financial reporting was effective as of December 31, 2004, based on the criteria in the Internal Control-Integrated Framework issued by the COSO. Therefore, management will conclude in its Report on Internal Control over Financial Reporting to be filed in an amendment to the 2004 Form 10-K that the Company’s internal control over financial reporting was not effective as of December 31, 2004. Additionally the Company’s independent registered public accounting firm is expected to issue an adverse opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004 when their assessment is complete.

The Company’s management with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation they have concluded that the Company’s disclosure controls and procedures are not effective in ensuring that all material information required to be filed with the Securities and Exchange Commission is recorded, processed, summarized and reported within the time period specified in the rules and forms of the Commission because of material weaknesses in its internal control over financial reporting as discussed above and in the Company’s 2004 Form 10-K which was filed on September 30, 2005.

In light of the material weaknesses described in the 2004 Form 10-K, management continues to perform additional analysis and other post-closing procedures to ensure the Condensed Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States. Accordingly, management believes that the interim consolidated financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the period presented.

(b) Changes in Internal Control over Financial Reporting

As previously reported in the 2004 Form 10-K, the Company is implementing enhancements and changes to its internal control over financial reporting to provide reasonable assurance that errors and control deficiencies will not recur. For the most part, these remediation initiatives began in 2005 and represent the Company’s plan to remediate the material weaknesses identified above, with some of the remediation plans impacting only one material weakness, while other remediation plans will, after their implementation, remedy several of the material weaknesses after their implementation.

The Company recognizes the importance of the control environment as it sets the overall tone for the organization and is the foundation for all other components of internal control. Consequently, remediation programs have begun to eliminate the material weaknesses related to the Company’s control environment that is inclusive of Information Technology General Controls (ITGC). The remediation programs that have been initiated are as follows:

	a)		The Company has enhanced the competence of the organization by hiring staff competent in accounting, regulatory affairs, and network operations. The Company will continue to enhance its financial accounting and reporting competencies by recruiting additional qualified staff and further developing its existing staff by reinforcing existing continuing education programs. In September, 2005, the Company initiated the first phase of a reorganization to improve operating efficiencies and financial reporting functionality.

	b)		The Company recognizes the importance of its ITGC and their use as an effective tool for managing and controlling processes that affect the financial reporting process. Consequently, and to eliminate existing material weaknesses, management has implemented procedures to enhance controls over the “change management” process. Additionally, the Company is in the process of upgrading its overall system security with final implementation scheduled for the fourth quarter of 2005. Furthermore, the Company has issued an RFP for the purpose of simultaneously upgrading its Operating Support System and integrating it with the Financial Reporting system. The system is scheduled for implementation by the third quarter of 2006, and through this automation, the Company will reduce the number of manual controls that have been identified as material weaknesses and advance the maturation of its control environment.

ii.

The Company recognizes the importance of having staff with the competencies required for the accurate interpretation and application of generally accepted accounting principles (GAAP); for having effective internal controls over financial reporting; and for establishing the appropriate policies and procedures to assure timely, accurate, and reliable financial information. Consequently management has initiated the following remediation programs to address the identified material weaknesses:

The Company has been and continues to be in the process of remediating those material weaknesses related to the inappropriate application of GAAP by:

	1)		Entering into a contract with qualified telecommunications industry tax specialists to assist the Company with its preparation, filing, and related accounting for all elements of taxation at both the state and federal levels;

	2)		Hiring a qualified CFO in January 2005 and recruiting additional financial resources to provide the appropriate level of accounting competency;

	3)		Hiring a qualified firm in November, 2005 to establish an internal audit function that meets professional standards;

	4)		Establishing documented procedures to effectively manage the Company’s equity investments; and

Improving the revenue recognition function at the Company by:

	A.		Reorganizing and providing the appropriate training to personnel responsible for managing the various revenue cycles;

	B.		Implementing the appropriate controls for the independent review and approval of the processes related to service activation, customer payments and applications, customer billing adjustments and write-offs, service orders, or rates and the related financial reporting;

	C.		Entering into a contract with a service provider to automate invoice generation and distribution as well as collection and account application with an implementation date scheduled for the end of the fourth quarter 2005; and

	D.		Beginning the search for someone to fill the newly created staff position – Manager of Revenue Assurance.

The Company is in the process of remediating material weaknesses in its internal controls related to the period-end financial reporting process that have the potential of preventing the accurate preparation and review of the Company’s consolidated financial statements in future financial periods. The Company’s planned remediation includes:

	1)		Implementing processes and procedures to perform the necessary analysis, critical review, approval, and reconciliation of journal entries and account balances;

	2)		Establishing procedures for period end cut-offs, including, but not limited to, identifying and recognizing all incurred liabilities;

	3)		Increasing supervisory review of the consolidation process in anticipation of implementing an automated consolidation process by the first quarter of 2006;

	4)		Entering into a contract with a service provider to automate and integrate the Payroll process with implementation having been completed in October 2005;

	5)		Further enhancing the Disclosure Committee’s charter to more closely oversee the accuracy and timeliness of disclosures made by the Company; and

	6)		In anticipation of an IT system conversion outlined in Section i(b) above, and for those processes where automation will not occur, implementing controls to ensure that spreadsheets used in the period-end financial reporting process are appropriately managed.

iii.

The Company recognizes the importance of segregating duties to maximize its ability to detect and prevent fraud. The Company’s remediation process for this function includes the following:

	a)		Implementation of the new IT system as outlined in Section i(b) above, which is expected to address certain of the material weaknesses related to improper segregation of duties in the current manual processes; and

	b)		In anticipation of the implementation of the new IT system, management is establishing manual controls to segregate the duties associated with the creation, critical review, approval, and reconciliation of transactions related to the financial reporting process.

iv.

The Company recognizes that only those personnel with the appropriate authorization should have access to the programs and processes that ultimately affect financial reporting. The Company is in the process of remediating related material weaknesses by establishing and enforcing authorization procedures for limiting access to those functions that have an affect on financial reporting. In conjunction with the authorization process, the Company is upgrading security in its IT system by electronically restricting access to only authorized personnel.


Part I — Financial Information

Item 1. Financial Statements (September 30, 2005 and 2004 are unaudited)

Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004			3

Consolidated Statements of Income for the three and nine months ended September 30, 2005 and 2004			4

Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2004			5

Notes to Consolidated Financial Statements			6-12

Item. 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			13-20

Item. 3. Quantitative and Qualitative Disclosures about Market Risk			20

Item. 4. Controls and Procedures			20-22

Part II — Other Information

Item 5. Other Information			23

Item 6. Exhibits			23-28
EX-31.1 Section 302 PEO Certification
EX-31.2
EX-32.1
EX-32.2


		Warwick Valley Telephone Company Registrant

Date 11/9/05		/s/Herbert Gareiss, Jr.
		Herbert Gareiss, Jr.,
		President, Duly Authorized Officer

Date 11/9/05		/s/Michael Cutler
		Michael Cutler,
		Vice President, Principal Financial Officer

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